The most common strategies for investors are
- Buy and hold – a stock is bought with a long term objective and the price corrections are accepted as part of the normal course of investing.
- Two step approach – a stock is purchased at an entry price and sold at a target price for a profit.
Trading Around a Core Position blends these two strategies into a dynamic process between the initial entry and the long term price objective to maximize overall profits and minimize losses.
At moneywiseHQ we conduct a fundamental analysis of a companies business, management, and growth potential to identify the best of breed stocks to invest in. Technical analysis helps identify the best entry price and define the downside risk and the upside reward. Many stocks provide trade opportunities for short term profits and some provide long term stability to a portfolio.
The Strateegy
The natural ebb and flow of the stock market provides Big Money managers the opportunity to take profits, which causes ‘corrections’, or a pullback, in a stocks’ price. Corrections provide entry prices for new investors which then causes prices to rise.
The strategy of trading around a core position takes advantage of this natural ebb and flow. Stocks which have long term potential are purchased at an entry price and this becomes the ‘core position’. As the stock price increases towards short term targets, the position size is gradually reduced, profits are realized and the exposure to potential downside is minimized. When the stock price experiences a correction, shares are repurchased and the position size is rebuilt.
During a market correction, the Buy and Hold strategy generates a loss. Trading around a core position locks in profits as prices rise while allowing investors to still maintain a position with exposure to further upside. Rebuilding the position from a correction point, effectively generates a profit which would not have been realized using a Buy and Hold strategy.
The more volatile a stock price pattern is, the greater the opportunity to generate profits so even if the stock trades flat, within a range or doesn’t meet the price objective, overall profit is still generated by reducing exposure in uptrends and rebuilding on corrections. Reducing exposure in uptrends minimizes the impact of stock or market corrections to a portfolio.
Let’s take a look at JPMORGAN (JPM).
Applying the Trading Around a Core Position Strategy to JPMorgan, starting with an initial core position of 400 shares, highlights the ability to lock in profits and minimize downside exposure at various price targets while always maintaining at least 200 shares in the event prices continue in an uptrend. Rebuilding the position on corrections to the core position size of 400 shares effectively generates profit in a stock which has not increased in price over a period of five months.
In this case, the strategy only requires one trade per month to be effective in a high volatility environment. The flexibility of this strategy allows investors to vary how aggressive they are in adjusting position size or trade frequency to maximize profits or minimize losses.
The Catch
The Trading Around a Core Position Strategy becomes less effective in a stock which is continuously trending upwards. This can happen in a high quality stock and a low volatility market.
As the stock price rises towards the required target and position size is reduced without the corresponding correction for re-entry, profits are generated, however overall profit is smaller than would otherwise have been achieved with a buy and hold strategy.
moneywiseHQ Bottom Line
- Trading around a core position is important to trading success and allows investors to exceed the total returns of the overall market, protect gains and effectively generate profits during corrections.
- Maintaining a core position gives exposure to an uptrend where a two step approach would exit a trade once a specific target is reached. Position size can be quickly adjusted if a stock breaks out or breaks down from an established trading range..
- Reducing position size as prices rise may mean giving up a small amount of upside profit, but will keep you in a good stock with a strong investment thesis.