Knowing when to buy a stock can be just as difficult as knowing when to sell and timing the market is a near-impossible endeavour. That’s why at KeyStone we believe laying into your stock positions, especially during volatile times in the market could benefit you over the long term. Where just like drinking a freshly brewed hot cup of coffee you can avoid getting burnt by taking a few sips at first, rather than swigging it all down.
Layering into a portfolio position is the strategy of using a partial amount of the total capital an investor is willing to commit to a stock to gain some exposure to the company – rather than purchasing it all at once. For example, if an investor has $10,000 to allocate to a specific stock position, they could break the purchases up between two $5,000 trades. Thereafter, an investor could wait patiently and decide to either dollar-cost-average-down or dollar-cost-average-up in the future, depending on the business’s execution or general price action in the market.
Buying some now (layering in) and waiting patiently to potentially fill up to that full position is essentially a method of hedging both the business’s operational risk and the price action risk in the market.
By purchasing some now, an investor is gaining exposure to the stock in case it continues to run. Investors sometimes learn this the hard way – just ask our Associate Analyst, Brennan, about his attempt to time XPEL (XPEL: NASDAQ). He waited for the stock to possibly pull back to $14.00 while it traded at just $18.00. Sadly, for him, the stock never did come back to the $14.00 entry point he had hoped for. And by buying a half position and layering in, he would have at least given himself some exposure to the tremendous run the stock made over the following year, rather than sitting completely on the sidelines.
On the one hand, an investor is taking an option to execute (buy more) on the future performance of the business. If perhaps the stock price continues to run higher, and the management team is executing on its strategy successfully with accretive acquisitions, organic growth, or great financial results – all reducing investment risk – an investor could decide to dollar-cost-average-up by buying that additional $5,000 tranche. It may seem contrary, but if a stock’s price continues to run higher and the business executes financially, one may be getting better value with the second purchase (even though the share price is higher).
On the other hand, if the fundamentals of a business remain strong but the price of the stock falls after purchasing the first $5,000 tranche, an investor could also decide to dollar-cost-average-down. It must be made clear that just because a stock’s price falls does not necessarily mean that one should buy more of it. But if the investment thesis remains intact, it may be diligent to buy more to fill up to the full $10,000 position and dollar down on the stock.
Layering into a position is a great tool for investors to mitigate risk (especially in a volatile market) and build up their simple 15-25 stock portfolios. Remember, an investor could layer into an individual stock by purchasing four separate tranches over a year or longer (rather than just two tranches like we used in this article) but this ultimately comes down to the investors’ preference and the perceived operational and price action risk they would like to mitigate into the future.