Remember that it’s your principal that counts most—that money you worked so hard and so long to earn. That money you may need in your later years. That money you earmarked for your kids’ education, or a vacation, or a home. This point cannot be overemphasized enough! Don’t let dividend considerations distract you from that thought.
In a similar vein, with interest rates on depositors’ bank deposits and money market funds hovering slightly above the zero mark in recent years, cries of “my bank pays me next to nothing on my money” could be heard throughout the land. Trouble is, some investors were using these seemingly paltry rates as an excuse to invest in higher-yielding opportunities elsewhere. Is that wrong in and of itself? Yes, and I’ll tell you why. Risking your hard-earned capital for no other reason than that you’re unsatisfied with your return is actually the bigger risk. How many folks lost 10 percent, 20 percent, 30 percent, and even more of their capital in a particular stock or other higher-yielding instrument, which proved far riskier than the tiny but still positive sum they were receiving in their bank money market fund? If the market is in the throes of a primary downtrend, you don’t want to empty your funds into that southerly swell no matter what the yield is from your bank money market fund or certificate of deposit (CD). In fact, in a primary bear market downtrend, that’s just where you want to be—in the relative safety of cash.
Remember that capital preservation concerns should always precede capital appreciation considerations in any investment discipline. Why yield considerations often take priority is a serious problem that needs to be addressed. Believe me, there are many investors who wish they hadn’t abandoned the relative safety of their money market funds for other investments only because of their seemingly low rates.
Look at it like this: If you were simply bored and having a blasé day, would you remedy the situation by leaving the safety of your home to undertake a risky, potentially dangerous task that could lead to injury? There’s nothing wrong with taking the “lower-yielding” route in either life or the stock market. Sometimes being sidelined means being safer.
Moral: Low-yielding is always preferable to losing. Your capital and its preservation is consideration number one—always. Besides, if you don’t preserve that capital, you’re not going to have it to invest to receive a yield in the first place! Realize that above-average dividend yields will not automatically insulate you from market losses. And beware: a stock with an unusually high dividend yield that has a visibly weak chart pattern may be an indication that the company’s ability to maintain that payout is in jeopardy.
Chapter 20
Bob Barker
I can’t help but think of Bob Barker, the game show legend, when I hear a stock market discussion centered on a stock’s price. I remember him from his Truth or Consequences television show days, well before his huge Price Is Right success.
As an analyst recommending securities, I’d sometimes be asked if I had anything cheaper to suggest because the price of the stock in question seemed high. You’d think I was selling goods from a cart on a street corner. My response to that unfortunate question is that stocks should be bought or sold based on their potential, not their price. True, psychologically speaking, it seems much more advisable to buy 1,000 shares of a $9 stock than 100 shares of a $90 stock. But what would you rather have: a $90 security that you own that goes up or that $9 stock you have that goes down?
Refusing to consider a stock purchase because of its price should not be part of your investment strategy. By doing this, you may be omitting a potentially large winner from your portfolio. As a kid, I remember not buying a “high-priced” priced stock because I could purchase only a very small quantity, only to see the shares skyrocket thereafter. It was called Teledyne. That experience instantly cured me of that investment affliction. Think of it like this: when you calculate your investment results each year, do you care in the least whether the money you made or lost was in higher or lower-priced shares? C’mon.
Using price as a category to screen for purchase or sale candidates is one that should not be used any more than you would employ zodiac signs, hair color, or height as a reason to date someone. Are these among the vital statistics that lead to choosing a lifelong mate? Why exclude a group of potential winners from either group by using such narrowly based measures? You could be missing out on a real opportunity, especially when it comes to relationships.
Being a technical analyst, I base my analysis of a stock or market on its potential—irrespective of price. In fact, a lower-priced stock may actually have more technical risk than the higher-priced stock based on an analysis of the price graphs. Take a look at a list of seemingly high-priced securities, and you’ll notice that they probably seemed high-priced on many other occasions along their northerly routes. The same applies to stocks that may appear low in price but continue to trend lower. This is particularly true in bear markets where the “cheap get cheaper,” as the saying goes.
Moral: When it comes to buying stocks, the share price isn’t what counts. Don’t use it as a factor when trying to uncover stock market winners, as they come in a variety of “right prices.” It’s hard enough trying to correctly gauge stock price movements without using price as a screening tool. Don’t fall into the psychological trap of low profit expectations based on buying fewer shares of a higher-priced stock. As my own example illustrates, you might just find out how wrong that thinking can be.
Chapter 21
Crowd Control
Legendary market maven Newton Zinder (the man who gave me my big break in the technical analysis world by hiring me at E. F. Hutton & Company in 1982) once remarked that, on Wall Street, “to know what everyone else knows is to know nothing.” This was but one of many brilliant phrases uttered in his long and ultra-distinguished career.
Psychologically speaking, it’s difficult to take and maintain one’s market or stock view in the midst of an ever growing crowd that’s singing a totally opposite market tune. It’s a lonely feeling, no question about it. Nerves of steel are often required, as the news background is probably aligned lopsidedly against you, and your friends and associates are questioning your judgment. In fact, you may even be questioning it yourself. But if your view is backed up by the action of the market itself (which as a technical analyst I believe is the key ingredient) and you have a well-designed risk management plan in place, it doesn’t matter how many voices may disagree with yours because it’s the action of the stock market that speaks the loudest!
A correctly interpreted message from these movements is more powerful than all the so-called expert opinions combined. After all, the consensus view is often wrong at key turning points. Go back and research the opinions of many of these pundits at major market turning points and judge for yourself. On a related note, being an authority on a company or industry doesn’t automatically translate into being correct on their underlying share price direction. Analyzing a company and successfully trading its underlying shares are two different things. Just because you know a car’s every engineering detail doesn’t mean that you’ll make a good test track driver.
At this juncture I need to state that one should never be contrary only for the sake of being contrary. Just because market sentiment is overly bullish or solidly bearish does not, in and of itself, necessitate an opposing view. That’s never an investment strategy. Besides, the consensus market view can be correct for some time. Using sentiment statistics (gauges of bullishness or bearishness among market watchers) on which to base investment decisions is no substitute for analyzing the market’s far more important structural supply-demand credentials. Not even close, in my view. That’s because the former measures what people are saying and thinking about the market, not what they are actually doing with their capital. Gauges that measure the latter are far more useful.
In life, we want our kids to be independent in their thinking and not do something simply because their friends are doing it. We want them to be able to say no. That will req
uire going against the prevailing view in those instances where following in lockstep with the other kids is deemed to be wrong or, worse yet, dangerous. We also wouldn’t want to leave this sensible thinking behind when we delve into stocks.
Moral: Take no comfort in siding with the crowd when investing your hard-earned dollars. While noting that sentiment considerations are used today to varying extents by some market watchers, they shouldn’t be the leading reason on which to base your purchase and sale decisions. Rather, trust the market’s judgment first and foremost. For me, chart analysis and supply-demand gauges are the determining factors in my investment decisions, not the consensus conclusions. Once again we see a non-investment-based, psychological consideration seeping into the investing mix.
Chapter 22
The Macy’s Approach
All too often, and unfortunately so, some market participants search for stock market bargains as if they were shopping in a department store. They scour the “new lows” list in their newspaper in the hope of finding a “sale-priced” stock—a share price trading significantly below its 52-week high, or close to its annual or possibly even multiyear low. Or maybe they use some other metric. When viewed in this context, the shares in question may indeed seem like a bargain, but it’s a dangerous premise. Investing one’s hard-earned capital based on how poorly a stock is acting and where it trades in relation to a specific range is hardly an investment strategy. You’re actually going out of your way to purposely search for underperformers.
This type of thinking is financially dangerous and must be banished from your investment repertoire. How do you think your life would fare if you followed that “bargain basement” approach? Looking to buy a stock simply because it’s on the new lows list is like going out of your way to purchase a house in poor structural condition or a car with mechanical difficulties because you think their respective price markdowns somehow insulate you from further risk. They don’t.
Let’s get something straight: You don’t shop for stocks as you would goods in a department store. They’re completely different things. When you buy a marked-down item in a retail store, you own it, the purchase is final, and it ceases to fluctuate in price. Not so with that poorly acting stock on the new lows list or in a downtrend, which can continue to decline in value (and probably will if a bear market is in progress) long after you buy it. Beware! Those seemingly low-priced “steals” can rob you of your investment capital.
Buying a stock only because you think it’s at a low point is like assuming that a deteriorating relationship that you believe has troughed can’t get any worse. Unfortunately, each can and often does—especially if the main trend in both instances is down. In cases like these, there’s usually no plan to deal with the worsening condition because of the mistaken belief that things have bottomed out and are about to take a turn for the better. When that scenario fails to materialize, it can take an emotional toll.
Searching for equities like they were department store items is a dangerous financial undertaking and certainly not a part of my investment approach. Unlike a discounted department store item, stocks trading near their lows often aren’t the bargains you think they are. If you’re truly convinced that a stock is near its low and have made a decision to purchase it, at least consider a small initial investment. If the shares continue to slide, you’ll be glad you withheld the bulk of the remaining capital, and if they start to act better (from a technical analysis standpoint on the charts), you can always add to the position while employing a risk management discipline.
“Buy low, sell high” are four words I never utter, as some of the most serious market money in primary bull markets is made buying at (what seems like at the time) a high price and selling much higher. The opposite is true in a primary bear market, where what looks cheap can become much, much cheaper. Chances are that you’ll run out of capital to invest in those so-called bargains long before their share quotes bottom.
Moral: You cannot treat your stock market purchases in the same fashion in which you shop for department store goods. They’re totally different. Lower isn’t necessarily better. In fact, the best bull market bargains are often those stocks that are acting well on a technical analysis basis and even rising in price or appearing on the “new highs” list. This analogy fits with our relationship theme of spending more time with individuals who enhance, contribute to, and brighten your life as opposed to those who continually drain your energy.
Chapter 23
Stop It
I’ve never believed that “stop orders” (predetermined prices at which to sell on the downside or buy on the upside) get the respect they deserve. Not only can they offer an important risk management tool as part of a disciplined investment approach, but they can also serve as an early warning indicator of potential trouble ahead. Unfortunately, too few market participants consider using the stop order, which comes in several varieties. Maybe that’s because this tool has a negative connotation since it’s often associated with the term “stop loss order”—where the selling price is below the investor’s purchase price. Maybe it’s because a predetermined loss level isn’t an avenue investors wish to address as soon as they purchase an issue or “sell short”—where the investor, expecting a share price decline, borrows shares to sell through his brokerage firm in the hope of buying them back (referred to as “covering”) at a lower future price and profiting from the difference. Or maybe some consider the discipline as overly stringent. Whatever the reasons, they don’t make a convincing argument. Many years ago I wrote the following words in a Letters to the Editor column in Barron’s.
Technical analysis is the only discipline I know that can help control risk by the correct use of the oft-forgotten stop order—where emphasis is placed on capital preservation, not just capital appreciation. Since the market is a discounting mechanism, the reason for a sharp decline in a stock price often doesn’t surface until after the issue has plummeted. By then, many investors feel (wrongly) that it’s “too late to sell.” Thus, technical analysis has tremendous merit as an early warning signal. Most clients have difficulty understanding (and this is especially true in bear markets) that their companies are performing well fundamentally, yet the underlying stock is doing poorly. But by understanding that poor technical stock performance may be a warning sign of an impending fundamental development the client learns to anticipate changes, not simply follow them.
There are several ways to use the stop order. One is to have a “mental stop,” where you need to be at your computer or mobile device to see your stop price hit, and then enter your order. Another is to have a pre-entered stop order on either all or a portion of one’s position. If you’re not around to continuously monitor your position, that’s an option to consider. Yes, there’s always the possibility that you’ll be relieved of part or all of the position prior to the stock’s reversing course, but in the stock market, as in life, there are no guarantees. Volatility and uncertainty are its trademarks.
In the vast number of cases when placing a stop order below the market, I would not place a “limit” order (the lowest price I would accept once the stop is triggered). Remember, the reason you place a stop order to sell a particular security is to get out of it on the southerly end and take out some or all of your money. Placing a limit raises the possibility that you will not get out of a stock even if your stop price is hit. That’s a potential problem, particularly if you own the bulk of your position as opposed to the last bit you’re trying to dispose of. The risk is simply too great.
As an example, let’s say that you’ve placed a stop order to sell a stock at $25 with a $24.98 downside limit. The shares subsequently hit $25, but the next trade is at $24.95. Since your limit at $24.98 meant that you were not willing to accept anything lower than that once your stop price was hit, you would still own the position even though your stop price was reached. That’s a real potential risk.
One idea I consider when an attractive paper gain is being realized
is to place a stop on a small (10 percent to 15 percent, for example) portion of the position at the highest price that makes sense according to my chart analysis. If triggered, this serves as a reminder to immediately reevaluate the holding and consider placing additional stops on portions of the position at successively lower prices. If the shares act well thereafter and suffered only a near-term setback, I should retain the bulk of the position and can consider raising my stop(s). If not, I’ll continue to lighten the position on weakness and not reward the shares for declining in value, in keeping with our relationship investing theme. What a relief it is, after being stopped out of a position three, four, maybe even five times or more at successively lower prices, to look back and see how much money (and anguish) you’ve saved yourself by not rewarding a stock whose share price is falling. As with a relationship that’s heading south, the goal of this approach is to become increasingly less involved with a steadily deteriorating situation, moving further away the worse it gets.
On the northerly end, remember that when you’re “averaging up” a winning position, it’s psychologically easier to place a stop order since you’re experiencing a “paper gain” (meaning that the position is profitable at the moment but remains unsold). Contrast this to buying shares of a declining issue, watching it fall further in price and then having to place a stop order at a lower quote still, and you can see why that’s not a situation most market participants want to address. Not doing so leaves them potentially vulnerable to an even worse outcome, however.
In our everyday relationships and interactions there are limits and boundaries beyond which we won’t agree to go, whether price-wise or life-wise. It can be when discussing a curfew with our kids, negotiating the terms of an agreement, planning a wedding or vacation, having your in-laws stay with you (that’s a touchy subject)—you name it. These are really our “life stops,” limits that, if violated, necessitate a change in strategy. Stops can also be matched to your particular investment time frame (short, intermediate, longer term, or a combination thereof).
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