Market Timing - Lesson 2

It has been said that timing is everything. In investing, market timing may not be everything, but it is a big thing. By using market timing strategies, you can identify the best times to buy and sell a stock, thereby maximizing your profits.

Finding a great growth stock and getting in on the ground floor can be like finding romance. It’s full of intangibles and mystery. It can be exciting, with even your greatest expectations exceeded. And pleasant surprises just keep on coming, often convincing you that the good times will never end.

Where do we find this romance? It’s usually concentrated in the market highfliers (including some of our Cabot Market Letter recommendations). Thousands of investors simply cannot understand why certain young growth stocks soar month after month to astronomical valuation levels for no apparent reason. Often, these stocks have growing sales but no earnings. The product or service may not be well understood by the masses. And yet, the stock continues to advance past everyone’s wildest expectations. “What does he see in her?” you might wonder.

An old Wall Street adage, one that we’ve found as useful as any, explains this phenomenon: A stock, like love, thrives on romance and dies on statistics. There are plenty of investors out there who are able to understand the long-term potential for the aforementioned growth companies. These investors see something exceptional and even revolutionary that other investors miss, and are willing to buy and hold onto the stock, even at prices that appear to be completely unreasonable and unjustifiable to other investors.

It isn’t until much later that the romance fades. At this time, the mystery and sexy expectations are replaced by cold, hard facts. This reality, even though it may be exceptional, seldom matches the dream. Reality, in fact, tends to suggest limitations. And that’s when the early investors usually jump ship, pushing the stock down and ending its run to record heights.

So how does all this help you make money? Our studies over the years have convinced us that you can make a great deal of money from a stock in its romance phase, before most investors realize the full thrust of the company’s story. If you wait for reality and a slew of fundamental facts (like growing earnings and a knockout of all competitors) to pour in, chances are you’re too late; the stock has already factored in the great news you’re now reading.

Our advice is to look for exciting growth companies that are presently in their romance phase. Once invested, your job is to exit your position at the end of the stock’s romance phase, when, frankly, all of the news is usually excellent. The fundamental facts will begin to support the stock’s lofty price, and investor sentiment regarding the company will be outstanding. However, you’ll notice the stock price and the relative performance (RP) line gradually eroding, unable to reach new highs. (Relative performance measures the stock’s performance relative to the market as a whole—see Lesson 5.) Over a period of weeks, if the RP line falters, you’ll know the romance has ended, and reality is taking over. At this point, you’ll want to sell the stock and look for your next love affair.

Mike Cintolo uses Cabot’s market timing indicators to analyze stocks in Cabot Growth Investor and Cabot Top Ten Trader.

Next: How to Make Money in the Stock Market

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