Replies to post #19067 on A.I.M. Users Bulletin Board (AIMUSERS)

[Mr Core Position]

newbee03: You do need stocks that don't tank completely. You need a crystal ball for that. Lacking that, diversification, as others like the Grabber post 19068 mentioned. Others do mutual funds (proprietary or ETFs).

Most people jump on a stock that they think is going up or will go up. Then what? Or they dump a stock that is going down. Then what? Now, if you had a crystal ball and could actually pick tops and bottoms, then you could follow the conventional wisdom and do OK. Do you or your friend actually have a crystal ball?
Technical Analysis (TA) is, for most people, a VERY cloudy crystal ball.

Now, ask yourself and your friend: When the crowd is jumping on -- buying -- a rising stock, WHO is selling to them? When the crowd is panicking and dumping a falling stock, WHO is buying from them? Answer: Us AIMsters among others.

As Baron Rothschild once (reputedly) said, "Buy when the blood is running in the streets."

Tom Veale's motto is something like: "Buy from the scared, sell to the greedy." (See the little gif at the end of his posts.)

[Neil Scott]

Hello Newbee

I must admit, coming from the momentum side of investing it can be a little daunting to be told to buy going the other way.
But, you know what, each time I tried the momentum method of pyramiding into a stock (like they tell you to do) I would end up losing money as the stock would reverse hit my stop and make me close out with a loss.
I think the best way of dipping your toes in the market is to use the method I use with nervous people. I buy a small amount of stock $1000 then use a 10% safe buy and will only sell out on 100% gain.
What this says is basically I have no idea where the stock is going to travel next and I can't assume I have picked the best entry point. If it goes down I can get a better average price and build inventory.
I would do this more so on speculative type stocks and so far I have had 4 or 5 stocks that have doubled in price or better and I have sold out completely.
You always have to look for a company that has some qualities, such as real earnings or potential earnings.

Regards

Neil

[AIMster]

The first question he asked me, which sort of left me stumped was - AIM is asking you to buy when the stock is going down. This is exactly what leads to you loosing all the money when the stock is coming down from a high (like what happened in the market bust in 2000) - so why would you want to not get out of the position and take you profits or cut your losses, as the situation may be, instead of buying more ??

- Is AIM assuming that we are dealing with good quality stocks which never tank ?
- Does it have a mechanism to sense that a stock is really tanking and it's time to get out while you can ?

Hi, Satbir,

Your question is quite valid and a good one. Stocks like this are referred to as "Deep Divers," ones that go down and stay there. Certainly if one had been holding Enron or WorldCom one would have gotten into a lot of trouble.

That being said, the basic AIM theory is to "buy low and sell high". This is demonstrated in the chart where the stocks portfolio start at a value of 10, go down to 4 and never go above 10 again, still making one $1,000,000 in the stock market automatically. One must keep in mind that it is a long term, rather than short term or day-trading type of system. The point is to get stocks of some quality, yes, and it is over the long term of riding the ups-and-downs that AIM works the compounding "magic."

Lichello gets around this deep diver issue thus:

He AIM's a portfolio of stocks, rather than just one stock at a time. Thus, if the whole group is moving down, when AIM directs a BUY order, how you implement that is up to you. You can either buy a new security to add to the portfolio with the amount of the buy order. You may only want to add part of the buy order to the worst offender in the portfolio, spreading the amount of the buy order among all the holdings in the portfolio. He points out that the portfolio management isn't AIM's responsibility - all AIM is concerned with is shifting the balance between the cash and the equity sides based on the movement of the stocks relative to the parameters of the Hold Zone with which your AIM program is running. That would give you more control over how much more (or how little) you want to invest additionally into the "deep diver" stock.

Further, Lichello suggested a good portion in "blue chip" mainline securities which are less likely to become deep divers than more thinly capitalized companies.

Some AIM users get around this issue by not investing in stocks at all, but rather limiting their investments to funds of one sort or another, no-load mutuals, closed end (which can often be purchased at a discount relative to their Net Asset Value (NAV), giving further internal appreciation potential), or ETF's - exchange traded funds. The idea here being that a fund is far less likely to go 'belly-up' than an individual stock will. You trade volatility for potentially greater economic certainty with a fund, but if that helps you sleep better at night, so be it.

Personally I invest in both funds and stocks - and of stocks I've been limiting my choice to those that pay dividends - I figure I might as well have some income coming in whilst I'm waiting in between AIM directed buys-and-sells.

Hope this answers some of your questions. Keep 'em coming- we're all here to help each other out.

Best,

AIMster

[The Grabber]

Hi newbie.

I've already read the 3 prior responses (all excellent BTW) to your question, so won't repeat that advice (too much).

However, you bring up a very valid point with respect to 'cutting your losses' rather than buying more. I think the answer to your question depends on one's point of view and objectives.

Specifically:
- Cutting one's 'losses' is somewhat of a mistatement. The 'loss' isn't one until you sell. Until that time it is unrealized. Just as if the price went way up. You don't really have that 'gain' until you sell. It also is unrealized.

- There is a big difference between investing and trading. Investors have a much longer view than a trader. Most investors buy and hold. Traders Buy and Sell. AIM is somewhere in the middle. AIM's approach of investing in a core position, and then having cash reserve to take advantage of opportunities as they present themselves is really different than trading as well as Mr. Buy and Hold as Lichello points out in his book.

To your questions:

so why would you want to not get out of the position and take you profits or cut your losses, as the situation may be, instead of buying more ??

See difference between Investing and Trading above.

Is AIM assuming that we are dealing with good quality stocks which never tank ?

Yes. Lichello says as much in all 4 editions of his book. Now not all of us follow that advice all the time, but good fundamentals are important in stock selection; and the first steps in selecting AIM-able stock See Tom's site for his normal approach using Value Line. It is very good. Also as was mentioned in one of those replies, there is some safety in Mutual Funds and/or Sector or Style ETF's.

Does it have a mechanism to sense that a stock is really tanking and it's time to get out while you can ?

No. Not in the slightest. However, the 'mechanism' (and maybe a little bit-o-magic) of AIM lies is it's response to changes in price (both up and down).

So, if you choose well, follow the AIM calcs, and take a long view, your first question with respect to 'cutting one's losses' becomes somewhat moot.

Hope this helps in some way. Feel free to expand on this thread.

[Toofuzzy]

Hi Satbir

1)You do not have enough money to buy individual stocks and use AIM.

To have a minimum trade of $500 = 5% of stock value you would need to invest $10,000 in stock and $5,000 in cash reserve. If you want to own 20 stocks to be diversified (if one tanks at most a 5% loss) you would need $150,000 at a minimum to start.

Yes there are other ways but I won't go there in this discussion.

2)The ONLY risk in using AIM is that an INDIVIDUAL stock will become worthless.

That is not a problem with Index Funds or Exchange Traded Funds

3)If you use funds you can be diversified with as few as five funds......and you can use TIME to diversify!

4)You can use time to diversify. Buy one fund every year or two. Decide which funds you want to own when you start and add the ones you don't yet own each year.

5)Own only five funds (large value, small value, forien, REIT, Bond)

6)Are you investing because you want something to do or are you investing to spend time doing what you enjoy?

Not always
Toofuzzy

[Capitalist]

Hi newbee03,

Your question, although "really basic" is an excellent one because it brings out a very fundamental truth about market strategies. So here's the basic answer:

There are two opposing schools of thought in strategy; Momentum vs. Contrarian.

The Momentum school says "the trend is your friend". They buy stock when it's going up, and sell it when it's going down.

The Contrarian school says "what goes up must come down and vice-versa". They buy stock when it's falling and sell when it's rising.

Your friend sounds like he subscribes to the Momentum view. AIM is definitely on the other side of the fence; firmly in the Contrarian camp.

Hope this helps!

[aptus]

Hello Satbir,

I see you've already received a number of excellent answers to your question so I won't repeat what's already been said.

The main problem most new investors face is how to handle contradictions expounded by the various experts.

Just as there are many types of people in this world, there are many types of investors who follow many different types of investment strategies.

And many of these strategies contradict each other. It's funny because everyone's ultimate goal is to end up with more money at some point in the future, but the path each type of person takes to reach that goal is vastly different.

So, if you're new to investing you need to determine which path you want to take. Is it a short-term trading strategy, do you want to day trade, are you a buy and hold investor or something in between? (Keep in mind that you can mix and match strategies if you like, for example your retirement savings might be managed with a long-term strategy while a portion of your non-retirement funds might be day-traded.)

As soon as you decide on your strategy, things become clearer.

Of course some things are relevant regardless of the strategy you choose to implement.

First and foremost is risk management. Most new investors focus solely on returns. That's a big mistake. Whether you're day trading or investing for the long-term, you need to focus first on risk and then on returns.

AIM provides one type of risk management and as such you need to feed it stocks that can be used with that risk strategy. Mainly that means selecting undervalued, fundamentally solid stocks that are volatile and then diversifying and allocating appropriately.

If you have limited funds, then sector ETFs are great because they generally have low expenses and provide instant diversification.

Note that I said sector ETFs rather than just ETFs that mimic a broad index.

The reason is to attempt to capture volatility. If you simply invest in a broad index, much of the volatility of its components will be cancelled out. By splitting into sectors, you should get diversification plus increased volatility.

If you have more funds (e.g. $30,000 +) and some experience behind you, then individual stocks are the way to go (that's my opinion only, you have to decide for yourself if you're comfortable with individual stocks).

By selecting undervalued fundamentally sound stocks you limit your risk when the price drops. Good stocks can drop as we've all seen, but because of their earnings over a relatively long time frame, they tend to hit a bottom and then rebound.

Fundamentally shaky stocks (and stocks that are overvalued, whether fundamentally sound or not), tend to drop and not recover or are either delisted or go bankrupt (these are not good candidates for AIM, although they might be excellent candidates for other strategies).

So if you've done your homework and selected the appropriate AIM stocks, you should not have to worry about purchasing when the price drops, because you know that over time it should come back up (if that's the case, then you might as well pick up some bargains along the way).

Compare this with a short-term strategy. If you're in for a day or a week or 2 weeks, then if the price starts to come down, you will most likely want to cut your losses and sell. That's because your time horizon is so short that you can't be sure the stock will rebound in the next day or week or 2 weeks.

If you're following this type of strategy, then you would definitely not want to average down by purchasing more. You'd simply take your loss and find the next short-term darling.

To summarize, if you've decided to use AIM for all or part of your investments, then the following steps should help....

1) Have a longer term time frame (4+ years) in mind.

2) Select only undervalued, quality stocks that are fundamentally sound. Or select sector ETFs.

3) Diversify according to a proven strategy (generally you should look to hold stocks/ETFs with low correlations).

4) Allocate according to a proven strategy (there are many ways to allocate).

5) Manage your equity positions with AIM (although there are a number of AIM variations, stick with a By the Book strategy to start with until you build up some experience).

6) Periodically check to ensure your selected stocks haven't changed for the worse fundamentally or become ridiculously overvalued. If so, find a new stock to replace it (if you're using sector ETFs, you don't have to worry about step 6).

And that's about it in a nutshell.

The other thing you might want to check out is Tom's Idiot Wave. It gives you an indication of how much equity (as a percentage of your initial investment amount) you might want to allocate to equities.