Sunday, November 16, 2014

the 80/25 strategy

one of jim cramer's favorite investing themes is to trade with 'house' money. what he is talking about is buying a stock, waiting for it to double and then selling half - at which point you have recovered the money you invested and your remaining shares have zero cost-basis (zcb.) then you retain the zcb shares until some other investment objective is met.
do you really need to wait for a doubling of price to create a zcb position?
no! the sell-half-after-doubling strategy is just the most facile arithmetic (1/2 is the inversion of 2 - anybody could do that in their head.) in reality it is somewhat rare for a stock to double within my patience time-horizon - about a business quarter - which i don't think is so unusual considering the great many choices of momentum stocks to choose from. a far more likely scenario is that a favorable stock rises by 25% in a quarter. given a 25% appreciation one could sell 80% (since 4/5 is the inversion of 5/4) of one's shares and have a house-money position on the remaining 20%. once i have my money back, i can have a great deal of patience - this is the essence my 80/25 strategy. 

one could pick other ratios to work with, say, a 75/33 (sell 75% after 33% gain since 3/4 is the inversion of 4/3), 67/50 (2/3 is 3/2 inverted) or for those golden ratio fans 61.8/61.8 (sell 61.8% of shares after a 61.8% gain - since .618 is the inversion of 1.618 - try it!) however, there is good reason to concentrate on 80/25 because our friends at investor's business daily have researched that 25% is the most common run-up in a quality stock before a pull-back occurs. ibd's strategy calls for selling 100% of the stock after a 25% gain but i think it makes sense to take the profit in stock since nobody is paying interest on cash these days, and especially if the stock pays a dividend (in which case one essentially has a small, but free, annuity.)

i have more ideas about how to implement this strategy that i will explore in follow-up posts.

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