): What's in a Name?
Two Common Investing Pitfalls
Short-Term Extended, Longer-Term Bullish
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
And finally you have the stock's relative performance (
) 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
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.
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.
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 (
, 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
) 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
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.
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,
Cabot Market Letter
Cabot Top Ten Trader
Finding the Investing System that Works for
How to Stop Being a Stock Chump
Apple, the Major Indexes and Cyclical
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