The stock market decline since the start of 2022 has taught us a great deal about our portfolio management process and trading disciplines. The S&P 500 declined 12% in a straight line, quickly cut the loss in half, and now we're really close to the low again. Under the surface, a lot of stocks are in bear-market mode, down more than 20% from the highs, even our favorite Ford Motors (F) is now 32% off from its high made in January. It has been great that going into this volatility, we always reserve a significant cash position (greater than 5%, at points more than 10%). This allows us to add to damaged stocks of strong companies, with a long-term horizon strong fundamentals will be reflected in the stock over time. 

However, a lesson that we haven't had that much chance to practice since we founded the WIC portfolio is deciding which price levels to buy when a stock is down. That is because the stock market hasn't seen this level of decline since September of 2020. That is why in today's post, we would like to discuss with you how to strategically build a position, how to decide which levels to buy.  

The concept that we want to highlight here is "not buying at every single price." You can't buy at the same price every day. You need to wait at least 3%, if not 5% lower from your previous buy to make another purchase. 

Let's take a look at the S&P 500 (represented by the SPY ETF here) in recent months for example. Let's say in early January 2022 we wanted to build a position in the SPY. When it was above $460, our portfolio manager did the research work and said the fundamentals look good, but on the technical side, the price is not quite a good risk/ reward, let's wait for $450. So we waited for $450, but we didn't buy all at once. If we allocate 3% towards the S&P 500, we started with a 1% purchase. 

Now as you can see, after we bought at $450, the SPY continued to go down. We ask, where do we decide to add. The answer would be at 5% lower or at $420 - 430. So when the SPY declined to $420, we bought another 1%. At this point, we have averaged down our SPY position, with the cost basis of $435 and at 2%. There's another 1% left to buy.

If you continue to follow the chart, after the SPY declined to $420, it made a very quick move up to $460 (end of January). One might ask, do you want to buy some here? The answer is absolutely not. With our cost basis at $435, if we bought at $460, we would be hurting our cost basis. And remember, when we decided to start the position in early January 2022, we didn't quite like the SPY at 460. So we would do nothing at $460.

That proved to be correct, as now we're currently sitting at our cost basis of $435. The same question "do you buy here?" At this point, the answer is not as easy, because it depends on your risk tolerance. If you're aggressive and you are ultra-positive that the market will not break the $420 low, you may say let's buy it here and that would be fine. We are more nimble, protective, and what we would do right now is wait for prices much lower than the previous low of $420.      

The concept and example we discussed above is "averaging down". Some may say that this is "catch a falling knife" and that's dangerous. We say no, because we've done the fundamental research work in the first place, identified a price level at which we are comfortable with, and now we're just trying to find such level if not lower. Our discipline is in stark contrast to the ARK Invest Fund Manager Cathy Wood. Based on our following of her trading, what she would have done was to do the fundamental research on the SPY at $460, and just bought a ton and a ton, again and again at $460. We say that's a dangerous way to destroy capital. That's how her flagship ETF ARKK is 60% off from all-time high, because she bought a ton of Palantir (PLTR) in the $20 and the stock is now at $11, she bought a ton of Teladoc (TDOC) in the upper $100 and the stock is now at $65.  

So the problem with Cathy Wood's ARK Invest is they do great research work on the fundamentals of the company but they don't offer great position building strategies. Let's be clear, her research team is full of talented specialists, for example Simon Barnett who focuses on next-generation DNA sequencing, molecular diagnostics, bioinformatics and synthetic biology. He has a Bachelor of Science in Chemical and Biomolecular Engineering, and has spent time interning in labs. Sure, he is somewhat knowledgeable in this field (arguably more than general fund managers) and has put out some quality research work. However, Simon Barnett is not a trader and has no experience in the stock market. That is why this guy ends up with the ARK Genomics ETF which is down 60% from its all time high, recommending Pacific Biosciences (PACB) in the $30s with the stock now at $11. 

Generally, at hedge funds, the flow is as following: there are people who do research work on companies (both fundamental and valuation), they take the work to the fund manager, the fund manager decides and takes it to the trader. The trader is responsible for building the position, deciding when to buy or sell because of their specialty. We don't think that's what's happening at ARK, or if it is happening, the fund managers and the traders have been doing a very poor job (with their funds down 60% from all time high). 

The bottom line, we hope this post has provided you some guidelines about position-building for your portfolio, knowing when to buy, and offer an example of how this process can turn ugly.