Money & Investing
Keep a Cool Head; Follow Your Strategy and Not Your Emotions --
A Look at How to Time the Buying and Selling of Your Stocks
If you've ever played competitive sports, you know how it is!
You are in that critical make-or-break situation. You know it. Your emotions are running high. You can feel the adrenalin flowing. You want to win, and you want to win badly. Then, you make your move. If you maintain your rhythm, timing and execution, you win. If you get frazzled and flustered, you lose.
Emotions can play a big part in investing.
If you can control your emotions and follow your strategy and timing, you can do well. It takes discipline. You need to follow the tested rules and not get carried away with greed and the crowd.
If you get caught up in your emotions and chase a stock during a market rally, you could get into big trouble.
Buying a stock is always exciting. The chart on the right gives an example of the potential ups and downs.
The key is to have a set plan of buying and selling stocks that fits your temperament and makes you comfortable. It should be a strategy that you have back tested and have learned the various probabilities and nuances for. But, what you do not want to do is "shoot from the hip".
The stock market is now in a bull phase. So, market rallies will be enticing.
I recently spoke with a young investor who told me he bought a position in Universal Technical Institute, Inc. (UTI). The company, with sales of 380 million dollars, provides education for those seeking jobs as technicians for cars, motorcycles and boats.
There are two basic components to investing in individual stocks. One is stock selection, and the other is timing.
UTI would appear to be a good fundamental stock. Analysts look for earnings for the fiscal year ending September 30 to jump 146 percent to 1.18 a share from 48 cents a year ago. Going out to fiscal 2011, they see net climbing another 25 percent to 1.48 a share.
So, UTI, based in Phoenix, looks to be a good growth stock. The stock's price-earnings ratio, based on fiscal 2010 net, is a reasonable 21. So, our young investor has selected well.
As far as timing his buy, he bought UTI at 25 in late February. Ah! Not so good. He made the emotional mistake of buying a stock in what would appear to be late in its rally phase. (See the chart.)
In technical terminology, he bought when the stock was "extended in price". That is a no-no! Why? Because it leaves him vulnerable to a pull-back in the stock's price based on profit-taking.
UTI climbed from a low of 18 to 26. That is an 8-point gain, or 44 percent. A normal 50 percent retracement and the stock could easily pull back to 22. That probably would make our young investor -- or anyone -- nervous, and possibly a seller who might panic and take a loss.
In a bull market, one's faulty timing in buying may not be punished as severely as in a bear market. However, one should definitely try to buy at favorable points to lessen downside risk.
In the case of UTI, one could have been a buyer at the technical breakout point at 20.85. In bull markets, breakouts generally have a better success rate. For instance, in February, Ticker Tape Digest found 86 percent of breakouts of high-earnings growth stocks followed through in price to the up side. That is an extremely high success rate.
The other point at which our young investor could have entered would have been at 19.16. If one used a "bargain hunting" approach, one could use a momentum indicator, such as the Commodity Channel Index (CCI) or Stochastic Oscillator or Relative Strength Index, to time the buy on a turn up within the base.
eSignal's programs have all three of these indicators. To fine-tune them, you need to set the parameters at the ideal cyclical setting for the individual stock and not just go with some preset setting, such as 14 or 9 (as seen in some programs).
Of course, no buying strategy is fool-proof. So, in both approaches, you need to have an emergency exit strategy if the stock should back up.
There are other methods of buying. Some are based on valuation levels or a combination of technicals and valuation. The point, though, is not to go barreling into a stock just because the market is rallying strongly, and you want to get in no matter what.
You could also use a scale-in strategy to take a long position in a stock. Again, be watchful of not buying extended. Also, seek to average up in price, not down. You want the stock to begin working for you, not to be pulling back below a recent buy price.
Selling a stock requires discipline and following certain rules. I often hear people complain that they either sold too early or too late. The old saying is that the only person who sells at the top is a liar.
Some selling strategies are based on technicals and some on fundamentals.
Generally, some technical action showing strong distribution (that is, heavy volume on a down day in price) could be a warning signal of a top. There are other tell-tale signs, such as a stock being very extended in price, or the time sequence of the advance could be great, giving a hint of potential exhaustion point. Some of those warning signs can be determined by studying the past chart history of a stock.
Also, you may be more inclined to hold as long as fundamentals, such as earnings growth and valuations, remain favorable. Usually, in a bull market, leading stocks will see a significant expansion in their price-earnings ratios, more than one would normally expect. That is because institutions tend to want to put the best stocks in their portfolios at any cost.
Finally, you should never get overly emotional or angry if you sold a stock too early. A cardinal rule to remember: The idea is not to be perfect but to make money.
Mr. Fasciocco is the publisher of Ticker Tape Digest at www.tickertapedigest.com. He is a contributing writer for several publications. Mr. Fasciocco can be reached at leo@tickertapedigest.com.
