A.I.M. Users Bulletin Board

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When deciding what cash reserve to set, does anyone set it by considering what is the worst case price level they can project? For example, if a stock sells at $10 today, and based on fundamentals and past price action, you believe it very unlikely it would ever sell below $6, some simple math or iterating an AIM spreadsheet reveals that for a 10%safe, $1,000 minimum trade, you would invest another $1150 at $7, and $1054 at $6.19. Thus you would need a maximum of $2204 in cash reserves or 31% of the initial portfolio. This could also be a risk reduction measure. You have limited your maximum loss, and now have an objective measure of error. If the price falls below $6, your initial judgment was clearly in error, and this would call for a re-evaluation and possibly liquidation of the stock.

Indeed, you might try buying stocks closer to the bottom. In the above example, we might have judged $8 as the lowest probable price. In this case, we would need no cash reserves. If the price fell below $8, we would take another look and perhaps cut our losses.