These days, I spend quite a bit of my time talking with and mentoring people who are either just getting started on their trading journey, or who are trying to turn around their performance after an unsuccessful start. I use the things I learned in nearly twenty years in dealing rooms around the world. When I do that, what frequently surprises people is that the things I talk about are not complicated. Too many people seem to think that being a successful trader means needing a math degree from MIT or something, when actually, you just need a big dose of common sense.
One of the most common errors I see is a focus that is too narrow. I get it: trading, as opposed to investing, is short-term, but that doesn’t mean that you should consider only short-term factors when trading. When assessing the potential of a short-term move or, more importantly, the potential for a loss on a trade, the underlying reasons for a move have to be considered. No matter how detailed your chart study and technical analysis are, none of it matters in the face of a sustained move driven by fundamentals.
This all came to mind yesterday during a conversation with a friend who trades a little in his investment account. He told me he was thinking of shorting Tetra Tech (TTEK). His rationale sounded reasonable: the stock is up well over 100% from its lows almost a year ago, and has now backed off of a resistance level five times, as the chart below shows:
That all made sense to me in theory, but then I asked him what the company did. "They're some kind of tech company," was his response, which is not only vague but also fundamentally incorrect. Tetra Tech is, in fact, a company that offers consulting services to government entities and corporations on issues such as water, infrastructure and environmental impact. Talk about a business for the times!
In that context, the stock’s gains over the last few months look not only justified, but if anything, underdone. You shouldn’t need me to tell you that we recently had a change in the White House, nor that the new administration is focused on the environment and that its first major push has been for a massive infrastructure bill. So, as much as the chart may suggest selling, reality says that would be foolish.
This morning, we heard the news that Tetra Tech acquired IBRA-RMAC Automation Systems, a company that specializes in the digitization of water systems instrumentation and data analytics related to water. That will probably give TTEK a boost this morning and make a break above that resistance level look far more likely than any sustained drop. I am waiting for the “thank you” call now for dissuading my friend from shorting.
There are a couple of extremely important lessons here for both traders and investors.
First, you should never even consider putting your money into something unless you have a clear idea of what that thing is. That applies to the business behind individual stocks, but also to different types of security. Don’t trade options, for example, unless you know what an option is and how they work. Don’t buy stock in a company unless you know and understand how they make money.
Second, if you are considering a trade, look beyond the obvious, short-term factors. My point to my friend yesterday was not that I knew that TTEK would be announcing some good news, or that it would be trading higher this morning, it was simply that there were underlying fundamental factors that would severely limit the downside, even if it did pull back a bit. They are a company that is in the right space at the right time and, when that is true, it really doesn’t matter how the chart looks.
All of this comes down to a simple thing. When trading or investing, understand context. Look back further than the short-term chart and consider the reasons for a move, not just its magnitude. That won’t mean that you will never lose money on trade. Nothing can prevent that, but understanding the company and the context it is in will increase your chances of success.
Do you want more of Martin? If you are familiar with Martin’s work, you will know that he brings a unique perspective to markets and actionable ideas based on that perspective. In addition to writing here, Martin also writes a free weekly newsletter with in-depth analysis and trade ideas focused on just one recently underperforming sector that is bouncing fast. To find out more and sign up for the free newsletter, just click here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.