Three Ways to Become a More Successful Investor
Apple Has Bottomed, But Should You Buy It?
One High-Potential Young Stock
When I was young, I wanted to be a brain expert … but I didn't particularly like medicine. What I've found more interesting and intelligible over the years is psychology, and that's come in mighty handy in the investing business.
Psychology, of course, is what moves stocks. Sure, the media will pretend that it's fundamentals that move stocks, but it's not. Fundamentals don't buy and sell stocks; people buy and sell stocks. And people, as we all know, are not always rational.
But people can be taught! Ideally, you get a great education when you're young, because the younger you are, the more teachable you are. But there's no reason that you can't learn at any age, given sufficient motivation and perseverance.
For this knowledge, we are indebted to those brain experts who did go through medical school, and who continue to discover more about the amazing bundle of nerves we carry inside our skulls.
They tell us that when we're young, the brain is amazingly malleable, that it's a cinch to learn French when you're six years old. And they tell us that as we age, learning new skills gets just a little bit harder every year.
But we are always capable of learning, and what typically fades before the ability to learn is the desire. We get set in our ways. We get comfortable. And we see little benefit to doing things differently than we've done before.
But I'm a strong believer in life-long learning. And today I'm going to give you three lessons on becoming a better investor.
Note: It’s not enough to just read the list and say, "Yeah, I'm going to do that." To learn these habits, you have to practice them. You have to put in the time. In essence, you have to train your brain to think in new patterns.
It's the same thing in any profession.
The more a baseball player takes batting practice, the more efficiently he makes the necessary connections in his brain, and the better his hand-eye coordination, reflexes and the like. They call it muscle memory, but it all happens in the brain.
The same is true of a piano player; he's using small muscles instead of big muscles, and he's also using the part of the brain that recognizes tempo, pitch, tonality, rhythm and more.
It's true of the geologist interpreting seismic data in a hunt for oil.
And it's true of the mailman, who learns the names and addresses on his route by simple repetition, whether he tries to or not.
In brief, all this learning happens because neurons in the brain produce impulses, which carry tiny electrical currents. These currents cross the synapses between neurons with chemical transporters called neurotransmitters, and the more often the same paths are used, the more efficient those pathways become.
Unfortunately, pathways left unused get progressively less efficient, which is why if you've never learned a foreign language, you're going to have a heck of a time doing it once you're past middle age.
So here are the three habits that will make you a better investor.
One: Learn to keep your losses small.
Think of investing as a pinball game at the arcade. You pay an entry fee, and as long as you have credits, you can continue playing. If you're good, your credits increase. But if you fail to make the right moves, and your credit drops to zero, you can't play anymore. In the investing world, where the credits are real dollars, you never want that to happen. So when the trend turns against you, you sell and take a loss.
When you take a loss, the world doesn't end. You're left holding cash, which is a very good thing, and that cash is the entry fee to the game's next round.
Sure, taking losses means admitting you were wrong, and that's a tough thing to do the first few times. But with practice, your ego learns to let go. You accept that small losses are necessary if you're going to have the entry fee for the next game. And you learn to take losses quickly and easily.
Sometimes stocks you sell will bounce back and move on to new highs. That's life. But the key is getting out of that one stock that just keeps falling and falling. Lost opportunity is far less painful than lost money, so learn to sell quickly.
Two: Learn to look at charts.
We're all raised as fundamental thinkers, and thus most investors focus on fundamentals, reasoning that if a company has growing revenues and earnings, its stock should increase.
But stocks do not move on fundamentals alone. They move because of hopes and dreams, fear and greed. And the best way to see how investors are feeling is to watch the charts.
Now, chart-reading is not easy. And it's not a perfect science; there is no perfection in investing. But the more charts you look at, the more you come to recognize the patterns and rhythms that matter. We call it "looking for familiar faces," or patterns that we've seen before that usually lead to an upmove or a downmove. Over time, charts become your friends, and if you look at enough of them, over time, you'll one day find that you are unable to buy a stock without first getting a good look at its chart.
Three: Learn to imagine how big success might be achieved.
Over the years, some of Cabot's best winners have come from companies that provided a revolutionary product or service to the mass market. A decade ago it was Amazon (AMZN), which started by selling books but eventually came to sell almost everything. If you had the foresight at the beginning to see that possibility, you might have been an earlier buyer of Amazon!
More recently, Tesla Motors (TSLA) has been a big winner for readers of Cabot Stock of the Month, in part because I saw big potential in its revolutionary products and in part because I believed in the chart, which was uptrending when I first recommended it more than a year ago.
Admittedly, it's not easy to think creatively about where companies might go. But when you do, you'll find that you can more easily justify investing in revolutionary companies, and that's where some of the biggest profits are made. So practice it . . . starting today. Look at each stock in your portfolio and ask yourself, "What are the growth opportunities for this company?"
With practice, you'll train your brain to more readily identify these big profit-makers, and you'll find yourself being an early buyer of revolutionary world-changing companies.
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Which brings us to Apple.
Apple (AAPL), as most investors are aware, is now 40% off its high of last year. That fact alone makes it a bargain in some investors’ books. But I don’t like to buy stocks just because they’re cheap; I like to buy stocks because they’re going up—and if they’re cheap, so much the better. So is Apple going up or not?
Consider this chart of AAPL’s daily trading action.
You can see the big high-volume drop in late January, when first quarter earnings were disappointing. And you can see the same thing again three months later, when second-quarter earnings disappointed again and the stock hit a low of 382.
But look at the pattern since. There’s a higher low at 420, which mirrors the low of early March. And there’s a higher low—just last week—of 430, which mirrors the low of the late-January sell-off.
In short, the odds are good that AAPL has just built a reverse head-and-shoulders pattern. (The head is at 390, the shoulders at 420 and the biceps—impressive but not required—are at 430).
So the odds are very good that Apple could see upside from here.
But should you buy it?
I say probably not, and here’s why.
Many of the people buying Apple today are doing so with the memory of the stock as a great investment. They want to relive those days, whether they profited the first time around or not.
But AAPL is not only one of the most well-known brands in the world, it was also the most popular stock in the world not long ago. And it was the tiny decrease in that popularity, more than anything else, that kicked off the stock’s downtrend. So one question to ask yourself now, if you’re considering investing in Apple, is this: “Who is going to be buying this stock and driving it back up?”
It won’t be people who are just learning about the business, which is often a great driver of young stocks, and it won’t be people who are developing a better opinion of the company. So who does that leave? Only bargain-hunting professional investors. Yes, they can do the job alone, but not as well. In short, I’d rather have a stock that can benefit from the actions of all those factions.
So, instead of buying Apple, because of its past great products and past great history as an investment, what I recommend instead is trying to find the next Apple, the next great growth stock that captures the investing public’s attention.
That takes some imaginative thinking, and it’s easier to simply remember the past (see tip number Three above). But if you try, you might find something like the stock recommended below.
The company is Yelp, and its symbol is YELP, which is easy to remember. Here’s what Mike Cintolo wrote about it back on May 5 in Cabot Top Ten Trader.
“The company is becoming the 21st century, interactive version of the yellow pages; it’s essentially the de-facto search engine that connects local businesses with consumers who are ready to buy. One study showed that just having a decent presence on Yelp can boost sales by about $8,000, with that number tripling if it’s combined with marketing efforts. All of this is leading to more businesses signing up, which is attracting more individuals to the site, which is leading to greater and greater advertising opportunities. Revenue growth has been rapid, as has the growth in reviews (now 39 million, up 42% from a year ago), monthly unique visitors to the site (102 million, up 43%) and active local business accounts (45,000, up 63%). These days, much of the viewership is taking place on mobile devices, and Yelp has a burgeoning business in that area; 45% of the firm’s searches in Q1 came on mobile devices, and Yelp’s mobile app is used on more than 10 million devices. Today, most of the revenue is in the U.S., but the company now has operations in 21 countries (New Zealand is the latest), so there’s every reason to expect years of growth ahead. Earnings remain in the red, but that’s because management is investing; cash flow is already positive and the bottom line should hit the black during the next couple of quarters. With competition at bay (Yelp is the hands-down leader in content and viewership), we think this is a good, sustainable growth story.”
In sum, Yelp has a great growth story. Yet as a company, it has nowhere near the mind-presence or reputation of Apple. But as millions more people use its site, it might get there! And in that POTENTIAL for increased perception lies the potential for great stock performance.
So, you could simply buy the stock right here—it’s been holding nicely above its uptrending 50-day moving average—but you’d be on your own. What I recommend instead is that you take a risk-free subscription to Cabot Top Ten Trader, to get Mike’s latest insight on the stock, and many more like it.
Yours in pursuit of wisdom and wealth,
Editor of Cabot Stock of the Month