One section tells a good tale about finding your system, and I wanted to include it here, before getting on to the current market. The passage picks up after Livermore (dubbed Larry Livingston in the book) is talking about his own system to an old, wise gentleman who responds:
"Yes! Yes! You're right. The way you're built, the way your mind runs, makes your system a good system for you. I recollect Pat Hearne. He would buy one hundred shares of some active stock and when, or if, it went up 1% he would buy another hundred. On another's point advance, another hundred, and so on. [And] he would put in a stop-loss order one point below the price of his last purchase.
"You know, a professional gambler is not looking for long shots, but for sure money. In the stock market, Pat wasn't after tips ... but sure money in sufficient quantity to provide him with a good living.
"After Hearne's death one of our customers who had always traded with Pat and used his system made over $100,000 in Lackawanna. Then he switched over to some other stock and because he had made a big stake he thought he need not stick to Pat's way. When a [correction] came, instead of cutting losses short, he let them run - as if they were profits. Of course every cent went.
"I remember that he used to admit that he had been ten thousands kinds of an ass not to stick to Pat Hearne's style of play. Well, one day he came to me greatly excited and asked me to let him sell some stock short in our office ... I told him I personally would guarantee his account for 100 shares.
"He sold short 100 shares of Lake Shore. My friend put out that [short line] at exactly the right time and kept [shorting] it on the way down as he had been wont to do in the old successful days before he forsook Pat Hearne's system and instead listened to hope's whispers.
"Well, sir, in four days of successful pyramiding, [the customer's] account showed him a profit of $15,000. Observing that he had not put in a stop-loss order I spoke to him about it and he told me that the break hadn't fairly begun and he wasn't going to be shaken out by any one-point reaction. This was in August. Before the middle of September he borrowed ten dollars from me for a baby carriage - his fourth. He did not stick to his own proved system. That's the trouble with most of them."
It's a great short story, encompassing discipline, system-building, loss-cutting, and the constant battle to suppress a person's own emotions - as Livermore said later, you must reverse your natural impulses by hoping when you're normally fearful (of losing your profit) and fearing when you're normally hopeful (that your lagging stock will rally back).
That leads to me back to the present time, my current system, and what it's telling me to do. As I write this, the market's trends are down by our measures - all the indexes have broken down below their 50-day moving averages, the broad market remains horribly weak, and most important to me, the leading stocks of the August-October upmove have taken on a lot of water.
Simply put, it's time to be defensive. Lots of cash. Little new buying. But plenty of studying up.
In a way, these can be the toughest times for an investor, especially if you've grown accustomed to buying and selling stocks every day or two during the past few months. Think about it - if you tell a marketer to stop sending out sales pieces, he wonders what to do. Tell a chef to make just salads, and he has a hard time getting excited for work.
So if you tell an investor to sit on his hands, most don't have the discipline to do it; they get pleasure out of "being in the game," and thus they put on a few positions ... usually just as the market begins another leg down.
Instead of putting my effort into buying and selling stocks, I'm spending my time developing a plan - I know for a fact that a new bull move will begin at some point, and I want to have all my ducks in a row when it comes.
That means (a) doing some post-mortem work on my trades of the past few months, and (b) putting together a watch list of tomorrow's potential leaders.
On the first front, there are two simple questions you should be asking yourself right now: What were your biggest winners and losers during the past few months? And what did those winners and losers have in common? Often, if you spend some Q.T. dissecting these questions, you'll find that your winners have lots of similarities (for instance, they all had triple-digit revenue growth, or you bought them just as the market turned up), as did your losers (you failed to cut your loss short, you got greedy and invested too much money in one stock).
I've always been a big believer on focusing on the future, but I began doing post-op work a couple of years ago and it's had a big positive impact. I heard once that the payback on the time and effort you put into this type of research is ten-fold. I believe it.
For instance, I've found that when I buy growth stocks when the shares are trading tightly (consolidating in a small range after a strong upmove) during a bull market, my winning percentage is very high. So, naturally, I hunt for those types of patterns, and highlight many of them in my Cabot Top Ten Report.
I've also discovered that, because I use very tight stops, I've missed out on some winners - I looked for only perfect set-ups, which, while not costing me actual money, did cost me opportunity. So I'm thinking of loosening my stops a bit, so I won't shy away from some would-be big winners just because the setup isn't pristine.
But that's just me. You surely have different strengths and weaknesses, which is why I strongly urge you to spend an hour or so this week looking back over your records and finding some common themes in your trading. The time you put in studying up now will yield greater profits once the bulls arrive.
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That leads me to the topic of building a watch list, which could take up five pages all by itself. Besides a lack of patience (described above), one reason down market periods can be so hard on investors is because it takes them out of their element - instead of going through their "normal" investing routine each day or week, they begin to listen to CNBC, read about some fancy-sounding ideas, get some tips from friends, and so on.
And before you know it they've got money tied up in Canadian oil trusts, a Chinese coal stock and some bum retailer that's supposed to do well during Christmas ... all because someone else told them to.
To avoid these temptations, you should keep yourself busy - I make it a point to update my watch list of about three dozen stocks every two or three days, crossing off those that have suffered a bout of selling, and adding some new names that have shown signs of accumulation. I also try to listen to an archived presentation or two of some new, exciting growth company every week. (There are a ton of these online, usually in the investor relations sections of company's websites.)
Doing this keeps my mind focused on where the big money is made - in buying new, revolutionary growth firms at the start of bull move.
So what am I finding now? Here are three potential leaders for you to keep an eye on:
Suntech Power (STP) has emerged as my second favorite solar stock, next to the oft-mentioned First Solar. The company's earnings report last week was great, but the big news was that, due to big demand and a steady supply of silicon (the main raw material for solar cells), Suntech expects to have one gigawatt of annual capacity on-line by the end of 2008. So it's on track to be the biggest solar producer on the planet, which likely means earnings can multiply many-fold in the years ahead.
LG Philips (LPL) isn't a pure growth stock, but it's the second-largest maker of liquid crystal displays in the world. The cyclicality in this business is harsh, but the cycle appears to be turning up thanks to plenty of demand for laptops and HDTVs. Selling prices rose 7% sequentially in the third quarter, and earnings boomed. Analysts are guessing that earnings will top $3 per share next year, which could be conservative ... and the stock is under 30 per share. Best of all, LPL staged a big breakout a few weeks ago and is holding well since.
MasterCard (MA) is probably the #1 leading big-cap growth stock in the market today. Sure, AAPL, GOOG and RIMM still have a chance to get going again, but MasterCard blew away earnings estimates recently, gapped to new peaks, and has held tight the past three weeks. The trend toward plastic over cash is accelerating, especially overseas and in emerging markets. True, it's not the undiscovered stock that many big winners are, but we believe it can deliver solid profits in the next bull run.
I'm not buying into anything in a big way these days, but if you have to nibble on one, I recommend MasterCard, seeing that it's big, liquid (trades nearly four million shares per day) and, if you buy some in the mid 180s, you could put a tight stop in the 175 area.
But, again, the real money isn't going to be made by buying into a resilient stock today and hoping the market doesn't drag it down. The big, big profits come when all the selling is done, and a major new bull move produces leaders that double or triple within months. That is what I'm focused on, and it's definitely worth waiting for.
All the best,
Mike Cintolo for Cabot Wealth Advisory
Editor's Note: Mike Cintolo is Vice President of Investments for Cabot Heritage Corp., as well as Editor of Cabot Top Ten. Mike's proprietary OptiMo stock screening system, used in Top Ten, uncovers the market's strongest stocks - the stocks the institutions are accumulating despite the weak stock market. But he doesn't just give you a list of ten strong stocks; you'll also find out the ruling reason behind the stock's strength, what price you should buy each stock, and sage market commentary, letting you know which trends are emerging (or submerging). As Mike would say, "If you fish in the ocean of Top Ten stocks, you're guaranteed to be invested in the leaders of any market advance." It's all delivered to your e-mail inbox every Monday evening. Interested? Click the link below to receive our special charter rate.