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A
Good Reason Not To Place a Trade |
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We
almost
had a new stock pick for you today. The reason we don't,
however,
is a discussion easily worth more to you than a single successful
trade.
 There's
an old Wall Street adage ... 'timing is everything'. Though the
cliche isn't 100% true, it's true enough that it should make any investor
think twice before blindly jumping on board their next big 'undervalued'
find. Timing may not be everything, but it's a big thing.
With that as
a backdrop, the current market scenario is the perfect venue to give our
readers a glimpse into the mindset of the editorial staff at the Micro
Cap Press.
To give credit
where credit is due, we have to acknowledge Bill O'Neil's insight
on the matter of choosing not to fight an uphill battle. He wrote the book
(several of them actually) on investing....what works, what doesn't,
and how to take a disciplined approach.
We're not going
to review the whole book. We would like to point out one of his foundational
realities though. In simplest terms, 3 out of 4 stocks move in the same
direction as the market's trend.
The point is
simple enough....if you're going long in a bear market, you're fighting
the odds. You may well own the 1 in 4 stocks that manages to make a
gain. Even then though, with all the tidal forces working against you,
how
big can those gains be? Probably not all that tremendous.
So are we
saying we'd never suggest a bullish trade in a bearish environment?
Nope. We have, can, and will do so again in the future. However, we're
(1) careful, and (2) realistic when we do it. And, if we do end up taking
on long exposure in a tough environment, yes, we really do think
that stock is one of the ones apt to go higher despite the odds. For that
to happen though, let's face it - all the proverbial planets have to line
up just the right way...the technicals, the fundamentals, and investors'
opinion of both.
Perhaps an illustration
of the concept is in order.
Good Companies
Don't Necessarily Mean Good Stocks
 Let's
use Aqua
America (NYSE: WTR) as an example of why you can't always rely
on good fundamental data to spot a good investment.
In early 2006,
Aqua America had earned 72 cents per share on a trailing twelve month basis
(the sum of the prior four reported quarters). At the time, shares were
worth as $29.
In the first
quarter of 2008, the trailing-twelve month earnings rate was once again
72 cents per share. Yet, shares traded as low as $14.46 with results identical
to 2006's.
A stock is
worth half of what it was two years earlier, when the company's results
are exactly the same? So much for faith in fundamentals.
Is Aqua America
an extreme case? Yes, but it's not an unusual case - these kinds of disparities
are everywhere if you do a little digging.
Remember, you
only make money if your stocks go up - you're not just buying into
a company's performance. So no, earnings aren't everything.
Charts Tell
You When To Buy or Sell
In the same
line of thinking as 'good companies don't necessarily mean good stocks',
we'll round out the discussion by saying for most stocks, strong
corporate results will eventually be reflected in the stock's price.
The question is, when?
This is where
chart-reading comes into play. We've found stock charts can be pretty darn
predictive of points in time when a stock's finally getting some deserved
traction.
 Take
a look at Western
Digital (NYSE: WDC) to see what we mean. Between 2004 and 2006,
earnings steadily rose, but there was nothing steady about the stock....we
saw a lot of wild swings.
You could have
just bought and held for the entire duration of the chart. After all, earnings
were rising the entire time. If you had, you'd be 'in' at $8.40, and 'out'
at $17.61....the left-most and right-most ends of the charts. That
would translate into a nice gain of 109%.
Or, you
could only trade the MACD signals for Western Digital....the crosses of
the two lines on the lowest indicator on the graph (circled). The entries
and exits on the price chart are marked with up and down arrows (respectively).
Using this strategy,
you would have been in at $8.01, then out at $14.28, for a 78% gain. Then,
you would have gotten in again at $14.75, and then back out at $22.51 for
a 52% win. The sum of the gain on those two trades would have been 130%....and
you wouldn't have had to tie up precious capital for the entire two year
span.
Both returns
would have been good, but an extra 21% over a two-year period, when
repeated over and over again, can really add up.
The point is,
there were two periods for WDC where a strong-performing company didn't
translate into a strong-performing stock. You didn't need to waste time
being in a trade during those periods. (And yes, we know what you're
thinking....what about taxes? Over time, being in or out at the right time
can still be more fruitful to your bottom line, even with taxes.)
With the brief
- and hopefully clear - glimpse into our line of thinking, we can
now come full circle...
We didn't want
to pull the trigger on the trade today for two key reasons:
The first
is, we just weren't crazy about the way everything was lining up. The fundamentals
look reasonably healthy, and the chart looks like it could soon materialize
into something technically attractive. However, we just want to wait for
a lower-risk and higher-payoff situation.
The second
reason? If your stocks feel like they're spinning their wheels right
now, it has a lot to do with the fact that the market is doing just that.
Remember, 3 out of 4 stocks follow the market's lead, which includes
non-movement. So, it may be tough - though not impossible -
to find a really compelling chart in this environment.
The bigger message
is also a lesson you should be remember before you pick your next stock...there's
more to successful trading than just finding a great company. That's
still
a good start though.
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Updated: 3:10 pm PST (23:10 GMT), November 20, 2008
