Value Investing – Setting Buy and Sell Points (Lesson 16)

Buy and Sell Points

“The big money is not in the buying and selling … but in the waiting”. –¬†Charlie Munger

Setting buy and sell points for any investment security determines the investment’s final return. If the buy is made too early while the security is falling in price, the value investor loses out on not only additional margin upon the sale of that security, but also reduces their margin of safety associated with the intrinsic value point. It is similar on the other side of intrinsic value. If sold too soon, the value investor leaves money on the table. Thus, setting the buy and sell points are important decisions for every investment.

There are tools available to determine these two values. In the simplest of statements, the easiest rule to follow is the Pareto Principle; commonly referred to as the old 80/20 rule. This rule basically states that roughly 80% of all outcomes are within 20% of a focal point. With security pricing, this principle is simply that 80% of the value changes will occur within 20% of intrinsic value. Therefore, if a security’s intrinsic value is $80, then the probability is that 80% of the maximum change in value will happen within 20% of the core value. Therefore, the buy is approximately $64 and the sell point is $96. Almost certainly, this rule isn’t pure with security investing. The conception is that if the end results are beyond this 20 percent under and over the intrinsic value point, the value investor must have additional financial support and a lot of history with the security to validate expanding the buy and sell points beyond 20% fluctuation. This does not mean that the buy and sell points are exactly 20% deviation from intrinsic value; it merely states that there is an 80% probability that the buy and sell trigger points are within 20% of intrinsic value. The key point here is that if you can find 20% deviation on both sides of intrinsic value with high quality securities, then you have an excellent potential for a good return.

This lesson first introduces a basic model to illustrate and reinforce

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