Pennsylvania Investment Observer

Trading Around

by Daniel J. Nestlerode

The decline in stock prices over the past eighteen months has left many stock trading below ten dollars per share. Among this group are many first rate companies that will survive and flourish in the coming years. Yet those of us who bought these stocks are higher prices now have unrealized losses and, most likely, a real hesitancy to change any holdings in our portfolio. The tendency to hunker down and wait for stock prices to recover is strong even in investment advisors. Yet these are things that investors can do to enhance their portfolios. One of these things is what I call trading around.

When you have a stock that is trading for less than you paid for it, you can always sell the stock for a tax loss. Losses on stock trading are generally first set against any gains you have taken. If you have losses greater than your gains, then you can deduct up to $3,000 of net losses per year against your earned income, thus reducing your Federal Income Taxes. Please check with your tax professional about taking tax losses. If, however, your believe that your stock is a good one and likely to rise in price in the coming months, selling it to take a tax loss might result in you buying back into your good investment at higher prices. To avoid this possibility, I recommend that you trade the stock around to avoid buying it higher than the current trading price.

What do I mean by trading around? When you take a tax loss on a stock, you cannot buy back your position for a month, else the sale becomes a wash sale and the loss is not deductible. If your stock goes up in price after you sell to take the loss you are stuck watching it rise when you cannot buy it. As an alternative, you can buy more shares of the stock in which you want to take a loss. Then wait thirty days and sell your original batch of shares for the tax loss. In this manner you do not have a transaction in the stock that you are selling for a tax loss within thirty days of making the tax loss sale. In this manner, you will not take the risk of having to buy your tax loss stock back at a higher price in the future.

Of course, this technique is not a sure fire moneymaker. The stock you are doubling up on to take the loss later could fall in price. Then your loss will be larger than if you just sold the stock outright and waited to buy back in. So you need to be as sure as possible that the stock you want to take the tax loss in is likely to be a winner in the coming months, if you are going to trade it around.

In conjunction with this trading technique, we are heading rapidly into what might be a banner year for the January effect. The January effect is the tendency for small cap and low priced stocks to trade higher in price from mid December through mid February because of the end of tax loss selling. The stage is set this year for a banner January effect, because stock prices have been declining in general for the past eighteen months. The stocks that trade at or near their multiyear lows in October and November are the prime candidates for participating in the January effect rally. If you have holdings that are near their lows for the past several years, then trading the stock around and setting yourself up for benefiting from the January effect might be a real moneymaker for your portfolio. Right now is when you set up your portfolio to benefit from the coming rally in stock prices. These portfolio management techniques do not guarantee you profits. Yet I believe they are better than hunkering down and doing nothing.

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