A Couple of Good Trades

Even before the market followed-through on March 20th to begin the most recent rally, my screens began returning a half-dozen or more oil stocks every night. The screens worked well, they spotted the strongest group and I didn't act on it.

As I've mentioned, I listened to all of Bill O'Neil's radio interviews on TFNN. One thing he stressed over and over was that the biggest winners tended to be companies which have IPO'd within the last eight years. Most of the oil companies coming up on my screen were 'stodgy' older companies that had been plodding along for years.

However, like the recent fertilizer boom, I could have recognized that the 'N' in CAN SLIM - the 'New' - was the incredible market forces moving oil prices higher. This was great for the group but another reason I avoided it - I don't understand commodities and try to leave alone stocks that trade off the dollar, inflation, or other similar factors.

I'm not sure I was wrong in this. There are a reasonable number of good opportunities in the market. If I really don't have a 'feel' for a particular sector of the market, I don't see much harm in avoiding it. I've been communicating via email with a reader of my blog who's been very successful using the CAN SLIM system, and he filters out all commodity stocks so they don't even show up in his screens. If he doesn't feel he can understand the business to some extent, he doesn't want to own it. I don't think anyone can argue with this approach - perhaps feeling some level of confidence in a stock is part of the intangibles that go into making one a successful trader.

I'll add that I also thought the oil sector looked extended, and many of the stocks that were breaking out of this group were doing so on poor volume. In a new rally after a large correction, I was looking for new leadership. To see the same old energy group moving up further in low volume looked like a red flag to me.

I did see (CLR) take off and in early April I bought a bit of (SD) as it looked similar. It didn't do much for me and I stopped out even before it took off recently. My experience trying to find the second best stock in a group has not done well recently - I've stopped out on: (PWRD) - the leader is (SOHU); (GU) - the leader is (SOL); and the above-mentioned (SD).

Then on April 16th my Pitbull screen showed a stock that had exploded from a v-shaped cup base on massive volume - (SOL). Technically the cup was flawed - you want to see a rounder cup pattern, not a 'v' shape. However the fundamentals were tremendous as was the volume pouring into the stock on it's move up. It had IPO'd just six months ago, and the growth estimates were good. It was trading around $15 and I calculated a two year price target of $84. As far as the base was concerned, I'd read a number of times in IBD that IPO's don't always form perfect bases. I decided to buy it.

I had missed this stock's breakout and bought a bit higher than the rules call for. The buy point was $14.29 and I bought at $15.25 - almost 7% above the buy point (the limit is 5%). I liked how the stock was acting post-breakout so I took a chance. (SOL) increased over 30% in the next three days, which qualified it as a potential 'big winner' according to 'How to Make Money in Stocks.' This means I should try to hold the stock for at least eight weeks from the breakout.

I had never had a stock act this well. It went on to advance as high as $29 - 92% above my buy point. As I've discussed in prior posts the book is not written on this trade yet - but even if I botch it now I still have the experience of finding this kind of big winner stock. That should benefit me greatly in future trades.

By the time I purchased (SOHU) in late April I had already started this blog and I wrote about it then, so I won't rehash the specifics of that trade now. Suffice it to say that for the first time I owned two winning stocks. I wiffed on (PWRD) and (GU), then decided I didn't want to risk any more losses eating into the gains of my winners. I had learned my lesson on that last year. If I hadn't made another trade after buying (RIMM), I could have finished the year up 10%, instead of down 20%.

I guess that completes my synopsis of what brought me to this point - if you're looking for a sleep aid you'll have to go elsewhere now! This has been a very valuable exercise for me, and at the risk of sounding like I'm bragging it's helped me see the progress I've made over the past year. This is not to say that I'm doing great now, but rather that I think I'm reasonably less moronic.

In the future I'll spend my time here devoted to my thoughts on the market, my portfolio, failed trades (I still need to review (PWRD) and (GU) in depth), and whatever else comes to mind related to trading stocks.

-Geoff

Signs of Progress

My previous discussion of my investing history dealt with the time leading up to and including the November '07 through March '08 correction. I had subscribed to the IBD premium services of Daily Graphs Online and the Custom Screen Wizard. By this time I had some growing confidence in my ability to read charts, and felt it was worth paying $91.50 a month for accurate information to work from. I believed then, and still do, that I will easily recoup this cost if it helps me to improve my investing as I expect it will.

The Custom Screen Wizard can by difficult to use at first. When I tried to put in all the criteria I've read about in 'How to Make Money in Stocks' and see discussed in IBD, it wouldn't return any stocks. This was an important lesson to learn - almost no stock is 'perfect.' If it were that easy, anyone could put this screen together and buy whatever stocks it returned. As I've said before, trading stocks is as much an art as a science.

So, with little experience under my belt, I had to try to weight criteria and decide which to jettison and which to loosen up a bit. I made a strict CAN SLIM screen just in case it returned any hits (so far the only stock it's returned is CLR - well after it made it's big run). I made a few more relaxed screens as well, one that focused on accelerating earnings, one that focused on big earnings growth in the most recent quarter, and one that focused on just the top twenty industry groups.

I also built one screen looser than all the rest, based on the Pitbull system that had introduced me to IBD and CAN SLIM so many years ago (I still have the original Pitbull document I ordered for $50 back then). This screen was targeted mainly at stocks nearing a 52 week high on volume at least 50% higher than average, along with a few basic criteria to return only fundamentally sound companies.

One of the first stocks that came up on several of my screens was (BRKR). This stock had outstanding fundamentals and was a member of the same industry group as (ISRG), a huge winner last year. The group was in the top 40 and I had wanted to stay in the top 20 industry groups, but the fundamentals on (BRKR) and big volume breakout lured me in. I traded the stock several times to a net of zero - I risked a great deal of capital for no return. Looking back on it, the industry group was not necessarily too low, but it was trending downward. (BRKR) ended up lowering guidance due to currency exchange rates and falling apart shortly after I stopped out of it in early April. I had sold half of my position just prior to this, a good move that preserved some gains. I want to remember in the future that it never hurts to take some profits off the table. I'm often hesitant to sell. It's also an excellent reminder that the sell stop is my friend - I stopped out even the remainder of my position, the stock proceeded to quickly drop another 20% or so.

After (BRKR) I resolved myself again to stick with the top groups, and next (MOS) caught my eye. I knew the fertilizer play was extended, but I'd had success with solar and steel last year when they were extended too, and I thought the fertilizer group had at least one more run in it. I thought (MOS) looked the best in the group based on past performance and future earnings estimates. What I was just beginning to play around with was forward PE, and I didn't really apply it when I looked for a fertilizer stock to go with - otherwise I might have chosen to buy (CF) instead of (MOS).

I believe what 'How to Make Money in Stocks' teaches, that I don't want to avoid a stock due to a high PE ratio. However, I think the book understates (or ignores) the value that a forward PE can offer when trying to compare group mates to see which has the best growth prospects. I won't base a buy decision entirely on forward PE, but I do include it in my evaluation.

I had as much as an 18% gain on (MOS) and let it come back, selling for just a 2% gain. Honestly, I just wasn't paying attention to it well enough. It got up and I felt pretty good about it, when it came back I remained a bit too calm on it, until finally it stopped out just above my buy point. This was another good lesson for me. Since I believed this group was extended, I should have placed a stop loss to lock in a 15% gain once I had it. This was not the kind of trade to relax and let ride for the long run.

It was an expensive lesson, but I had reason to be optimistic. Throughout the previous year, my mistakes cost me capital. In 2008, my mistakes were costing me unrealized gains. I felt this was a big step, and my confidence began to grow.

Boy, did I miss the oil trade though.

-Geoff

Happy Memorial Day

I hope everyone is enjoying a safe and happy Memorial Day weekend.

My gratitude goes out to all the men and women - and their families - who've served our country. Today especially we honor those who made the ultimate sacrifice to protect our freedom.

Thank you.

-Geoff

Sell Stop:(GU)

I stopped out of (GU) today for a 5.4% loss. This stock was up as much as 11% intraday from the buy point (16.16) in the time I owned it, but never closed above 17 and never got much traction. It usually takes me some time away from a trade before I get an idea where I might've gone wrong. Looking at it, the company is a bio-diesel play in a top five industry group while the biggest story going is oil prices and energy. Looks like a no-brainer, and it's a good lesson in why it's a good idea to cut your losses - no matter how good the story is, if a the market or a stock rolls over you can get creamed.

I think this might be a case of right stock, wrong time. I've followed a lot of good looking stocks that broke out the past week or two only to collapse soon after. That should've been my sign not to put any more money at risk. Next time when I'm so apprehensive to make another buy, I will take the more conservative approach.

I'm also pretty sick of the add-on buy within 5% of the original purchase. I don't think I'm going to do it anymore. I think I'm going to manage my money like this:

1) With my current portfolio size, I'll own a maximum of three stocks
2) My initial purchase into a stock will be for 20% of my overall capital, as close to the buy point as possible
3) If the stock works, and offers an additional buy point, I'll purchase another 10% of my overall capital - that will complete my position with one third of my capital in the stock
4) If a stock is really working well, I may divert another 10% of my capital to it at the next buy point, and so on

This suits me better, I think. It has me going in slightly stronger that recommended in the beginning, but since I don't follow up the initial purchase until I'm well ahead, I should quickly be either out of the stock or reasonably allocated.

I also think I will move my stop loss orders a little tighter. When I pick the right stocks, they seem to take off and not look back. I think past the first day or two after my purchase, if a stock is still flirting around below the buy point I just want to cut it loose and move on. I'm still thinking about this one, and tend to place my stops situationally rather than by a hard and fast rule - of course never more than 8% below my purchase price.

I took a beating on (SOL) today to. It's one thing to talk about how I'm going to hold on to a big winner for a long stretch, it's another altogether to watch my gain evaporate from 92% to 50% in just three days. Ouch. I think I need to turn off the ticker and just check the chart in the evenings or I will have a bleeding ulcer by the Fall. If I'm right, it will find support at the 50 dma. If I'm wrong it will hurt, I'll recover and learn from it and move on. I must view this process as a marathon rather than a sprint.

I'm never as smart as I think I am on the good days, nor am I as dumb as I feel today.

I'm not looking for anything new now, the market's in a correction and it's just a waiting game at this point. I have never held a stock more than a couple of months, so it's almost relaxing to resign myself that I'm in for the long haul on (SOL) and (SOHU). Of course the market will dictate how long I hold them, but I think I'll last longer in this business if I find a winner or two and ride them for awhile then keep searching constantly for the next fast buck. You can make money either way, it's just a matter of finding the style that suits you.

-Geoff

Thanks for the Feedback

Just wanted to leave a quick note of thanks to all the folks out there who've given my feedback on the blog. I hope you're getting something useful out of it - I sure am.

A week or two ago I added a link to the feed to 'email the author.' I didn't test it. It turns out that some of you actually attempted to email me, but I didn't receive your notes. I'm very sorry for this.

It turns out that blogger doesn't actually pass along the necessary data so feedburner doesn't know where to send the email. I don't want to post a link to my email because the spam-bots will get me.

I welcome all feedback. If you would like to send me your thoughts you can either:

1) Leave a comment - this is public
2) Subscribe to the feed. When you receive the next post it will arrive from my email address, which you can then reply to - this is private

I've gotten the 'email the author' link working now for new posts - just make sure it doesn't say 'noreply@blogger.com' and then it will come to me.

Sorry again to anyone who previously took the time to email me.

Thanks again for spending a little time here!

-Geoff

One Year in the Books

One year ago today I began a concentrated effort to become a successful stock trader. The market didn't throw me much of a celebration for my first anniversary.


The overall market extended it's decline today, crashing into the close following the 2pm release of the minutes from the last FOMC meeting. If I invest for 50 more years, maybe I'll understand why the market would sell off on the 'news' that inflation is a problem and growth is slowing. Who on planet earth hasn't heard these topics for the past year? That's why it's a fool's errand to try to figure out why the market moves - I spend my time on how it moves and what that means for me.


That brings me to my second frustration. I'm a big fan of Investor's Business Daily and the associated premium services. I read the paper every night. One section I never miss is the 'Big Picture,' which provides a synopsis of the market's action along with a statement of the market's outlook - whether it's in a rally, rally under pressure, or correction. I make my own decisions about the health of the market, but I also rely on the paper as a resource.


In the year I've been investing, I don't ever remember the market outlook going straight from Rally to Correction, but that's exactly what happened today. The column went from an almost too bullish stance straight to an end of the rally. They might be right, but to skip the 'rally under pressure' step almost implies that they were behind the curve on this one. I'm still not sure I agree we're in a correction, the S&P 500 and Nasdaq are still above their 50 dma's and have not even tested them yet. The Dow fell below it's 50 dma, but this index does not represent the health of the overall market well anymore.


Nonetheless, I will go ahead with the defensive playbook. Here's how I plan to handle my portfolio:


(SOL) is off it's highs but still up about 70%. I should be able to ride out a correction if it finds support at the 50 dma. It should, but obviously I don't know if it will. I may sell half of my position to lock in the gains and leave the other half for now.

(SOHU) is up about 14%. This one is trickier. Even if it does find support at the 50 dma, I don't know if it will hit it below my buy point - the 50 dma is still only around $60 and my cost basis is around $69. I may trail a stop up behind this one and just get out. I can always buy back in if it does bounce off the 50 dma.

(GU) is even. I will see how it opens and either lose a couple percent if it opens down or trail a stop up behind it if it opens up. I like the stock but I have no cushion to play with so it's best if I just try to get out of it.

As for the results of my first year trading, I lost about 8% of my capital. Considering that 2 weeks ago I was down 20%, I'll take it.

-Geoff

Time to Play Some Defense?

Today was the kind of day that really tests my fortitude investing. It highlights my lack of knowledge and experience and leaves me scratching my head what to do.

I don't worry too much about bad news - I try to stay focused on the price and volume action of the market. However, today some of the old stories popped up again: inflation and recession. To some degree the market appeared to have moved past these - or maybe gotten used to them is a better way to put it - but a surprise increase in core inflation sent the market tumbling today.

The NYSE, Dow, and S&P 500 each logged a distribution day; that's now five for the S&P 500 in the past four weeks - a real danger sign. However, the Nasdaq - which has been leading the charge - again avoided a distribution day (today's volume was lower than yesterday's) and still remains at just one. Both the Nasdaq and the S&P 500 remain above their 50 dma, the Nasdaq by 8% and the S&P 500 by 3%.

Even with the progress this rally has made, I still can't see much leadership outside of Energy, Agriculture, and Commodities. This is obviously a catch-22 - if the market's leadership is derived from inflation plays, the rally cannot last long. Somehow though it's managed to muscle ahead for some nice gains, in an orderly fashion even.

Once again I'm wondering what to do. It would be easy to sell everything and take my profits. It wouldn't be wrong, I'm up a good deal. However, when I hear about how O'Neil traded, I'm struck by how often he owned stocks for several years. I think it's possible, and maybe ideal, to find a few great growth stocks and hold them for longer periods. But would O'Neil do that in this market?

Another option is a compromise - I could take some profits to reduce my exposure and let the remainder ride. At this time I'm about 80% invested, and that might be too much. Of course I have my stops in place so I don't really have any capital at risk - but if I lose my gains that's not much better. This option is attractive to me.

I could also sell the positions that are up less and hold my big winner, (SOL). I'm up enough in (SOL) that I should be able to ride out another correction, but my other two stocks would lose their gains or could even become a loss.

My preference would be to wait until I'm more certain the uptrend is over. The problem is, if I hold until I'm sure it's time to sell, it's already too late.

I'm trying to find a balance between greed and patience. My preference is to hold on and see how far the stocks I own can go. I don't mind riding out a correction. I'd like to have some stability and not become 'panicked' into selling each time the market doesn't look great.

I'm not going to plan any new action at this time. Only the DJIA lost it's 10 dma, and the S&P 500 and Nasdaq have the 50 dma to catch them if they continue to fall. Though the market doesn't look as good today as it did last Friday, I don't think the sky is falling - yet. However I'm more skeptical now and I will continue to evaluate my defensive options. If the NYSE should log another distribution day this week I think I'll be forced to make a decision and move on it.

-Geoff

A New Beginning

When I last left off the story of our intrepid investor, I was flailing about like a drowning man looking for a life preserver. I was down almost 19% in just six months, and desperate for a winning stock that would get me even. I was using a service designed to provide buy and sell signals based technicals, and if the fundamentals met CAN SLIM criteria I would consider buying.

It wasn't working for me.

Looking back on my trading those first six months, it's embarrassing. I read my trade logs and I want to go back in time and tell myself to calm down. I had no patience, and little discipline. Fortunately, I never violated the 8% stop loss rule, and that prevented me from really ruining myself.

I can clearly remember the sick feeling I had with each new loss. I'd dug the hole a little deeper, and would now need an even bigger winner to climb back out. That was my mindset. I think I probably was trading like a gambler who gets behind - and we all know how that story ends.

However, at some point just before the brief rally of November last year, a small bit of sanity began to emerge. As emotional as I was about my situation, I forced myself to evaluate my trades and think about what I was doing wrong. I tried to recall what I'd read from the book's by Livermore and Darvas, as they were a bit more simplistic than How to Make Money in Stocks. In particular I looked at Livermore's 'top down' approach. I thought maybe I was making things too complicated, and I decided to start reviewing the best industry groups and looking for the best stocks in these groups that were near a buy point.

I believe this was a key step in my investing career. I previously made a habit of 'making excuses' for stocks - I would forgive their flaws and try to find a reason I should by them. However, I had now suffered enough losses that all stocks began to look bad to me. Instead of opportunities for gains, every stock looked like an opportunity for a loss. I was skeptical of them all. If I was going to put my money on the line with a stock now, it had to have a pedigree. I wanted it to prove to me why I should risk my hard earned capital on it. I think this is the way it should be.

My perusal of the top industry groups led me to two stocks: (STP) and (MTL). The former was a solar power company that had made a nice run, the latter a vertically integrated Russian steel company that had also been on a tear. Both were near a buy point, both were top ranked in their groups, and both industry groups were in the top five out of 197.

As simple as this was, it worked fairly well. Despite the fact that both stocks had already had large advances and the rally was a difficult one, I made a small profit. For me at that time a small profit was a big deal. It confirmed for me that no matter what, I should look for and buy only the very best stocks - no matter how long it took them to come along.

The November rally failed fairly quickly, and I tried some shorting a few times as the market corrected. If I ever short again, it won't be for a very long time. It is much more difficult that being long a rally, and with my lack of experience not worth the risk.

We were in this correction as the New Year came, and this yielded the next step in my progress. I keep very detailed records of my trading activity and my returns. I use Google Docs and would recommend it for anyone. I have access to my records from any Internet connected PC, and it's free. For tax reasons and clarity I decided to 'retire' my 2007 trading activity, so I copied the spreadsheet to a new tab for that year, then took the original tab and made it my overall return. Finally, I created another new tab for 2008, and put in the starting capital numbers as the ending capital from 2007. Obviously, this meant my returns were zero.

That zero looked great. No negative, just a zero. If I didn't do anything, didn't buy or sell, I would not be negative. I didn't have to catch up. I wasn't behind. I was even - zero. My mind shift was tangible. I was going to preserve this capital - 2008 would not be a repeat of 2007. Patience and discipline.

As the correction continued, I spent more time evaluating my past trading behavior and began reading 'The Battle for Investment Survival' by Gerald Loeb. I find this book slow going, and I still haven't finished it. I cancelled my subscription to the Market Edge service, and got a subscription to Daily Graphs Online and Custom Screen Wizard - both premium services from O'Neil + Company. They are expensive - I pay $91.50 a month for them - but I could not find consistent and accurate financial information for free on the Internet, and I believed if they improved my investing the tools would easily pay for themselves. I felt more confident reading charts by now, and I believed in my ability to learn and grow more than any recommendation service.

I began building different screens and tweaking them. I didn't know when a new rally would come along, but I wanted to be ready. I had a nervous anticipation - now that the fog had cleared I wondered if I would see the new industry groups moving in strength, or if I would miss them. I wondered if my screens were too tight, or too loose. I listened to a series of interviews William O'Neil did on the Tiger Financial News Network, took notes, and tweaked my screens based on what he said. Just nine days after his last interview on the show, when no one was expecting it, Bear Stearns nearly collapsed and the market found it's bottom.

It was time to see if I'd really learned anything.

-Geoff

Quite a Week

Normally I have a fairly clear idea what I want to say, or I just take a break and don't add anything here. This week is a bit different. It was a tremendous week, and I want to write about it, but I'm having a little trouble composing my thoughts. I have a feeling what you end up reading will be several revisions from the original.

In my short investing career, which will be one year next week, this was by far my best week. (SOL) advanced 33% this week to a total gain of 70% from my buy point. That is double my prior best return on a stock - though I must add that until I sell, there is no gain at all.

I've had to accept that I may mishandle this winner, simply because I lack experience. My first year has taught me, without any question, that I don't know squat. In trading stocks, more than any other endeavor I've... well... endeavored, experience is key - and that only comes with time. I don't learn what to do with a big winner until I've held a big winner.

If we were in a bull market, I'd probably just leave this stock on auto-pilot and expect it to triple in the next couple of years. But there's plenty of reasons to think that we are in a bear market rally rather than a bull market. So what to do then? Assuming we have another leg down in the bear market, do I risk holding this stock through a correction? I think this stock has all the markings of the past winners that went on huge runs over several years - but the market doesn't care what I think.

Last fall at one point I went all in to the market - 100% cash and margin. In just a few weeks, with moderate (about 10%) returns, I wiped out an 18% deficit from my account. I remember clearly it was a Friday afternoon, my parents were in town, and I came home to triumphantly announce to my Dad that I had 'gone green' - swung my return from negative to positive. By the end of the following week, I had given it all back, plus a little.

I know how fleeting gains can be. I've felt the karmic kick to the groin when I started thinking too much of myself. Pride goeth before the fall; in the stock market this is the one guarantee.

Now that I've once again come so close to erasing my early losses, the temptation is to bank my gains. Part of me wants to cash in, take a deep breath, and relax. I would have the satisfaction of bagging a big winner - a 70% gain in four weeks - and my portfolio would look a lot better no matter what the market does. However, the challenge here is to take the proper action, not the easy one.

The CAN SLIM approach for a stock that advances 20% in two or three weeks is to 'try to hold it for eight weeks.' This amendment to the normal rule - selling once you have a 20 to 25% gain - kept me from getting shaken out when this stock came back within a dime of my buy point after having been up 20%. That's why O'Neil made this special caveat to the normal sell rule, because he himself sold too soon a stock that went on to huge gains.

This rule kept me in (SOL) then, and I see no reason to diverge from it now. Any thoughts or fears I have about market direction or what might happen are just emotion and conjecture - I won't make trading decisions based on these. A wise man once told me, if you're not sure what to do - don't do anything. Jesse Livermore said 'It's not the thinking that makes me money, it's the sitting.' I think both apply here. Unless and until something changes materially, I will try to hold (SOL) for eight weeks.

Though my gains in (SOHU) in far smaller than (SOL) at 22%, it also advanced more than 20% in two weeks, and I will also try to hold it for the eight week duration. My concern is that after the early strength in this group - some twelve stocks were really firing off - no other stock from the group has emerged as the kind of leader (SOHU) has been. (SINA) and (JRJC) both had strong moves last week - the former on earnings and the latter on raised revenue guidance - and I'm hoping one or both will continue to show some strength as (SOHU) really needs a group mate to move with it. (BIDU) also has the look that it could break to new highs at any time.

(GU) ended the week well, though not with the kind of powerful move I was looking for. Maybe my expectations are getting too high after (SOL) and (SOHU). It is up 5% from my original purchase, and seemed to find support around the 16.25 to 16.30 area Thursday and Friday. This is above the 16.16 buy point, which is positive. With the soaring price of diesel in China, it's membership in the number one industry group, accelerating sales and earnings growth, and it's recent IPO status (GU) should be positioned to make a nice move. There is no fund ownership listed in my daily graphs online chart at this time - same as (SOL) when I bought it.

I will keep (GU) on a fairly short leash though. I have not missed the fact that neither (SOL) nor (SOHU) have returned to their buy point once passing it, and they've been the best stocks I've owned. I'm considering having my stops just under the buy point in the future, to quickly dump any stock that doesn't move up authoritatively. For now I'll leave a little wiggle room until I have some more experience. Since I have a couple of winners though, I'll try to make sure that (GU) doesn't eat into my gains.

-Geoff

Add-on Buy:(GU)

Today I added on to my (GU) position with a second buy at 16.933 - 5% above the buy point. This raised my cost basis to 16.50. I believe pyramiding up is the right way to build a position, but have to admit I find it stressful. Just when a stock I own moves enough that I start to feel comfortable with it, I'm buying more (albeit a smaller buy than my initial one) and raising my cost basis. In fact, (GU) faded this afternoon below my cost basis, then came back enough to just barely close above it at 16.57. It did stay above the 16.16 buy point today, and again traded on big volume, both positive signs.

The market itself showed some positive action to follow up yesterday's bearish reversal. The Nasdaq was up 1.5% on higher volume than yesterday, and above average volume which has been rare for several months. More importantly, after reversing when it hit the 200 day moving average and closing flat yesterday, today the Nasdaq passed that key resistance level and stayed above it - that it did so on higher volume is quite positive.

I'm pleased too that there seems to remain a healthy level of negative sentiment out there. For whatever reason, the market likes this. The strength of the Nasdaq could begin to yield moves from industry groups outside of energy and agriculture, adding further momentum to an already resilient market. As always, the landscape can change tomorrow, but for right now this looks like a healthy uptrend.

-Geoff

New Buy:(GU)

I made a new buy today, picking up an initial purchase of (GU) Gushan Enviro Energy. This is a Chinese alternative energy company that produces bio-diesel among other things.

The amount of capital I invest with makes it appropriate for me to own about three stocks maximum. I don't need to own that many, and it was my intention to stand pat with (SOL) and (SOHU) rather than expose my capital to risk elsewhere.

However, (GU) came up last night on the same screen that yielded (SOL) and (SOHU) and I had to take a close look at it.

First I'll talk about what I liked. (GU) is in the Energy-Other industry group - the same as (SOL). This group is ranked number one right now, and though (GU) is in a slightly different business than many of it's group mates, it should benefit from the group's strength.

The stock is a recent IPO (12/19/07) and is on a pullback to the 50 day moving average from a first stage base. It only has 31 million shares in the float. After several poor quarters, they just beat estimates and increased earnings 73% over 1st Quarter last year. Sales are accelerating and rang in this quarter at 60%. The forward earnings estimates call for 154% growth in 2008 and 37% growth in 2009. I like to see companies that are doubling earnings year over year.

The accumulation/distribution rating and up/down volume are great, indicating institutions are buying. Despite this, no fund ownership is listed, which means there is plenty of room for (GU) to move as funds build their positions. Volume has been very high as the stock has come off the 50 dma. The moment I saw it, (GU) reminded me a lot of (SOL).

Two key points bother me. First, the chart pattern is a bit wide and loose. Stocks with good institutional sponsorship will tend to trade in tighter ranges. Second - and this one really bothered men - the relative strength line is lagging. For this reason I came very close to passing on this stock. Truth be told, if I hadn't seen what (SOL) did, I probably would've passed on (GU). Perhaps for that reason alone, I should have. It's my impression at this point in my investing career that a leading RS line is a very important indicator to the potential success of a stock.

Why did I buy it anyway then? Maybe I'm flying too close to the sun. Drunk on the success of (SOL), maybe my ego is clouding my decisions. The stocks earnings surprise was just two days ago, and my opinion is that it's not surprising that the RS was lagging since the stock's earnings were too. Now that (hopefully) the company has turned a corner, I believe the relative strength of the stock's price should 'catch up' quickly.

I was also conflicted on where to purchase the stock. You can buy any time a stock comes off the 50 dma in big volume, all the way up to 5% over the recent high. Buying as soon as the stock comes of the moving average in volume gives you a bigger price, but also more risk as the stock has not 'proved' yet that it will clear all of the overhead resistance. Buying after the stock clears the resistance is a more conservative approach, but gets you in at a higher price thereby adding risk as well.

I chose the conservative approach and set my buy stop order at $16.16, ten cents above the recent high. As it turned out, the stock pulled back a bit and close below my purchase price at $15.83. That is a bit nerve wracking, but not all buys will do exactly what I want them to. The group has a tremendous amount of momentum, and hopefully that will translate into a continued move up for (GU).

-Geoff

'Twas the Night Before Earnings...

(SOL) announces their First Quarter results tomorrow morning before the market's open. I think most investors would admit that the time leading up to their stock's earnings release is stressful.

I've seen stocks blow away numbers and drop on guidance. I've seen stocks meet analyst's estimates and sell off. I've seen companies miss and really get hammered. The night before earnings, it's hard not to imagine the worst.

A good rule of thumb I try to follow is not buying a stock within three weeks of earnings. This allows for a profit cushion to be built up prior to the announcement and allows more options. If the stock doesn't move as expected, I can sell it before the announcement. If it does increase in price, I now have some profit in case the stock gaps down on the earnings news. As I've discussed previously, I'm looking to never take more than an 8% loss in a stock, so a 15% gap down on earnings could be pretty devastating.

There are a couple of behaviors I've seen stocks exhibit commonly the week leading into earnings. One is that they'll catch some serious buying interest. I don't know if this is speculators or funds that don't want to risk paying more after an earnings beat. The other is the stock will sell off. I assume this is folks who, for whatever reason, don't want to take the earnings news risk. I have not noticed any correlation between the action of a stock right before earnings and the earnings themselves. Someone may have inside info, but the majority doesn't.

I guess that brings me back to (SOL). This one broke the mold. I had a nice profit cushion and expected a quiet few days leading into earnings. I even planned to buy more if the earnings were good and it passed $18.95 - ten cents above the previous high. Instead, in the past three days is exploded 24% from $17.43 to $21.67 on massive volume. Today's volume was the highest ever, and it was up 15%. What to make of that?

On the one hand, I'm afraid of a 'sell the news' scenario. Sometimes when the market expects some good news, the stock will move up in advance of it, and then the smart money will sell into the news and shortly after the stock will begin to drop.

I'm also concerned how much more this stock can run without taking a break. It's up 52% from the $14.29 buy point on April 15th. I wonder if it makes a big move on earnings tomorrow if it will soon after go parabolic (retrace right back to the buy point and even lower).

I don't think either of those will happen though. I think this is the right stock at the right time. They've raised guidance on favorable supply contracts. Almost every stock in the solar group is beating estimates and raising guidance. There is a very small amount of fund ownership in (SOL), when I bought it there were none reported and it just ticked up from four to five yesterday. That means these funds are probably still building their positions, and there is plenty of room for more to buy in. The move up in price was on huge volume, indicating something more than speculation. Even with the recent move in the price, the 2009 forward PE is still a ridiculously low 12.

No, I think there are more reasons to be optimistic than to worry. I'm going to hold on for now and see how far this ride goes.

-Geoff

Why Not Paper Trade?

It occurred to me that anyone who read yesterday's post would not be out of line to ask why I didn't 'paper trade' for a time before committing real money to the market. For anyone unfamiliar with the term, paper trading is a fancy way of saying 'pretend.' You simply track your pretend buys and sells, with the idea being that you can determine if your trading method is viable. It would certainly seem I could've saved myself a great deal of money if I'd practiced before putting my money on the line.


The problem is, it just doesn't work.

As I've discussed frequently on this blog, management of emotion is one of the key traits that ends up separating the successful traders from the also-rans. When the market is in an uptrend, three out of four stocks will go up in price. We're all geniuses with those odds. Once we hold a stock though, that's when the emotions start to cloud the judgement.

What if the stock drops five or six percent below my purchase price? Do I cut my losses and move on, or wait to see if it will come back? If I sell and it comes back, how will that affect my thinking next time I'm in a similar position?

What if a stock I own advances 15% quickly? Should I sell and take my gains, or is this a winner that I should hold onto?

Even with the predefined set of trading rules I adhere to, trading on paper cannot possibly replicate the feelings that accompany having money in the stock market. There is exhilaration when a stock launches 9% in one day, and despair when it drops 10% another day.

As I've posted on this site, I currently own (SOL) and (SOHU). If you take a look at the charts, you can see that each of them advanced over 20% from a buy point recently only to return within 5% of it a week or two later on high volume. Only through having actual money on the line could I experience the fear of watching huge gains evaporate like this. Self doubt tried to creep in, I wondered if I was wrong again in my picks, as I'd been so often before. There is no way to fake this - only by living the experience can one learn to combat the emotions and develop the discipline necessary to trade effectively in spite of them.

I held both of these stocks through this shakeout period, and today they are both over 20% above my purchase price. Of course that could all change tomorrow, but the point is over time I've learned to put the emotions to the side and trade within my rules. I believe I have to do this if I want to have any sustained success in the market.

-Geoff

No Easy Way Out

As I began studying and preparing myself to trade stocks, I created an account at Charles Schwab. They were recommended to me and have given my great service and fair commission prices. In their research section they included a variety of ratings services for stocks, one of which was Market Edge. It caught my eye and I took a closer look.

This service gives Avoid, Neutral, or Long rankings on stocks based on their technical action. I looked at their performance record and it was good. They had a trial deal and special price for Schwab customers, so I decided to look into it further. I still figured if I had some help on the technical end of things I could make the CAN SLIM system work for me.

Market Edge provides a market posture which the designate as 'bullish' or 'bearish' and then ranks around 2,000 individual stocks, I believe. They have a lot of services which I won't bother to go into. I began looking at the rankings for stocks that had done well recently and Market Edge seemed to upgrade them to Long before the CAN SLIM buy point. This seemed to be what I was looking for.

I decided that each night I would go through the Market Edge upgrade list, find all of the stocks upgraded to Long, and evaluate the fundamentals of each one. I would let the service determine if the timing was right for the buy, and I'd determine if the fundamentals met the CAN SLIM criteria.

It was only a day or two before I came up with two stocks that I thought were worth buying: (HOS) and (RIMM). (HOS) is Hornbeck Offshore Services and (RIMM) is Research in Motion. At that time, I didn't even know that (RIMM) was the maker of the Blackberry. I planned to buy one of the two stocks, and thought that (HOS) would be a better choice (I can't remember why). However, (RIMM) met every CAN SLIM criteria perfectly, and so I ended up buying both of them on Monday, May 21st.

As it turned out, (RIMM) ended up being a model for how I should try to invest in the future. At the time I bought it, it was a leading stock in a leading industry group. The earnings and sales growth were outstanding and had been accelerating for six quarters (at the time I'm writing this the streak is eight quarters and counting). The ROE was huge, institutions loved the stock, and consumers loved the product - even referring to it as the 'Crackberry.' I didn't understand at the time how all of these factors converged to make this exactly the kind of stock the CAN SLIM method is meant to lead me to.

I continued checking the Market Edge upgrade list nightly and in a couple of weeks found a stock I thought had more potential than (HOS). This stock was (ICE), or Intercontinental Exchange, an electronic futures trading platform. It had been a big winner the year before, still had great numbers but there were some technical reasons I could've avoided it. Still, I sold (HOS) and bought (ICE). The day I did this (ICE) went up about 5% and I thought I was a prodigy.

It is hard now to describe my emotional state when I began trading (mainly because it's embarrassing). I've always been more emotional than I would like, and with the trading I would just get on top of the world with a 5% pop and then stress out over a drop of the same amount. I have to battle against this still, though I'm far more even-keeled today than I was a year ago.

Having no frame of reference I just didn't know what a stock was supposed to do once I bought it. I didn't know if I should give it two weeks or ten to take off, and really I didn't even know what 'take off' was. I stopped out on (ICE) in June for a loss and went on a frenetic tear buying one stock after another, the great majority of which I stopped out on for losses. Really the only thing that saved me losing my entire capital in 2007 is the 8% stop loss rule.

During this time I still held (RIMM) which had a huge earnings beat and went up 20% in one day. I couldn't believe it. Again, I thought I was destined for greatness. I had added on to my initial buy and had a good position in the stock.

My coworker kept asking my why I was buying more stocks. I didn't understand the question at all. He said I had found a winner in (RIMM), why not just wait to add more shares to that position? The question made no sense to me - the way I saw it was if I had cash, I should be looking to buy stock. He knew what I didn't - the first rule of investing is don't lose money and it's hard work to find a great stock. Once you do, it's wisest not to expose yourself to other, unproven stocks, but instead to ride that winner for all she's worth.

I had no patience and little discipline. I ended up banking 30% gains in (RIMM) in just a few months, yet finishing up 2007 down almost 19%. I did have some other winners, (OTEX) was big for me, but I squandered any profits with many other poor choices.

I tried ultra-short ETF's when I thought the market was going down, I jumped on almost any stock that met my criteria when I thought it was going up. I think I made some 70 trades in 6 months. As I lost money in each trade, I became desperate to find the next big winner. I was terrified that I would pass on a stock and it would go on to big gains. I should've been afraid of losing more money, which is exactly what would happen.

The way I was doing things was not working, and I didn't have the discipline to pull out and re-evaluate - something critical for traders to do if they hit a slump. It took the start of a new year and a bull market to give me pause and perspective.

-Geoff

Got By With a Little Help From a Friend

I was surprised tonight to see that it's been almost two weeks since I left off talking about my investing history. I want to pick up that topic again.

Having determined in 1997 that I was unable to successfully develop the technical skill and market timing necessary to use the CAN SLIM methodology, I resigned myself to investing my money into an S&P 500 Index fund.

Actually, this really isn't a bad option for many people. If anyone asks my advice on investing (and even sometimes when they don't ask) I'll suggest that if they don't want to make a second job out of it, the S&P 500 Index funds are the way to go. Certainly there are time horizon factors to consider, but the point is that if you can get something like 10% over the long run you should come out OK. All of my 401k and IRA money goes into mutual funds, and 33% of it is in S&P 500 Index funds. The rest is in Energy, International, and Small Cap Value funds.

From time to time, I would break out the Pitbull Investor system again and paper trade it for awhile. I always felt it was rooted in sound principles - those from 'How to Make Money in Stocks' - and I kept hoping I could put it to use. I never did get the kind of results I was looking for, though. I could not find any purely mechanical way to screen the paper that would yield even half of my picks being winners. Still, I continued trying.

Then a couple of years ago I switched teams at work and was paired with a consultant who developed and supported the application we use to request access to IT systems for our company. He had a good reputation as a sharp guy, and it didn't take long for me to believe he'd earned it.

It is interesting to me how things can fall into place in life sometimes. I don't want to get too existential on a blog devoted to investing, but in retrospect it's interesting to me that at the same time I began working closely with this consultant (we were and still are a two man team) I also began a process of personal re-evaluation.

I became very dissatisfied with the way I was spending my free time. I watched what I think is the average amount of television, but when I thought about what was on I became disgusted that I watched any. I have over 100 channels, and most of them are some reality (which is nothing like reality) based nonsense - why would I watch someone else's life instead of living my own?

I had a wife and a newborn son and felt that I needed to set a better example for him. I wanted to use my time wisely and effectively, so I committed myself to reading during my free time instead of watching television. It was a small gesture, but it coincided with a conversation with my coworker that started me down this path - perhaps I should say got me to continue down the path that had started some years ago.

We were talking and I asked my coworker what he did with his free time. He said tennis and investing. I recounted my interest in investing and asked him if he had a methodology. He said he used the CAN SLIM method.

I told him I had tried this and could not make it work. I said that I had settled on mutual funds and was happy with that. To his credit, he wouldn't let that slide. He made some kind of remark that made it clear he thought it was pretty weak to accept a return that low. I think I made some further excuses about not having the time, but both of us knew that I was full of crap.

This conversation stayed with me and nagged at me. I started to bother him at work with more questions - I wanted to know how he'd made it work. I was frustrated because he was very guarded about what he owned (to this day he will not tell me what he's bought) and instead of giving me answers to all my questions, he'd tell me where I could find the answers.

Though it frustrated me then, I'm know grateful for the way he helped me. He forced me to take responsibility for my investing education and growth. I bought almost every book he recommended to me: the new edition of 'How to Make Money in Stocks,' 'How I Made $2,000,000 in the Stock Market,' 'How to Trade in Stocks,' and 'The Battle for Investment Survival.' I read the first three (this was about my fifth read of 'How to Make Money in Stocks' - I use it as a reference regularly) and I'm reading the fourth now. I subscribed to the electronic edition of 'Investors Business Daily' and began reading it every day. I went through the Investors Education section of the website and absorbed what I could (it's HUGE).

Once I was making these efforts, my coworker would answer my questions - though often I still could not understand his answers. I'd look at a chart that I thought was great and he'd point out that there was more distribution than accumulation, that the sides of the cup pattern were too steep, that the RS line was lagging... I couldn't see what he could.

Still, I felt I was getting close to putting things together, if I could just get a handle on the technical aspect. That's when I discovered Market Edge.

-Geoff

Sell Stop:(PWRD)

Well, I got my answer in less than 24 hours - rules are no good if I break them.

Yesterday I averaged down into (PWRD) as it pulled back into buying range, and today that meant I lost even more money as the stock tanked and I took 7% loss on my entire position (I stopped out at $29.14). I think the group took a hit because of a cut on (SOHU) from buy to hold, but it really doesn't matter. The group had made a lot of progress and it's not surprising to see a pullback - nonetheless the fact that I bought the stock as it was moving against me simply added to my loss.

The tough part for me now is getting a handle on my emotions. Driving in this morning I had a feeling we might be in for a correction, simply because things had been too easy lately. Whenever I start feeling comfortable with my position in the market, it usually does something to remind me that investing is hard work. My portfolio was down 5% today - what a wake up call.

It's easy at this point to lose confidence. Part of me wants to go to cash and preserve what gains I have left. Fear steps in. What if the rally is over? What if I picked the wrong stocks? What if, just when I thought I was improving, I lose more money instead?

While I can't necessarily control what emotions I feel, I can refuse to act on them - and that's what I choose to do.

At some point I'll do a careful post-mortem on (PWRD) and try to see where (or if) I went wrong. Was the stock a laggard in the group? Were the low sponsorship, or the decreasing number of funds owning the stock obvious clues? I think it's sometimes easier to evaluate failed purchases after some time has passed and I'm less emotionally involved, so that's what I'll do. For now I'll focus on what's left of my portfolio.

My remaining positions, (SOL) and (SOHU), both met the qualification for a potentially big winner by gaining 20% in less than three weeks. This means that unless I'm going to take a loss, I should try to hold them at least eight weeks. The rule exists because these stocks can be hard to hold, suffering huge drops on volume that would normally shake most investors out. For better or worse, I've held both stocks through such drops. I will continue to hold them, simply because I don't see any new indication to sell them.

Yes, (SOHU) dropped 11% on huge volume today - but the stock has doubled in eight weeks. Today's action has to be taken in context. The big winners often have this kind of day - it helps to sort out the 'weak' holders of the stock, leaving the strong holders and allowing the stock to move on to new highs. Doesn't mean it's guaranteed to go up - but I have to do the best I can to evaluate the stock with a cool head. When I'm most tempted to sell may be the best time to hang on, and vice versa.

As for the overall market, I've heard many folks saying this rally won't work as it's run up 10% from the 'Bear Stearns bottom.' Yes, we picked up a distribution day today, but again I see no reason to panic. The market has been on a healthy uptrend and yesterday all of the major indices settled just below their 200 day moving average. This will certainly be a point of resistance, and I'm not at all suprised to see folks take some profits off the table here. I would not be surprised to see the market fall further tomorrow, in lower volume.

It is a concern that the S&P 500 did not hold the 1400 level, and that this index has now logged 4 distribution days in recent weeks. Still, I think we will test the 1440 level again at least a couple of times before we break through or start another leg down in the bear market. Regardless what I speculate about in the future, I don't see enough signals that I must go to cashe today.

Having said this, I'm also not going to further expose myself to the market right now. In a healthy bull market, I would potentially buy back into a stock like (PWRD) if it passed the buy point again after shaking me out. However, with my history of over-aggressive trading and my thoughts that this is a bear market rally rather than a bull market, I don't see any reason to put more money at risk.

Last year my big winner was (RIMM). I bought it the first day I traded, and it's still the best stock I ever owned. When other stocks didn't work out, I kept loading up and trying to find the next big winner. My coworker, who I'll talk more about in a future post, kept asking me why I was looking for another stock when I had a winner. I didn't get it then - but I do now. All stocks are bad, unless they go up. When I'm lucky enough to find one that's going up, there's no sense putting my capital at risk elsewhere. As much as possible, I should look to add on to the stock that has proven itself a winner.

That's what I'll try to do now. We'll see what tomorrow brings.

-Geoff

Add-on Buy:(PWRD)

I made another purchase of (PWRD) today, which makes for a good topic as I actually bought more of the stock below my original purchase price, therefore by definition I averaged down. If you've been following my blog, you may have seen my rant about value investing which included my thoughts against averaging down. I think it's worth discussing why I decided to do it.

First the facts: I originally bought (PWRD) at 31.58 which was 5% past the buy point of $30.10 in a 10 week cup pattern. I've only been using my stock screener tool for a few months, and I was late to pick up on this group because of some of my criteria. I was filtering it out based on the weakness of the industry group, which I discussed at the time of my purchase of (SOHU).

At any rate, by the time I caught on to the Chinese Internet stocks, the five I liked had already all broken out. I picked up (SOHU) and (PWRD) each 5% past the buy point - which is acceptable.

In the ideal situation, however, I would want to make my first purchase at the buy point, add on more shares when the stock increased 2.5%, and again when it increased 5% from the buy point. Each add-on purchase would be for a lower dollar amount than the prior purchase. This is called pyramiding, and a number of great traders have used the technique (Livermore, Darvas, O'Neil to name a few). Let's say that I want to eventually own $10,000 worth of a stock with a buy point of $100; my first purchase would 50 shares at $100, then another 30 shares at $102.50, and finally 20 shares at $105 - of course it rarely works out that neatly.

Instead, I found myself buying at the high end of the safe range - therefore I bought my half position and resolved that I would have to wait for a pullback or a new base to add more shares. There are a number of chart formations that can signal a safe point to add shares. However, all of these happen at a higher price than the original purchase.

I added on today as (PWRD) pulled back to $30.85, 2.5% above the buy point. To some of you it may seem like it's not worth all this discussion - either way I buy the stock at $30.85 - what difference does it make if it's more or less than the previous purchase?

Fair question, and one I considered before buying. The quick answer is, I almost never want to buy a stock when it's moving against me. No matter whether a buy point forms with a pullback to a moving average or a base, the time to buy is when the stock moves up on big volume past a buy point formed by the pullback or base. I want to buy when the stock is moving up.

However... sometimes a good stock will breakout and then retreat into buying range again. In this case, it is possible to consider this a second chance to purchase the stock if I missed the initial breakout. Still, I would typically not want to do this if I already own the stock, as now I'm averaging down.

This is where the waters get a bit muddy. Whether or not I already own a stock clearly has no bearing on the potential success of a new purchase. The stock doesn't know that I own it (if it did, it would probably go to zero immediately). I believe the rule exists to manage the investor's psyche. It takes a great deal of discipline to invest successfully, and if I get into making new buys of a stock that is already moving against me, it sets me up to get emotional about the situation. Let's say it corrects a little further, I may not want to admit I was wrong twice and may even be tempted to add-on again. Ludicrous as it sounds, the market can drive an investor to do such things.

Having said all of this, why did I do it? Discipline and patience have been lacking in my investing, which is a good part of the reason I started this blog. I second-guess decisions like the one I made today, and try to determine if it was a shrewd move or an unnecessary risk. There is a strong argument for the latter.

What I liked was that the stock pulled back in lighter volume than the past four days when it moved higher. That's a healthy break for a stock that has increased 15% in four days. I also liked that it didn't drop to the buy point - it went as low as $30.20 and then came right back up to the $30.85 area. I like that the group is breaking out one stock after another, and I think there is an excellent chance that (PWRD) will be the next to fire off. I wanted to increase my holdings in this group, and (PWRD) gave me a chance to do so.

I could say that time will tell if it was a wise decision, and that's true but not in the way it sounds. If I make money on (PWRD) that doesn't mean I was right to make the buy today. Trading stocks is about swinging the odds as much in my favor as possible, and time and experience will tell me if this kind of a buy hurts my odds or not.

I think that's what I love most about investing. I can read and study hours a day (and I try to do that), but in the end there is no substitute for experience. I don't know what a bear market 'feels' like until I live through one. I don't know about the beginning of a bull market until I live it. If I do this for the next 30 years, something new will still come along every week.

-Geoff

New Additions

Just wanted to take a quick moment to let anyone who's reading this via subscription or feed reader know about some of the things I've added to the site.

I added a yahoo portfolio widget and I keep it up-to-date with my holdings. It's the best stock widget I've found because it includes a little chart and recent news for each stock. It also allows anyone to enter a ticker and get quotes, charts, and info from yahoo finance.

I've also begun posting my returns from the day I started investing 'seriously.' I include any prior years results, the current year's results, and overall results from day one. I also list both real and annualized returns. I'll update my results weekly.

After some thought I've also decided that I will continue to post new buys I make with the reasons for the purchase. For me, this is the most valuable part of this process - it really keeps me honest. It's harder to make a risky move when I have to come here and try to justify it. My goal is to post about any new buy and the reasons for it the day I make the purchase, after the market's close. I will disclose the price at which I purchased the stock - including commissions, but not how many shares I bought. I added a disclaimer to the site which should be obvious - I'm not making any recommendations, I only recount my activity and experiences.

-Geoff

New Buy:(PWRD)

It was another interesting week in the market with the FMOC meeting, job numbers, consumer confidence, and other economic data. As it's done the past few meetings, the market picked one direction after the Fed released the news of the rate cut (in this case down) only to reverse the next day and have a very strong move up.

We are still in a confirmed uptrend since the follow through day that occured on March 20th, and with the S&P 500 finally clearing 1400, and the major indices have passed the significant resistance areas which should now act as support.

There does appear to be a rotation of market leadership. The commodity stocks are flashing some warning signs and have had a difficult couple of weeks. Technology has stepped in along with retail and even financials this week. In the top 20 Industry groups (as tracked by IBD) I've not seen any compelling opportunities - it is mostly made up of extended groups (oil) or old leaders ready to roll over (agriculture).

As I mentioned on Monday though, I saw movement in the Chinese stocks in the Internet-Content group and I bought (SOHU), which is doing well so far - I'm up 14%. When I buy a stock I track members of the same group in order to keep a feel for the strength of it, so I put (JRJC), (PWRD), (SNDA), (GA), and (SINA) on my watchlist. They were all acting very well, so last night I decided to take another close look at the group and see if there was another buying opportunity.

The first thing I did was export a list of every stock in the Internet-Content industry group to a spreadsheet where I could filter the data a bit. I removed any stock with an SMR (proprietary IBD rating which measures a stock's Sales, Profit Margins, and ROE) below C - this cut the list from 36 to about half that. Then I removed the stocks that had an EPS rating below 70 and removed the few remaining US companies in the group. I was left with 8 Chinese companies, the 6 listed above, (BIDU), and (NTES).

I already own (SOHU) so I began looking at the rest. I eliminated (BIDU) because it is a former leader and has a forward PE twice that of any other stock in the group at 56. I do not use a PE to measure a stock's worth, but I will take into account a stock's forward PE relative to it's group mates as I think it helps determine which stock might have the most growth potential. This is something I may change or do away with over time.

(NTES), (SNDA), and (SINA) do not have the eps growth (historical or estimated) that the others do and were therefore fairly easy to eliminate from consideration as well.

This left me with (JRJC), (PWRD), and (GA). All are recent ipos and excellent prospects, and all have some flaws.

(JRJC) is phenomenal fundamentally, with triple digit earnings and sales growth quarter after quarter. It's forward PE is the lowest of the group at 12. It's problem, I believe, is technical. Last fall this stock rocketed from $13 to $45 in just a couple of weeks. Then over the next 6 months it came all the way back to $13. Of note is the fact that the stock saw relatively little high volume down weeks (3, to be exact) for a drop like this, but that is small consolation for a round trip. When a stock corrects that drastically it creates a large overhead supply which causes resistance as the stock tries to rally. In simple terms, the guy who bought 3 months ago at $25 is looking to get out even, so he sells when the stock gets close to that. Only instead of that one guy, there's a bunch of them all the way from $45 down to $13 looking to get out. For that reason, I passed on JRJC - though honestly I think it will perform well.

(GA) is a great looking stock I'll keep on my watchlist, but it broke out on Monday past a $13.44 buy point off a double bottom with high handle pattern and was already up to $16. I could've bought as much as 5% past the buy point, but that was 14.11. Still, this is (GA)'s first base since it's IPO so if it does well it will offer another buying opportunity.

I think I like (PWRD) better anyway. It actually broke out Thursday from a 9 week cup pattern with a $30.10 buy point on triple it's normal daily volume. Fundamentally this stock looks great, the earnings and sales growth are triple digits the last 4 quarters and it's expected to double earnings in 2008. The up/down volume is 2 and the Accumulation/Distribution rating is A+ which both suggest strong institutional support, though the number of funds invested in the stock has dropped significantly in the past year, a red flag. (PWRD) boasts an ROE of 50 with no long term debt, though the cash flow is less than 10% higher than it's earnings.

The chart looks good, with the stock closing up on higher volume and down on lower volume most weeks. The relative strength line is making new highs already though the stock is not - this is a bullish sign.

All things considered, I decided to purchase (PWRD). With the buy point at $30.10 my suitable purchase price was from there to $31.61. The stock had closed the previous day at $30.97 and gapped up this morning and went to $32 almost immediately. I waited out my 15 minutes per my rule, and the stock did come back to 'fill the gap.' I got in at $31.58, and could've had it for less. I don't fool around too much looking for the perfect price though - if it get's within 5% of the buy point I will buy, otherwise it could just take off and leave me behind.

The stock closed up a little for me today, but I expect it will backtrack a bit at some point next week. If it comes back into the buy range in a health, low volume pullback I'll add shares around $30.85.

-Geoff

A Quick Word about Value

A friend and I were speaking about a topic as old as the stock market today - 'Value.' 'Value Investing' - seeking investment in stocks that one feels are under-valued - is probably the oldest and most widely used methodology. Despite this, I don't think it's the best way for the individual investor to go.

I have to start out by saying I have a problem in principle with the term 'under-valued.' The best thing about the stock market is you immediately know the value of any stock simply by checking the bid price. That's the value, period. It may seem like a semantic argument, but I believe it goes a bit deeper.

I think the concept is rooted deeply into the psyche of the value investor, right there next to 'buy and hold.' The value investor evaluates a stock, determines what they believe to be a 'fair value' based on a number of factors (which by the way may be very sound), and then will buy a stock depending on how far it is below their assessment of it's 'real' value. If the price of the stock drops after the initial purchase, the value investor may add to their position, as it is now even 'cheaper.'

At this point I want to be completely fair and say first that many folks are successful value investing. I don't know how, but they are. Value Funds have outperformed Growth Funds over time - I have an idea why this is true. Not all value investors average down, and not all value investors work without a stop loss point or 'buy and hold.' I'm generalizing, and I'll continue to do so. If you're a value investor don't get mad, just make a ton of money and prove me wrong! I'll be the first to congratulate anyone who's successful trading stocks, whatever their methodology.

Back to the topic at hand. I believe strongly that the market itself sets a stock's value based on the quoted price. I don't buy a stock because I think it's under-valued - I buy it because I believe that demand will outweigh supply. This is the only thing that will drive a stock higher. The reason for the demand may be that big money institutions find the stock under-valued - I won't argue with them, I'll just hop on board and enjoy the ride. It's the fact that buying interest is stronger than selling interest that I look for. The reason I think that value investing works for mutual funds and other institutions is that they have the money to generate the buying support a stock needs to move higher - a sort of self-fulfilling prophecy. I don't know about you, but unfortunately I don't have that kind of cash.

Again you may feel this is just playing with words. I think the distinction is important because it determines which stocks you will buy and how you will hold them or sell them.

For instance, take a stock (FRPT), trading at $3 down from $30 less than a year ago. This stock's fundamentals are outstanding - triple digit eps growth the last 6 quarters, forecast to grow earnings 462% this year and 60% the year after that. It's PE is 6. It's forward PE for 2009 is 4. There are no outstanding news items I know of to justify the fall. As a value investor, this would be the kind of stock I would look at when it was trading at $25, or $18, or $11... Even now, it's the 'deal of the century' - though I think most sane investors would not buy a stock trading under $10.

The point is, this stock was 'under-valued' by almost any measure from $30 all the way down to $3. It didn't matter, because demand for the stock did not exceed supply. As a value investor, with the mindset that cheap is getting cheaper, how do you know when to pull the ripcord and bail out?

I think the value investor (any investor, for that matter) would be well suited to maintain a stop loss rule and consider technicals along with fundamental evaluation. A saavy value investor should be adept at finding stocks which seem to justify a higher price - combine this with an assessment of the stock's chart pattern and price and volume action and now I think you're on to something. Wait until you see the big money come in and move that stock up on volume well above average. Look at the up/down volume and other signs that tell you institutions are accumulating the stock. That's the time to move in.

Then, in growth or value investing, if the stock turns on you consider your evaluation wrong and get out. I'm like everyone else - I don't like to be wrong - but there's no place in the market for ego or emotion. That's why I try to maintain a set of rules I follow, to take emotion out of the equation as much as possible. I've read several books from some of the great traders: Livermore, Darvas, O'Neil, Loeb, and all of them echo the same thought - cut your losses close.

This is one rule I've never broken. I set a stop no further than 8% below my purchase price, and I've never moved one lower. This allowed me to suffer 'only' 20% loss of capital in my first 6 months back trading stocks last year despite being right in only about 1 out of 10 stocks. I'll talk more about my 2007 performance (or lack of, to be more accurate) in the near future. Hope you found some 'value' in tonight's post (never afraid of taking the easy one.)

-Geoff