How Much Are You Willing to Pay to be Right?
Stockscores.com Perspectives for the week ending February 13, 2005
In this week's issue:
Trying to be right in the stock market can be expensive. Men are the worst offenders of egotistical investing, it seems their inability to ask for driving directions transfers to the stock market. They fail to yield to what the market tells them to do, choosing instead to merge with their intellectual side. Certain that they have the fundamentals figured out, they trade with little regard for the direction that the markets give.
All traders should ask themselves, would you rather be right, or make money? All but the most silver spooned trust fund kids will agree that it is best to make money in the market and oppose the need for intellectual stimulation. Yet, I meet so many investors who take the high road and try to be right when the market proves them wrong each month upon the arrival of their brokerage account statement.
Remember that the stock market is a great forum for debate where those with enough money to buy an opinion cast their vote on the value of companies. Those who think the company is worth more than the trading price of the stock are inclined to buy, those who think the stock is worth less sell. Every market transaction has a buyer and a seller, and one of them is always wrong.
Every known, minute detail of the company's business is factored in to price through this process of monetary argument. The resulting price is not a matter of rational deduction of the facts, but rather, the perception of those facts by the crowd.
Do not ever try to assert that the market is wrong, for when it is wrong, it is right. You may be right in your assertion of facts, but in arguing with the market, you make a very wrong move. The market is always right because it represents the collective opinion and you can only successfully argue with the crowd when the collective appears poised to change its view.
Value investors were correct when they argued that the astronomical prices of technology stocks in the late 1990's made no sense. For three years, they argued with the market while many of these stocks enjoyed exponential returns. Did they enjoy being right? Did they enjoy watching their irrational investing counterparts make millions on foolish notions of stock value?
It is dangerous to have an opinion that is too far ahead of the market's collective mindset. The best investor is the one who can figure out what the next movement of the crowd will be. If you think too many steps ahead, you are doomed to be poor but respected for your foresight.
Timing is everything.
Do not apply logic to the market. Instead, look at the movement of the crowd and focus on signs of what its next move will be. If the buyers are in control, look for signs that they are losing control so you can go short. Until then, buy. When the sellers take the wheel of the market machine, enjoy the ride from the short side, cognizant that eventually the crowd will stop and ask for directions, and reverse direction to find its way out of irrationality. Of course, as someone who watches the crowd with no ego or opinion, you will lead the way.
That is how you can be right, even if you are in the wrong.
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A common theme among Head and Shoulder Bottom, Ascending Triangles, Pennants and Rectangle Consolidation patterns is a break through resistance from low price volatility, usually with volume supporting the breakout. Rising price bottom formations in to the breakout point are common, but what market dynamic do these patterns really represent?
Rising bottoms are a sign of growing optimism among investors. As time passes, they demonstrate a weakening of selling force and increase power among buyers. As a stock moves up toward a resistance price point, the market is faced with the upper limit on what investors believe the company to be worth. We often see that stocks will go in to narrow trading ranges under resistance as investors come to a consensus on the value of the company. When stocks break out from this condition, they may be signaling significant new fundamental information at work in the market since resistance has been broken from strong consensus out of a period of optimism.
The Sentiment Stockscore is useful for finding optimism in the market, and the Signal Stockscore is heavily weighted on the abnormal market activity that comes with breakouts. By looking for stocks that have a Sentiment Stockscore of 60 or higher, and a Signal Stockscore of 80 or higher, we can consider charts that may have a good chart pattern set up. The Stockscores Simple Market Scan adds in some other technical filters to shorten the list of potential candidates further.
This strategy is not solely about finding stocks with good Stockscores. The most important step is visually inspecting the charts to ensure that the chart patterns are what we are looking for. A good chart pattern will have the following characteristics:
A break through resistance
Abnormal activity, in terms of price and volume activity
The break through resistance should be from a period of low price volatility. Low price volatility is characterized by the price range of trading on each day (how tall the trading range is on the chart) and by the range of trading over a number of days (are the trading days side by side on the chart, or is there a price trend?)
A show of optimism leading in to the break through resistance from low price volatility.
It is necessary to have all of these criteria, many traders forget to check whether the stock was trading with low price volatility before the breakout, or to make sure that the stock is truly breaking through resistance and will not encounter more selling pressure soon.
I ran this Market Scan strategy on the Toronto Stock Exchange, and found a couple of very similar chart pattern set ups that look likely to lead in to up trends.
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1. T.CLL
A pennant pattern has been forming on T.CLL over the past four months, but Friday brought a breakout from the low volatility tip of the pennant with very strong volume support. We may see the stock pause at the November highs of about $0.80, but I think it is likely that this stock is entering the second phase of its uptrend. Support is at about $0.60.
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2. T.AUR
T.AUR gapped up Friday, indicating investors are excited about something that the company is doing. The stock is breaking from low volatility and out of a pennant pattern, with very strong volume support. Good potential to go higher in the weeks to come provided it can hold support at $6.25.
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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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