Perceptions Come First
Stockscores.com Perspectives for the week ending May 5, 2006
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In this week's issue:
What moves stock price? Information filtered by the psychology of the market defines the market's perception of a company's fundamentals. It is the perception of fundamentals that determines stock price, and it is changes in the perception that leads to changes in price.
There are many investors and market experts who base investment decisions on fundamentals alone. They apply scientific analysis to the financial reality of a company's business to arrive at the value of their stock. If this logical value of the stock is higher than the price the stock trades at, the stock is deemed worthy of purchase.
This analysis process leaves little room for the artful interpretation of value. Fundamental analysis is either black or white, leaving little room for the color of reality.
What make the financial markets colorful are the characters, motives and moods that taint the process of logical deduction. A stock whose fundamental value is $20 may only trade at $10 because a large investor has lots of stock to sell, a group of short sellers may have the stock gripped in fear, or investors may simply not like the color of the story.
There is an art to predicting stock price change.
It is not enough to know what the fundamentals will be tomorrow, it is also important to know how the market will judge those fundamentals. It seems obvious that a company announcing positive news will go up in price, yet we as investors have often seen the opposite happen.
Investors will judge fundamentals not only on their merit, but also on how they relate to expectations. Sometimes, fundamental change will be ignored in favor of more pressing macro economic issues.
Suppose you are told that a mining company will announce the discovery of a significant gold discovery in two days. In anticipation of news, and based on your privileged information, you buy the stock. You are excited by the prospect of what will be easy money, to materialize when the news is made public.
Two days later, the news is announced and you watch the stock with excited anticipation. But instead of jumping higher and higher, it goes up for a couple of minutes, and then suddenly begins a free fall lower. Your expectation of quick and easy profit quickly and easily turns to loss.
You can not understand why, it seems to make no logical sense.
Here are some of the colorful smears on your black and white dreams:
1. The stock market is not fair. The inside information that you received two days before the news was obtained by others weeks earlier, and the stock already priced in its value. Your stock has been going up in anticipation of news for some time.
2. Expectations rarely live up to reality. Investors have a wonderful imagination, and the visions of those who were buying the stock in anticipation of the news pushed the stock beyond what the news was worth.
3. Without a reason to own, investors will sell. Many short term investors bought this stock in anticipation of news. When the news came out, so went the reason for owning the stock. Investors who buy in anticipation of news often sell when it is released.
4. The exit door is only so big. When a stock starts to do what investors don't expect it to do, investors panic and all try to get out at once. This creates emotional selling that has no regard for fundamentals.
5. The tipster has motives different than yours. Believe it or not, the only person who cares about your money is you. Whoever gave you the "inside" information is only concerned about their money, and probably encouraged you to buy the stock because they already had.
6. Every stock correlates to the market. If the market is going down and pessimistic, buying a stock is like trying to paddle up stream. Some can succeed, but most eventually go with the flow.
Do not ever judge a stock through scientific analysis of fundamentals alone. You must always ask, what does the market think? How will the market judge this company? What effect will the mood of the market have on the perception of fundamentals?
Fundamentals don't matter, only the perception of fundamentals is important.
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Swing trading is a short term style of trading that typically has a hold period of 3 - 7 days. Once of my favorite swing trade strategy is the Pullback Play where we buy strong stocks that have been showing weakness. When there is a reversal signal of the short term downward trend we enter with anticipation of a bounce back over the following week. By looking for stocks that have been in a strong upward trend but have suffered over the past 3 to 5 days, we can often acquire a stock that is "on sale" and ready to bounce back.Back To Top
1. T.NWI
T.NWI made a quick run up last week and then went it to pull back mode this week. After three down days in a row the stock closed above its open and up for the day, making a flag pattern breakout. It looks like the uptrend may continue, provided support at $0.33 can hold up.
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2. T.CVI.A
T.CVI.A has been in a strong upward trend for about five months but saw three days of profit taking, likely because oil prices were backing up as well. The stock has pulled back to its upward trend line and closed above its open, so it should be able to make a few up days in the short term. Support at $8.10 needs to hold up.
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References
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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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