This post is part of Craig Turner’s Innovative Trading Concepts series.
Jim Cramer vs. Dennis Gartman
Two of my favorite financial commentators are Dennis Gartman and Jim Cramer. Say what you will about them (and I’ve read criticism about both), but they are well respected, successful traders that everyone can learn from. One issue I have seen in blogs and message boards is there positions on “averaging down” or “adding to losing positions.” While their approach to this issue differs, I think in the end they are doing the same thing, but just going about with different styles of trading.
“Never Add to a Losing Position” – Dennis Gartman
Dennis Gartman is a big believer in “never add to a losing position”. Dennis Gartman comes from a commodity futures trading background, and this makes perfect sense. If he wants to get long gold at $1400, then he will be long a $140,000 Gold futures contract ($1400/oz X 100oz = $140,000 Gold). When he gets into a position, either that contract is going to hold those support levels and start going up, or he wants out. He might get in due to technical or fundamental analysis, and if he is correct, he wants the market to tell him so. If he is wrong, he is happy to get out with a small loss, which could be a break below the nearest support lines.
It makes sense to trade this way in commodity futures because of the leverage being used. When you are trading on margin and leverage, the gains (and losses) can pile up fast. Plus you can’t buy gold $25K at a time; you have to commit to the full value of the commodity futures contract. For Gartman, $140,000 of Gold is the minimum amount to play and that is where he will start.
The Jim Cramer Method
Jim Cramer is primarily an equities trader and tends to buy his positions in 4 or 5 trades. It is easier to do this in stocks because one share is typically under $100. Let’s say Jim Cramer wanted to have an initial position of $140,000 in Ford when it is trading at $14.00/share. That is 10,000 shares of Ford. For that kind of size, you most likely have to split it up into 4 orders of 2,500 shares. Plus, Jim Cramer is a fundamental expert and he might have a price range for Ford between 13.50 and 14.50. He might buy his first 2,500 shares at $14.00 and wait to see what happens. If it goes down to 13.75, he will buy 5,000 shares, and then pick up the last 2,500 on the next break or if it rallies back to 14.00.
Now, if the stock breaks below $12.50, he might be ready to get out and just take a loss if he thinks it is a bad trade. One thing I don’t think Jim Cramer is doing is “averaging down” a loser. I think he has a very strong opinion on where the market should be fundamentally, and he knows the market can go up and down based on news and events unrelated to the stock he is buying. That reason, combined with the size of his purchases, probably makes it more efficient for him to buy his positions in multiple trades.
The most important thing to note is that Cramer is not getting into a full position and then buying a dollar lower and doubling up. He commits to the size he wants in terms of shares and works the order for a few days. If it loses too much value, he gets out. He will also buy more as the price goes in his favor, a technique that Dennis Gartman also employs.
The confusion I see on the blogs and message boards is that Jim Cramer is averaging down losers. However, what Cramer is really doing is defining a full position and then buying that position in 4 or 5 equal parts. The dollar cost average exists because he breaks up his buys for the initial position, not because he is doubling up due to the market is going against him.
Cramer & Gartman Risk Management
Dennis Gartman and Jim Cramer may have different trading styles, but their risk management is the same. They take small losses. If something is not working out, they get rid of it. They don’t throw good money after bad. Dennis Gartman, being so involved in futures, is probably the more risk adverse of the two, and that is mostly likely due to the leverage used in futures when compared to stocks.
In the end, it doesn’t matter which method you use, as long as you have a risk management plan to limit the size of your losing trades. Both Jim Cramer and Dennis Gartman recognize the importance of this trading practice and do their best to follow their own rules. Traders need to find a style of risk management that fits their trading and investing styles, just like Cramer and Gartman have. If you want to be a successful trader, make sure you always know the size of the position you want and the risk you are willing to take before you initiate the trade.