Three Rules for Being an Investing Optimist


Stock Market Video

Three Rules for Being an Investing Optimist

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In this week's Stock Market Video, Mike Cintolo believes the market has shown a few signs of resilience of late. Mike names about a dozen resilient stocks (some of which are on his watch list) that are near resistance areas-if a few burst higher, it would be the first sign that institutional investors are growing bullish. Click below to view the names of resilient stocks.


Three Rules for Being an Investing Optimist

You might think that it would be easy to be an optimist when markets are going up. But I'm here to tell you that some investors find themselves absolutely paralyzed by a bull market.

The main worry that pops up for investors when stocks are on a roll is the fear that they may have already missed the opportunity. And the higher the market goes, the greater the anxiety and regret. If I had a nickel for every time I've heard someone say during a bull market "It's too high; I've already missed it," I'd have a lot of nickels. And that goes double for individual stocks that have made big gains after a good earnings report. Right now, markets are in a volatile state and growth stocks are falling out of favor as investors swerve toward income stocks and the energy sector. So, in the minds of many investors, that's another strike against optimism. But they're wrong, and I'll tell you why.

A bear market actually creates opportunities for investors with their heads on straight, whether they favor growth or value. Everybody loves a bargain, no matter how they calculate it. (All I can say to any index investors whose net asset values go down during corrections is that time will probably eventually bring your portfolios around too. Be patient.)

For growth investors, the periods of declining prices that follow big rallies are harvest time, when the market reaps its latest crop of hot money. As bull markets mature, more and more investors, including many novices and enthusiasts, are pulled off the sidelines by the reports of big gains in stocks. And as these latecomers bid prices up, value investors peel off, selling their now fairly priced stocks. Then, as the last wave of hot money arrives, markets start to tip over and growth investors start to take their profits, leaving the newbies to watch as their stocks head lower and lower.

It's like the California Gold Rush. The first people who discover the gold field pick up the nuggets. The second wave of prospectors pans out the gold dust. And the third wave pays inflated prices for the now-depleted claims. Not a pretty picture.

But I'm being depressing. Here are three rules that will keep you on the right side of the market. As I think of them, they are the Three Rules for Being an Investing Optimist.

Rule #1: Follow the Market.

By following the market, I mean that you need to know what markets are doing right now. This has nothing to do with predicting market movements or anticipating bull moves. And the best way to follow the market is to look at how an index is performing relative to its 25- and 50-day moving averages. The S&P 500 Index and the Nasdaq Composite Index are two good choices.

If the index is above those moving averages and the averages themselves are trending up, it's a bull market. And the sooner you notice this, the closer you will be to the picking-up-nuggets end of the Gold Rush. Bull markets improve the odds of advancement for all kinds of stocks. Bulls make stock pickers feel smart. And they make them money.

At Cabot, we take young bull markets very seriously. When markets first turn positive, we start small, buying stocks of companies with good stories, good charts and solid fundamentals. If the market turns sour again and our first picks don't do well, we back away. But if those first stocks make money for us, we continue to increase our exposure, allowing our profits to pull us into heavier positions.

Rule #2: Know When to Put the Hammer Down.

If you had moved into the market in early 2012, you probably would have been shaken out of your positions during the big correction in April and May of that year. You would have stepped back into the market in August and September, then exited during the October/November pullback. But you would have gotten back in early in 2013 and you would have been treated to a powerful rally that lasted until the end of February 2014.

And if you had known how to increase your exposure to growth stocks during that long rally, you would have had a chance to pick one or more of the 20 stocks that appreciated by 300% or more during that calendar year. (These were solid stocks too, not flash-in-the-pan penny stocks.)

Growth investors historically make the bulk of their gains in just a few stocks each year, and being an optimist who recognizes the importance of putting substantial money to work during big rallies can have a huge effect on your results.

Rule #3: Learn How to Get Out of the Way.

Being optimistic in bear markets is great, but it may be a little counterproductive if you start to believe that you can pick winners and make money no matter what the market is doing. If you refuse to acknowledge that a down-trending market shifts the odds from in your favor to against you, the market will be happy to give you a schooling.

The right way to be optimistic in a down market is to be heavily in cash in your portfolio and to avoid big losses in your holdings. If you have your protective stops in place and abide by them, you keep losses small, which ensures that you will have a longer line to swing when markets turn back up. Having a big cash position during a bear market is like sitting by the fire while you watch a bad storm rage outside. How does this make you an optimist? It makes you one because you know that all storms eventually blow themselves out and all bears eventually leave town. And when that happens, you will have a nice, fresh supply of gold nuggets that always await those who recognize when the bulls are back in charge.

If all this sounds a little too fairy tale cute for you, let me put it a little more bluntly.

Save your money. You're going to need it when the #!%@*+ bulls take charge again!


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Here's this week's Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion buttons here.

Tim's Comment: The most common mistake of beginning investors is holding onto losers in the mistaken belief that the market is somehow wrong. But the market is never wrong, and the sooner the investor learns that success comes from listening to the market and admitting you're wrong-like George Soros-the more quickly he learns to put his mistakes behind him and move onto new opportunities.

Paul's Comment: I have great sympathy for those who buy a stock and watch while it bumps downstairs day after day. I know that, for many beginning investors, buying is such a big step that they have to really believe in the stock just to get their nerve up and hit the "BUY" button. It's hard to back off from that kind of emotional and intellectual commitment. But it's something you have to learn if you're going to follow the growth investing style.


In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 4/28/14 - Why Apple's Stock Split Will Help-Temporarily

Tim Lutts, Chief Analyst for Cabot Stock of the Month, writes about the boost Apple (AAPL) stock will get from the company's stock split, and why it won't really matter in the long run. He also looks at some reaction from his U.S./Canada merger proposal. Stock discussed: WhiteWave (WWAV).

Cabot Wealth Advisory 4/29/14 - 6 Price Multiples to Determine a Stock's Value

Cabot's value investing expert and Chief Analyst of Cabot Benjamin Graham Value Investor Roy Ward explains how he uses six yardsticks to uncover undervalued stocks that offer strong profit opportunities.

Cabot Wealth Advisory 5/1/14 - How to Use Options to Limit Your Risk

Cabot Options Trader's Chief Analyst Jacob Mintz writes in this issue about the perils of trying to buy stocks on the way down. But he points out that using call options can give you bullish exposure to some out-of-favor growth stocks with much less capital at risk than going long.

Have a great weekend,

Paul Goodwin
Chief Analyst, Cabot China & Emerging Markets Report
and Editor of Cabot Wealth Advisory

Paul Goodwin can be found on Google Plus.

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