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Investing by the rule of 10 or Operation CFD

November 22, 2021

I may change the name in future but for the moment I am going to call this ‘Investing by the Rule of 10’ although already I am thinking of calling it Operation CFD because it is going to involve both those things. I think it could be fun and very profitable. I have shown above a chart of the US Nasdaq Composite index because this strategy relies for its effectiveness on the assumption that the US stock market is in a long-running secular bull market with a long way still to run. Mind you all equity investing strategies make that assumption.

The main driver of this bull market is a mixture of globalisation, an increasingly affluent global middle class and an accelerating technology revolution driven by dramatically increasing spending on research and development, especially across the corporate sector. This last is a phenomenon of extraordinary power. It is not only accelerating but I suspect it is accelerating at an accelerating rate. The world is experiencing a tsunami of technological advances embracing AI, 5G, the Metaverse and so much more, driven by a corresponding tsunami of spending on innovative research. Where it is going to take us who knows but it is an exciting period for humanity.

I have just had a look at Nvidia to see what is happening to their spending on r&d. Between 2013 and 2018 it grew from $1.15bn to $1.8bn but in the last three years that growth has accelerated dramatically to $3.92bn for fiscal 2021 (ending 31 January 2021). For the latest quarter, Q3 2022, it grew to $1.4bn from $1.047 so annualised it is currently running at $5.6bn. If Nvidia is anything to go by and I believe it is then it is easy to see why the technology revolution is accelerating so rapidly.

The core of Quentinvest investing is choosing shares with 3G (great chart, great growth, great story) and building them into a large portfolio. Many of the gains will come from the biggest winners so another aspect of the strategy is to never sell. Most people who buy a share that rises 10 times, a 100 times or occasionally even 1,000 times sell long before those gains are realised. They may even sell at a time when they lose money. My impression is that for most people the only way to capitalise on these huge winners is to never sell anything once bought. This works because the gains from big winners vastly outweigh the losses on losers (think minus 100pc at worst v a possible 1000-fold gain). It is part of what Warren Buffett calls behaving like an owner. You are not just buying a piece of paper, as it were, but a tiny piece of the business.

So that is the core of the strategy. The second thing I like to do is to use leverage to amplify the gains. I do this by buying CFDs and making spread bets on IG. I am treated as a retail investor which means my maximum leverage is five times my equity and I can never lose more than I have invested.

The problem with leverage is that it is difficult to deal with stock market crashes. Losses multiply with terrifying speed and even large gains can melt away. As a result many subscribers who have tried leveraged investing don’t like it. This is totally understandable and I think for most investors the core of their portfolio should be unleveraged but perhaps not all which brings me to the Rule of 10.

I am going to tell you how I plan to apply it but you can tweak the strategy to suit your circumstances or temperament. I do think it could be a lot of fun and highly profitable over the long haul.

Every month, at least but often several times a month, I update my various tables of past recommendations. I do this mainly to find shares giving buy signals or with strong momentum. This then forms the basis of the stories I write for Quentinvest. Great Stocks for Quentinvest focuses on some eight stocks that look good and which I want to profile. Great Charts is about 17 or 18 shares with great charts (all still 3G of course or they don’t get considered). Share Alerts are a deeper dive into stocks which I like, often ones where I am planning a larger investment. ETF Alerts are alerts for strongly performing ETFs, often focused on the leveraged ETFS. that have performed so well over time albeit with great volatility.

The stocks I like the most have great momentum, the more the better. My feeling is that if a share is going to be a monster winner it needs to be in a powerful uptrend. It is the same idea as if a company is going to become very large it needs too scale very rapidly. I love explosive growth.

So here is how the R10 strategy works. I go through a table, probably the QV for Shares table but it could be another table, the companies in the tables are much the same though one very large table also contains so far unrecommended newcomers, which are candidates for selection. I choose 10 shares exhibiting strong momentum. I now invest approximately $1,500 in each one so $15,000 in all. But here is the first crafty bit. I buy them as CFDs with maximum retail investor leverage. This means I put $3,000 into my account and IG lends me the rest at a rate of interest similar to a mortgage rate albeit charged on the entire principal.

I know have a $15,000 portfolio in which my equity stake, the bit I own, is $3,000.

This is immediately risky. The slightest weakness and I will get a margin call. However, even if I get one, I don’t have to do anything. IG will only start to sell my stocks if my equity drops below 50pc of my required margin. This means shares can fall a long way before they start to sell me out. Even so this can happen in a crash so it is a risk.

Fingers crossed we survive the first month without being sold out and end the month at least at breakeven or into profit. This is quite likely to be the case because the 10 shares I bought all have strong momentum.

Now we come to month two and again I choose 10 shares for R10 investing. What I normally do is use any additional equity that has built up in the portfolio to make additional purchases. This means I spend most of the time leveraged to the max and vulnerable to market weakness. More seriously it means I am forced to sell at low prices whenever the stock market does crash so it seriously impedes my long-term strategy as well as being stressful.

The twist here is that we are not going to do that. Any profit that builds in the portfolio will sit there unused. If I want to buy the new group of 10 stocks, which may or may not include names from the first month’s selection, I must put another $3,000 into my account to fund those purchases.

I now carry on with this strategy ad infinitum, choosing 10 shares to buy each month but always funding the purchases with an injection of $3,000 into my account. Over the course of a year I will put $36,000 into my account to buy $180,000 worth of shares. This $36,000 doesn’t have to come from income. It could come from capital. One source of funding for me will be profits on my spread betting account.

Now back to the opening paragraph. We are doing this against the background of a strong secular bull market, especially in US shares. The shares selected for the QV for Shares portfolio are all 3G so an elite within the US market. The rule of 10 shares are chosen monthly for their strong momentum within this elite group so effectively an elite within an elite selected from the world’s best performing stock market. These shares are the stock market equivalent of Napoleon’s Imperial Guard, who conquered most of Europe and came within an ace of victory at Waterloo. These are shares in the front runners of the global bull market and the technology revolution. They are the companies making that revolution happen. The odds are good that as the years unfold this portfolio will appreciate strongly in value. My selections have done very well in the past.

Now remember that NONE of that appreciation is being reinvested. This means that although the portfolio starts by being leveraged to the maximum that leverage should fall over time. Imagine that in a five year period your portfolio doubles in value. Not impossible if that is what the index has done. The Nasdaq Composite has actually trebled in the last five years and, as noted above, the forces driving it higher are accelerating. Other indices like the Nasdaq 100 have done even better.

Over five years you have bought $900,000 worth of shares that could now be worth $1.8m or even more. The equity you committed to buy those shares was $180,000 but your total equity, not allowing for interest, is now $1,080,000 ($900,000 of appreciation + $180,000 injected by you as cash leaving you with borrowings of $720,000 to deduct from that portfolio value of $1.8m). If we knock off $130,000 for interest and commission charges (which has been rolled up to make your borrowings more like $850,000 than $720,000) we are still talking about net equity of $950,000 supporting a portfolio worth $1.8m. Your leverage is no longer five times but less than two times.

Best of all you are starting the next five year period with a portfolio already worth $1.8m. This is where things could get really interesting!

Subscribers, familiar with IG, are welcome and positively encouraged to check my calculations and let me know if I have missed something. Even if there is a mistake in the details the general drift of the argument should not be changed.

This is what might have happened over five years. Over a 10 year period your leverage should become even less and the value creation could be seriously exciting, even life changing.

My guess is that with this strategy the hardest bit will be surviving the first crash while your leverage is still near the maximum. Ideally, you could inject some additional funds to manage this period. Alternatively you could react to margin calls by selling shares to keep your margin at the permitted level starting with the shares showing the greatest weakness. Once the crash is survived, even if with some damage, you should be back in business and on track for long term gains.

There are many riffs on this approach. I began by thinking in terms of investing on a zero commission platform so that it could be done with small investments in each stock and no leverage and that is still an option. However, when I though about it more, I realised that the act of funding each fresh round of purchases and leaving profits untapped meant that over time leverage would fall and the portfolio would become steadily more secure so suddenly leverage becomes an option for many more people and should be much more compatible with an effective never sell long term strategy.

The key problem with my always maxed out approach to leverage is that you are bound to be slammed by a correction/ crash eventually but if all investments are funded and all appreciation is left unused this problem starts to solve itself over time.

This could be a very exciting way of building a valuable portfolio while keeping one’s main funds in an unleveraged form or in my case in tax sheltered spread bets because I am such a wild gambler. The best bit about it is the tendency for the portfolio to become less leveraged and more resilient over time. It is the failure to let this happen that is the major weakness of my current approach.

So the plan is that each month I am going to choose around 10 shares for this strategy. There will be no attempt to create diversification although I think that will happen naturally. These shares are going to be chosen for momentum, excitement and massive potential. I will be very disappointed if they do not deliver an exceptional performance over time with the gains multiplied by leverage but growing security as that leverage falls.

The reason I have chosen to invest $1,500 in each stock is that IG charges a minimum commission of $15 on US stocks. This is one per cent of $1500 so a bearable cost. You can have more than one CFD account on IG so I plan to operate this strategy in a dedicated CFD account where I will be able to see exactly what is happening in real time with real money.

This is similar to the strategy I adopted when I first launched Quentinvest for Shares. The difference is the funding element. The first time around I reinvested all profits in new investments so was hopelessly vulnerable to market weakness. Even so the strategy might well have worked if I had held my nerve. The new bit is the regular cash injections so that all purchases are funded with new money and can only be made when the portfolio is in surplus.

Another variant on the strategy would be to invest with leverage on IG, $1500 a time but buy five shares or three shares each month. Even three shares bought is $4,500 invested a month, $54,000 a year which could quickly build serious value in an appreciating market. The financial cost of such a strategy would be $10,800 a year, $900 a month or £670 a month.

At the moment I am thinking of doing this around the first of the month although I don’t want to clash with Great Stocks or Great Charts which arguably are doing something similar. Subscribers will have noticed my enthusiasm for investing into strength, again and again and again.

I am currently watching Amazon, which is close to make a spectacular chart breakout from a pattern which chartists call a line. This is one of the most exciting patterns in the chart book and can support massive moves. Amazon has a new CEO and seems to have adopted a strategy of flexing its muscles to make sizeable investments in fast-growing companies while using its vast scale to help those companies grow even faster. Plus, with Amazon, you never know what is happening behind the scenes.

Meanwhile and most exciting of all is the incredible choice of hyper growth companies out there. Companies offering exciting new products and services can grow with incredibly speed for an astonishingly long time. This is why being an aggressive equity investor in today’s stock markets has the potential to be such a rewarding strategy.

Finding 10 shares to recommend each month for the Rule of 10 will not be the problem. The hard bit will be choosing 10 from the many exciting names available.

I don’t claim to have all the answers or anywhere near when it comes to investing so any feedback from subscribers will always be welcome. One problem I can already anticipate which tends to happen with many of my recommendations is that because I am attracted to shares showing strong momentum they often succumb to profit taking the minute I recommend them. I have learned that most often this is a temporary phenomenon but one which perhaps needs to be taken into account with a leveraged approached.

I am also thinking of how the strategy could be applied to ETFs, where it should work very well. As far as leveraged ETFs are concerned they need to be bought in a share account and with three or more purchases a month there is zero commission on IG so you can invest much smaller amounts, which is exactly what I do.

I have also come to the conclusion that wracking your brains about timing on these ETFs is a waste of time. My latest strategy is just to buy a few every month in my favourite leveraged ETFs, which all featured in a recent QV for ETFs alert if you are wondering what they are. The beauty of most ETFs, even leveraged ones, is that however severe any periods of weakness they ALWAYS go on to make new highs. This makes them perfect for a dollar cost averaging strategy.

In my share account now I only have leveraged ETFs. I invest similar amounts in each one so it is like a horse race, watching to see who wins.

Since writing this I have had some further thoughts. It is not easy to invest exactly $1500 in a share, at least on IG where they don’t offer fractional investing. So another rule is that you never invest less than $1500 in a share but as little over that amount as is practicable. In the case of shares like Amazon and Alphabet with prices around $3,000 or more this means it will be impossible to invest in 10 shares with funding of $3,000. In those cases I will just buy fewer shares, seven or eight instead of 10. It is not a big problem.

So here is a summary of the rules for Operation CFD.

  1. Open a CFD account with IG (a beginner’s account so you cannot invest with more than five times leverage and can never lose more than you have invested)
  2. Put the sterling equivalent of $3,000 or whatever amount you have decided to invest into the account each month.
  3. Buy the recommended shares which will be chosen (a) for great momentum and (b) to use that $3,000 of funding as exactly as possible.
  4. Never sell.
  5. Never invest the appreciation on the portfolio which is to be left to grow unleveraged.

 

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