Why Be Normal?
Stockscores.com Perspectives for the week ending October 29, 2006
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In this week's issue:
In life, if you want to be successful, you have to avoid being average. The same holds true in the stock market. If your performance fits in to the largest group of investors, you are average. All forces acting in the stock market are pushing you toward being average and the only way to break out of mediocrity is to do things that are very not average. They key is to focus on being abnormal.
You have to be abnormal in many ways. When I talk to a group of average investors about ways to avoid being average, I often ask if the members of my audience consider themselves normal. Do you like to make money? Normal people do. Do you like to avoid losing money? Normal people do. And that is precisely why most people are predisposed to fail in the stock market.
Because they are average.
Stocks can be average too. 95% of the time, stocks will trade in an average way and provide average returns. Average people buying average stocks will achieve average results. That means earning what the market earns which has averaged out to be about 7% a year.
Average is not bad, but it is not better than your average friends or co-workers. Bragging rights, the ability to say that you beat the market, requires that you beat the market. Do better than the crowd.
To do this you have to focus on abnormal stocks and think in abnormal ways. When the crowd is buying with great excitement, you need to think about selling. When the sellers are gripped with fear and throwing their shares to the market, you have to be buying. When the above average investors are buying or selling, you have to be doing the same.
Let's get specific now. Most stocks most of the time trade with the same price volatility as they have averaged over their recent past. The best opportunities to make money in stocks come when they trade with very abnormal price volatility. Most abnormal money making upward trends start with abnormal price behavior.
So too goes volume. Opportunities appear where there is abnormal volume accompanying abnormal price volatility. The smart money accumulates stocks before the masses do. The smart money sells to the masses at higher prices. Do you want to be the part of the crowd left holding the bag?
Being abnormal must go beyond how you identify and assess investing opportunities. You also have to think differently, you have to reverse your emotional attachments to money. The best investors are those who do not care about losing. The best investors are those who do not let greed play a role in their decision making.
Consider the chart below. Where did the up trend in this stock start? If you answered, March 15 then you have picked the correct day. Now, was the stock trading normally on the day the up trend started?
You should notice that the price action was abnormal and volume was higher than normal. The abnormal activity combined with the good chart pattern telegraphed the future upward trend. Notice that the Sentiment Stockscore was above 60 and the Signal Stockscore was above 80 at the start of the upward trend as well.
This chart is no different from the chart of most stocks that beat the market. Most start with abnormal behavior. But buying them on that first day of the trend requires that you think ahead of the crowd. Selling the stock near the top, when the speculative hype is at its height, requires you go against the belief of the crowd.
The Stockscores Approach focuses on abnormal behavior. The largest component of the Stocskcores indicators relates to abnormal price and volume activity. We want to identify stocks that are standing out from the crowd and trading on new information that the masses don't yet now. Abnormal market behavior is the key.
When making a decision to buy or sell, ask yourself a simple question. "What is the crowd doing and I am going to do the same thing?" If you hope to consistently beat the stock market, you want the answer to be a no. Say no to being average.
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Bottom fishing is the quest for stocks that are inexpensive relative to previous levels, but show signs that the bargain is going to end soon. We want to look for stocks that are a showing a break from pessimism, an increased level of confidence that the stock is undervalued, and signs of optimism for the future. Filtering for these situations gives the investor a short list of companies to perform their necessary due diligence on before speculating on a change in trend.
Buying a stock that is in a long standing down trend can be as dangerous as stepping in front of a freight train. It takes time for stocks to reverse trends, and buying what seems to be a bargain can be a crush to your portfolio. However, bargain hunting can be profitable if the timing is right. To effectively bottom fish beat-up stocks, you have to enter when there are signs that the downslide is slowing and a move back upward is imminent.
Market psychology takes time to reverse. When bottom fishing, we want to focus on stocks that have suffered a sell off and are cheap relative to where they once were. However, we want to also look for signs that market psychology is turning favorable on these stocks and that they are ready to head higher again.
This strategy focuses on three stages:
Stage 1 - a break from the show of pessimism
Stage 2 - a show of confidence
Stage 3 - a show of optimism
Stage 1 is essentially a breaking of the downtrend. If we draw a line along the top of the declining trend, we have defined the downtrend. A break of the trend arises when the stock can break upward and through that declining trend.
In Stage 2, we want to see signs that there is confidence in the break from pessimism. The market needs to show resilience that the downtrend is indeed slowing, and that the potential for an up trend is real. A consolidation following the break is a good show of this, and is more significant if it as at a level higher than the previous low. This is a rising bottom.
Finally, we want to find signs that there is optimism about the future of the stock. A breakout from a rising bottom is Stage 3.
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1. T.IVW
T.IVW is breaking to the upside from a rising bottom pattern to complete stage three of the reversal process. The downward trend line was broken earlier in October and it looks like investors have started to accumulate the stock. I think this stock can get to the next level of important resistance at $2.25 pretty easily provided support at $1.29 holds up.
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2. PNR
PNR broke its downward trend line around the middle of October and then went in to a sideways price consolidation that formed the rising bottom that we look for as a show of optimism. The stock made an abnormal break from that consolidation on Friday making me think that the mood of investors is changing on this stock. Support at $29.70 has to hold up for this stock to remain worth considering.
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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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