Admirable Qualities in Life can Cause Trouble in the Market
An Earnings Play for Next Week
On my desktop right in front of me I have a few sticky notes taped to the bottom of my monitor. A few months ago I started writing down witty market truisms whenever I read or heard them, and then putting them in a place where I can see them. It sounds lame, but every now and then when I’m stressing out about a stock or a decision (to buy or sell), one of these catches my eye and gives me some clarity.
Some examples include “It’s hardest to keep things simplest,” “Only egotists and fools try to pick tops and bottoms—which one are you?” and (one of my favorites) “In theory, theory and practice are the same; in practice they are not.” I only have a handful right now but hope to expand the list in the months ahead.
One I recently heard that really made a lot of sense to me was “Don’t believe everything you think.” The novice might view this as just a cute, self-depreciating saying that pokes fun at us fallible stock pickers. But the meaning is much deeper than that, and is the subject of my Wealth Advisory today.
Believing everything you think is, in my opinion, one of the hardest traits for investors to overcome, especially newbies.
In life, for instance, we believe that quitters never win; those who make the extra effort are usually the ones that are able to get ahead in life and accomplish seemingly incredible tasks. A person who has been successful thanks to this determination then begins investing. What happens? As soon as they have a losing trade, they start digging deeper into the stock, believing the bullish story, possibly even buying more as the stock declines.
A couple of times this might work … but eventually, this person latches on to a real loser near the start of a big downmove in the market. The stock collapses 50%, 60% or more, crushing the investor’s portfolio. As an investor, you see, it’s often better to be a quitter, to run at the first sign of adversity. Cutting losses short is important!
Another example involves being an optimist. In the long run, yes, you want to be an optimist when it comes to the market. But in the intermediate-term, you almost have to approach each trade and your investments with a bit of pessimism; calculating your stop-loss points, preparing what you’ll do if something goes wrong, etc. The investor who thinks his picks are always going to work is the one who has poor stock selection and can get ground to pieces.
One last example concerns risk. To most people, a stock that’s had a huge run-up over a period of the past few weeks or months seems too high. After all, in life, a penny saved is a penny earned; it’s good to get a bargain! But in the market, those “too high” stocks are often your leaders that can push much higher as a bull market matures.
A corollary of that involves the use of stops. Everyone preaches cutting losses short (including me), and one way to do that is to use tight stops. After all, if you only lose 4% or 5% when you’re wrong, it’s hard to get too far behind the curve. But often, using a stop that tight means you have to be exactly right on the timing (both in terms of the stock and the market) to not get stopped out on normal fluctuations. Said another way, often your risk is greater if you use very tight stops; looser stops actually lead to lower risk by allowing you to stay with a trade through a few days of adversity.
So what’s the upshot of this? Is it time to change your whole personality so you can make a few bucks in the market? Good luck with that! No, the reason I’m writing this is so that you, the investor, can think more about … how you think. Usually knowing how you think, and thus, how you react to certain situations, is key to understanding what you can do (or not do) better when it comes to the stock market.
Keep in mind that your normal tendencies as a regular person in the real world are often your worst enemy in the stock market, so try to do less “feeling” and more evaluating when taking action in the market.
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Next Week’s Economic Reports to Trigger New Profit Run
We’re only a few weeks into the New Year, and I’m seeing more momentum in the marketplace than I’ve seen in the past six months.
If our optimum technical momentum indicators are on target again, as they were throughout 2010, this is going to be THE WEEK to trade this market. Full details online now.
As to the current market, there’s no question that this market uptrend has been on thinner and thinner ice during the past few weeks. The number of stocks hitting new highs (one measure of breadth) has declined each time the indexes reach new-high ground during recent weeks. And this past Friday’s huge-volume selloff (just as the Nasdaq was trying to hit another new high) was a clear indication that the bears were making a stand.
So it’s time to get out our bearish playbook, right? Not so fast. One thought that occurred to me this past weekend is that the advance that began on September 1 has been so persistent that you just can’t count this advance out until you see definitive evidence that the trend has changed. And that means focusing on the indexes and leading stocks, not secondary indicators like sentiment or the number of new highs.
At some point, I do believe we’re going to get an intermediate-term correction, something like a 5% to 10% pullback (likely sharper among individual stocks). That correction could start very soon … or not occur for another month or two. Like I said, it’s best to stick with the action of the market to guide you. In the meantime, it’s best to watch your current holdings, and to be discerning when it comes to new buys—stick with institutional-quality stocks with good set-ups and great stories.
One stock to consider is OpenTable (OPEN), the hands-down leader in online restaurant reservations. The story is pristine, as the company is by far the top dog in the industry, and it gets paid recurring monthly fees from restaurants using its system, as well as a small cut of any diner that books a reservation using its service. The result is rapid, accelerating growth and profit margins that are going through the roof. (Third quarter sales were up 44%, earnings were up 188% and the after-tax margin was a whopping 22.9%.)
It’s also resulted in a stock that has come a long, long way—OPEN’s advance kicked off about a year ago, as it gapped up to 30 on earnings. Now the stock is around 80, so it’s clear shares aren’t exactly early in their advance. Still, I think the stock could have another leg up soon. Here’s why.
First, the stock has formed something akin to an “ascending base;” it’s had three sharp pullbacks during the past 18 weeks, but each one found support near or just below the 50-day moving average. And, also, each successive pullback came at higher prices than the prior one … hence the ascending-look to the stock’s chart.
OpenTable is reporting earnings next Tuesday (February 8) evening, which will probably make or break the stock’s near-term future. But if you see a strong move above 83 or so, I think it’s buyable. But please note that OPEN is a wild character, so if you buy, I think it’s best to keep the position smaller than normal (whatever that means to you), and to use a stop down in the mid-70s. It’s got some risk, but a powerful breakout could bring you plenty of reward as well.
All the best,
Editor’s Note: Mike Cintolo is Vice President of Investments for Cabot, as well as editor of Cabot Market Letter, a Model Portfolio-based newsletter of the best leading growth stocks in the market. Thanks to top-notch stock picking and market timing, Mike’s simple to follow and concentrated (no more than 12 stocks) portfolio has crushed the market by 14% annually since the start of 2007; he was up 24.5% in 2010. If you want to own the top leaders in every market cycle, be sure to give Cabot Market Letter a try by clicking here.