PERFECTING THE FUTURE
irfan | January 20, 2009Markets rise and fall on a perception of what will happen in the future. I have two problems with this.
1. No one knows what will happen. Too many other things change. What seems logical turns illogical.
2. We still must take into account our biases—how we as individuals and groups view such things. Life is too fluid to predict.
Most of the future’s news is discounted long before it happens. Look at the last example! We want to discern things, to have peace of mind, to have things fit—to make sense. What twisted logical path did the market (the invisible “they”) walk down to come to a conclusion that a stock’s price will fall in nine to eighteen months, and then have the price fall now? With this type of logic at work and the crazy reaction to it, what are we to do? More importantly, what plays can we make to build up our income?
I’ll give specifics in a few moments, but first, my list of important observations:
A. Individual Investors
1. There is in each of us (even at the corporate level) a desire to grow, to build, to achieve.
2. We all, even companies, have a desperate need to not only survive, but to thrive.
B. Market Movement
1. The market has a mind of its own and will usually do that which it must do to make fools out of a majority of investors.
2. The market is not right. It just isn’t. It’s fluid, it moves unexpectedly.
3. There are short term plays and long term plays—you decide the length of time.
4. There are opportunities everywhere.
5. Investors’ actions shape future events, not predict them. They cause change, not reflect it.
6. Investor bias rationalizes (and hence changes) the facts.
7. You can profit going both ways—up prices, down prices.
8. The “herd” mentality takes over and when it’s played out (the boom), then prices start down as they bottom out (the bust), then the cycle starts over.
9. It is at this precise moment when you capitalize on profits.
That took a lot to get to these points, so let’s keep rolling. Let’s use a stock moving up for whatever reason as our example. We own a stock or have an option on it. The stock moves with a mind of its own. It’s reflective of news—good earnings, higher dividend paid out, prospects for the next few years. Everyone wants in. The price goes up and up. However, it will turn around to some degree. The sentiment will change.
The time comes when the momentum will turn. Perhaps the turn will come when an analyst at a major firm, a person who has loved this stock (to death!), now thinks it shouldn’t be an “aggressive buy,” but a “buy,” or a “hold.” A small downgrade. If you are into buying puts or going short on the stock, wouldn’t it be great to sell at the peak, or buy the puts just as it’s about to fall?
This is it. Playing this high point and the corresponding reverse (bottom) is point for action. And, it’s just not that tough to make money this way. We’ll call this point a “crossover,” or a convergence. Crossovers occur at both peaks and valleys.
We’ll explore this premise after we look at a scenario. This scenario conforms to this strategy. Not all scenarios do, but the ones which do, allow us to get in, then get out with a lot of cash. This scenario plays out frequently, I’m not investing in “the market” but in certain stocks and options within the general market. And if you think the market has a mind of its own, go with the trend. Don’t try to “catch a falling piano.” But only go so far.
Five Sections (Stages) Of A Crossover (The Boom/Bust Scenario)
First: the price movement is unnoticeable. The trend starts, the price rises or falls inordinately quickly, compared to its historical moves. Volume increases as stock momentum builds. Look at the following:
Speedway Motorsports (TRK)
December 1995, stock had been trading between $25 and $30 for the last four months with no big trend. Volume (interest)
in TRK increased in December of 1995 and January of 1996 and the stock started to climb. The stock split in mid March and has been trading between $25 and $30 for the last six months.
K-Mart(KM)
K - M a r t showed a building trend in September and Oc-
tober of 1995, with a big trend up in early 1996. K-Mart then showed trend reversal from December of 1995 to February of 1996. As the stock was falling, so was the volume. The stock changed trend in March, volume increased and so did the stock price.
Second: activity reinforces more activity. Recommendations (from the professionals) fly. Everyone wants in. Major purchases occur.
Third: the strength (or weakness) is tested. Doubts occur in the wisdom of the recommendation.
New recommendations appear, after all the facts are used, distorted and abused to prove points.
Fourth: the main point, or question, is simple—is the price sustainable?
1. Where is the market headed?
2. Check other news.
3. How was the news received?
4. How much buying has been going on?
5. How many institutions jumped in?
6. When the high and low was tested, did the price return to the previous support level or did it break support?
Fifth: divergence. If there is no compelling reason for it to stay high, it will decline. BUT IF
THERE IS NO COMPELLING REASON FOR A FALL, it may fluctuate, but the stock might establish a new range. The price will be tested repeatedly. The opposite is true for a falling stock, once it hits bottom. The bottom support level will be tested repeatedly.
A Perspective
Go with the “herd” until the time is right. Buck the trend at that time. I have seen very rapid movements up and down. I hope after this next sentence or two, my strategy will make sense. So much doesn’t make sense, but this does. The stock price will change.
If I own a stock at $80 and it gets trendy—caught in an updraft, I’d rather sell at $110—even if it goes to $120, because in two hours it could fall to $90, or a $50 stock could fall to $35 (IOM). A good time to get out would be when you wouldn’t get in.
