Part of that, of course, involves what growth stocks to buy. But most of it (far more than most investors understand) comes from having a solid foundation of what works, and what doesn't, in the stock market. In fact, I like to say that the system we use in Cabot Growth Investor and Cabot Top Ten Trader (both of which I write) is not MY system, per se, but the MARKET'S system—it's based on what has actually produced profits during the past many decades.
When I first became interested in the stock market, I was naturally attracted to systems that made the most money in the market. I wasn't looking for some dude who sounded good on TV—I wanted profits!
That's why the system I follow is one that is based on what has worked over and over again in the past 50 years, including what growth stocks look like when they break out, how they act while they advance and what warning signs mark meaningful tops. The same goes with the overall market ... at Cabot we have charts going back to 1920, showing us what all the major tops and bottoms looked like.
Thus, when I tell subscribers that, say, the education stocks have topped out and they should be sold (which I did for Cabot Top Ten Trader subscribers in mid-February), it's not because I came up with an opinion willy-nilly. In that case, it was because every stock in the group suffered outsized price drops on huge volume, with some breaking their 50-day moving average. That's a sell signal.
So how can this help you? Today I want to give you 10 tools to put in your investing toolkit.
1. Most big-winning growth stocks advance for 12-24 months, from breakout to top. In other words, if you've owned something for more than a year and it's been pretty much straight up, the stock's likely in the latter stages of its advance. True, some great stocks (take Apple, for instance), can go up longer, but even then, the stock tends to have a very nasty (50%+) correction, something that's hard to sit through.
2. Most big-winners in new bull markets are new stocks. By new, I mean most stocks have come public during the past few years and did NOT enjoy spectacular run-ups during the prior bull market. So if all your attention today is on Apple, Google, First Solar and the like (or even worse, Citigroup, A.I.G. and Bank of America) then you're looking under the wrong rocks. A corollary of this is that only one or two out of 10 leaders of the last bull market end up leading the next bull market. It's possible, but unlikely.
3. The best stocks begin their runs when they break out to new 52-week highs. When a stock is moving up off its lows, like so many have in recent days, it's tempting to jump onboard. However, these stocks have quick moves, and also quickly hit resistance. So to make money on these names you either have to buy early (not recommended), or have impeccable timing (difficult). Contrarily, the biggest winners have chewed through all potential sellers, and begin their moves from their breakout into new-high territory.
4. The biggest winners will breakout to new highs within a few weeks of a market low. If you're buying a bunch of beaten-down stocks after a major market low, you'll probably do OK ... but you won't own any true leaders, and your performance will eventually lag.
5. The 50-day moving average will contain most of a great stock's intermediate-term advance. Usually, once a winner gets going, it will find support a couple of times at the 50-day moving average. That means, if your stock breaks decisively below its 50-day line, it's probably time to sell and move on.
6. If an entire group is strong for many weeks, and then most stocks suffer their biggest drops in many weeks, then a top is likely in. This is what happened to the education stocks a few weeks ago, which I wrote about above, and also happened to the commodity stocks in early July 2008. This could give you an early-warning sign, instead of waiting for the trailing 50-day line.
7. A big move (more than 10%) the day after an earnings release usually leads to more movement in that direction. Nobody likes to sell after their stock has just been crushed 20% on an earnings announcement, but that's often the best thing to do. Same goes on the upside--a large move higher on earnings is often buyable (if the market is healthy, of course). The bigger the move, the more meaningful it is.
8. "Strong then Tight = Flight." This is a great rule of thumb. If you see a stock break powerfully to new highs (Strong), and then trade in a tight range, say, within 10% for couple of weeks afterwards (Tight), it's usually a sign that big investors are still accumulating shares, and the next big move will be up (Flight). This is one of my favorite set-ups.
9. A stock split (or stock split announcement) will often mark a meaningful top for a stock. Most investors, for some reason, have been trained to think of stock splits as good. But if your holding has been advancing for many weeks (at least a couple of months), and then spikes on stock-split news, you're usually better off selling at least some of your shares.
10. Good stocks can go bad in a hurry in bad markets. Last but not least, you should always keep in mind what the market is doing. Is it trending lower? If so, no matter how good the set-up, you're more likely to lose money. If it's trending higher, it'll be like running with the wind at your back. Using the 50-day moving average on the major indexes is a simple-but-good way to know whether the trend is up or down.
Now, I know not all of these rules and tools will be of help right now, but if you print these out and refer to them, I guarantee they'll come in handy sometime in the months ahead.