Care Less to Make More
Stockscores.com Perspectives for the week ending April 17, 2005
In this week's issue:
Hear Stockscores Founder Tyler Bollhorn on the "Talk to the Experts" radio show, CHQR 770 - Calgary on Saturday, April 23 at 5:00 pm MT (7:00 pm ET). For those not in the Calgary area, listen over the web by clicking on Listen Live
To be a successful investor or trader, you need to take your emotions out of your decision making. With emotion, you will see what you want to see, think what you want to think. Since most of us want stocks to go higher, we tend to see only the signs that a stock is likely to go up. However, since stocks do not always go up, the emotional investor will only make money in a bull market. Here are ways to take emotion out of your decision making.
Write Down Your Strategies
After we have been investing and trading for some time, most of us have a set of criteria that we look for in an opportunity. I teach many different Strategies in the StockSchool courses, and all have a set of rules. However, what is more important than understanding the rules is to actually write them down and methodically check off each rule when considering a stock.
It is too easy to get emotional at the point of entry in a stock and, thus, forget one or more of your rules. By having a check list and taking the time to use it, you can remind your self of all of the rules and avoid breaking the rules because of an emotional cloud over your judgement.
Establish Stop Loss Prices
You will never be right all of the time. When considering any trade or investment, set a stop loss point that you will stick to if the market proves you wrong. It is important that this stop loss point be set at the appropriate place; you want it to be where the market has proven that your decision was incorrect rather than base it on an arbitrary percentage or dollar loss value. More importantly, have the discipline to get out when the stock gets there.
Define Your Exit Strategy
Just as you should have a set of rules for entering a position, you should also have a set of rules for exiting a system. Write down the rules, and when you think there is an exit signal, go through your sell strategy check list and check off the criteria. Most of us sell because it feels good or because we fear our profits are going to disappear. Make sure that you are selling because the market is telling you that the stock is likely to go against your position, rather than for emotional reasons.
Don't Believe
There are so many biased sources of information about stocks that you should never trust anything you hear. The more you learn about a company and what they do, the more likely you are to fall in love with the company. Love is blind so strive to be a cold hearted emotionless vacuum and you will make better decisions.
Take Less Risk
If you care about the position too much, you will get emotional. Establish for yourself what amount of money causes you to start to care too much. Limit the risk exposure on a any one trade at that limit, because if you worry to much about the potential for loss, you will be much more likely to make an emotional decision. The best investors and traders are those who don't care about the money.
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The most important factor affecting stock price is information. As information about the earnings potential of a company is made public, prices move to reflect the new knowledge. Often, stocks move in advance of the public release of information because there are market participants who have access to the information early. In other words, the process of information dissemination is gradual and not always fair.
Fortunately, this process often shows up in market activity. If significant new information is available, those with access to that information at an early stage may buy or sell in the market. In doing so, they can cause abnormal market activity.
Mathematically, we can define what a normal price move for a stock is based on its past trading history. A stock like Microsoft may move up or down 3% on average in a day. A smaller, more speculative stock may have a greater range of price movement. Based on their specific trading history, it is possible to extrapolate an expected range of price movement for the next trading session. If that stock moves outside of that range, it is deemed to have made an abnormal price change.
We can apply the same reasoning to the quantity of stock traded on a particular day as well. If a stock trades far beyond the average number of shares that it has traded historically then, statistically, it has traded an abnormal number of shares. Identifying stocks that make statistically significant abnormal price movements while trading an abnormal quantity of shares provides clues that the stock is trading on significant new information. That information may have been made public, market participants may be making an educated guess on future information, or privileged market participants are trading on private information. In certain situations, stocks that behave abnormally are often telegraphing future price trends.
Identifying stocks that have made statistically significant abnormal price losses is an excellent way to find stocks that may continue into down trends. However, using only this filter is insufficient as you will simply find too many candidates and a success rate for finding winners that is too low.
Recognizing that price volatility defines uncertainty, we also want to focus on stocks that have recently been in a period of low volatility, relative to the past trading history of the stock. Market participants are confident about the value of a company that shows little volatility. In other words, the market is confident about the price it has given to all available information. Therefore, if a stock breaks from this period of low volatility with an abnormal loss, we hypothesize that the move was motivated by new information. This new information will take the stock lower as more people learn about it. If the stock makes this abnormal break out of a period of low volatility with strong volume support, we have even more evidence that there is new information causing some investors to get excited.
The concept of support is very important to this strategy. When looking at a stock chart, it is relatively easy to see that there are price floors that seem to prevent a stock from moving lower. This line of support is really just a boundary below which the market is unwilling to sell. Based on all the information that the market has about a company, the market is unwilling to sell for less than the support more than the resistance price. If a stock breaks below support, it may imply that there is new information that makes the company worth less, and therefore, the market is prepared to sell at a lower price.
Therefore, the logic of this strategy is as follows. Identify stocks that are behaving abnormally to the downside and trading abnormal amounts of volume because that is an indication that there is something negative happening. If the stock is moving from a period of low volatility, we can assume that the market was confident about the valuation it has given the stock. Further evidence of new information is found if the stock breaks from this period of low volatility and below a line of support to prices beyond which the market was previously unwilling to sell. Use these criteria to find good short selling opportunities.
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1. DSPG
Rising Wedge patterns demonstrate a weakening of buyer enthusiasm. A break down from the tip of a Rising Wedge is often a good indication that investors are changing their mind about a stock, and profit taking is likely. DSPG broke down from a rising wedge pattern on Friday at the top of a lengthy up trend. It looks like the optimism may be turning on this stock, making it a likely to head lower provided that the stock does not move back above resistance at $26.50.
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2. MIK
The long term upward trend line has been broken on MIK with a very abnormal move to the downside. With upward momentum still there, we may see MIK bounce back in the short term, but the chart pattern indicates that a longer term trend reversal is quite possible and this stock is likely to be lower looking out weeks and months. Resistance is at $37, consider this idea wrong if the stock is able to come back and close above that price ceiling.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
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Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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