How To Buy A Value Stock When Your Scared To Pull The Trigger
Are you currently following stocks that have risen over 100% that you wanted to buy a year or two ago but chose not to? Deep down you knew they were great values at the time but you did not buy because you were too scared to take the risk.
I feel your pain and want to give you a solution so next time you find a stock with very large upside but high uncertainty you have a plan to pull the trigger with confidence.
Let’s take an example like JC Penney which I recently recommended for members of turnaround stock investing premium service. JC Penney is a leveraged company with many investors betting it won’t survive. However, management is following the turnaround prescription and with its high operating leverage, the share price can rise dramatically if things just stabilize. So yes, it’s possible JC Penny can implode with the equity wiped out but it can also go to 7 or 8 dollars.
The solution then is buy the stock with a stop loss and reenter strategy. Say you buy the stock at 3 and set a stop loss at 2.50. The most you can lose is 50 cents. If the turnaround is successful and the stock rises to 7 you will have a gain of 4 points versus a potential loss of 50 cents. You have a reward to risk of 8 to 1. Any stock that has 5 to 1 reward to risk should be carefully considered.
The stop loss will give you peace of mind to take a risk when you have large upside potential and high uncertainty.
Yes, I know that value investors hate stop loss orders. However, if you don’t use a stop order and limit your risk you will likely never buy the stock and lose out on a large potential gain. As I mentioned in my last blog post just one multi-bagger can have a dramatic impact on your portfolio.
Now let’s talk about the reenter order if you are stopped out. As you know bottoms can be very messy affairs with a lot of volatility. So, while protecting your capital you may be stopped out yet still have the fundamental belief the turnaround will work out.
As a result, as mentally tough as it will be, you have to plan to rebuy the stock, if it looks like the market will confirm your original fundamental analysis.
Let’s go back to JC Penny. You bought the stock at 3 and are stopped out at 2.50. If the turnaround fails the stock will head down and your stop will be executed at 2.50. In this case, you did the right thing and protected capital. You took a rational bet that did not pay off and that’s fine. However, let’s say the stop is executed because the turnaround is volatile but ultimately stays on track and the stock goes from 2 back to 3 on its way to 7 and you did not re-enter after being stopped out. Once again you will find yourself in the position of being on the sidelines missing a gain that has the potential to really improve your returns. This is why you need a reenter plan after being stopped out.
Protecting capital while also being able to participate in large gains takes work and effort. There is no free lunch but this system is very elegant and diminishes mental anxiety as you don’t have to think about the trades. It’s all preplanned when you make your first buy.
This may sound hard to execute but imagine if you had this strategy last year when you were looking at all of those stocks that turned into 2 to 5 Baggers. You would have probably purchased them with this plan. You would be much happier now.
The stop and reenter strategy is perfect for deep value risky turnaround stocks that will often scare you. It gives you the peace of mind to invest with controlled risk.
One good turn around stock can dramatically increase your returns. Peter Lynch commented in his book,” One Off Wall Street,” that 5 to 10 baggers were the sole reason he outperformed for many years,
If you want to find some 2 to 10 baggers for your portfolio and get practice implementing the stop and reenter strategy consider a membership to turnaround stock investing.
