Is There a "Best" Way to Open a Stock Position?

By Markets Fool.com

It's mailbag time again on theRule Breaker Investingpodcast, and there are plenty of great questions forMotley Fool co-founder David Gardner. In this segment, a listener wonders how to know when it's the best time to open a position on a stock.

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A transcript follows the video.

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This podcast was recorded on July 27, 2016.

David Gardner: And next one up is from my friend Troy Springer. I got to know Troy at the University of Richmond, where I was leader in residence at the Jepson School of Leadership Studies over the past year. And Troy, I think you were ROTC, so I know that you have some military background, but you've also been a very faithful podcast listener. And it was a pleasure to shake hands with you in Richmond.

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Troy, you're asking here, you write: "I've been meaning to get this question out for some time now. What is your favorite way to get into a position?" For example, you write: "I have recently gotten into the habit of placing 'good till canceled' limit orders on stocks I like. A lot of times I'll buy a stock at its market price and then the next day it will be down something like 2%. And I'll say to myself, 'Oh, man. I should have been a little more patient.' I know it's impossible to predict where the market will go and time the market, but I think being able to save a little when you enter a position is valuable. Plus, by placing such limit orders, I don't have to pull out my phone all the time and check the price of a few stocks."

You go on: "Motley Fool recommendations don't seem to give too much insight into the moment of the actual transaction. Even Best Buys Now seem to be not especially time-bound. How would a Fool save a bit on his transactions, aside from commissions?"

Well, that's a great question. And let me start by saying that there isn't any one approach here. So I'm going to tell you what I do and how I think about it, but you might well do this better than I do, because, frankly, I don't think I'm particularly good at picking prices or picking entry points for stocks -- or picking the right time of day or having the right approach.

So Troy, here's what I do. I just place market orders. I remember when I was an earlier David Gardner -- somewhere around a 30-years-younger David Gardner, so I'm around 20 years old at the time -- I would place limit orders at that point. I felt like -- and I was often buying smaller-cap companies -- and the smaller cap the company, the more illiquid the stock, the more it's worth placing limit orders to ensure you get a price that you want.

But back in those days, that was more consistently how I bought stocks, and it was a less liquid market, much lower volumes than we see today. The spreads were much wider. So the differences between the asking price and the offer price were substantial, and so you'd have to buy a stock at, I don't know, $20 1/2, and a second later it would be basically bid at $20. In other words, you would have paid up a half a dollar just to buy that stock. So that was, again, in more illiquid stocks in a more illiquid time.

These days, I don't really approach the markets that way, and there's a lot more liquidity. The spreads between the bid and the ask are more like a cent. Sometimes they're less than that. And so I don't really find it that important for me to try to put in a limit order. Also, how many times -- and it happened enough times that I remember -- how many times did I put in a limit order, the stock never quite crested down to that price that I wanted, and I never got that stock?

And here's the bad news -- when it never did go back down to that price that I wanted, that means it went up from there, and I missed a winning stock because I was trying to grab a couple pennies here or there. And so I decided that for me, as an investor, I'm not going to worry or be too intense about when I buy a stock, or what price I buy the stock at. I'm going to place a market order when I'm ready. It will fill instantaneously from that point, and I will be a part owner of that company.

So that's my approach, but I'm the person who is convinced that within a day or two of whenever I buy a stock, it will be lower the next day, and whenever I sell a stock -- and I don't know how this happens -- it goes up the very next day. And so I'm just at peace with the idea that I'm never going to get it right. But here's the good news: It's so short-term, it's so meaningless a year, or two, or three later, that I don't think it's that worth it.

Now, all that said, there are many different approaches here, and especially if you're starting out as an investor -- and commissions can be a substantial chunk, sometimes, of your purchases -- maybe you do want to pick your prices. And if you're a more precise person, or exactitude matters to you, maybe you want your order to fill right at the price that you have predetermined if the stock hits that price, so I completely understand it.

I'll close by mentioning that we've talked a lot over the years about just buying stocks in thirds. So this is something that The Motley Fool certainly popularized -- the idea that rather than go all in with your full position right away, sometimes we found it's smarter to parcel it out. To divide it, let's say, into three pieces, and buy your first third right now. Don't worry about whether it's high or low. Don't sweat your limit orders. Just get invested. Get your feet wet. Become a part owner of that stock with one-third of your position. And then, perhaps a month from now, buy your next third, and a month after that, fill out your final third.

Why does this work and why do we recommend this approach? Well, I think it's for this reason. It's because for a lot of us, we're gun-shy. We don't actually even want to buy. It feels all or nothing, and so sometimes we wait. Or we put in a limit order that's not even realistic, and we never get invested. Or we wait too long to invest.

So I think for a lot of people, when you make it piecemeal, and you just give yourself an opportunity to get your feet wet and start with the investment, you put yourself in a good mental place, because here's the trick: From that point forward, you've already bought a third, so now if the stock goes up from there, you can say, "Well, darn it, I'm awfully glad I bought some that day. That I had the courage to step in and bought some. And it is up some, so I'm already making money. I like the company, and I'm already making money, so I'll buy the rest now, or in the future."

On the other hand -- and here's the mental trick -- if the stock has gone down from there, what are you saying? You're saying something like this: "Well, I did buy some, but here's the good news: It's down, and I still have two-thirds of the position left to buy, so here I am able, on sale, at a discount, to get what I was paying up for a little bit earlier, and I still have more money off the table than on, so now I'm going to buy happily and confidently at these prices." So if you followed me through that example, Troy, and everybody else listening, you'll see that I think it's a fun mental trick we can play on ourselves to get invested.

I will close by saying that there are documented studies that show the longer you wait to buy, the less well you will perform overall. So dollar-cost averaging, which is kind of what I just described, or buying in thirds, if you space it out over time and you do that systematically, and you track the results, 30 years later you're going to find that more often than not, you would have had more money if you did not do that.

And why is that? Well, that's because the stock market, on average, tends to rise over the course of time 10% a year. So with every passing day or month, you're paying a little bit of an opportunity cost waiting to put your money into the market. It certainly feels great when the market, one year out of three, declines and you waited. That feels great. But two years out of three, it keeps going up. So studies will show that dollar-cost averaging is actually less efficient for long-term returns, but for a lot of us, humans as we are, it's more emotionally efficient. Sometimes it gets us off our duff, gets us moving to start practicing buying in thirds. And if that helps you, then that's another way to enter a position as well.

Always more to think about these subjects than I can possibly cover, but I hope that was pretty good.

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