Discussion 1: Kick DCA Out Of The Game!

Whenever I had a discussion on this topic, it would almost inevitably triggers my memory of an interesting conversation which I overheard between a stockbroker and his client. It was around May 2008, when the Malaysian economy was heading towards downtrend. To make the matter worse, I was unexpectedly out of employment and on the road.

I was having my breakfast at Mc Donalds alone that morning, and was delighted to overhear this conversation, hoping to get a good tip on the market to make my ends meet. The stockbroker recommended his client to buy a stock that its price was trending downwards at that time. I was a little surprised to hear that. The conversation followed on like this:

"Isn't that stock (price) dropping currently? Why would you recommend me to buy that?"
"Yes, it is, that is why you need to buy it. It's cheap now."
"What if it heads down even further?"
"Then we Dollar Cost Average (DCA) them. When the stock (price) comes up, you'll earn a lot that you'll come thanking me at my foot."

I then shoke my head, and continued my morning coffee.

To me, the idea of buying a blue chip stock that pays handsome dividends every month, and then DCA them when the price goes down, is already as old as dinosaur.

Now I'm assuming that most of you readers would have already known how DCA works. For those who do not, it's a mechanism to lower your average cost per share by buying up more shares when the price is trending downwards, and then selling them when the price goes up.

Illustration (i)
Investor X puts aside RM100.00 every month and invests in Stock ABC, regardless of the price of the stock. Every month, as the price drops, he would stock up an amount of shares equal to the worth of RM100.00. In month 5, he sold his portfolio for RM0.35, and made RM282.50. Obviously, he's practicing the DCA technique.

The question I would ask to any practitioners of such technique would be, "When you accidentally put one of your feet into a quicksand, would you quickly pull your foot out, or will you put both feet in, and then wait for helicopter's rescue?"

Most of the time, investors just do not realise that they are putting another foot into the quicksand when they pump more of their hard-earned money into the stock. All they do thereafter is to pray hard to the sun and moon that favourable news (helicopter) will come along and the price will go up, not realizing that the helicopter might not even come for them after all!

Let us take a closer look at the situation:

Illustration (ii)
When investors look at the portfolio in this manner, probably they may realize something. As you can see, the investments in Month 1 and 2 result in total losses (totalling RM42.50). While Month 3 and 4 earns, these profits are then knocked off against the previous losses, bringing down the investment earnings to only RM282.50.

Well, let us see how a sophisticated investor (Investor S) would have approached this situation:

Illustration (iii)
Investor S would have the guts to own up his mistake and painfully departed with his loss. Therefore, he sold the stock which he had bought at RM0.50 in Month 1 at RM0.40 early in Month 2. He lost RM20.00 in the process. He then watches the stock from Month 2 to Month 3 for any signals of reversal in price trend.

Come Month 4, the stock price hit the low at RM0.10. He waited for a confirmation when the prices rebounded to RM0.15, and purchased 2546 stocks worth just a little under RM380.00 (RM200.00 saved in Month 2 and 3 + RM100.00 injection in Month 4 + RM80.00 leftover from Month 1). Assuming that he sold the shares at RM0.35 (the price Investor X sold his portfolio for), he made RM486.60 from this trade, after deducting the earlier RM20.00 loss.

So what are the differences?

• Return on Investment (ROI)
• Absolute Returns (RM)
• X - RM282.50
• S - RM486.60 (72.24% higher than X)
• Percentage (%)
• X - 70.63%
• S -  121.65%
• Payback Period
• X - 5 months (or more! if the price doesn't go up and continue downwards for say 12 months?)
• S - 1 month
• Opportunity Profits
• S could use the remaining funds on hand (RM280) to invest in other stocks to earn short term returns, while waiting for Stock ABC to recover.
• X has all his liquid funds tied up in Stock ABC. If Stock ABC does not offer dividends or offers low dividends, then these money will not be working for Investor X during the tied up periods.

With this understanding in mind, it cringes me when I hear brokers, fund agents and alike speak so majesticly on DCA. Very often I hear mutual fund agents persuade their clients to place a certain amount of money in the fund every month, often automatically deducted from their salaries, on the catch that when they retire, they will have access to a huge amount of money. What if there is an economic crisis when they are 55 and the funds' value are slashed into half by that wave? >.<

To be successful in stocktrading as well as other financial instruments, the DCA concept is the only one concept that should be kicked out, dumped, and completely deleted from the investors' memories. In comes Technical Analysis to complement your Fundamental knowledge in the quest of becoming a successful Sophisticated Investor.

Thank you for reading, and happy investing!