Studies of Life

Learning by doing.

Part 3: Anatomy of a Piotroski Portfolio: Buying and Selling

16 January 2014 by Jim

This post is the third in a series about the Piotroski stock-picking methodology and its real-life application:

How many stocks should you buy?

According to statistical research, most of the benefit of diversification is obtained with 10 to 20 positions. Beyond that, you’re paying commissions for nothing, really. Right now I’m at 15 position, which seems to be a good middle way. 10 should be an absolute minimum.

When and how to sell

Knowing how and when to sell is, to me, just as important as knowing what to buy (but not ‘when’ to buy, since that would be market-timing, which is a no-no for rational people!). Why should we sell any stocks if the Piotroski method is so great at finding winners? We sell regularly because we want to:

  1. keep our exposure (measured as percentage of net worth held in stocks) at the same level, in my case 50% of my – admittedly still modest – net worth, and
  2. transform potential gains into actual gains before some crash or some other unfortunate turn of events takes them away from us.

All the potential gains you have transformed into real gains by selling constitute a reduction in total risk and a gain that nobody can take away from you anymore. So selling is a really good thing if you have a winning strategy, even if it costs a small commission each time. Additionally, if you’re shooting for a big ROI, as I am with the Piotroski method, it shouldn’t be bothering you too much to, as is the case in some countries like the USA and most of Europe, have to pay taxes on your investment profits. As a citizen of the wonderful small country of Luxembourg, and – more generally – the European Union, I think the state I live in deserves to get a share of what I earn to continue doing the wonderful job it has done so far. (Yes, any US readers may call me a socialist devil at this point.)

My personal recommendation is to periodically sell as many stocks as necessary to realise your portfolio gains minus the initial amount of your investment. So if your portfolio shows potential gains of +3000 EUR, sell an amount of stocks equal to 3000 EUR, so your portfolio retains its initial size and you just skim off the profits. Wait until your paper gains are big enough to make the trading commission for selling negligible. I try to keep it at or below 2% of the transacted amount. This way, once you have skimmed off some profits (which I know have, too) you’ll be quite relaxed once a small correction or crash happens, because you will know that all things add up to a net profit for you, and you’re not gambling away the house.

Next, you need to decide on which stocks to sell. The easiest thing to do is to periodically check the Piotroski scores and then sell whichever stock has fallen below an F-Score of 8.

If that doesn’t happen for some time and you still want to sell, you can use a spreadsheet to rank the stocks from most to least sellable. Here’s how it’s done:

  1. rank the stocks from biggest to smallest position in real terms (we want to sell parts of the biggest position first, to keep our portfolio well balanced!)
  2. rank the stocks again from highest profit to lowest
  3. combine both ranks (use an additional spreadsheet column where you add up the two previous columns / ranks) and then sell the lowest ranking stock, because that will be the stock that has the best combination of big position and gains, so you sell the stock high and increase the diversification of your portfolio with one tradeThat’s it! You now have pure profit on your hands, and a portfolio that’s just as big as it initially was.

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