Welcome to Profit Confidential • Thursday, September 6, 2012
Stock picking is the process investors or traders use to analyze and buy stocks or equities. The key to success in stock picking is to know how to analyze stocks based on fundamental and technical analysis through a stock picking screening process. For instance, if you are analyzing small-cap technology stocks, there are literally thousands of companies that require a system for analyzing in order to narrow down the list to a more manageable group for closer examination.
This is an exciting time of the year, as we near the end of the baseball season with the race to the playoffs heating up. Success in baseball swirls around the abundant statistics, as is the case in trading stocks, but there are major and subtle differences. In fact, the key to achieving stock market success is more akin to pitching than batting.
Let me explain. In baseball, the ultimate goal for every batter would likely be to hit over .300—that is three hits for every 10 at bat for you baseball neophytes. Of course, there are exceptions for the home-run hitters like Willie Mays—one of the top baseball players in history. In trading, stock market success doesn’t equate to winning in only 30% of your trades; this would actually send you to the sidelines or poorhouse quickly.
Stock market success is more like pitching. A pitcher who wins 65% of his starts would win about 21 games based on 32 starts. Winning at a 70% win-rate would equate to 22 games and a possible Cy Young award (top pitcher) for the mantelpiece. In trading, if your win rate was 65%–70% and you cut your losers, you would likely achieve stock market success.
The key to stock picking and stock market success is simple—make sure you make more money than you lose. To do this, you need to make sure you cut your losses and, at the same time, ride the winners.
Many inexperienced traders often get caught-up in the emotional roller coaster by taking profits on the top stocks, while keeping the poor performers and refusing to admit a mistake was made, which does not bode well for stock market success.
At this time, stocks are facing chart resistance, as evidenced by the S&P 500 at 1,400. The bullish investor sentiment in the stock market continues to ad support for stocks, but I’m seeing some stalling on the charts. The lack of strong volume is a red flag.
You need to understand that being prudent is important for stock market success just like it is in baseball. Let’s assume the bases are loaded. The batter in this situation doesn’t necessarily try to hit a home run, but aims for a hit to drive in runners. This is called playing “small ball.”
The same goes for trading. Aiming for a home run with each trade is fruitless and doesn’t mean stock market success. I would rather play small ball and drive in runs, albeit hitting that occasional long ball over the fences would be a bonus.
Risk management drives stock market success as it does in baseball.
It would be unlikely that a pitcher would throw a fastball down the middle of the plate on a 0-2 count—instead, perhaps he would offer up a curveball, splitter, or change up.
The key with both baseball and trading stocks is monitoring your pitches and situation.
When the price of a stock trends higher, you should think about a potential exit strategy for overall stock market success. This does not mean liquidating profitable trades; it’s more like protecting your unrealized gains. Take the current stock market rally as an opportunity to take some profits. Trust me, you’ll feel better about it if stocks slide.
Another stock market strategy that needs to be considered is the use of mental or physical stop-loss limits. But you need to be careful when the volatility increases and wild swings in the stock market materialize that could take you out of your position prematurely.
And for those of you familiar with options, you can employ put options to help minimize the downside loss in the stock market. (Read “Stock Market Success: It’s About How You Manage Your Risk.”)
Babe Ruth was arguably the best baseball player in history, while Warren Buffett is widely considered one of the top long-term investors. As these men have proven, the key to success in both baseball and trading is to understand the situation, know the risk, and have an exit strategy.
One piece of stock market advice for you at this time—be careful.
Success in stock picking is trading in the right direction, while also making sure you have a defensive strategy should the trade turn against you, and using puts as a hedge.
I see some danger on the S&P 500 chart.
In January, I noted the S&P 500 could test 1,400 this year, writing that how much the index rises will be dependent on the global and U.S. economies. (See “My Market View: A Risky Start to 2012.”)
The S&P 500 is hovering at 1,335 and will need to advance another 4.9% to hit 1,400. Of course, the threat of global and domestic slowing could impede the upward move.
The S&P 500 could fall to 1,180 by the year-end, according to research by the Financial Forecast Center. A break at 1,300 is predicted by the end of August and 1,200 by the end of September.
Following the break at 1,400 in March, on two subsequent attempts at 1,400 in late April and early May, the S&P 500 retrenched and failed to hold.
Since June, the S&P 500 showed three successive higher peaks at 1,363, 1,374, and 1,380. Yet unless we see support at around the 50-day moving average (MA) of 1,332 and 200-day MA of 1,315, the index may falter and head lower towards a pivot point at 1,306.
The moving average convergence divergence (MACD) indicator, an indicator I like to look at, also appears set to be flashing a sell signal; but on the three previous occasions, it managed to hold. The fear is of the S&P 500 MACD possibly turning down. In May, when the MACD turned bearish, the index corrected from 1,415 to 1,291, a decline of 8.8%. So be very careful now, and perhaps wait and buy on a possible pending correction.
My stock analysis is also partly based on the light trading volume during the upward streak. Failure to see high volume indicates an absence of mass market participation.
The market will need leadership to have any chance of advancing higher. The banking sector is looking more positive and could drive some buying.
The current sentiment is one of uneasiness, as there is a feeling of not wanting to miss out on more potential upside opportunities should stocks rally. Investor sentiment, defined by the new-high/new-low ratio, improved in July, but continues to hold a cautious tone.
So what to do?
Option traders could use call options to play potential gains, while taking some profits on current stock positions. In this way, you can manage the risk.
Enter into smaller positions, so if the market slides, the loss would not be as critical to your trading base.
If the tide turns, make sure you are not tied emotionally to the stock. Sell it.
I believe in adopting strong risk management to protect your investments and hard-earned capital. Use put options to hedge against a downside move.
If you’ve been stock picking the last little while, you know it’s tough just to keep your buck, let alone make one. Stock picking is a lot easier when there’s wind at your back. During the technology bubble of the late 1990s, you didn’t even need to do much stock picking; you could have just bought the NASDAQ Composite. Now, in a slow growth environment, making money from the stock market is a lot more difficult.
Stock picking is a lot harder these days, but that doesn’t mean that there aren’t great companies out there benefiting from the big changes taking place in the U.S. economy. Times might be tough at Saks Incorporated (NYSE/SKS), but things are booming at Ross Stores, Inc. (NASDAQ/ROST) and Dollar Tree, Inc. (NASDAQ/DLTR). Thinking about the retail demographic and weak consumer spending, a great investment strategy was to sell the luxury providers and to buy the discount retailers.
The recent stock market performances of Ross Stores and Dollar Tree speak for themselves. Ross Stores was trading just a bit over $20.00 a share in early 2010; now it’s around $70.00. Dollar Tree was trading at $16.00 a share in January 2010; now it’s at $53.00. Just as simple as it was to buy any big, brand-name technology stock in the late 1990s; some of the best stocks in recent history were discount retailers.
Hindsight is always 20/20, but stock picking in any environment can be as simple as asking: who benefits? In any given time period, some industries do much better than others. The key is to be just in front of the trend, before the stocks get into the headlines. As a stock picking investor or speculator, you always want to know which companies benefit from the times you’re living in.
The stock market moves quickly on growth stories in a slow economy, so who benefits from stagnant employment growth, weakening expectations, and a generally lousy outlook? Well, people still need to buy their medicines, benefiting pharmaceutical companies, biotechnology stocks, and Wal-Mart Stores, Inc. (NYSE/WMT). Sales of cigarettes and beer are likely holding up well, meaning Altria Group, Inc. (NYSE/MO) and Anheuser-Bush InBev SA/NV (NYSE/BUD) are benefiting. And people still have to eat food that needs to be shipped, so Kraft Foods Inc. (NASDAQ/KFT) and J.B. Hunt Transport Services, Inc. (NASDAQ/JBHT) benefit. (See “The Blue-chips Hitting New All-time Highs in Spite of Market Correction.”)
When things slow down, everything goes back to basics, and in my view, so should the stock picking strategy. The stock market today isn’t primed for anything except the age of austerity, which is itself a great investment theme. The stock market has already rewarded stores that are working in times like these, and it should continue to do so. Stock picking is just a relative thing; the only thing the stock market cares about is earnings growth.
One of the largest electronic retailers in the world, Best Buy Co., Inc. (NYSE/BBY), is at a crossroads. The future is looking bleak, at least according to investor sentiment, for what was once a mighty organization. Large format retailers have been difficult for stock picking as they’ve lost significant market share to online retailers. Consumers prefer to touch the product in the store and purchase the goods at home. Best Buy has been among several large retailers that has tried, and has so far failed, to overcome this hurdle. A great example of these difficulties is when its direct competition, Circuit City, filed for bankruptcy; yet Best Buy was still unable to significantly increase corporate earnings. Other large retailers like Borders Group Inc. have also filed bankruptcy due to the onslaught of online retail. This has led to investor sentiment turning negative toward any large-format, mall-oriented retail stores.
On the heels of continued declines in market share and poor investor sentiment, Best Buy had a recent scandal regarding former CEO Brian Dunn who had an alleged affair with a subordinate. This is yet another sign that management didn’t have the proper focus. Following Dunn’s resignation, the founder and largest shareholder of Best Buy Richard Schulze announced that he is resigning as Chairman of the Board and is interested in selling his 20% stake of the company.
Obviously this is a company deep in turmoil, not knowing what direction it wants to go. While it is announcing the closure of 50 stores and building smaller format operations, most analysts think it’s too little too late, leading to poor investor sentiment. Stock picking is difficult to begin with, but even more so when a new technology changes the rules of the game.
Even though investor sentiment is poor right now, I think it’s very positive that the founder is leaving. This means that the new CEO will not have him under his thumb. The founder has hand-picked the last several CEOs, which more than likely means that they were not allowed to make the decisions they wanted. Sometimes having an overbearing boss will prevent you from making the proper decision. As the founder is now about to leave, a new CEO might be the spark of life to revamp and revitalize the well-known name that is Best Buy—a shake-up is needed to shift investor sentiment.
Chart courtesy of www.StockCharts.com
While the stock has recently bounced up, significant headwinds remain for the stock to overcome. The 50% retracement area is of obvious significance as seen by the numerous times it’s been used as support and resistance going back to last year. This is an area of mixed investor sentiment, as the bulls and bears will battle it out. Personally I would not buy the stock at this point. I would want to see more positive technical indications as well as a solid plan that can ensure this business will be viable for the future. You’re never going to catch the ultimate top or bottom when stock picking, but you can lose a lot of money trying. Wait for management to be finalized and investor sentiment to start to turn before making a bullish call.
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