10 Simple Things
Stockscores.com Perspectives for the week ending June 3, 2007
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In this week's issue:
Experience has taught that the simple approach is usually the best, it seems to capture the essence of what is important. So, with that in mind, here is a list of the 10 simple things everyone should know about the stock market:
1. Price Trends Are Made of Moves and Counter Moves
A move occurs when the stock moves either up or down for a sustained period of time without a move in the opposite direction. A counter move is a price move in the opposite direction but with less intensity than the original move. Up trends join the bottoms of counter moves and downtrends form the tops of counter moves. Therefore, a trend is a series of upward moves, each followed by a short term downward counter move. The trend line is drawn across the lows of the counter moves, creating an upward sloping line.
2. Irrational Valuations Can Not Last Forever
Stock price is based on the present value of future earnings expectations. That means the company is worth what it can make in the future. The market's job is to figure out what a company can make in the future and discount that value back in to today's dollars and adjust for risk. When stock's price in earnings expectations that are far beyond the company's ability, the market is being irrational. Eventually, irrational behavior is corrected.
3. Irrational Behavior Can Last Longer Than Your Bank Account Can Afford
The market is efficient at pricing stocks but that does not mean it can not make mistakes in the short term. Investor emotion can cause the market to pay too high a price or accept too low a price for a stock and may inspire some investors to trade against this emotion, citing irrational behavior. However, the market has been known to stay irrational for a very long time and in doing so, take the hard earned investment capital of those betting against it. The lesson: don't fight against the market, it is always right.
4. Rising Bottoms Mean the Buyers Are In Control
If you look at a stock chart and see that the lows of the counter moves over time are rising from left to right then the buyers are in control of the market. Your success in buying stocks will be higher when you wait for the buyers to take control.
5. Falling Tops Mean the Sellers Are In Control
If you look at a stock chart and see that the highs of the counter moves over time are falling from left to right then the sellers are in control of the market. Your success in shorting stocks will be higher when you wait for the sellers to take control.
6. Uptrends Start Slowly and End Quickly
Bull markets are founded in skepticism and take time to develop. The upward trend will steepen as more and more investors take a buying interest in a stock. Eventually, too many investors will buy the stock and send it to irrational price levels which may then sharply correct downward.
7. Downtrends Start Quickly and End Slowly
Downtrends tend to start when irrational buying pressure gives way to a correction and the stock falls sharply, very quickly. The intensity of the downward move tends to dissipate over time until the downward trend becomes flat.
8. Trend Reversals Take Time, Exiting a Stock Takes Seconds
Investors are often unwilling to own markets that are acting irrationally, citing the likelihood of a correction is near. While this is true it should always be remembered that exiting a trade takes mere seconds and can be automatically executed with a stop loss order. Trend reversals usually take a few days to begin.
9. Public Information is Useless
There is no free money in the stock market. Companies that announce significant changes in the fundamentals of their business will see their stock price move almost immediately to reflect that new information. Using information that is already well disseminated will only produce random results.
10. Abnormal Activity Indicates Something Out of the Ordinary is Happening
To beat the market requires you trade on information that is not already well disseminated. This can be achieved with in depth research or inside knowledge. Within every company there are some people with this kind of information and they act in the market, leaving a trail to follow. New information is often highlighted by abnormal trading activity
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I strongly believe that the stock market is not fair. There are people that know more about a company than the general public and some of them act on their better information to make risk free profits. Trading on private information is common and when it happens on a large scale, it creates abnormal trading activity. The Stockscores Market Scan has special filters to find this abnormal activity so that you can find good trading opportunities.
I did a Google search for large stock mergers in 2007 so that I could find a list of deals or potential deals where the stock made a large one day gain on the announcement of the deal. I then applied the abnormal activity algorithm that we use on Stockscores to the price and volume history of these stocks to see if there was abnormal trading activity before the news came out that indicated some people may have been trading on the news before it was public. Consider:
Rupert Murdoch's bid for Dow Jones (DJ) on May 1. On April 17th the stock traded with an abnormal price gain and abnormal volume. From the close on April 17th to the close on May 1, the stock gained 55%.
AstraZeneca makes a friendly offer for Medimmune (MEDI) on April 23 but the stock showed statistically significant abnormal price and volume behavior on April 12. The gain from the 12th to the 23rd was 30%.
A Private Equity Group bids for SLM Corp (SLM on April 16 but the market seemed to know about it on April 13 because the stock traded very abnormal price and volume on that day, giving a clue that the stock could trade higher. On April 16th, the stock gained 18%.
So, how do we find these sort of deals before they happen? I did a Stockscores Market Scan on Friday to find stocks that were up abnormally with abnormal volume. I then went through the charts of these stocks to see which had decent chart patterns (The Understanding Chart Patterns video on Stockscores will teach you what to look for, go to the Online Video Training area of Stockscores.com for information).
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1. PRST
PRST is breaking from a rising bottom consolidation today with abnormal volume supporting the price break. The stock was also abnormal about two weeks ago so this is the second jump which makes it a bit more risky. Support at $6.55.
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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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