Apple and Two Common Mistakes to Avoid

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Apple ( AAPL ): What's in a Name?

Two Common Investing Pitfalls

Short-Term Extended, Longer-Term Bullish

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I spend a good amount of time in my Cabot Wealth Advisories helping readers develop a set of rules and tools so that they can succeed in the market. Of course, stock picks are always nice (and I provide one in every one of my Advisories) but I also try to show people how to fish, so to speak.

That's all well and good, but I've found there's a more important factor to master than just having a set of rules or tools: It's having the ability to follow them! I'm always amazed by how many investors I correspond with who know all of the basic, sound rules of the growth stock game-cut losses short, let winners run, follow the market's trend, etc-but somehow find themselves holding onto a dog of a stock, or riding the market down for months at a time.

A perfect example of this comes from Apple. Just using some simple rules, there have been a multitude of sell signals from the stock during the past couple of months. First was the break of the 50-day moving average on October 8; admittedly, AAPL had broken that line countless times in recent years, but at the very least, it was a sign that further selling was likely.

Then came the break of the 200-day moving average on November 2 (it remained below that line for many days after). That was NOT a common occurrence; the last time AAPL traded below its 200-day line for more than a few days was in early 2009!

Then there was the fact that the stock suffered eight straight down weeks in a row ... seven of which came on greater than average volume (usually much greater). Clearly distribution!

Then came the "death cross" (not sure who comes up with these silly names) on December 10, when the faster-moving 50-day line crossed below the longer-term 200-day line. Personally, I'm not big fan of this "indicator" but it certainly told you the trend was down.

And finally you have the stock's relative performance ( RP ) line, which skidded sharply during the aforementioned eight weeks down, then hit a lower low the week of December 7 ... then again in early January ... and, of course, skidded sharply again two weeks ago.

All told, I see a stock that's in a clear downtrend, that's been vastly underperforming the market while hundreds of other stocks are hitting new highs. Yet many people still own it!

Why? For most investors, it's because they put their personal love of the company and its products ahead of the investing rules and tools they usually follow. In other words, they had the ability and the system to get out ... but human nature got in the way.

I call this the "veggie problem"-we all know we should eat veggies and get plenty of exercise ... but how many of us do it? It's the same with stocks-many of us know to cut losses short and stick with uptrending stocks, but every now and then, for some reason, we just don't.

So how can you avoid this problem? Unfortunately, there's no easy answer or else everyone would do it. First, though, I would say belief is the most important factor-if you don't truly believe that cutting losses short helps, or that taking some off the table after a break of the 50-day line is a good idea, then you won't do it consistently. To strengthen that belief, you need to learn from your personal experience; that's why I urge you to keep records of your trades and performance, study them for improvements, and then make your own rules.

Another something that could help is focusing on the process, not necessarily the result. Of course, we all watch our P&L every day or week, but really, you should focus just as much on whether you followed your system-if you do that over the long run, you'll come out ahead.

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Another stumbling block that often has investors ignoring their rules is rear-view mirror thinking-that is, investors are overly influenced by recent evidence. Frankly, I'm seeing a lot of this right now.

Obviously, we've seen a great upmove in the market so far in January, and even more so since mid-November. And, as you'd expect with that kind of action, many measures have become "overbought," whether you're talking about the number of stocks hitting new highs, the ratio of stocks advancing vs. declining, or certain investor sentiment measures-the number of bullish respondents in the American Association of Individual Investors recently hit a two-year high, for instance.

If you plot these various indicators on a chart and look at the last handful of times they reached such levels, they'll tell you that now is a pretty good time to sell stocks. That is, these indicators have last reached these elevated levels in September last year, in March last year, and during the early summer of 2011 ... all right before the market pulled back hard.

Thus, many professional investors are aflutter about this and raising some cash. And, you know what? They could be right-this could be yet another eight- to 10-week rally that peters out and leads to a tedious market pullback.

But my thought process is slightly different ... what I'm seeing is that most investors' minds are overly burdened by the chop of the past two years. I say that because if you look back further, the "overbought" readings often didn't lead to trouble for weeks, or even months! That's one reason I'm not a huge fan of such measurements, either overbought or oversold-they often work, but when they don't, they lead you astray in a big way.

Back to my original point, if you use a trend-following system, you should be generally bullish right now-that doesn't mean you shouldn't take partial profits here or there, or possibly trade around core positions. But it does mean you should be thinking of making money, as opposed to being fearful of losing all you've gained. However, because of the past two years, I'm seeing many trend followers abandon their system and preemptively cut back.

Anyway, I don't offer any predictions-like I said above, maybe cutting back here is going to prove the best thing. But I can tell you that the trend of the major indexes and the vast majority of stocks is strongly up. A pullback or consolidation can come at any time, and if the overall bullish evidence changes, I'll change right along with it. But so far, I'd rather stick with the system and remain optimistic.

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A good example of this "overbought" stuff can be seen in many cyclical stocks. On a short-term chart, many of these names have had nosebleed run-ups during the past few weeks; they're miles above support, and usually 10% to 15% above their 50-day moving averages (sometimes more!). Again, that has many investors booking profits before they're taken away.

But on a longer-term chart, I'm seeing tons of stocks and sectors emerge from 12- to 24-month basing efforts. Thus, when looking at the major trend, this looks more like a kick-off than a blow-off. That's not saying I'd be buying these stocks here, but the point is to keep your optimist's hat on and look for prudent entry points.

A good example of this comes from Chicago Bridge & Iron ( CBI ) , a construction firm that does big business in the oil and gas, chemical and, more recently, the liquid natural gas industries. Here's what I said on January 14 when I wrote about the company in Cabot Top Ten Trader:

"The oil and gas industry has been kind to construction services and infrastructure firm Chicago Bridge & Iron. The company is currently building a $2.3 billion liquefied natural gas ( LNG ) plant in Western Australia, a set of $500 million LNG storage tanks in the same area, and a $60 million LNG tank complex in Saudi Arabia. Chicago was also recently awarded a $250 million design services contract by Daewoo Ship Building & Marine Engineering. However, the real headline grabber recently has been Chicago's acquisition of fellow energy infrastructure firm Shaw Group. The $3 billion deal is moving forward after holders of 83% of Shaw's outstanding shares backed the acquisition, ending a long period of analyst speculation and concern that the deal could face resistance.

"Outside of oil and LNG, Chicago Bridge & Iron provides development and construction expertise for the water, nuclear and metals production segments as well, with this business unit accounting for half of company income. Management recently raised its revenue guidance to $6.3 to $6.7 billion for 2012, ending December 31, projecting that earnings per share will arrive in a range of $3.35 to $3.65 per share. The new figures far exceeded the consensus estimates for $5.4 billion in revenue and $2.98 per share in earnings, and could attract a wealth of new investors."

As for the stock, it has ripped ahead in a straight line from 36.5 in mid-November to north of 51 today. It stands about 14% above its 50-day line and has risen nine of the past 10 weeks. Overbought!

However, when you take a step back, you see that CBI topped at 42 in March 2011, and didn't permanently get through that level until December of last year-effectively 21 months of consolidation. Thus, on a longer-term basis, it looks like CBI might just be getting going.

I still don't advise chasing the stock up here, especially with earnings due out in a couple of weeks. But my guess is that CBI's first pullback to its 50-day line (now around 45) is buyable; you could consider a small position (say, half of what you'd normally buy, dollar-wise) on a dip of a couple of points, with the idea of either cutting the loss at 45 if things go awry ... or, more likely, adding shares should CBI push ahead after its quarterly report.

All the best,

Michael Cintolo
Editor of Cabot Market Letter
and Cabot Top Ten Trader

Related Articles: 

Finding the Investing System that Works for You

How to Stop Being a Stock Chump

Apple, the Major Indexes and Cyclical Leaders

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AAPL , CBI , LNG , RP

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