Consider this scenario: Major averages just confirmed a new uptrend, with big percentage gains in higher . You buy a growth stock with strong fundamentals breaking out of a good base in heavy volume.
A few months later, the stock is up 40% to 60%. Now what
Well, the market has shown you that you're holding a potential market leader — a stock that could be up triple digits over time. So it's time to go into savvy portfolio-management mode. A big gain won't mean much if you start with a small position.
There's nothing wrong with taking a 20% gain in a stock when you have it. But if you're holding a truly innovative company that's still potentially in the early stages of its move, it's smart to add to the position and make it a larger portion of your portfolio.
Portfolio management is one of the most overlooked parts of investing. It takes time to learn how to identify fundamentally and technically healthy stocks on the verge of big price runs. But handling a stock properly after a is just as important.
Say you have $100,000 to invest in stocks. For the first stock, starting out with a $20,000 purchase is reasonable. You buy a breakout that's powerful and convincing. The stock runs up sharply for a while, then starts to move sideways, showing little in the way of selling pressure.
It forms another base and breaks out again. In this case, you might decide to add another $20,000, especially if the market is acting well, you have conviction in the stock, and your profit cushion with the first buy is large.
The other option: Add a smaller amount to keep your cost basis in check while giving the position a chance to grow into a big gain.
The decision to add to a stock isn't always easy, especially during market uptrends marred by institutional selling. Choppy, volatile markets — even in a confirmed uptrend — can make it difficult to average up in a stock. If a second purchase doesn't make progress, consider cutting losses on the second buy and sitting tight with the initial position.
Deckers Outdoor (DECK) reset its base count in 2005, thanks to a 65% pullback. No one wanted to own the stock at the time, but Deckers rallied more than 164% off its low and eventually formed a first-stage base. It broke out past a 45.35 in mid-September 2006 and rallied 34% before settling into a new base.
At the initial breakout, a starter $20,000 position would've been fine. At the second breakout past the shallow at 60.66 in February 2007, the market continued to rise. An investor with strong conviction could have added another $20,000, forming a second full-size position.
A smaller add-on buy could have been made when Deckers found support at its 10-week moving average in March or April 2007. By year's end, the stock rose as high as 166.50, up 267% from the first entry point.