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Stockscores.com Perspectives
For the week ending January 17, 2004
In this week's issue:
If a tree falls in the forest, and there is no one there to hear it, does it make a sound? If you share my philosophy on the stock market, your answer will be an obvious no. What do gravity and trees have to do with investing? Let me explain.
The most common approach to identifying stock market opportunities is fundamental analysis. By analyzing the company's business and industry, the fundamental analyst can calculate the value of the company. If this calculated value is less than the value given to it by the stock market, the stock deserves purchase. The idea is, eventually, the market will figure out that the stock deserves to be higher and make it so, creating a profitable investment for the fundamental stock picker.
Alternatively, the fundamental analyst will compare statistics of companies in the same industry. If the average price/earnings ratio (PE Ratio) for large oil companies is 10, then those with lower PE Ratios should be bought, and those with higher PE Ratios should be sold. This same approach can be applied using a multitude of calculations from the company income statement or balance sheet.
While all this makes good sense to the analytical mind, I have always wondered why so much in the stock market does not make sense when viewed under the fundamentalist microscope. Why does Yahoo (YHOO) trade at a PE ratio of 165.8? Why does book seller Amazon (AMZN) have a market capitalization of over 22 billion dollars when they can't even make a profit? Why do hundreds of photographers, reports and fans drive and wait for hours to see Michael Jackson walk in to a courtroom? Admittedly, I am not the smartest guy on the planet, but am I missing something?
The truth is, fundamentals are not the most important factor in determining share value. What matters more than anything when determining if a stock will go up or not is whether invstors are willing to pay more for the shares. We are destined to fail in the stock market if we think that fundamentals are the soul motivation for opening our wallet. Fundamentals certainly contribute to our view of the stock market, but our perceptions of fundamentals are often swayed by our emotions.
If no one is in the forest when the tree falls, it makes no sound. If CNN, NBC, ABC, CBS, BBC, CBC and 1500 passionate tree huggers are there to witness the crackling of a falling tree, the tree makes a sound heard around the world. Similarly, fundamentals only matter if we as investors care about them.
I am proponent of technical analysis because I believe that it is the perception of fundamentals that matter, not the fundamentals themselves. How we as investors judge information is based on our state of mind. The behaviour of a crowd can cause some unexplainable perceptions of reality.
Many investors are more motivated to buy a stock because it is going up than because they like the company's business. That is why there is a tendency for volumes to increase dramatically when stocks move in sharp up trends. Like the bargain table at Wal Mart, crowds bring in more crowds of curious onlookers. Greed captures the dreams of the onlooker, and sucks them in to ownership at prices that don't make sense. Fundamentally speaking of course.
The madness of crowds does cause the market to make mistakes in pricing stocks. Eventually, perceptions change, and over time, I believe that stocks regress to their fundamental value. Does that mean that we should not take advantage of the rise and fall of the market through the process? It is a simple fact that any fundamental analyst can understand; it is easier to make a profit on a lousy company whose stock goes from $1 to $10 than a good company that goes from $5 to $3.
When considering a stock for purchase, you must first ask if the market is listening to the company with a favorable ear. If investors like the story, and are optimistic about the company, then any positive fundamental change will be rewarded with higher prices. Otherwise, the company is a lonely tree destined to fall.Back To Top
I usually use this portion of the newsletter to feature stocks that I think have a good potential to go higher or lower. However, stock picking is only part of the formula for a winning approach to stock trading. Knowing when to sell, and how to manage risk are other key components, so this week I will provide a lesson on how to know when to take a loss.
I will use recent picks that I have made from the Stockscores Feature Stock that appears on the Stockscores.com and Stockhouse.ca web sites as examples. The basic idea is that we should sell stocks when they go below support. If that means selling the stock at a loss, then it is essential that we do so. The reason is simple; stocks that go through support have a higher probability of going lower.
Support is most easily identified as the floor price of recent trading activity. If you imagine a horizontal bar being pushed up against the stock chart's recent trading activity, where would it get stuck? Here are some examples.Back To Top
1. V.BPN
I picked this stock on Novemner 12 at $0.58. At the time, the stock had support at about $0.40. The breakout from the previous trading range was a good indication of a future upward trend, and remained valid as a buy signal so long as the stock stayed above that support price. If V.BPN had fallen back through $0.40, I would take the loss and move on. Fortunately, the stock continued higher and never triggered the stop loss.
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2. CSAR
On November 8, I featured CSAR as the Stockscores Feature Stock. It had a Sentiment Stockscore higher than 60, and a Signal Stockscore greater than 80. It was also breaking from a good chart pattern with support at $9. That $9 support level became the stop loss point, which again, was not triggered as the stock went higher. Had the stock pulled back to $9, a small loss would have been taken.
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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.
Scan the market using extensive filter criteria.
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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