Getting Started with Chart Reading
The Next LED Superstar?
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One topic I like to write about every few months (partly to remind myself) is the principle that, in the stock market, early is not always better. Of course, this is the opposite of the usual wisdom (the early bird catches the worm, and so on), and it also doesn't jibe with most investors who (over)react to every wiggle in the market.
To these investors, it's all about being early--after all, if the market has bottomed, it's better to buy on the first or second day up than the eighth or ninth day up, right? In this limited example, yes; obviously, having identified the low, you're better off buying as close to the low as possible.
The only problem is, correctly identifying the low point is nearly impossible to do in real time. If we're talking about the general market, for every sustainable, multi-month low, there are dozens of days that are false lows, after which the market keeps on slipping. In other words, the only way to get in at the very bottom is to bottom fish during a downtrend ... but if you do that, you're going to be wrong many times before you finally catch a low. And the end result will be lost money!
Thus, the first lesson of "don't be early" is to always wait for confirmation of a new uptrend (or downtrend, for that matter). Market timing is not about being the first to get in at the bottom or out at the top; it's about correctly identifying the trend and riding it as long as it persists. Yes, that means you'll never buy at the bottom or sell at the top. But it also means you won't die a death of a thousand cuts (by continually trying to pick the bottom) or ever miss out on a major move in either direction.
I'm writing about this topic because of its implications for buying individual stocks ... something that is very timely given the current market environment.
A few years ago, I was trying to buy early like most investors. Now, I was never trying to pick a bottom, but if the market had a few good days (including a good gain on a volume thrust within a few days of a low) I would usually put on a couple of small positions and see how they did. I would do this even if our own intermediate-term trend indicator, the Cabot Tides, was still negative.
Now, realize that these volume thrusts tend to work pretty well at identifying a low, and they tend to come a week or even two before the Cabot Tides give a bullish signal. Thus, you'd think my results would be enhanced by buying a couple of stocks at this earlier stage, right?
Wrong! I went back and studied my trades, and here's what I found: There were numerous stocks I bought on the volume thrust that turned out NOT to be leaders. They looked good initially, but eventually, they petered out and lagged the market.
Also, even among the stocks I bought that WERE leaders of the new advance, most didn't make immediate upward progress. There were a few exceptions, but the vast majority bobbed and weaved for a while before kicking into gear. Finally, of course, there were those times when the Tides never did turn positive, so most everything I bought turned out to be a small loss.
All in all, the study showed that, on balance, buying before the Cabot Tides turned bullish wasn't helping my results ... in fact, it was slightly hurting them! Waiting for the Tides to turn positive--it usually takes two or three weeks after a significant low point--allows you to a) home in on the true leaders of the advance, and b) take out a little extra insurance that the rally is the real McCoy.
What about today, you ask? Well, even though I've been highlighting a couple dozen potential leaders to subscribers, I've mostly been cooling my heels, waiting patiently for the Tides to give a green light. For the most part, that has once again been the right move--while some leaders have lifted off in recent days, few have really made big moves (especially after Monday's reversal lower) and some have pulled back into their bases. If we get a Tides buy signal in the days ahead (we're close), my guess is that there will be plenty of good opportunities to make money.
The Cabot Tides appear in our flagship newsletter, Cabot Market Letter, which I'm the editor of. Subscribe today to get the Cabot Tides latest reading, along with that of our other two market timing indicators and recommendations for the market's top growth stocks.
Switching gears, I wanted to write briefly about getting started in chart reading. I've found that most investors make a few mistakes early on that can be easily avoided.
The first mistake is that some investors try to become jacks of all trades ... and end up being masters of none. What I mean is that novices will focus on way too many indicators and time frames. First they look at the RSI Index and the Slow Stochastic. Then they add on the MACD. Then add on 5 different moving averages (including exponential and simple moving averages). Then they add on Bollinger Bands. Yikes!
This is just way too much information, most of which will be too short-term and too contradictory. You should approach reading charts like you should approach learning to golf--you don't go out and hit every club two or three times. No, you focus on a couple of irons (or maybe your driver) and try to develop some consistency with them. Then you work on some other clubs. In other words, it's a step-by-step process.
With charts, I can tell you that, to this day, I only have four things I look at regularly--price, volume, two moving averages (25-day and 50-day simple) and relative performance lines (how a stock is doing compared to the market). That's it. Now, I'm not saying my way is THE right way to look at charts, but I just want to show that it's usually better to have less on your chart. So keep it simple, especially in the beginning.
Another mistake to avoid is that you should never assume that charts are going to do something they can't--predict the future with certainty. Realize the chart is simply a current look at a stock (or sector's or market's) current supply and demand situation, not a crystal ball. Yes, examining charts can help put the odds in your favor, but there are no sure things in the market, and a chart's picture can change quickly.
In total, chart reading is a skill you need to learn if you're going to be a successful growth stock investor over the long haul, and keeping things simple, and realizing what charts can do (put the odds in your favor) and can't do (predict to the day what will happen) will help you get off to a good start in your education.
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As for the market, I already mentioned that we're on the verge of a new buy signal, and if we get one, I'll be putting some money to work. However, right now is one of those times when I don't have a super-strong conviction about what's likely to come.
On one hand, the market has built a decent-looking bottom during the past few weeks, and there are a few dozen potential leading stocks with good growth stories that resisted the market's May-June correction.
On the other hand, the broad market and even the charts of the major indexes are in rough shape, and this latest upmove has come on super light volume; even the biggest volume day (last Tuesday, June 15) saw the Nasdaq's total volume 12% below average. So it's hard to really have faith that big investors are piling into stocks.
So what do you do? First, you follow the system--as I said, if our Cabot Tides turn bullish, I'll be putting some money to work. However, I think taking a gradual approach is the best course of action. That means buying two or three small positions ... maybe half your normal investment, dollar-wise.
Then, over a few days, if the market is acting well and your stocks are making you money, you can buy a little more, either of your current holdings, or new purchases. After two or three weeks, if all goes well, you'll be heavily invested in some strong stocks. Of course, if the rally peters out (failures usually occur quickly and violently, so it won't be hard to notice), you won't get heavily invested; you'll stop buying if your stocks aren't showing you a profit.
One tiny company I'm keeping my eye on is Rubicon Technology (RBCN), which isn't a household name, but is helping to lead the way forward in the LED industry. Here's what I wrote about the firm in Cabot Top Ten Report earlier this month:
"If MEMC Electronic Materials was the raw material supplier (silicon) that benefited greatly from the solar and chip boom of the 2005-2007 period, then Rubicon looks like the winner in supplying raw materials (in this case, sapphire substrates) for the current and upcoming LED boom. The company is a leader in producing these substrates in the Western hemisphere, and is the world leader in larger sapphire wafers, which the industry is moving toward (and which have significantly higher barriers to entry than smaller wafers). The stock is strong today because demand is miles ahead of supply--LEDs in notebooks, networks, LED monitors and TVs are using more and more LEDs, and the industry is racing to expand capacity to meet that demand. That, indirectly, is pushing prices for Rubicon's wafers up; prices roared ahead 20% sequentially in the first quarter, and management sees higher prices going ahead. Revenues have soared the past couple of quarters and the firm just booked its first profitable quarter in two years. Eventually, this industry will over-expand and prices will fall ... but management believes that's at least a couple of years off. In the meantime, we see major growth ahead."
Since that time RBCN has broken out powerfully from a choppy base, successfully completed a share offering and, importantly, has refused to give up ground during this week's slide in the market. The stock is relatively thinly traded, but business is picking up in a big way, and if the LED trend continues for a few more quarters, Rubicon will have a bright future. I think a little could be bought around here, or preferably, on a pullback toward 30.
All the best,
For Cabot Wealth Advisory