Dollar Cost Averaging - Part 2
I posted on DCA recently (read here)and I was in a similar discussion with a friend but the difference is that we are not talking about funds, but a particular stock.
He told me that if a stock is good, you should not use up all your capital and purchase it at one go, i.e. showhand. It is wise to leave some of your capital so that when the stock drops, you can execute DCA.
So I asked him why is it that since he feels so good about a particular stock, and he is predicting that it might drop? Then he said that it would be naive not to consider market shocks, which means that some adverse news can bring a market down no matter how strong your pick is. True.
Then the real question comes. How do you know that the stock is good? Based on what? Historical price? Business model? Future growth?
Then what? How do I know how much it should be worth (intrinsic value) now? How much should I sell?
Take a look at the chart below. One of the scariest charts of all time... Cosco Corp
So here we address the first question: Picking stock based on historical price. The stock was selling at less than $3 for the first half of 2007, then it went up to $8 in Oct07, which got you so excited and ready to pounce. Less than a year later, it dropped back to $3, so you thought that the perfect time had came. You entered at $3 hoping that it will go back to $8, which will translate into more than 250% return and you can become the first millionaire made in the stock market. So you sell your house and play showhand. $300,000 in, and you are still sitting in a pile of shit today, with a loss of 60%. Too bad, your wife and children have left you.
Next question on DCA. One other stupid man also saw the opportunity. He decided to enter 10% of his wealth first, $30,000 in. One week later the price was $2.50, still convinced that his investment is sound and this time it's cheaper, he threw in another $50,000. 1 month later, price $2, "and this cannot be", he thought to himself, so he decide to dump 30% of his wealth into the sea, $100,000. The average cost works out to be $2.25 only!! "I found gold!"
October 2008, the price officially drop below the $1 mark. And he still believed that your stock is a good pick and the phrase "what goes down must come back up". So he also played showhand - $120,000 of remaining wealth all in. This time your investment really cheap liao, $1.50 per share only. Until today, the stock has never risen back to $1.50. By now I think his wife would have left him too.
I posted on DCA recently (read here)and I was in a similar discussion with a friend but the difference is that we are not talking about funds, but a particular stock.
He told me that if a stock is good, you should not use up all your capital and purchase it at one go, i.e. showhand. It is wise to leave some of your capital so that when the stock drops, you can execute DCA.
So I asked him why is it that since he feels so good about a particular stock, and he is predicting that it might drop? Then he said that it would be naive not to consider market shocks, which means that some adverse news can bring a market down no matter how strong your pick is. True.
Then the real question comes. How do you know that the stock is good? Based on what? Historical price? Business model? Future growth?
Then what? How do I know how much it should be worth (intrinsic value) now? How much should I sell?
Take a look at the chart below. One of the scariest charts of all time... Cosco Corp
So here we address the first question: Picking stock based on historical price. The stock was selling at less than $3 for the first half of 2007, then it went up to $8 in Oct07, which got you so excited and ready to pounce. Less than a year later, it dropped back to $3, so you thought that the perfect time had came. You entered at $3 hoping that it will go back to $8, which will translate into more than 250% return and you can become the first millionaire made in the stock market. So you sell your house and play showhand. $300,000 in, and you are still sitting in a pile of shit today, with a loss of 60%. Too bad, your wife and children have left you.
Next question on DCA. One other stupid man also saw the opportunity. He decided to enter 10% of his wealth first, $30,000 in. One week later the price was $2.50, still convinced that his investment is sound and this time it's cheaper, he threw in another $50,000. 1 month later, price $2, "and this cannot be", he thought to himself, so he decide to dump 30% of his wealth into the sea, $100,000. The average cost works out to be $2.25 only!! "I found gold!"
October 2008, the price officially drop below the $1 mark. And he still believed that your stock is a good pick and the phrase "what goes down must come back up". So he also played showhand - $120,000 of remaining wealth all in. This time your investment really cheap liao, $1.50 per share only. Until today, the stock has never risen back to $1.50. By now I think his wife would have left him too.
The wise one would have spotted it and left that stock alone. He is the one who doesn't buy without looking deep into the company. And he would probably end up sleeping with the two homeless wives.
Note: Life is contradicting. Some methods that should be there to help you destroys you. And remember that wives leave not because you are a lousy stock picker, they leave because you spend all your money on companies that don't make LV bags.
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