-- January: Sat in cash.
-- February: Bought some stocks, but was whipsawed out of all of them.
-- March: Went to cash, then bought some things as the market turned up ... but got whipsawed again.
-- So far in April: Again bought some things ... and am currently about even with them, net-net.
In total, so far this year, I've done just a few trades, lost money on almost all of them, and am currently sitting with a few positions that aren't showing me much profit. I'm off a few percent this year-much better than the market indexes, but still a frustrating Chinese water torture-like performance through three and a half months.
Coming along with this performance is a constant barrage of choppy action from leading stocks, and the most persistent and pervasive collection of negative news I've seen in my life. Last Friday, for instance, consumer confidence reached a 26-year low. Wachovia, Merrill Lynch, Citigroup and tons of other banks are writing off billions of dollars of bad loans. And my soon-to-be mother-in-law (50 days and counting!) told me two different times--after I explained why the market might be forming a bottom-how she heard "things were going to keep going down." Then, to rub salt in the wound, the market plunged 256 points last Friday (thanks GE!), making me look like a moron.
Why do I write about this? Because I'm not sweating it ... and if you've had a similar experience, I don't want you to sweat it, either.
Determining Your Profit
Remember that your win rate-your number of wins versus number of losses, also called your batting average--is only one of three pieces that determine your profits. So it's possible to have a low batting average and still make a ton of money.
The other factors that determine your profit are (1) the average size of your gains versus the average size of your losses, and (2) the position size of your winners versus the position size of your losers. Thus, if you cut all your losses short, start with small positions and average up if your initial purchases show you a gain, you can rack up lots of profits even if you encounter a tough stretch. In fact, this is how the very best investors go about things-a 50% batting average is considered terrific in the world of growth-stock investing.
This really comes down to the old question, "Do you want to be right, or make money?" They appear to go hand in hand, but if you lose $300 on 10 straight trades, and then make $10,000 on one trade, you're up $7,000 ... even though your batting average (how often you're right) is horrible.
So, my message to you is: If you're in the midst of a tough stretch, and you're being battered by all the negative headlines, don't despair. Remember that your goal is to make money, not to always be correct, and so you should be focusing on the opportunities that will come when the bulls truly re-take control.
OK, with that pep talk out of the way, I wanted to touch upon a couple of questions we've received via our Cabot Forum (http://www.cabot.net/forum for details) before getting to my stock pick today.
The first question is a very common one: Should you use trailing stops? A trailing stop is simply an order you place with your broker to sell your stock if it falls a certain percent off its high, or if it falls through a given price level.
In general, I do believe stops are a good tool for the average investor. They will, first and foremost, allow the investor to cut losses short if his stock heads south after purchase. And they do help lock in profits should your stock, after a good advance, begin to break its uptrend.
But as with all tools, the success of using trailing stops is based on the smarts of the user-in this case, the investor. Randomly placing trailing stops on a winning stock isn't a good idea; you can too easily get stopped out on normal fluctuations.
I think the key to successful selling isn't having a blanket "sell anytime my stock drops 20% from its peak" strategy; the key is studying and understanding charts. If you're going to use a stop, put it somewhere that's technically relevant-having it just below the 50-day moving average, for instance, is a sound strategy. Or, if you're shorter-term, you might place it below the stock's lowest price of the past few weeks.
Thus, I think stops are a good idea, especially if you can't watch the market and your stocks all day. But it's like anything else-if you put effort into learning the best methods to trail your stops, your results will improve.
Another common question: "Good weather is on the way, and I'm looking to learn more about investing, and charts in particular. Any book suggestions for some lazy spring and summer days?"
Yes! We're always perusing the bookstore, looking for new and interesting investing books. Actually, there aren't too many recent ones we'd recommend, but here is a handful to keep you busy.
"How to Trade in Stocks," by Jesse L. Livermore. It's a great account from Livermore himself on some of his key principles of trading. One of the big lessons I learned: Being patient not just with winning stocks, but also practicing patience when waiting for the next big move. (I might need to relearn this, given my words in the first section!)
"How I Made $2,000,000 in the Stock Market," by Nicholas Darvas. This will take you through a progression from total novice to super-successful investor. It's a great read to reinforce some of the market's basic principles.
"Technical Analysis and Stock Market Profits," by Richard Schabacker. If you're just beginning in the world of chart reading, this is a good guide. We don't subscribe to all of the patterns he talks about, but it's still a great place to start.
"The Intelligent Investor," by Benjamin Graham. It's not my cup of tea, as I'm a growth stock guy. But most value-oriented investors believe this is one of the best books ever written.
"Market Wizards," "The New Market Wizards" and "Stock Market Wizards," all by Jack Schwager. They contain great interviews with a few dozen of the best investors in the world. You are guaranteed to learn some things, about the market and yourself.
For more books recommended by our editors, go to the Cabot Web site, http://www.cabot.net, and click on Books on Investing under the Education section.
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As for the current market, you don't need an expert to tell you that the environment is tricky; a good week by the market is usually followed by a bad week, and if a stock has a few good days, it's likely to be downgraded and chopped off at the knees.
Even so, I remain cautiously optimistic the market is in a bottoming phase. Sentiment remains horrid (Fortune gave us another bearish magazine cover last week, a sign that most people still expect the worst), and the market's internal condition has s ... l ... o ... w ... l ... y improved in recent weeks. Both bode well for the future.
Interestingly, during the market's recent General Electric-spurred decline, trading volume was anemic-yes, even during last Friday's 256-point drubbing. The institutional investors who have hammered the market so often since October are currently taking a back seat, refusing to dump shares. As I've written before, I think the current earnings season will make or break the market ... but right now, I'm leaning toward a new bull market beginning.
Steel is Strong
I am by no means fully bullish (our Cabot Market Letter remains 50% in cash), but I do believe nibbling on a strong stock or two will prove worthwhile. So today I'm writing about Steel Dynamics (STLD), whose group is one of the very strongest in the market. The reason? Supply is rather limited, demand is accelerating, and prices are surging. Here's what I wrote about the stock back on March 31 in Cabot Top Ten Report:
"Steel stocks are largely unfazed by the volatility in commodity stocks, and Steel Dynamics remains one of the leaders. The company has always been a relatively efficient producer, but the big story here is the recent price hikes; usually, when steel firms start to successfully raise prices, there are more to come, as demand trends for steel tend to be long-lasting and somewhat 'sticky.' It doesn't hurt that other steel firms also are starting to hike prices. That's causing investors to look ahead and think that even the current bullish earnings forecast for 2008 ($5.76 per share, which would be up 41% from 2007) could be conservative. Obviously, this story doesn't have anything new going for it, but the wind is at the industry's back right now, and Steel Dynamics is helping to lead the way."
Since that write-up, STLD has moved higher in a stair-step fashion, finding support near its 25-day moving average this week before pushing higher on Wednesday. I like the fact that many steel names, including granddaddy U.S. Steel (X), are powering ahead, telling us this group move is both broad and powerful. Sure, steel firms aren't changing the world, but the trend is your friend, and this group's upmove appears to still be in its early stages.
All the best,
Editor's Note: Michael Cintolo is Cabot's Vice President of Investments, and editor of Cabot Market Letter. The Market Letter's claim to fame is simple-it operates a concentrated, easy-to-follow Model Portfolio (no more than 12 stocks) of fast-growing stocks that beat the market. Since the start of 2007, the Model Portfolio is up 30%, while the S&P 500 and Nasdaq are both down 5%. Over the past five years, the gain totals 16% per year, while the S&P 500 managed half that. With a new bull market possibly getting underway, now is a great time to join, as new additions are being made to the Model Portfolio. Click the link below to find out more.