In poker, it's perfectly acceptable to raise a bet or move "all in" under the right circumstances. But when it comes to stocks, adding to one's position can be tricky.
In the quest for big profits and outperformance, investors often focus too much on identifying the best stocks without paying any attention to managing cost basis. Buying too many shares at the wrong price will throw the average cost of your shares out of whack. And when sellers start to get out of the stock, a nice profit cushion can disappear quickly.
A position can get top-heavy in no time if you're not careful. Seeing a stock extend gains and trade well post-breakout is great, but it won't mean much if you don't manage the position properly.
Alexion Pharmaceuticals (ALXN) cleared a cup-with-handle base at 94.46 on June 19, 2012. It found support at its 10-week moving average in July, (1) then cleared a in September, (2) giving investors ample opportunities to build up a position.
Say you had a $150,000 portfolio that was two-thirds invested. You had another $50,000 to invest. Feeling slightly unsure despite a Nasdaq follow-through on June 15, you bought 100 shares when Alexion broke out over 94.46. The gained steam, but it was still a small position in your portfolio.
Alexion continued to rise and found support at its 10-week moving average. Instead of adding to the position, you didn't do anything, content to sit tight.
Finally, after that flat-base breakout on Sept. 7, you bought 250 shares at 110.06. This was a mistake. Your 100-share position grew to 350 shares and $36,961, a decent size. But your cost basis jumped from 94.46 to 105.60, up 12%. Not good.
A top-heavy position saw profits evaporate quickly when selling pressure started to build in October. In the Oct. 11 IBD, the Market Pulse outlook changed to "Market in correction." On Oct. 19, Alexion undercut its 50-day line, then fell another 13% to 93.56 in the next three days.
Compare this strategy to initially making the biggest buy at the breakout, then following up with smaller buys: 100 shares at 94.46; 60 shares at 96.82 (2% above the ); and 40 shares at 98.24 (up 4%). Your cost basis was 95.93. When Alexion found support at the 10-week moving average at 96.79, adding 100 shares moved your cost basis up to 96.21. With another 50 shares at the flat-base breakout, you owned 350 shares with an average cost of 98.19. Not top heavy at all.
- Investment & Company Information
- Alexion Pharmaceuticals