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July 23 - July 25, 2021
My philosophy and approach to trading is to be a conservative aggressive opportunist. Although this may seem like a contradiction in terms, it is not. It simply means that my style is to be aggressive in my pursuit of potential reward and at the same time be extremely risk-conscious. Although I may invest or trade aggressively, my primary thought process begins with “How much can I lose?” not just “How much can I gain?”
Most people get interested in trading but few make a real commitment. The difference between interest and commitment is the will not to give up. When you truly commit to something, you have no alternative but success.
The best traders wake up every day excited about trading and speculation. They can’t wait to get to work each day and find their next superperformer. They are challenged by the markets and feel the same passion and excitement that drives athletes to greatness.
For me, the greatest success came when I finally decided to forget about the money and concentrate on being the best trader I could be. Then the money followed. Those of you who enjoy investing and the art of speculation can learn the techniques and disciplines needed to succeed in the stock market. Concentrate on being the best you can be, and the money will follow. The main thing is to let your passion drive you.
To realize profits from investing in stocks, you must make three correct decisions: what to buy, when to buy, and when to sell. Not all of your decisions will turn out to be correct, but they can be intelligent.
As with any great achievement, superperformance is attained through knowledge, persistence, and skill, which is acquired over time through dedication and hard work. Most of all, long-term success in the stock market comes from discipline, the ability to consistently execute a sound plan and refrain from self-defeating behavior.
My first experience investing in the stock market was with a full-service stockbroker in the early 1980s, and it wasn’t pleasant. In a few short months my entire account was wiped out. Although this was painful and a major setback financially, it turned out to be one of my most valuable lessons about investing.
In hindsight, this broker did me a very big favor. It was precisely at that point that I decided to do my own research and trading; I vowed I would never again surrender my investment decisions to someone else. If you aren’t prepared to invest a good portion of your time before you invest your money, you’re just throwing darts. At some point, you will surely be taken to the cleaners.
Have confidence in your ability. Learn to do your own research and think for yourself. Your own resources are far superior to outside research, tips, and so-called expert opinions because they’re yours and therefore you can keep tabs on them. No one cares about your money and your future as much as you do. Do the work, own your failures, and you will own your success. No one is going to make you rich except you.
My style, in contrast, was to buy new, relatively unknown companies on the rise. I demanded that they be in a price uptrend, and if they went down much below my purchase price, I would sell them. At least that was the plan.
Both opportunities and perils surface suddenly in the market. It takes swift, resolute action to exploit one and elude the other. Nothing can unravel a trader’s courage more than a huge loss in a stock trade. It wasn’t until I suffered enough big losses that I made the decision that turned my performance from mediocre to stellar: I decided it was time to make money and stop stressing about my ego. I began selling off losing stocks quickly, which meant taking small losses but preserving the lion’s share of my hard-earned capital. Almost overnight, I regained a feeling of control.
Now I was analyzing my losers and learning from them. I saw my portfolio with fresh eyes and finally began to understand that trading is not about picking highs and lows or proving how smart you are; trading is about making money. If you want to reap big gains in the market, make up your mind right now that you are going to separate trading from your ego. It’s more important to make money than it is to be right.
Any pattern of action repeated continuously will eventually become habit. Therefore, practice does not make perfect; practice only makes habitual.
The reason most investors practice incorrectly is that they refuse to objectively analyze their results to discover where their approach is going wrong. They try to forget the losses and keep doing what they’ve always done.
Trading stocks and running a business are virtually identical. In fact, to be successful, you must trade just as if you were running a business. As an investor, your merchandise is stocks. Your objective is to buy shares that are in strong demand and sell them at a higher price. How much of a profit margin you make will depend a lot on the type of business (portfolio) you are running. You may be like Walmart, which operates on very small margins but does a tremendous amount of volume with high inventory turnover. Or you may be like a boutique that offers unique and trendy merchandise and earns
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This is the exact opposite of what we know to be a key factor for superperformance: a relatively small number of shares in the float.
In my experience, attaining superperformance in stocks comes from doing things that are different from what is obvious or popular. This is often misinterpreted as risky. Applying conventional wisdom produces conventional returns, not superperformance. If success were as easy as acting like everyone else, we could become rich by mimicking the crowd.
Odds are that you won’t be the best value trader, the best growth trader, the best day trader, and the best long-term investor. If you try to do it all, you will most likely end up a mediocre jack-of-all-trades.
When it comes to stock trading, I know no one who, for example, can successfully trade value in one cycle and then switch to growth the next or be a long-term investor one day and then a day trader to suit the market du jour. To become great at anything, you must be focused and must specialize.
The average trader spends the majority of his or her time vacillating between two emotions: indecisiveness and regret. This stems from not clearly defining one’s style. The only way to combat paralyzing emotions is to have a set of rules that you operate from with clearly stated goals. You simply must make a decision: Are you a trader or an investor? Some people have a personality best suited for trading, and some prefer a longer-term investment approach. You will have to decide for yourself which is best for you. Keep in mind that if you fail to define your trading, you will almost certainly
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If you are a short-term trader, recognize that selling a stock for a quick profit only to watch it go on to double in price is of no real concern to you. You operate in a particular zone of a stock’s price continuum, and someone else may operate in a totally different area of the curve. However, if you’re a longer-term investor, there will be many times when you make a decent short-term gain only to give it all back in the pursuit of a larger move. The key is to focus on a particular style, which means sacrificing other styles. Once you define your style and objectives, it becomes much easier
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Remember, if you choose not to take risks, to play it safe, you will never know what it feels like to accomplish your dreams. Go boldly after what you want and expect some setbacks, some disappointments, and some rotten days. Embrace them all as a valuable part of the process and learn to say, “Thank you, teacher.” Be happy, feel appreciative, and celebrate when you win. Don’t look back with regrets at failures. The past cannot be changed, only learned from. Most important, never let rotten days make you give up.
Love’s findings convinced me of three empowering points: 1. There is a right time and a wrong time to buy stocks. 2. Stocks with superperformance potential are identifiable before they increase dramatically in price. 3. By correctly investing in these stocks, it is possible to build a small amount of capital into a fortune in a relatively short period.
Among them was The Relative Strength Concept of Common Stock Price Forecasting by Robert A. Levy, which helped me banish the “buy weakness” mentality and was instrumental in my new approach of focusing on strength. Then there was Edward S. Jensen’s Stock Market Blueprints, published in 1967. Jensen’s book included his blueprints for each type of stock, which were based on criteria such as income, growth, cyclical growth, and dynamic growth.
Donchian is considered the creator of the managed futures industry. He developed a rule-based trading approach that became known as trend following. Among his principles was the buying and selling of stocks when the 5-period moving average crossed above and below the 20-period moving average.
From Love, I learned historical precedent analysis and the commonalities of superperformance stocks; from Jensen, blueprinting and profiling; from Donchian, trend following; and from Jiler, chart patterns, including his famous saucer with platform, which is now known as the cup-and-handle pattern, popularized by William O’Neil, who also worked at Hayden Stone in the 1960s.
The focus is not just on the magnitude of a price move—how much a stock goes up—but also on the time element of the equation: how fast it goes up and what accounts for the rapid rise. In the stock market, timing is crucial because time is money. When screening my database, I compare each stock candidate to how well it fits the optimal Leadership Profile and rank it accordingly.
SEPA combines corporate fundamentals with the technical behavior of a stock.
Trend. Virtually every superperformance phase in big, winning stocks occurred while the stock price was in a definite price uptrend. In almost every case, the trend was identifiable early in the superperformance advance. 2. Fundamentals. Most superperformance phases are driven by an improvement in earnings, revenue, and margins. This typically materializes before the start of the superperformance phase. In most cases, earnings and sales are on the table and measurable early on. During a stock’s superperformance phase, a material improvement almost always occurs in the fundamental picture with
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The SEPA ranking process can be summarized as follows: 1. Stocks must first meet my Trend Template (see Chapter 5) to be considered a potential SEPA candidate. 2. Stocks that meet the Trend Template are then screened through a series of filters that are based on earnings, sales and margin growth, relative strength, and price volatility. Approximately 95 percent of all stocks that qualify under the Trend Template fail to pass through this screen. 3. The remaining stocks are scrutinized for similarities to my Leadership Profile to determine whether they are in line with specific fundamental and
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I execute a trade only at the point of alignment across the spectrum with regard to company fundamentals, stock price, and volume activity as well as overall market conditions.
Over the years, I’ve concluded that most superperformance stocks have common identifiable characteristics. In the majority of cases, decent earnings were already on the table. In fact, the majority of superperformance stocks already had periods of outperformance in terms of fundamentals as well as technical action before they made their biggest gains. More than 90 percent of superperformance stocks began their phenomenal price surges as the general market came out of a correction or bear market. Interestingly, very few stocks had superperformance phases during a bear market.
Generally, a superperformance phase occurs when a stock is relatively young, for example, during the first 10 years after the initial public offering (IPO). Many superperformers were private companies for many years before going public, and when they finally did, they had a proven track record of earnings and growth. Some superperformance companies already established successful product lines and brands before coming public.
During the bear market correction of the early 1990s, I focused on stocks that were holding up well and then moved into new high ground first off the market’s low. Most of the names I traded were relatively unknown at the time. These stocks were propelled by characteristics such as big earnings growth and strong product demand.
Most companies have their high-growth phase when they’re relatively small and nimble. As they grow older, larger, and more mature, their growth begins to slow, as does the rate at which their stock prices appreciate. Superperformance stocks are often small-cap companies, although occasionally a big-cap name could see a surge in price after a turnaround or a period of depressed stock prices resulting from a bear market. Most of the time, however, it is a small-cap or a mid-cap stock that hits a period of accelerated growth, which in turn creates a superperformance price phase. Investors
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Look for candidates with a relatively small total market capitalization and amount of shares outstanding. All things being equal, a small-cap company will have the potential to appreciate more than a large-cap, based on the supply of stock available. It will take far less demand to move the stock of a small company with a comparatively small share float than a large-cap candidate.
When you are conducting quantitative analysis (stock screening), keeping it simple will serve you better than using a complicated model. You must be careful not to put too much into each screen. Otherwise, you may inadvertently eliminate good candidates that meet all your criteria except for one.
A better approach is to run separate screens that are based on smaller lists of compatible criteria, for example, one screen for relative price strength and trend and a separate fundamental screen that is based on earnings and sales. Often, as you run isolated screens, you will see some of the same names recurring, whereas a few names will appear on only one list.
Although strategy is important, it’s not as critical as knowledge and the discipline to apply and adhere to your rules. A trader who really knows the strengths and weaknesses of his or her strategy can do significantly better than someone who knows only a little about a superior strategy.
Although it may come as a surprise to you, historical analyses of superperformance stocks suggest that by themselves P/E ratios rank among one of the most useless statistics on Wall Street.
Buying a cheap stock is like a trap hand in poker; it’s hard to get away from. When you buy a stock solely because it’s cheap, it’s difficult to sell if it moves against you because then it’s even cheaper, which is the reason you bought it in the first place. The cheaper it gets, the more attractive it becomes based on the “it’s cheap” rationale. This is the type of thinking that gets investors in big trouble. Most investors look for bargains instead of looking for leaders, and more often than not they get what they pay for.
Most of the best growth stocks seldom trade at a low P/E ratio. In fact, many of the biggest winning stocks in history traded at more than 30 or 40 times earnings before they experienced their largest advance.
Most of the time money in stocks is lost not because the P/E was too high but because earnings did not grow at a high enough rate to sustain expectations; the growth potential of the company was misjudged. The ideal situation is to find a company whose growth prospects warrant a high P/E: a company that can deliver the goods—and the longer it can maintain strong growth, the better.
Many people get confused: they think we are trading the actual companies themselves, that the pieces of paper we are trading, investing, owning, are some sort of redemptive right, a coupon that will give you certain cents off, or an ownership right that will allow you to have a chunk of the brick and mortar if not the cash in the treasury of the joint; untrue. These are, in the end, simply pieces of paper, to be bought, sold, or manipulated up and down by those with more capital than others . . . the fundamentals of the company play only a part in what moves the stock up or down.
If analyzing balance sheets were the Holy Grail for stock investing, accountants would be the world’s greatest traders. Neither is the case. There is no magic formula or mechanistic model that can reliably generate excess returns in perpetuity. Everything is relative, subjective, and dynamic.
Value doesn’t move stock prices; people do by placing buy orders. Value is only part of the equation. Ultimately, you need demand. Only the perception of value can influence people to buy, not the mere reading of a valuation metric. Without a willing buyer, stocks of even the highest-quality companies are worthless pieces of paper. The sooner you realize this, the better off you will be as a speculator.
If tomorrow the price of a stock you own fell 25 percent from your purchase price, would you feel better knowing that the P/E had fallen below its industry average? Of course not. You should be asking yourself: Do the sellers know something I don’t?
Some of the best value investors were down 60 percent or more in the bear market that started in 2007. Their experience of buying and holding “solid” companies, which had worked so well for so long, led to complacent behavior that resulted in large losses. In 2008, the overall market suffered heavy losses, with the Value Line (Geometric) Index finishing the year down 48.7 percent. The Dow was down 34 percent for the year. However, the worst-performing Value Line categories were low price to sales, down 66.9 percent; low price to book value, down 68.8 percent; and low P/E ratio, down 70.9
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My suggestion is to forget this metric and seek out companies with the greatest potential for earnings growth. Most of the time, a true market leader is a much better value than a laggard despite its higher P/E multiple. Crossing a stock off your list because its P/E seems too high will result in your missing out on what could be the next great stock market winner.
As a rule of thumb, I’m very reluctant to buy shares of a company trading at an excessively low P/E, especially if the stock is at or near a 52-week low in price. A stock with an exceptionally low P/E ratio can turn out to be real trouble. A stock trading at a multiple of three, four, or five times earnings or at a number far below the prevailing industry multiple could have a fundamental problem. The future prospects of the company may be questionable; earnings could be headed much lower. The company might even be headed toward bankruptcy.
