THE MAGIC NUMBER IS 4

Whenever you are thinking of scaling into the market, remember that the magic number is 4. If you are trying to get an average price, you need to break your order into at least four equal parts. If you are trying to get a better than average price, then you cannot divide your order into more than three equal parts. Four or more equal parts gets you close to an average price, three or less gives you a chance to get a better than average price.

The best scenario is to buy your entire position at one time at the lowest price. We would all like that, but it’s unrealistic. Therefore, you decide how long you have to enter your position, a few hours or a few days, and look for opportunities during that window. Let’s say that prices are trading in a range from $35 to $40 and you expect good news to move prices through the $40 level to $50. It’s Monday morning and you think this will happen by the end of the week after dividends are announced. The price is now $38. What are your choices?

1. You could buy one-third of your position now, one-third on today’s close, and one third sometime tomorrow, for an average price.
2. You can wait for prices to test the low of $35, placing a buy order for your entire position at $35.50. However,what happens if you are right and prices move straight up to $50, never pulling back to $35? You’ve missed the move.
3. You can buy one-third now, one-third at $35.50, and one-third at $40.10 on a break above $40. That’s a bit better because you are sure of getting twothirds of your position at $39.05. If prices drop instead of rally, you have two-thirds of your position at $36.25. The only time you have a full position is if the price pattern is exactly as you predict—first declining to support, and then rallying up through resistance.

How realistic is case 3? Not very. If we knew how prices were going to move, we wouldn’t need all this planning. It’s difficult to forecast where prices will be in a few days; it’s even more difficult to predict the pattern prices will take to get to that goal. There is a very small chance you will be able do both.
Try the average price method. In the example above you might buy two of the three parts by averaging into the trade, and then add the third part on a breakout through $40 in order to have a confirmation. In that case you raise your average price, but have the comfort of knowing that you were right about your prediction.
Some traders would wait for the breakout before entering any of the position. They get a worse price but a better chance of success. Other traders would enter the entire position between $39.75 and $39.90 looking for the breakout and trying to get free exposure from the jump through $40—a little more risk, but a lot more reward.