Exposing a big myth

adamJim: Hello again, Adam. Before we move onto today’s topic, can I ask your take on the political nightmare in DC currently, how it will affect markets, and what the outcome will be?

Adam: Sure- If the situation wasn’t so sad, it would be funny. The problem here is classic, both parties are suffering from myopic point of view- each side says my way is right and the other guy is wrong, instead of doing what is in the best interest of the country they are doing what is in the best interest of their party… and that doesn’t help anyone. So what we are left with is uncertainty and in many ways markets are held hostage to what is happening in DC. Thousands of people (gov’t employees) are not working, and are not getting paid, so that adversely affects the economy, which in turn may hurt corporate earnings, and then hurt stock prices down the road. Moreover, the shutdown is only one piece of the overall political puzzle and we still have the debt ceiling issue to deal with

Jim: I notice a lot of stocks and indexes hanging on a knife-edge, technically. Close to or on support.

Adam: yes, and if support breaks- then we could easily see the S&P 500 fall to 1600 for starters. Previously, one of our topics was Moving Averages- we mentioned the importance of watching the 50 dma price line because large institutions tend to defend that area, and that is exactly what is happening here for the benchmark S&P 500

Jim: Yes in fact it bounced off the 50 day yesterday…

Adam: Since the Fed meeting last week the S&P 500 fell straight down towards its 50 dma line (almost like a magnet). It briefly undercut it but promptly bounced back and is currently hovering just above it. The other important point to watch from the shenanigans going on in DC is the possibility of another downgrade in US credit. Every day that passes with the US gov’t shutdown (Hollywood can’t make this up) exponentially increases the odds for a downgrade, and that will bode poorly for stocks.

Jim: So in a nutshell, what’s your advice to traders now?

Adam: Cautiously optimistic. Remember a very big advantage individual investors have over institutions is that they do not have to be invested everyday. Most of the larger institutions are mandated by their charters to always be invested…. that’s why they have such a hard time timing markets or navigating bear markets. The individual has the luxury of choosing to get in or get out at their leisure. When they are faced with several large unknown risks it is best to move to cash then revisit after the threat has passed.

Jim: Thanks. Today I’d like to discuss an old belief when it comes to investing: “Buy low, sell high.” What’s your thoughts on that phrase?

Adam: Conventional wisdom (which is usually wrong when it comes to Wall Street) says you want to buy low and sell high. This sounds great in theory but not in practice. To borrow a term from Science, one of Isaac Newton’s laws of motion says : An object in motion tends to stay in motion until acted upon by an unbalanced force. The same is true for stocks. This is difficult for most investors to understand until they stop and really take some time to think about it. How many times have they managed to pick the exact bottom? If they are honest, the answer is almost never, but they keep trying to buy low and sell high. What they do not realize is that, in most cases, the stock is in a down trend. Trends are critical in determining which stocks to buy, because by definition, trends are the “motion” in Newton’s law. Instead of buying low many professional investors prefer to buy high and sell higher. When done right this forces you to only participate in stocks that are in strong uptrends. And if you look back and study your trades your results will instantly improve, if you ask yourself one question: Did I follow the trend? By far, one of the most common mistakes people make is that they do not follow trends, and they try to “fight the market”….and lose. Here’s a quick and very helpful exercise I do at the end of every month, quarter and year. It is called post analysis— I print out all of my trades for that period then sort them in two categories: winners (profitable trades) and losers (broke even or lost money). Then I analyze my mistakes. You will be amazed at what you learn from this process, you will learn a lot about yourself and what common mistakes you make…

Jim: Ok, thanks very much. Are there any stocks currently that you think are a case of “buy high, sell higher”?

Adam: The easiest way is to find stocks that are out performing the market and breaking above resistance (prior chart highs). They tend to offer favorable low risk entry points.

Jim: What stocks fit that bill currently?

Adam: Netflix (NFLX) is the best example. YELP & Amazon (AMZN) also work. If they close above their prior chart highs.

Jim: Great- so find that runaway train and ride it as long as you can.

Adam: Yes, key is to get in early so you don’t get caught “chasing” the runaway train. If you do miss it, then be patient and wait for secondary buy points.

 

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