The King of Storage
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I remember reading an article on trading psychology a few years ago that researched which of four scenarios was the least stressful after an initial purchase of a stock—a quick, big loss; a gradual, slight decline; a gradual, slight rise; or a quick surge higher.
While most people would think that either of the latter two scenarios would cause the least stress—after all, the trader would have a profit in each case—it turns out that the second scenario (a gradual, tame decline) is actually the least stressful. Why? Because, after making the commitment, a small decline requires no action—the trader isn’t going to sell, as the loss is small and the story is still intact. Thus, because no action is needed, there’s less stress.
Contrast that to the recent market environment. If you’ve been following any sort of trend-following system like ours, you began buying at least a couple of weeks ago and have seen many of your holdings skyrocket, sometimes in dazzling fashion. Again, you would think such a scenario would be the least stressful—most investors have made good money in a short time!
But as it turns out, drastic market moves (in either direction) cause the most market stress. Again, the reason has to do with decision-making: A drastic move, even if it’s up, causes investors to consider taking action. Should they buy more? Sell some? Sell it all? The potential of taking action—buying or selling—is one of the main sources of investment stress.
What’s so bad about investment stress, you might ask? Nothing really—I’m not suggesting that having a few stocks make big movements will ruin your home life or cause you to wake up in a panic at 2 a.m. However, the real downside of feeling stressed is that it comes out … in your decision-making! Ironic! Said another way, the potential for making a decision causes stress, which can in turn causes you to make poorer decisions.
I’m convinced this is true, and is one reason why so many investors, even those who are fairly knowledgeable about the market, produce so-so returns (or worse) over time. Many investors get caught in this cycle of stressing over what to do, making a poor decision (say, selling out a powerful leading stock early in its advance to “lock in a profit”), which then leads to more poor decisions (say, chasing that same leader a few weeks later when it’s well extended).
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Of course, there must be a solution, or else everyone would fail. Part of the solution is to simply accept the following fact: Investing is really a business about making decisions. Sometimes you buy, sometimes you sell and sometimes you hold, but in all cases, the successful investor knows that he or she is going to have to make hundreds of decisions during the course of the year. And I think just realizing that is half the battle.
In terms of strategy, it’s all about planning. To paraphrase one successful investor, you can’t predict what the market or your stock is going to do, but you can be prepared for all the eventualities of what your stock could do. In other words, you need to think ahead of time what you might do if your stock falls sharply, or if it bolts to the heavens, or if it just sits there and does nothing for five weeks. And then follow the plan!
Personally, I don’t have rules for three or four different possibilities for each stock written out. But I think a good start for most investors is to have a line in the sand where you would sell the stock should things go awry. That, at least, helps you define your risk … which will definitely lessen any stress.
In fact, to me, quantifying my risk (“If all hell breaks loose tomorrow, and all my stops get hit, how much will I be left with?”) is one of the great liberating exercises for my investment mind—on one hand, it forces me to take a hard look at my stocks, but it also
allows me to think more calmly during those inevitable days when the market, or one of my stocks, is getting taken to the woodshed.
Another relatively simple tactic is something I’ve written about many times before—track your results and your portfolio, so you know where you stand. Again, it’s about eliminating the unknowns, and knowing some details (How much are you up this year? This month? How much cash do you have on the sideline?) so that you can make a rational decision when the time comes.
Back to the current market. My major thought process at this point is that considering the market’s September advance–which, remember, is coming on the heels of a four-and-a-half month, 17%-20% correction—has been so strong and so persistent that, at least for the best leading stocks, I believe any coming weakness is buyable.
Now, that doesn’t mean that if a big leader falls 20% on its earnings report next month, you buy. No! I’m talking about reasonable weakness … those normal pullbacks of 5% to 10% that can take place over a couple of weeks. The “good” news for investors looking to do new buying is that earnings season usually brings volatility, and many leaders are beginning to look a little tired, which is normal after their straight-up rallies of the past few weeks.
One stock I think is definitely worth keeping an eye on is NetApp (NTAP). To me, this stock is one of a dozen or so “liquid leaders”—those stocks that trade hundreds of millions of dollars every day, so you know big institutional investors are trafficking in the stock. Granted, it doesn’t have the name recognition of Apple or Baidu, but it has nearly as much potential.
Why? Because it’s developed into the King of Storage, which, in this new cloud computing world, is a great thing to be. Here’s what I wrote about NetApp in Cabot Top Ten Weekly on September 13:
“On one hand, NetApp is a data storage company, and we know from experience that data storage stocks that fly to the sun often crash and burn. On the other hand, NetApp is at the heart of the biggest driving force of information technology buying today, the move to cloud computing. As this movement evolves, more and more institutions and individuals are finding that they can lower costs and increase productivity by storing their data somewhere in the cloud, and by using applications that are hosted in the cloud. And the simple fact is that no one knows how far this trend will go. As students of trend analysis, we know that trends typically go further than people expect, and thus we think the movement toward cloud computing—and NetApp—can go very far indeed. Revenues at the company have grown every year of the past decade, while earnings have grown every year save for 2009, and now earnings are roaring back. Profit margins in the second quarter were the highest in more than three years!”
The stock has been one of the best performers since the market blasted off at the start of September, which portends higher prices down the road. Like many leaders, NTAP is a bit extended to the upside here, but I think any pullback of a couple of points will be buyable.
Click here to learn more about NetApp and the other leading stocks featured in Cabot Top Ten Weekly.
All the best,
For Cabot Wealth Advisory