The Holy Grail
My Favorite Turnaround Stock
I love reading investment books, but frankly, most of the recent releases I see online or in the bookstore fall short of really providing you with an edge. Nothing against the authors, but most seem either too introductory or contain too many forecasts and opinions that I just don't get anything out of them.
Because of that, I've actually narrowed down my reading lately; sometimes I get more out of re-reading an old classic than grinding through a new book. However, one set of books that I absolutely love are those that interview other traders-it doesn't matter if they trade stocks, bonds, currencies or commodities, the insight that they have into how the market actually works is always helpful.
The most popular of this genre is the Market Wizards series, by Jack Schwager. There are three books, each separated by a few years; the last was published in the early 2000s. I highly recommend them all. (FYI, I just bought a book dubbed "Millionaire Traders" and plan on reading it during the next couple of weeks. I'll let you know how it is.)
However, I actually don't want to write about books today; my goal is to discuss the Holy Grail of trading ... that mystical system or series of principles that will guide you to astronomical wealth. And for that I turn to Ed Seykota, who provided probably the most memorable interview among all of Schwager's books. Seykota was a trend-follower with an incredible understanding of the human mind, trading systems and how the two interact with each other. He made millions, mostly in futures.
You can (and should) read that interview in the book, but I wanted to jump forward to a song Seykota wrote and performed with a few friends a couple of years ago. After numerous requests over the years for his "secret" to trading success, he and a few friends produced the "Whipsaw Song," as it's called. It contains all you really need to become a top-notch trader or investor. I've relayed some of the lyrics below:
You get a whip, I get a saw, one good trend pays for them all ...
What do you do when we catch a trend? We ride that trend right to the end ...
What do you do when we show a loss? We give that dag'on loss a toss ...
How do you know when our risk is right? We make a lot of money and we sleep at night ...
What do you do when the price breaks through? Our stops are in so there's nothing to do ...
What do you do with a hot news flash? You stash that flash right in the trash ...
What do you do when the drawdown comes? What do you do when it gets real big? What do you do when it's even bigger? You stick to the plan and pull the trigger...
At this point you're probably thinking "Cute song Mike ... but what does it have to do with anything?" Well, this song was Seykota's way of telling investors that the real Holy Grail isn't a black box system with complex trading rules. Instead, the real Holy Grail contains lots of the simple, tried-and-true tactics we write about regularly-letting winners run, cutting losses short, using stops, not obsessing about today's news (the market looks six months ahead, not behind), and keeping your risk in line with your personal risk tolerance. (I would also add one more: Stick with the trend of the overall stock market.)
It really is true that just following these core principles will put you ahead of 80% or more of investors. So why don't most investors follow them? Because they're contrary to human nature. Human minds, for instance, yearn to maximize the percent of time they're correct, not necessarily to maximize their gains. That leads them to hold losers and lock in winners. The desire to avoid giving up hope also leads investors to hold on to stocks (winners or losers) too long.
Thus, even if you know about these rules, following them through thick and thin is the tough part. I know many experienced and successful investors who break the rules every now and again; just this week, I received a couple of emails from subscribers who are still holding some dogs they should have sold many months ago.
Granted, following these rules won't guarantee you'll make millions in the markets like Seykota, but I can say with confidence that these rules will put you in a position to earn outsized profits, assuming you're able to uncover the leading growth stocks in the market.
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The good news is that the market's recent correction has really made the stock picker's job that much easier. Those stocks that rode the bull market higher but really didn't have much institutional backing have fallen apart, some dropping 30% or more from their peaks. But those that have great stories and expectations of big growth ahead have hung in there beautifully, or even advanced somewhat, during the market's downturn.
As I've mentioned a couple of times in my recent Cabot Stock Market Analysis Video most stocks with big earnings growth that are resisting the market's decline can be thought of as coiled springs--they want to head higher, but the market's pressures are keeping a lid on them. Once those selling pressures ease, however, most should spring to life.
Thus, it's relatively easy to construct a Watch List of top-quality candidates right now. And most will be buyable if and when they break to new price highs on good volume ... assuming the market re-confirms its major uptrend. To this point, most indexes have recouped about half of the ground they lost during their pullbacks. But all remain at or below their flattening 50-day moving averages.
Thus, while a little new buying today is fine, I don't think there's a need to be a hero and buy with abandon until the market itself proves that it's back in an uptrend. So I'm spending most of my time listening to conference calls and presentations, analyzing chart action and determining which stocks are likely to lead the next upmove.
Now, usually in this Advisory, I highlight a great growth company with a revolutionary new product. Indeed, those are my favorite stocks, as history has proven they have the best chance to make huge moves.
However, today, I want to remind you of my favorite turnaround stock--Ford Motor (F). Obviously, most investors are aware of the company's recent past, and of its dramatic turnaround during the past year. But I think there's a good chance more upside is on the way.
Why? First, in a company like Ford Motor, the earnings leverage is huge because fixed costs (though they've been chipped away during the past couple of years) are still huge. When business falls, that results in steep losses, but when sales are rebounding, as they are today, earnings can shoot through the roof. The last two quarters saw Ford earn 26 and 43 cents per share, crushing estimates, and analysts now see 90 cents per share in 2010 ... a number that is likely very conservative.
Second, the stock itself, while having a massive run from its bear market lows (like everything else), doesn't appear overly stretched within its overall upmove. In fact, F built a 10-week base between 5 and 6.5 during last summer, then soared all the way to 9. But then the stock built another base-this one 18 weeks long-between 6.6 and 9. The breakout from that zone occurred in December. My point is that the stock had lots of back-and-forth action in the second half of last year, wearing out weak hands and setting the stage for a sustained advance.
Finally, F has held up very well during the market's correction, falling a maximum of 14% and really just moving straight sideways on its chart. I also like last week's tight trading range, a sign that no more selling is coming into the stock.
The way I would play it is this: If the major indexes rally back above their 50-day lines, and F breaks above 12 on heavy volume, you can buy some. And if it keeps advancing, buy a little more. My guess is that the stock has at least another spurt higher in the weeks or months ahead as business improves.
All the best,
Editor's Note: Michael Cintolo is the editor of Cabot Top Ten Report, which has featured Ford as a market leading stock. Each week, Mike combines our proprietary Optimum Momentum stock-screening tool with his expert growth stock advice to select the top 10 stocks in the market. Look at some of these 2009 one-month, double-digit gainers: Baidu (BIDU) UP 26%, Freeport-McMoRan (FCX) UP 36%, Par Pharmaceutical (PRX) UP 24% and Vistaprint (VPRT) UP 23%, among many others. Click below to get started with Mike's advice today!
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