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