I have great admiration for Beating the Index. The website provides very valuable analysis of the Canadian junior oil and gas sector, the major plays (esp. Bakken and Cardium), and the macro issue of why the price of oil will likely rise in the long term investment horizon. In addition, Mich, the website’s sole proprietor, reveals to us a part of his self-managed portfolio, what moves he makes as he beats the index. His style is his own, adapted to suit his particular portfolio. For example, because he is using leverage, he has to cash in on his winners–sometimes he also drops losers and holdings which remain static. In one post, his commentors on his blog praise him for being willing to take losses and move on, saying that this is the mark of great trader.
But then one has to wonder, if an analyst has done his due diligence and decided that a company is a good buy, and then the market decides to dump the stock, whether that stock just became a better deal. So in my trading, I very rarely dump losers, though I have sometimes done so to realize a tax loss or to implement a change of strategy. Rather, I’ve averaged down on losers, and most of the time it works, as I shared in a post critiquing Dennis Gartman’s first rule of trading, “Never, under any circumstance add to a losing position…. ever!” Gartman says to add to winning positions rather than to losing positions. Generally speaking, I ride the winners, but I don’t often add to my positions. Gartman’s rigid style seems to be flawed, and his own HAG fund is still going nowhere.
Now Keith Schaeffer, one of the leading independent analysts of the Canadian junior and intermediate oil sector, provides a compelling argument why it is better to add to the companies with momentum:
When it comes to the junior and intermediate North American oil and gas plays, I want to buy expensive stocks. I rarely buy cheap stocks. That sounds counter-intuitive, but it makes sense.
When a company trades at a high valuation it can raise money with less dilution, and can use its stock as currency to take over other companies. They can grow more quickly and more efficiently than companies with low valuations.
“Dilution” is one of the terms that junior oil and gas investors seem to fear. Indeed, share price usually seems to drop after a public offering. Crocotta Energy’s recent share offering is a great example:
One day on an airplane on the way to Barbados, I met A. Zoic, an experienced entrepreneur, who explained “dilution” to me: He said, “The number of shares are increased, but the size of the company also increases. So you have smaller percentage of the whole, but the company is much larger.” Zoic’s words came back to me, the inexperienced investor, time and time again as I watched Midway Energy, my largest holding, take on more and more new shares; and Zoic’s advice helped me over the last couple of years to understand that when a junior oil raises money in a public offering that that is a really good thing because it increases the overall size of the company. This has the added benefit of increasing the average volume of shares traded which in turn makes all shares more liquid. A great CEO with an established reputation, like Midway Energy’s Scott Ratushny, has been able to raise the investment dollars to create the momentum that makes a good value into a great investment.
In the end, the best strategy for trading junior and intermediate oil and gas is neither the value nor the momentum strategy alone. Rather, in my view, the two strategies should be implemented together in an artful Jeet Kune Do of (1) Momentum–buy winners: I keep adding to my position of CPG; (2) Averaging down seeking value: I kept buying MEL (when it was still TFL) as it plummeted in price; (3) Buy and hold: I watched MEL go from 0.39, my lowest price, to $5.19 (and am still holding). Junior oils are too volatile to cut losses early, and I’ve found for the last four years as a junior oil investor, that my overall gains far outweigh my losses.
What works depends as much on the investor, his liquidity, credit limit, available margin, size of portfolio, as it does on the style of investing. I rarely cut my losses. I don’t see that ability as the mark of good investor. The mark of good investor is perhaps better described as an even keel temperament to do the right thing without allowing the market to determine his next trade for him. According to the legendary martial artist, Bruce Lee, the best style is no style–consider how these words fit investing:
Too much horsing around with unrealistic stances and classic forms and rituals is just too artificial and mechanical, and doesn’t really prepare the student for actual combat. A guy could get clobbered while getting into this classical mess. Classical methods like these, which I consider a form of paralysis, only solidify and constrain what was once fluid. Their practitioners are merely blindly rehearsing routines and stunts that will lead nowhere.
I believe that the only way to teach anyone proper self-defence is to approach each individual personally. Each one of us is different and each one of us should be taught the correct form. By correct form I mean the most useful techniques the person is inclined toward. Find his ability and then develop these techniques. I don’t think it is important whether a side kick is performed with the heel higher than the toes, as long as the fundamental principle is not violated. Most classical martial arts training is a mere imitative repetition – a product – and individuality is lost.
When one has reached maturity in the art, one will have a formless form. It is like ice dissolving in water. When one has no form, one can be all forms; when one has no style, he can fit in with any style.
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I am humbled by your introductory paragraph. This is a great post and I whole heartily agree with the Jeet Kune Do approach. I rarely exit a position because it is at a loss, unless fundamentals change drastically for a company I will stick to my DD and add to it (REL for example). However, the fact that the portfolio is limited in size and uses margin most of the time, I have to be very careful with what to keep holding because even if there is value, there is no point in paying interest on a position that will be underwater for the next several weeks or months (the case with DEE) and miss out on other opportunities.
You did an excellent job holding MEL through the storm and this is a textbook example of identifying value and adding to a losing position.
As I was writing this post, I was thinking about your increasing your position in REL after it had gone up in fact.
“unless fundamentals change drastically for a company I will stick to my DD and add to it (REL for example)” The fundamentals are the important thing, indeed.
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