Another Way to Lower Risk and Squeeze Gains in the Market

R.Recently we discussed a very conservative strategy to increase your income and increase the chances of beating the market. These The simple option strategy is known as “selling covered calls”. But if options aren’t for you, I have another conservative strategy that will help you manage your risk and build a Rockstar stock portfolio.

It doesn’t matter if you’re on par with Warren Buffett or a first-time investor. Regardless of our experience, we all need a strategy to improve our chances of success. In turbulent market phases, I recommend that you build your portfolio using a simple strategy called “dollar cost averaging”.

What is it? And what are the advantages? Let’s dive in.

Define the dollar cost mean

Dollar cost averaging is a simple process. Here you buy a proportionate number of shares in different blocks. You buy them once a month, once a quarter, or some other set period of time. It is entirely up to you. Investors use this strategy to minimize the impact of stock market volatility. Rather than buying all of the stocks at once, investors can split their purchases into smaller purchases until they have exhausted the capital allocated to a particular asset.

For example, let’s say you have $ 20,000 and you want to buy shares of a stock. Let’s see how you can improve the overall performance of a portfolio. In the example below, you have $ 20,000 and two options. The first option is to purchase a one-time, lump sum of 800 shares at $ 25 each. This will use up all of the money on the account. In scenario 2, you split the purchases into 10 weekly purchases. In this case, buy as many shares as possible with $ 2,000.

On the right side of the chart, you can see that you could buy a different number of stocks each week, depending on the price action.

As you can see, the second option created a situation where the dollar cost average allowed you to own a larger number of stocks (822 versus 800) at the end of the period. Of course, the price declines in the first few weeks allowed investors to buy more shares with the $ 2,000 allotment.

Although the stock topped $ 25 in the past three weeks, the early volatility and decline made a big difference. In this example, you will end up with 22 more shares with the same capital. Pay attention to the last line. Let’s hypothetically assume that a few weeks later the stock should rise to $ 28 per share. Since the first strategy had a stagnant purchase price of $ 25, the net profits are $ 3 per share – 12%. That equates to a profit of about $ 2,400 over the next five weeks.

But in the second scenario, the average dollar cost calculation allowed the investor to buy stocks for an average of $ 24.45. Therefore, the investor gains more over the next five weeks – a return of 14.5% (or $ 2,918.10). And, as a result of that strategy, the second option generated $ 616 more than the first strategy over the 10 week period.

Now it is possible for the stock to go down. Of course, this scenario carries risks. Let’s say the stock falls to $ 24 per share in week 15. In the first option, you would lose $ 800, or 4% from the initial investment. However, the second scenario leads to smaller losses. Since you averaged each purchase at $ 24.45, you would save $ 369.90 from the combined investment of $ 20,097.90. This corresponds to a total loss of only 1.84%.

How to use this strategy

How can you apply this strategy now? Well it starts with using TradeSmith Finance. You can view various stocks on our platform. As always, you want to buy stocks in the Green Zone. As long as they stay in the green zone, you can buy stocks and build your position with confidence. If they fall in the yellow zone, do nothing. Wait to see if it trades in the Green Zone again and invest in your next stocks with confidence. And if it falls into the red zone, leave your positions and move your money elsewhere.

Originally published by Keith Kaplan for TradeSmith.com.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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