The Value Trap

Just a very short entry. Buying for value investors has frequently been a roller coaster ride. Buying when the stock is going down is a big faux pax for technical investors, but might be exactly what value investors are doing. Just a few points on what I think can be done to minimise being caught in a classical 'value trap' when prices that r cheap keep going down.

1) Stick to a big margin of safety before purchasing

Especially so in a bear market. Go for the big fat pitch, as Buffett says, rather than go for the small ones. If the stock does not fall within ur radar on valuation grounds, no matter how good it might be, do avoid it unless u have really sufficient reason to do so. Especially so since retail investors like us need to be more careful due to limited capital.

2) Yes, average ur way down, but don't put all in at one go

Do go for the big fat pitch. But prob is, if a stock goes down, it is likely to go down further for various reasons. So, hold ur cash first, don't put in a big portion at one go. The institutional investors with much deeper pockets can do that, but not the retail ones. Agreed, u might say that it's all about long-term investing, an it doesn't matter too much. BUT honestly speaking, who doesn't want to purchase at a lower price?

3) Only put in more if there's a substantial drop

I think that one shouldn't keep buying at approximately the same prices. It pays to be patient. Even averaging down is a skill; it doesn't mean simply buying when the prices come down further. If the stock only goes down say, 5%, do not think of purchasing more. If it goes much further down, put in more; if it goes up from here, be thankful u invested already and do not attempt to put in more when it goes up, because it will lower ur margin of safety.

4) Buy in smaller volumes at one go

Do determine how much u want to invest in a company, based on model's like Kelly Optimisation or anything that u find suitable. For example, if u think u want to invest $5,000, do not put in $5,000 in this company at one go. U might want to put in $1,000 first, and wait to see if it drops more, and put in another $2,000, before putting the remaining $2,000 if the stock still continues to drop. For myself, I try to invest 3 times and average down, if the stock does not go further down, I leave the remainder for another more attractive company. Well, I'm obviously not a guru, but just want to share some techniques that I use with others and invite comments.

5) However, do take note of transaction costs

Some might want to take note that u tend to incur transaction costs when u average down. Do calculate them and subsequently only average down if ur total value after transaction costs will bring down the average cost significantly.