HN: Beating the DJIA
The advice below is abbreviated, and thus is dependent upon market/economic trends of which I have broken it down into 3 scenarios. There is bear and bull markets, and trading ranges where there is, no clear or significant direction for the market over periods of 6 months and longer. Superior success is related to recognizing which strategy is applicable and to what degree.
1. You will come across many recommended ways to generate predictions about stock performance. What I have written above goes over much of what is being said by others, both good and bad. There is one fundamental concept, that of the balloon. If you pump more money into a stock/industry/market than is taken out, it will expand. Economic indicators are measurements of process that have an effect upon the flow of money into the market. Low interest-rates, for example, cause investors to pull money out of bonds and CD. Some that money goes to housing and other investments such as the stock market. A healthy world economy is another important force. Individual industrial groups and companies therein are mini-balloons. Good fundamental for a company means that more money will be pumped into it than other companies in that industrial group. Similarly a sector or industry which is benefiting from economic conditions will grow faster, and at the same time take money away from other sectors. Be flexible and attentive; do not sleep with your predictions.
2. Figure out the trend of the market based on economic indicators: Sentiment follows economy and the market leads the economy by an average of 3 months. However, do not try to guess the moves, but rather wait for solid economic signals. There will be plenty of profits still to be made. Do not fight the trend. Adjust your strategy according to whether the market is fluctuating within a trading range, or moving in a long-term (6 month or more) upward or downward direction. There are thus 3 different overall strategies based on market direction. http://economicindicators.gov and http://Whitehouse.gov/fsbr/income.html are two good sites for economic indicators.
3. 70% of the time there will be no clear direction. You can predict & recognize such periods by the weak economic indicators. During those periods the market will be in a trading range and drift slowly up or down for periods of 6 months or more and with pronounced oscillations therein.
4. Each industrial group has its own fundamental standards; therefore, within the group apply those standards. The P/E, book value, etc. for a utility, for example, does not apply to a technology stock. Apply within an industry its standards, and look to see if there is a significant move from its historical values. Clearstation.com lists industries both by fundamentals and technical values. And Provestor has in their 15-page summation of a company several pages of comparisons where the company you are reviewing is compared to their industry and the S&P.
5. If the move for the industry resulted from an external, compelling causal reason. If those conditions occur again be prepared to select that industry. For example, brokerage houses out perform in a bull market.
6. Two good sites for industrial groups: http://clearstation.etrade.com and http://smartmoney.com/sectortracker/. There are 13 sectors, which are divided into 110 industrial groups; or some number thereabouts. BarronBarrons updates weekly sector and industrial group performances that has had a long run, probably will cool down shortly. Use a computer stock screener, such as with TD Waterhouse and Charles Schwab. Then use a stock screener to select stocks within an industry.
7. Clearstation has a RS (relative strength based on 13 week price movement) rating of 110 industries. Select stocks from the top performing industrial groups or ones that should be making a move shortly.
8. News Vulture. Occasional there is a stock will be hammered for bad news that does not significantly impact the bottom lineas when Ross Pureot left GME in 1986. In that case it dropped 40% only to regain it within 6 months. Look for companies in deep financial troubles and industries whose market is being eroded. Short them. Go long if the news is good, act quickly to get the price movement; or if the new will effect earnings over the next quarter.
9. Pay attention to what is being said on Wall Street about industrial groups and the economy. Financial newspapers such as Barrons and the Wall Street Journal will have articles that will mention industries and their present and future performance. Recently, because of the weak dollar precious metals have been one of the top industries. But unless the dollar continues to lose value, gold wont remain strong. And at some point such stocks will be overbought. If there are saying that a change in banking laws will help finance companies, then if conditions are right pick a couple of stock from that industry, unless such change will not have an impact up P/Es for several years. Just do not look at RS numbers, use also insight.
But before making a buy, check how the industry is doing.
10. The rule of 6: purchase 6 stocks. Select at least 6 more in a backup portfolio. The more stocks in your portfolio, the more likely it is that the return will be near the market averages. If, for example, you at one time have 16 stocks in 3 industrial groups, you should average 93% (Fosback, 254) of the combine average return for those industrial groups. Then why bother looking at fundamentals? Besides having so many stock means more work: more reports, more checking news, and more confusion and errors. I divide my portfolio into 3rds, 3 industries, and then 2 stocks from each industry (sometimes having as many as eight stocks). If I feel particularly confident, 2 of the stocks will amount to half the portfoliobut most of the time I stick with the division of sixths. I also stay with 2 sectors and no more than 4 industrial groups.
10. If there is any important negative news, such as earning report, of down turn in product market, increased number of shares being traded; then I will sell the effected stock that day. Significant bad news, a study showed, entails that on an average that stock will under-perform their industrial group. Conversely, I will buy more shares on good news. On bad news pick a stock immediately from your backup portfolio.
11. Do not try to squeeze an extra tick from a stock; viz., do not try to guess the daily (or hourly) market action. And do not believe the chartists who say they can. You will be wasting many hours that could be profitable spent chasing the golden goose.
12. Do not become personally involved with your stock selections. Let the numbers and market conditions make your decisions. Similarly do not have faith in your analysis, but rather look at it being similar to a weather forecast with a certain probability of rain, clouds, and sunshine. You do not have radar to know what is in the immediate future.
13. Set up stops at 20% down side. After getting pulled from a stock by a stop due to a price adjustment (a decline following a run-up), if I am still bullish about that stock (and also the industry and market), I will pick what I consider its low point and then reposition myself. I will also pick an upper limit and sell out of a stock. These limits are adjusted for the current RS rating of its industry. Give a bit more room for stock with a high Bata and less for those with a low Bata.
14. I am looking for mountain climbers, and the climber usually lasts under 8 months. A speculative stock that noticeable under performs for a couple of weeks its industrial group, I will sell. Trades are cheap: a 5¢ move covers it.
15. Some stocks and industrial groups have their own logic. Medical stocks, e.g., are trading at about 3 times the book value of other industrial groups. Intel and Cisco also have inflated market capitalizations, several fold above their industrial groups.
16. Do not get buried in fundamentals analysis. Consider a company as a 3-week fling. For companies in an industrial group compare fundamentals: market capitalization, price to book, earnings and earnings growth, revenue, and debt load. Based on these fundamentals, figure for what you think the companies should be trading for. If the stock is selling for less than the figure you picked, then check the news and insider trading. You are shopping for value within an industrial group. You are also shopping for things that will attract the average investor.
17. Let profits run, and cut losses short (20% for a beta of 1 or less, accordingly for a higher beta). Following this strategy, if a flat market, there are typically in my portfolio 2 winners and 2 losers, and 2 neutral, the winners will gain enough for the portfolio to out perform the DJIA.
18. Watch out for fools. Most experts aren't; viz., their analysis is flawed. Try to find the ones, if you must, with the best understanding of the market. Peter Lynch is good. I have posted an article by Professor Martin Zweig, which shows of how off the experts are, and also read my article on charting. Those who pick stocks based upon technicals, have major, faulty assumptions in their selection process. Remember their position as a financial analyst for a brokerage house or mutual fund doesnt entail that they outperform the market. In fact 70% of the mutual funds do not. Moreover, those rated at the top for 5 years, this group as on average over the next 5 years will produce about the market average. If you find a winning stock picker, make sure it is because of technique and not chance, and remember they have a product to sell (themselves) so examine their performance claims. Most claim their ideal portfolio has out performed the market by several fold. They are not subjected, like the scientific community, to peer review. And a bad name on the street never stopped Wade Cook from making millions. Do not be sold by claims. In fact without a detailed explanation about what is good in a company, I normally will not even check out the stock recommended. Medical Technology Stock Letter is excellent.
19. Watch out for options and futures. One study showed that those who did best in these were the professional traders, while the ordinary trader lost money. This is the reverse of what occurs for stockbrokers, who on an average under perform the DJIA. The futures and options are not like the stock markets where everyone will make money as values goes up, rather you are betting against your fellow speculatorand the house (market makers and brokerage houses) gets a percentage. With futures and options there is a spread between the buy and sell price (which the market maker pockets minus the kickback he gives the brokerage house), and that in the long run consumes profits. And there is a premium which the buyer of a call or a put pays; it averages about 5% of the contract cost. Moreover, unlike stocks prices, which are like an inflating balloon during a bull market, futures and options are bets against fellow traders: there is no growth in value of the overall future market, like there is in the stock market. Everybody makes money in stocks, over half the people loose with futures and options.
20. Hedge your portfolio by buy shorts. Even during a bull market there are companies in trouble, for whom the market hasnt yet beat down its price. Being in such a stock entail that if the market undergoes a correction, your losses during that period will be less, and when the upswing resumes, you willbaring a turn around for that companyprofit from its problems.
21. Do not park your money: that is what Peter Lynch calls bonds. See my article based which relies on his book, Beating the Street. CDs are even worse.
22. I have found only 2 books worth studying: Norman Fosback, Stock Market Logic, and Martin Zweig, Winning on Wall Street (Zweig makes too much of sentiment indicators, although they do provide a degree of warning about market corrections). Read Fosback and Zweig, their focus is sharp.
23. Do not fear risk, for your exposure is nearly the same with blue chip stocks. A stock trading under $10 is just as likely to go up or down as is General Electric. While that stock could produce a greater loss it could also produce a greater gain, and you are working the averages. On an average the cheaper stocks will out perform the blue-chip stocks. Following economic indicators reduces risk, which is further reduced by going with the top performing industries. Moreover, cut your losses short, and let your profits run. After the first year you will be so far ahead that your exposure will be only the previous years winnings. Do not sit on the sidelines partly in cash, there are always positions (long and short) that on an average will produce several fold that paid by a bank.
24. Your gains are compounded; thus your greatest loss is what you didnt make at the start, and where you would have been with those extra winnings 20 years from now.
THREE MARKET PATTERNS, Adjustments
1. The more conservative large cap companies normally out-perform the small cap companies.
2. Hedge your portfolio with shorts when the economic indicators are becoming negative. The best way is to pick the worst industrial groups and then those companies therein that are most over-priced stocks. A second group to select is those that have had a speculative run-up in the bull market and now their support has evaporated. By riding both sides of the fence, even when the market inches upward, these shorts will yield a modest return; and they protect your portfolio if the market significantly declines.
3. Be nibble, for unless the economic indicators improve, run-ups and run-downs in stock prices are general only a month or so. Look for value and hot industrial groups. Do not take a long position, for in most cases you will only give back your profits. Set up a realistic price target 3 months out, and take your profits. Be satisfied with modest gains of 10 to 30% in a 3 to 6 month period for a stock.
4. Select stocks that have backed off there high by over 15% for no apparent reason that profit taking. Sell them after the 15% move up. Especially looks for stocks that have repeated this pattern several times.
1. When there is a strong sign of economic expansion following a recession, up to 75% speculative: 75% in stock trading under $10 and that are in industrial groups that either have 1) been clobbered, 2) were stellar during the previous bull market, 3) have already risen to out perform the market and still have lots of room.
2. In the beginning of a bull market following a recession, the high profile stocks in the best industrial groups that have been clobbered will out perform the market. So too will stock whose revenues have headed down during the recession and earnings have become negative, but now are climbing out of their holes.
3. Small-cap companies will out perform the market once the sentiment improves, especially those in the right industrial groups and showing superior revenue and earnings growth. The Oberweis Report screens for such companies.
4. Chasing the industry trends produces spectacular results. Stay with the hot onesa poor week for an industry then you should sell at least half your position in that industry. Adjust your selling according to economic news for the industry. If oil prices are going up and should remain high, then you can be more tolerant of a poor week for oil stocks; however, if the logic for the rise is thin, then be more responsive to a poor week for that industry, than you would with energy stocks.
5. As the bull market matures hedge your portfolio with shorts, and if inflation increases then also hedge with options and futures tied in to interest rates.
1. If it appears that a recession is on the horizon, then be aggressive in your shorts, especially if the worsening economic conditions follow a bull market.
2. Short the speculative bubble.
3. If no such bubble, then short the industrial groups that have had the greatest run up, those which are most effected by the recession, and those who are declining the most rapidly.
4. Once the rate of decline is slow, consider industries who are on the rise. However, if the economic indicators are rotten, then do not stick with shortsdo not fight the trend.