Buy-and-Hold/Dollar-Cost-Averaging Revisited

To take a break for a moment from rotation strategies, I wanted to introduce a strategy that I'm using for stocks that I'm looking to hold long-term. For me this includes blue chip dividend stocks that have been around for decades, have weathered through bad times and have a history of consistently increasing their dividend payout.

Timing the market is extremely hard. No one knows the future, so once invested, the only thing left to do is to adapt to changing conditions, whatever they may be. There are stocks that are on my "dividend champions" watch list, for example MSFT, that still haven't recovered to their all-time highs, even if the total market is making new highs.

Dollar-cost-averaging is a strategy advocated by many brokers and financial firms. It allows one to average out the cost-basis over time, without trying to time the market. This is great, assuming that a correcting asset will eventually rebound. It'll allow one to get back to break-even faster, since the cost-basis has been lowered from the initial purchase price. However if the asset just keeps on falling, one could keep on accumulating/compounding the losses, the whole concept approaching the principles of a martingale betting system.

So keeping in mind that if an asset is making new highs, we don't know if we're potentially buying at the top, and even if we buy on a dip we don't know if an asset will rebound or keep on falling, I created a "Buy-on-Dips" strategy, which allows one to gradually build up to a target allocation, without buying assets at the top, or without averaging down to zero.

The downsides of this strategy are that the target allocation isn't immediately reached, and that the asset could take a very long time (if ever) to recover accumulated losses.

Here's how the strategy works:

If an asset is -10% off its 52 week high, invest 10% of target amount of shares
If an asset is -25% off its 52 week high, invest 20% of target amount of shares

If an asset is -40% off its 52 week high, invest 30% of target amount of shares

If an asset is -55% off its 52 week high, invest 40% of target amount of shares

If an asset is -70% off its 52 week high, invest 50% of target amount of shares

I programmed the strategy to close the trade at a +20% profit, but one could modify this by for example taking half of the profits and trailing the rest with a stop etc. Or if fundamentally something with the company changes, where one no longer wanted to be invested, one could get out at break-even.

As a practical example, let's say that CVX (Chevron) is trading at $100 and the target amount of shares for CVX in a portfolio is 20 shares. If CVX corrects -10% from its 52 week high, one would buy 2 shares. If CVX corrects to -25% off its 52 week high, one would buy 4 shares. If CVX corrects to -40% off its 52 high, one would buy 6 shares.  If CVX corrects to -55% off its 52 high, one would buy 8 shares. If CVX corrects to -70% off its 52 high, one would buy 10 shares. After this, one wouldn't buy any more CVX, no matter the price action, until the target +20% return has been achieved (and the trade closed).

This results in the following transactions:
BUY 2 CVX @ $90 = $180

BUY 4 CVX @ $75 = $300

BUY 6 CVX @ $60 = $360

BUY 8 CVX @ $45 = $360

BUY 10 CVX @ $30 = $300

One would now hold 30 shares of CVX, with an average purchase price of $50 (totaling a $1500 investment ). To achieve a +20% return, CVX would have to climb back to $60.

The numbers I picked are somewhat arbitrary, one could probably try optimizing this strategy with TradeStation or AmiBroker, software which I don't have access to.

Here's a few screenshots of randomly picked stocks from my watchlist, showing when the strategy has bought and sold and the Profit&Loss curve below. As you can see in the first screenshot of MSFT, you would've had to wait 14 years from your initial purchase to get to a 20% profit, which is actually decent, considering MSFT still hasn't rebounded to the original purchase price levels. You could've gotten out at break-even though only about a year and a half after the initial purchase, despite the huge crash.

Below the same strategy applied to SPY, which showcases that maybe taking partial profits is better than the full 20%, because after taking profits in late 2011, there hasn't been any buy signals up to date.

Below is my current watch list of stocks, which also tells me if it's time to get in,

and with what allocation. At the bottom of this post, I've attached a link to the ThinkOrSwim BuyTheDips Strategies (5 of them in total, all to be applied in the "Edit Studies and Strategies" window). The same download link contains a text file that contains formulas for the watch list dividend yield and the indications of the current buy signals / allocations.

I've also attached a link to an automatically updating Google Drive Watchlist with the same info.

Links:

QH_BuyTheDips ThinkOrSwim Materials
QH Buy The Dips Google Drive Watchlist