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Let's say that I bought 500 shares of company ABC while the stock was doing well, and paid $10 per share for a total of $5,000. Then over the next year (while I was overseas, let's say) the company tanked and dropped to $2 per share. Since I had no safeties in place to trigger a sell off, I now own 500 shares worth $1000.

After I get over my initial frustration at the loss, I realize that even though only at a fraction of it's initial value, ABC is now regularly fluctuating between $2 and $3. I decide rather than taking an immediate $4000 loss, to start trading on smaller increments and take advantage of the regular fluctuations in price.

I purchase another 100 shares of ABC at $2, and then sell it a week later when the price hits $3. Because I am calculating capital gains using FIFO, I record a $700 loss on the 100 shares, but now I am still $100 richer. Assuming the price shortly turns around and hits $2 again, I repeat the process again and over the next several months I (hopefully) begin to recover a portion of my losses, all while avoiding short-term capital gains.

Neglecting transaction fees, are there any drawbacks to this approach?

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    I think the major problem here is the sunk cost fallacy. The history of what you paid for the stock is irrelevant in future decisions. Assuming you had your original $5K back, would you pursue this strategy? – JohnFx May 4 '15 at 23:13
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If the stock has dropped from $10 to $2 and now is range trading between $2 and $3, and you were not able to sell your shares earlier, then I would no be holding on to them now. As soon as the price hit $3 sell them.

After you have sold them and you noticed the stock still range trading one strategy you could apply is to go long after the price bounces off the $2 support placing a stop just below $2, then as the price moves up you trail your stop up with the price. As it starts getting close to $3 tighten your stop. If it keeps range trading and bounces off the resistance at $3 and you get stopped out, you can either go short and reverse the process or wait for it to bounce off the support at $2 again.

One word of warning though, the longer a stock range trades, the bigger the outbreak out of the rage (either up or down) will be, that is the reason why you should first wait for confirmation that the price has bounced off support/resistance before opening a position, and secondly why you should use a stop loss to get you out instead of just selling when it hits $3, because if it breaks through $3 you can continue profiting as it moves up.

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    Why would you sell? (In general, assuming you have no particular knowledge of the company's future prospects.) Isn't that how unsophisticated investors lose money in downturns? As for instance the recent crash: the market took a dive, lots of people panic-sold, driving it even lower. The people who sold lost money: those of us who held on have more than recovered from those paper losses. – jamesqf May 5 '15 at 4:28
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    I suspect @Victor and I have some deep philosophical differences. This isn't a good place to hash them out, but I feel obligated to say that I find day trading ill-advised. In my assessment, there is no good reason for an individual investor to pursue the broad category of strategy described in this answer, and many good reasons not to. – Mike Haskel May 5 '15 at 6:23
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    @jamesqf - I sold out once my stops were hit (market was down by 10% then), waited for the full fall and confirmation that the uptrend was tarting again before getting back in. So whilst you waited 6 years for your portfolio to recover I was up over 50% already. – Victor May 5 '15 at 7:04
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    @MikeHaskel - who said anything about day trading? I didn't, I'm talking about range trading, which if done properly and with risk management in place can be very profitable. See your bias in the markets is closing you off from some very profitable trades, and that is why again markets are not efficient. – Victor May 5 '15 at 7:08
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    @Derek_6424246 - you could possibly place a tailing stop on the initial purchase so that if it does go past $3 you may get a bit more of your money back. Regarding using it as a hedge, as you call it, against short term capital gains whilst range trading, well you will have a capital loss from selling it which you can use against any new capital gains. So until you use up all the capital losses you won't be paying any tax on capital gains made on other trades. It is silly to hold an investment purely due to saving some tax. Making a profit and paying tax is better than not making any profit. – Victor May 6 '15 at 0:28
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There are two things going on here, neither of which favors this approach. First, as @JohnFx noted, you should be wary of the sunk-cost fallacy, or throwing good money after bad. You already lost the money you lost, and there's no point in trying to "win it back" as opposed to just investing the money you still have as wisely as possible, forgetting your former fortune.

Furthermore, the specific strategy you suggest is not a good one. The problem is that you're assuming that, whenever the stock hits $2, it will eventually rebound to $3. While that may often happen, it's far from guaranteed. More specifically, assuming the efficient market hypothesis applies (which it almost certainly does), there are theorems that say you can't increase your expected earning with a strategy like the one you propose: the apparent stability of the steady stream of income is offset by the chance that you lose out if the stock does something you didn't anticipate.

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    Markets are definitely not efficient. All participants will have different biases and filter available information to suit their bias. If markets were efficient we would not have booms and crashes. – Victor May 5 '15 at 3:21
  • @Victor The question isn't whether markets are, in some abstract sense, efficient in that no improvement is possible. I merely assert that the efficient market hypothesis applies and is useful in this situation because the OP isn't claiming to know more than anyone else about how the stock will behave. In particular, if such a simple method were effective on general grounds, big financial institutions would already be exploiting it to the point where it wasn't effective. They're already doing much more sophisticated things, and I doubt this one slipped by unnoticed. – Mike Haskel May 5 '15 at 3:28
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    As I said Mike, markets are not efficient, different participants act on their own biases to make decisions on the markets. Just look at different analysts having different values and recommendations for the same stock. Why would this happen if markets were efficient and they all had access to the same info. Because their bias determines what info they rely on and don't rely on. The same with TA, there are many different indicators which can be used in many different ways to get different signals on the same stock. – Victor May 6 '15 at 0:49
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    Are you saying big financial institutions have a monopoly on every single FA and TA indicators and signals? Your bias of the markets has closed your eyes on the possibilities out there. There is endless amounts of information out there and you have chosen to only accept the information that makes you feel safe in your little world. This does not mean that someone else cannot use other information out there to make good regular profits on. – Victor May 6 '15 at 0:56

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