That's a large part of what this blog is trying to do...
I'm a big picture kind of person....
During my senior year UCLA (while I was still an undergraduate) I tutored the core biochemistry class to other undergrads. I was good at it. (not blowing my own horn… I just was). Primarily because I could take the complex scientific concepts and break them down into a logical flow that helped describe the why and not only the what. I loved tutoring and I also found that by teaching I was learned the material through and through myself. In biology the word is "symbiosis"... everybody wins...
"any interdependent or mutually beneficial relationship between two persons, groups, etc."
While I'm by no means a stock market tutor, if there is such a thing, I do love to learn about the markets and try to share what I learn. Hopefully we as fellow investors can learn and build together. To do this requires that we shore up our stock market "arsenal" so to speak. The more we understand, the more tools we have at our disposal, and the more precise our trading 'weaponry' the more likely we are to succeed. Part of success is simply knowing what stocks are out there. Since there are thousands of stocks part of investing is simply spending the time to research stock lists, sift through blogs, etc. Whenever I find a stock that is interesting I put it in a list so that I can watch it for the future and so I can pick the cream of the crop. However, this post is not about specifically finding stocks. There are others for that. This is a core 'big picture' post that I hope helps put the whole stock market game into perspective... Here goes...
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There are many different approaches to succeeding in the market. Some people like one or the other but I like to draw from many depending on the company or the situation. Throughout my posts my ideas and posts will tend to draw from a number of different strategies for success. Two ideas persist throughout all...
1. Understand what the heck is going on.
Top posts like it pays to be trendy and in a picture and a word why this market is so dangerous attempt to do this. Most stocks, no matter what, are affected by the macro picture of the overall market. At the very least they are affected by the nuances of their own industry. When the SP bounced off of the 200 SMA and the finance stocks (see UYG chart on stockcharts.com) formed what appears to be an "island reversal" it sure helped to understand the fundamentals of why this might occur so that the technicals could be put in the context of the fundamentals. Likewise the concepts of Dow theory (Post: It pays to be trendy)helped to explain a technical reason why the market could go up so much when the fundamentals were so atrocious. I always try to gain an understanding of the big picture... it is my nature... and it has helped me in the past...
2. Develop a systematic trading style and stick with it.
Emotion is a big reason that people make mistakes in the market. This especially becomes an issue when someone has a good chunk of money on the line. One of the ways to help neutralize this and to succeed is to have a "system". That system should be created by you, should have specific rules and guidelines to help guide you, and should be constantly assessed, re-evaluated, and updated. For example, one rule I like to stick by is: A transaction is a major action. Before making any trade/investment I want to double check myself to make sure that I have done the work, I know what my price target is and how much I am willing to lose, I know why I think the trade might be a good idea (fundamentally, technically, and ideally both), what could go wrong, if there is anything better out there, who I am likely buying from (do they likely know more or less than me on a given transaction... after in almost every trade someone wins and someone loses... though there are exceptions) and a number of other factors. Warren Buffet's first two rules of investing are:
1. Don't lose Money
2. Don't forget rule #1.
It's true. The fundamental pathway to success I believe is first and foremost being able to prevent huge losses from occurring. This means that when initiating a long or short position often no transaction is the best one (be selective... look for opportunities) and it is imperative to limit losses when a mistake has been made... even if its just luck that goes against you discipline is crucial... capital preservation allows you to move on and have the powder to make successful new investments. What I'm talking about here is risk management and a calculated, unemotional approach to success. I am developing my own skills in this as well and I have found that excellent readings, such as those by Wall Street Legend Victor Sperandeo have helped me enormously. At the same time.. allowing profits to run on great companies while preventing a winning investment/trade from turning into a losing one all help build in time-tested methods for long term success... I cannot emphasize this enough... especially in a tough market like this one.
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Ok... those are the big 2. The rest of the post looks at different strategies for stock picking success. Some people are very successful using one or two kinds... I like to have as many options in my arsenal as are possible and so I look to take advantage of opportunity in any of these methods. Also I am always trying to update and increase this list and this is by no means all inclusive- there are many other methods as well. The important thing here I believe is to know which kind of trade/investment you are looking at when you get in so that you can predefine risks and objectives before getting in... Ok here is my most updated list....
1. Long Term bull market stocks.
These are stocks that are in the early phases of a growing industry. Often there is growing demand and not enough supply to keep up. Or we are talking about a new industry that is no longer speculative but has not yet matured either... its potentially in the sweet spot. These stocks are often the very best because they often offer the best risk/reward profiles. In the very best cases you see charts like that of MA or POT... or CME a few years ago... just going crazy with an almost 45 degree long term upslope. Not all LT bull markets are so consistent. Alternative energy and solar stocks in particular are in a LT bull market but are also very volatile and require care and profit taking... however... that being said if you had bought one of my favorite solar stocks (CSIQ) only a few months ago you would have seen it double... this tends to happen in stocks that are growing earnings at enormous clips... A number of posts over time will fall into this category... in fact I'm working on an important one right now... but I won't publish it until I've gathered a bit more information...
Note: the ones below are in no particular order of importance... it depends on the situation...
2. Top Picks- Stocks of great companies, with stellar management.
William Danoff, the brilliant manager of Fidelity Contrafund, has claimed that his "style" in part is to pay up for top companies, as long as they aren't overpriced and the market isn't going to collapse, because great management and great companies produce time and time again. One may have to wait a long time for these companies to get "cheap" so it is worth it to ride the trend because these companies almost always find a way to justify the price... again assuming the prices haven't gotten out of control.
I think this is true to an extent. However, even better are when these great companies go on sale. In a down market or some unique situation sometimes the very best companies go on deep discount. Remember when, because of stock option news, AAPL was trading at $80? Recently because of the Comscore ad clicking issue GOOG went on sale as well. I always keep a list of the top stocks out there (the best of the best that I know of... and I constantly try to update this list) and I check to see if any of these companies go on sale. Sometimes the sale is justified and sometimes it isn't... but whenever a great company goes on sale it is worth investigating.
2. "Stocks of the future"
I am always looking for mostly small cap stocks that have a tremendous business concept that is not yet discovered by the big press and media. There are many such stocks and often only a few will pan out but that's why I make lists and follow these companies carefully and look for the cream of the crop. For example, CMED and SDTH were two stocks that not everybody knew about when I found them (or still knows about) but that I have come to understand and do well with. Also, I bought NUAN ( a very very promising company) in the summer of 06 for 8.50... and sold it late last year for about 18. Some stocks currently on that list are ARAY, CRNT, FEED, and lots of others. It is really important to do you DD on these kinds of companies especially because they tend to be volatile and some will simply not pan out.
3. Value stocks... fundamental plays...
Sometimes excellent companies go on deep sale. Sometimes this is due to sector rotation (I remember in the October of 06 that sector rotation moved money out of the oil stocks. I was able to snap up COP for under 60 when only a few months earlier it was over 80.) . Sometimes this occurs because the good stocks get thrown in with the bad, or because people give up on a company (blood in the streets). As long as these stocks have no chance of going bankrupt and do not have some fundamental problem the downside can be very limited and the upside enormous. Generally these stocks are out of favor and require patience. To use my COP example again I had to wait until the summer of 07... but was then able to unload my shares for almost 90... so you can see that these stocks can be worth the wait.
It really helps to understand fundamental analysis when it comes to this. I started with the markets first looking at fundies. This did very well in the last bull market but in this environment I knew I had to complement the fundamentals with technicals... and have studied that much more recently by buying books, reading blogs, looking at investopedia.com, etc...
Both are important. Fundamental understanding helps to identify companies that are undervalued. After all... what is the underlying value of a company? Intrinsically it is the total cash flow that a company is expected to generate in its entirety minus the competition for investing dollars with other companies that have a similar risk profile. At its core a Discounted Cash Flow, or DCF, calculation tells you what a company is worth. A great site to calculate DCF figures is here.
The difficulty with DCF calculations is that it uses estimates of future growth up to ten years out... and these are sometimes or often difficult to estimate ahead of time... so often PEG ratios are used. PEG ratios show how much the company is worth relative to earnings..... P/E ratio... then compares this to the estimated 5 year growth rate. Again this is a shorthand of the DCF essentially... and looks to gauge what the price of a company is relative to how much it is expected to grow earnings. It is very important to at least have a basic understanding of P/E ratios, PEG ratios, Operating Cash flow, current ratios, ROE, debt/equity etc... as these are ultimately used to provide a guide for where stocks are going long term and which ones are cheap and which ones are expensive. Generally stocks with a PEG under 1 are cheap... but it depends on the company and on the historical P/E ratios for a company and an industry. If you are not familiar with these terms I would suggest you go to investopedia.com and/or get your hands on some reading that explains this stuff. The point is this: just like with technicals the big fund managers and the guys who are really winning at the market know this stuff!... so you are at a disadvantage if you don't at least understand the basics and what it means... If you have any questions on this feel free... Im not an expert but this is certainly an area of strength.
One more good website is www.grahaminvestor.com.
Just to put the value of all this in perspective the value approach is a major way people like Buffett pick stocks. Using a DCF calculation and PEG ratio I found that COP was worth at least 80 a share at that time and had I PEG around .5 or so at the time... so this definitely helped me with this pick...
4. Trend plays and technical analysis
On the opposite spectrum are technical plays. As I mentioned on the post It pays to be Trendy finding strong trends and piggybacking with tight stops can be very profitable. Using reversing RSI on oversold or overbought stocks is a great way to screen for stocks for nice trades. So are looking at stocks that have broken above or below the 200 or 50 or other supp/res and fail... so are looking for certain triangle patterns, consolidation moves (like POT was clearly consolidating in the low 200s... making it a great buy when the fundamental confirmation was added in)... Generally for technical plays I like to have several points of confirmation before getting in. At least two technical indicators and/or fundamental confirmation of technical signals is necessary. That is my approach but others may have theirs...
5. Historical data plays
This is a broad field but here I am talking specifically about short term cash boosters. For example, stocks of strong companies like AAPL or RIMM often move upwards before earnings. If you don't have time or don't want to take a risk on actual earnings it may be worth it to get in on the long or short side of companies before the CC based on the history before the CC and then get out before the actual release. This is a trade but can create nice gains. I always recommend using stops in case the market or pre-announcements affect the stock in an unusual manner.
Another way to make some cash is to take advantage of window dressing, a practice in which big mutuals buy top performing stocks like MA towards the end of the quarter so that they can report having these companies on their books... even if they haven' had them most of the quarter. It is important to see if a stock has tended to go up towards the end of the 3, 6, 9, and 12 months of the year to see if this play makes sense. Again this is a trade and get out with profits or define narrow stops if it goes against. There are many more of these types of plays like playing GAPs and I won't get into them here but these can provide nice supplemental income... and some can make a lot on these... whenever I see something I add it to my list.
For example, CMED had most often gone up leading into earnings because they usually beat earnings. In Feb, though they beat earnings again in the winter quarter, the stock had gone from 40 to 57 leading into earnings, it was a bear market, there was some concern about HIFI, the company was misunderstood, and the stock just got crushed after earnings. For the first timin recent times the stock this quarter went down before earnings... which makes me think that the computers and trend traders were smelling blood... Those who knew nothing about CMED fundamentally but bought in a week or two before earnings last quarter and sold before earnings and/or shorted before earnings this quarter (but didn't hold on for the release!) would have done very nicely...
Something to keep in mind... and also a reason I felt the stock might be oversold and have a nice pop for those who understood the company and held through earnings...
There are many many other ways to play the markets. The more confirmation signals converge generally the better. I am always adding to these ideas as see them.
One more important idea: always try to learn from your past, especially from mistakes. To say it correctly (unlike Bush)...
Fool You Once... shame on me.
Fool You Twice... shame on you.
I hope that this post is helpful. Please ask questions or comment if you would like...
Best,
Jon
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