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Upside/downside – Taking Positions

Our Q&As are emailed in our Saturday Morning Report, find the answer to this question below.

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Upside/downside – Taking Positions

Dear MM, Thank you for your really excellent service! When you initiate a buy, are you guided by any general rule of thumb with regards to upside/downside - i.e. if the perceived upside/downside is +10%/-10%, you'd say - not worth getting out of bed for. However, if it is +20%/-10%, you'd say 'yes', worth it. What is x and y in +x%/-y% at initiation. Also, what is +x%/-y% when there is an 'Active' indication next to the stock? To make this real, I have been kicking myself that I did not get into GMG and WHC. They are up 67% and 24% respectively. They are still denoted 'Active'. Does this mean that in your view its OK to be buying in at these levels - i.e. the risk/reward still justifies buying (though I note in yesterday's note you are considering taking some profit off GMG). Thanks!

Answer

Hi,

A great question, hopefully the answer will clarify a few points around the MM website although there are obviously a few moving parts to MM’s investment process.

  • When we have “Active” by a stock, in a portfolio on the MM site, it means we remain happy buyers at current levels, e.g. Whitehaven Coal (WHC) which you mentioned in our Growth Portfolio.
  • The other stock you mentioned, GMG, is another good example as we recently removed the Active tab as we were considering taking some profit at current levels.
  • The premise around risk to reward is naturally to buy stocks when there is more perceived reward than risk. A strategy that has a 50% thit rate, average win of 20% and average loss 10% makes money. While we do not have a hard and fast rule, we consistently target a reward greater than the risk.
  • As an example, 10% upside shouldn’t be discounted for individual positions, as long as the hit rate of the strategy is high. Remember, the average annual gain of the ASX since 1900 is only 11%, – compounded, the results become exciting.
  • Another important aspect is related positions within a portfolio, we might like all the gold stocks looking for ~30% upside but we wouldn’t be allocating 20% of our portfolio to a relatively small portion of the market.
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