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 MARKET REPORTS |
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Resident Trader
Making money in a tough market
Will Kraa, May 08, 2008
I’m not telling you anything new by saying that it has been hard for traders to make headway in the market over the last few months. There has been little direction to indicate whether to go short or long.
For years now the market has been steadily rising and it has been easy to find stocks in an uptrend with the market reaching a peak early November last year. Many traders who started trading in the last few years have most likely got used to the idea that markets just keep going up. Especially for these folk the last few months have been a shock.
Trading short was not easy in the uptrending markets of the last few years and any retracements in the market were generally short lived with the market recovering quickly. Going short under those circumstances could be risky and so when the market started to fall late last year it was not easy to do what now seems so obvious – short anything to do with the financial markets such as banks and property trusts.
Since then, as we all know, it has been a choppy market, up one day, down the next as the mood of investors swung between hope and fear. There are some who advised that it was best to stay out of the market completely. Certainly I have had a lot of cash in my SMSF and the interest payments into the account have been good. Since trading CFDs and shorting is questionable in a SMSF it is a lot harder to continue making a profit under the recent conditions.
But I have bought stocks during this time and made good money from them. Even in this volatile market there are stocks, which have trended up nicely and some of them were hardly affected by the recent turmoil. It is not hard to find them. Just scan the market for shares where the price is trading above a long term moving average. I use a 150-day or 30 week MA and the shares I look for are those where the price is trading above a rising 150 day MA. For those of you who use AmiBroker I can give you a formula you can use to find these. (Just ask for it in the ‘your 2 cents’ worth forum.) It should be possible to do the same in other charting software.
I include a condition in the exploration that the turnover of the stock has to be high enough to provide sufficient liquidity. You can adjust the figures to suit the liquidity you need. It is usually suggested that the daily turnover has to be at least 10 times the size of the position you might want to take. There are no hard and fast rules about this but it is not advisable to buy stocks where it may be very hard to exit if the price starts to retreat. I don’t like being in the position where I want to sell and there are just a very few buyers. It usually means having to take a much lower price than you expect. If you have a very long term perspective this may not be quite so important but when doing short term trades it plays havoc with your risk management strategies.
The shorter the trading timeframe the higher the turnover needs to be. Also if you are trading using a market maker CFD provider good liquidity is important since you are obliged to take the trade on offer or not deal at all. With Direct Market Access providers it is possible to place orders in the market queue to be executed as the market meets your price.
After running the exploration over the weekend I use the results to make a watchlist of rising stocks to buy (for my SMSF) or for possible trades during the week for my CFD accounts. If the market is changing quickly it may be advisable to do the exploration more often. Doing this exploration usually brings up a list of some 60 or 70 stocks that meet all my criteria. Of course not all of these are suitable for trading – these are just candidates for further investigation. Some of the stocks that are on this list have awful looking charts and it may be best to avoid them. There are always a few good ones so it is not necessary to buy ones that are questionable.
From this list I have found some excellent stocks to buy for my SMSF. Unfortunately (or fortunately for me) I can’t share with you any completed trades that I selected using this group of stocks as my list of candidates. I am still holding them since they have not given exit signals and currently there is a very nice profit in my account from the open positions.
Some on the list have gone up very quickly in the last few weeks so it may be necessary to wait for an entry signal. The Jim Berg method described in this previous article can be used to find the best place to buy (and also to give the exit signal when necessary).
It may be that the market is finding some direction at the moment and it could be possible to find some stocks that have been sold down in the panic and are ready to stage a recovery in prices. These will not necessarily show up in this exploration since they may not be trading above a long term moving average. If you are keen to find such stocks it may be that you need to use other means to find suitable ones. This could be a case where fundamental information can be of some help in identifying companies that have been sold down far below what is justified. Personally I have found that from time to time this can be very useful but I have also found that the market is boss. No matter how good a company is, if the market (as shown by a downtrending chart) has a negative attitude to the stock it is no use trying to hang on hoping that the market will realise its mistake. There is no way of telling how far down a stock can go or what is not shown by the fundamentals. You must remember two things, firstly, by its very nature fundamental data is old information and much may have changed since it was compiled, and secondly, stocks are largely not judged by what has happened in the past but by what people feel is likely to happen in the future.
There are well known stocks out there with an extremely low PE and a very high dividend and you would think that surely the price should rise. However it may well be that the market perceives that the high earnings are not sustainable and so may very likely drive down the price even further. There are many other factors that may be at work so in the end I have found that no matter how good the story, if the price is not going up I avoid them. This may mean that you will not get in at the bottom but getting in at the bottom and getting out at the top is an unachievable dream, like a hole in one at golf. Occasionally it happens but even the best professional will seldom achieve that and would be foolish to count on doing it.
I remember someone telling me he was hanging on to the shares of some medical stock since they had a wonderful device, one of the worlds best, and it was now approved for sale in many countries. He was sure this was going to be the next Cochlear. Maybe it is, but the share price has been declining for years and since he bought it has gone from around a dollar to 30 cents. I’ll just wait till it starts going up. Remember there was plenty of time to buy Cochlear before it reached $50 and after it then declined to $20 there was then lots of opportunity to get it at just over $20 as it started to rise to $80. There was absolutely no need to buy it at the times when it was going down. Lots of profit could be made while it was going up without hanging on as it was going down.
Finally, I would like to say that most times the charts you view have a linear price scale. As a result the last drop in the market looks very dramatic compared to the previous decline in 2002/2003 as shown on the chart below of the ASX S&P 200 (the XJO):
Notice that it looks like a huge drop compared to what happened in 2002/2003. But now have a look at the same chart using a logarithmic price scale. (For those who are mathematically challenged, a logarithmic scale ensures that the scale makes things better in proportion, true to the actual percentage change in price. For instance a 50 cent change in price for a $2 stock is huge compared to a 50 cent change in an $80 stock. The log scale fixes that.) So here is the same chart in a log scale.
It now becomes easier to see that in 2003 the market decline was slightly larger than the recent decline and it was over two years before the market recovered to where it was before the drop. So be very careful, the happy times of the last few years may not yet have returned. Find stocks that are going up and use stops to get out if things change. Don’t try to make a killing buying things that are going down.
Even if you think they surely can’t go down further, you may be surprised at what can happen. There was a time when I lost more money than most people save in a lifetime by thinking like that. Fortunately I was able to get it all back and much more but not everyone has the resources to do that.
Note:
In Amibroker to change the scale to logarithmic is easy, right click on a blank part of the chart, click on ‘Parameters’, then in the small window that opens click on the ‘Axes & Grid’ tab and click where it says ‘Linear’. It will now change to ‘Logarithmic’, so click OK.
More articles from this edition of CompareShares:
Sector Picks: Sectors to target and avoid in 2008
Resident Trader: Making money in a tough market
Property: Are tax concessions on property really worthwhile?
Stocks: Small, undiscovered stocks to watch
Companies: Qantas engineers poised to strike
Commodities: Petrol chief criticises Coles Express
Companies: Sims reports record NPAT of $80.3m in Q3
Finance: Lincoln questions health of financials
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
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