Betting with Conviction

It’s easy to write articles when my position has done poorly, such as Big Lots.

I learn my lesson, share it with you guys, and then deal with the fact that I lost some money.

But reporting a big win feels weird.?

It always feels like I’m putting a jinx on the situation, but I can't put my faith in a jinx when I have faith in God. So if you didn’t read my last article on my Aemetis position which is up 100% in two months, check it out .

How confident are you?

Investing, like life, is all about bets and playing the odds. You never have perfect information and variables are constantly changing.?

To deal with that, one has to weigh their options, apply their own analysis, and make a decision they believe has the highest likelihood of success.?

This framework is crucial in investing and it’s something I’ve realized that is going to be a centerpiece of my investing strategy.

How am I leveraging my conviction levels in investing?

Going forward I’m going to use it religiously to determine my bet size.

You see, I was very confident in Aemetis even before the drop in earnings. And once they fell after earnings, I was able to digest what happened, review the facts, and determined that I was even more confident in my thesis and this was an opportunity to buy in at a cheaper price.

That takes a lot of conviction when you’re down 45%.

Unlike Aemetis, I was less confident in my Big Lots position.?

However, I didn’t take a measured approach in applying my confidence levels to the position size. As a result, I put on a much bigger position in the stock than I was comfortable with. As the weeks passed, I found myself down 25%.

This was a hefty chunk of change given the large position size and one I was not comfortable holding as earnings approached (today).?

I’m fairly confident that over 2-3 years Big Lots would rebound and provide a decent return; however, there is nothing in the earnings report tomorrow that would make me think their turnaround will start now.

This was an important realization because if they missed earnings and then the stock dropped another 25%, I would be very uncomfortable in that position and I might be forced to sell at a big loss.

After consulting with my “trading doula”, I realized I needed to cut my position in half, eat some losses, and prepare my portfolio for a potentially bad earnings report. I determined that I could withstand holding onto the stock if the position size was smaller even through a tumultuous year or two, but I could not do it at the current position size.?

This proved to be a great decision as Big Lots dropped 14% following their earnings report this morning.

So, I’ve cut my Big Lots position in half eating a decent size loss. I’ve also exited my Mattel (Barbie) position up about 1% because I realized that my conviction was fairly weak, and I only had one reason I was holding the stock – because of a movie that a famous trader said would move the stock.

Looking back, this wasn’t enough conviction for me to place the trade and I realized that most of the positive effect would likely take place after the move is released. So Mattel could have been a dangerous stock to hold in the meantime as retail spending slows.

Maybe this is obvious to some investors, but I’m beginning to realize that what matters isn’t the potential size of a return, 5%, 50%, or 50x, but rather it’s the conviction levels of your bets.?

If you’re extremely confident on a bet that will likely move 5%, then you can put on leverage and generate returns that have enormous effects on your portfolio. Similarly, even if you think a stock price will increase 10x if you’re not confident enough to put the bet on in size, it might only return 5% to your overall portfolio… and that’s something you can get in a “risk-free” CD right now!

Anyways, the lesson of the week for me is:?

Measure my conviction levels. Visualize how I would feel if this position was down 30%. Enter my position sizes accordingly. Periodically reevaluate my conviction levels as time goes on and adjust position sizes accordingly.?

Graham, out.

This is not financial advice. The information provided here is for general informational purposes only and does not constitute financial, legal, or professional advice. Always do your own research and due diligence before making any investment decisions. The views and opinions expressed here are solely those of the author and do not reflect the views of my employers or any other organization. The information provided here is not intended to be a substitute for professional advice and should not be relied on as such. If you have any specific questions about any financial matter you should consult a licensed financial or legal professional.