|
|
|
|
|
 MARKET REPORTS |
|
Resident Trader
Resident Trader: technical analysis comes to good use in these markets
Will Kraa, January 23, 2008
Finally we’re seeing something that most newer market participants have never experienced before – a fall in the market similar to the 2002 bear market. Only this time instead of taking all year to drop about 22%, this time it has taken only a few weeks to drop by almost as much and who knows where it will finish. There are all sorts of prognostications but the truth is that there is nobody, and I mean nobody, who knows what will happen. Research has shown that most predictions about market performance are wrong. Of course some predictions will turn out to be correct since the range of predictions cover just about all possible scenarios.
It’s a bit like medical schools – half of what they teach you there turns out to be not correct, the problem is that you don’t know which half that is. Those who turn out to have predicted the market correctly will make some capital out of it and the rest will be forgotten. I am, as you can see, justifiably cynical about those who try to predict things and that includes those who set price targets for stocks. This might lead you to conclude that I am one of those who have no time for fundamental analysis.
There are two camps of traders, those who pour scorn on technical analysis, and those who think fundamental analysis is a waste of time. The truth in my opinion is somewhere between those two extremes. In this time of great market uncertainty we need all the help we can get in making good decisions. For very short term trading technical analysis is what you need to use but in the long term it is stocks with good fundamentals that go up in price. The problem is that those who look for 'cheap' stocks to recommend may not have noticed that the market can continue to discount stocks which seem to have excellent fundamentals and there are also stocks where prices can rise way beyond what may seem to be a reasonable price to pay.
I am fascinated that one stock which I mentioned in a recent article which has held up remarkably well so far. You might remember the one which has no business, very little capital, and just the remote possibility that by selling heaps more shares (severely diluting existing shares) it may be able to buy a business which is speculative in itself. The code is RCH (Richfield Group) and the price has gone up threefold over the last few months and is staying there. While the price of good businesses has plummeted this one has not. (Today it did finally go down but is still well up on what it was at the start of the rush to buy)
So even fundamental analysis does not always give the desired results. Time and again I have seen stocks recommended as 'buys' or even 'strong buys' only to see the price decline continually. What then are we to do in the current climate?
If you are trading CFDs it is possible to short stocks but just at the moment it may not be the best time since, after the severe drop in the last couple of weeks, a rally in prices may lead to losses. Always remember that in short trades the risk is unlimited since there is no limit to the rise of a share price. It is safer to short indices as they are not likely to have extreme upward moves as some stocks do, for instance if there is a takover offer. Otherwise it is much safer to use guaranteed stops for short trades in individual shares.
For longer-term trades it is important to remember that in the end it is fundamentals that drive up the share price. So if you can find stocks with very good fundamentals there is a greater probability that the price will rise. When looking at the fundamentals it is more important to find a company with a very good return on equity than simply one that pays a good dividend or has a low PE. You want to find a business that is making a very good return on the money they use. Otherwise the money might as well be in a bank account earning interest. Another thing to look for is a business that does not have too much debt and that is well able to fund the interest payments.
You can subscribe to a service that gives recommendations based on the fundamentals or fundamental software that scans the market for you or do them for free through an online broker's service. Whatever you do, don’t simply buy something because the fundamentals look good or someone recommends it as a 'buy'. I have found that the best policy is to look for good companies on a fundamental basis and then apply a technical system like the Jim Berg strategy outlined in my volatility articles to time entry and exits. Remember, if it’s not going up, don’t buy it.
I've seen companies that folded with 'buy' recommendations and others with apparently good fundamentals spent a long time going nowhere. I used to subscribe to a newsletter which did a lot of research finding companies they thought were worth buying. On backtesting their recommendations I found that I could dramatically improve on the results they got by simply buying when the stocks started to go up. This also avoided buying stocks which later became so 'cheap' that they stopped trading!
Occasionally they did discover stocks that were truly outstanding value, one of them was actually much better than money in the bank. It was a trade I did a fair while ago and the circumstances for this stock hold parallels to what is happening now.
At the time (2002) there was a bear market and the tax man was making noises about shutting down the tax dodges associated with agricultural schemes. Great Southern Plantations (GTP) was being sold off in the genral panic to prices as low as 50 cents. The interesting thing was that at the same time the company owned land and cash to the value of over 90 cents per share. It was also paying a fully franked dividend nearly twice bank interest. So it was literally better than money in the bank.
The price had dropped from a high of $4.80 in March 2000 to $0.50 but then started to recover and by early 2003 was once again trading above the 30 Week MA. Seeing they were now trending up I decided to buy and on 30 January 2003 bought 50,000 at the price of $0.66. After some more volatility the real climb began and by early July had risen to over $1.15. By now I had a good profit and was thinking of what might happen if they reached as much as say $2. I was thinking more of my profit than about trading well and so when the price retreated to nearer $1.00 I began to think it was time to lock in the profit.
The price was now above the $0.90 per share in cash and property so it seemed no longer as good as money in the bank. One day when the price fell to $1.05 (21 July 2003) I decided it was time to sell at $1.05. My profit for the trade was $19,500 less commission which was very pleasing.
While this seemed good at the time there was something I had not yet discovered. By now the company had made more profit and now owned cash and land to the value of $1.28 per share (if I remember correctly) so my selling at this price was altogether premature. What I should have done with such a long term trade was to look at the weekly chart (shown below) and then there would have been no real exit signal until somewhere about $4.20 using the 2ATR(10) stop on a weekly chart and looking for a second consecutive close below the line.
This would have made me a profit of an additional $157,500. I did actually get back in to GTP and did make more profit but not as much as would have been the case if I had not been so keen to lock in the profit.
It was an article written by one of the well known newsletters that alerted me to this trade and technical analysis that provided the entry signal. If I had followed technical analysis more accurately, it would also have provided me with a good exit.
At the present time similar things are happening. For instance, since the ridiculous Centro debacle (and if using charts properly you would not have owned this stock when it crashed) all property trusts have been sold down but not all deserve this. Soon there will be some very good buys but it pays to find good companies and then wait for your system to give a buy signal. Under the present circumstances it is all the more important to ensure you filter the companies you want to buy, either do this yourself or get someone to do it for you.
It is also important to keep in mind the sectors that should do well. Sooner or later oil will become scarce for instance and while in the short term oil prices might drop, this will change and the time will come when it will be very good to own energy suppliers. (I'm not implying that now is the time to buy them, just using this as an example of what may happen.)
If the present market develops into a sustained bear market, there will still be stocks that do well. They will very likely do very well since there will be fewer stocks going up and more people will want to buy those that are rising.
At the moment I have most of my money in cash and will wait to see when I get signals to get back into the market. It is very likely that there will then be some good profits to be made.
More articles from this edition of CompareShares:
Markets: Market turmoil: the next 24-48 hours are crucial
Resident Trader: Technical analysis comes to good use in these markets
Markets:ASX expected to open higher
Market Wrap: US stocks fall on recession fears
Stocks: Stocks to Watch on the ASX today
US: US Federal Reserve slashes rates
Markets: Asian markets fall, Europe mixed
Commodities: US stocks climb back from early plunge
Commodities: World needs US to act quickly: Treasury
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
|
|
