ZST Digital Networks Teaches Me a Lesson in Religion

Jan.19.10 | About: ZST Digital (ZSTN)

By Platinum Tiger
Whether we’re conscious of it or not, each of us has a strategy for trading equities. This hit home for me last week when I bungled a trade, and I realized that I’d better examine my own strategy and see where I went wrong.

My usual strategy for trading Chinese OTC stocks goes as follows:

1. Screen stock choices by reviewing their chart patterns and technicals. I’m a fan of the point and figure method of charting, and I typically buy stocks that are at or near new chart highs on price action that is strong and rising relative to the broader markets. I also pay careful attention to support and resistance levels, avoiding those that are too high off their bases or that have looming resistance levels. My best source for new stock ideas: my blogging partner, China OTC Player.

2. Once I’ve narrowed the selection pool using technical indicators, I follow up with analysis of the stocks’ fundamentals. I like small companies with positive earnings, low PEG ratios, floats that are under 20 million shares, and high trading volumes relative to their float. New developments such as pending uplistings, rumored acquisitions or newly introduced products or business lines also get serious consideration from me.

3. Steps 1 and 2 usually narrow me down to a couple of top choices. After I check these again for auspicious chart patterns, I set my buy-in price target, my selling price target, and loss limit parameters.

4. Then I buy the stock using strict price limits. I usually buy immediately after I’ve made my decision, and I’ll rarely chase a stock if it gets away from my buy-in target. But if a stock exhibits strong price action I’ll often add to my position as it moves up.

5. As a position trader, I’ll check in on each of my stocks at least 4 or 5 times each trading day. As long is a stock is behaving well on a daily basis I leave it alone. I sell either when the stock hits my price objective, or when its action gets wobbly and I lose confidence in the trend.

The key to this strategy is to remain fairly mechanical about my objectives, buying and selling when my rules tell me to, and leaving emotion outside of the equation.

Things don’t always work this way though.

In late December and the first week of January I bought three lots of ZST Digital Networks (ZSTN) in the high 8’s and low 9’s, for an average cost of $9.36, looking to get out when the price doubled. I posted a buy alert here at $9.55, and watched as it rose to almost $12.00 over the next three sessions.

That’s where my strategy fell apart. I convinced myself that the stock was going straight to $15.00, with a sense of inevitability that is usually reserved for biblical prophets.

But the market gods didn’t care a whit about what I wanted. Truth is, they never do. A battle between the bulls and bears ensued, and ZSTN gyrated in a volatile range for the next few days, dipping as low as $10.50. When it bounced up to the mid $11’s for a few hours my instincts told me to sell.

But my hubris got the better of me: I was sure that I was still right, market action be damned. Next thing I knew the stock was down at $10.00, and most of my gains had evaporated. I sold half my position the following day at $10.35, kicking myself for missing several better selling opportunities.

My purpose here is not to bash ZSTN. I still believe my fundamental analysis was valid, and that ZSTN is a good company with a strong future. China OTC Player and I both still hold positions in the stock.

My purpose, rather, is to point out what has been a fundamental and recurring flaw in my trading strategy, one that I suspect afflicts many of us. Somewhere between steps 4 and 5 I often get “religion” about a stock. I invest it with certain powers that transcend the normal laws of gravity. I hold on to the belief that it will behave as I want it to. I get emotional.

But religious fervor rarely benefits a lowly, mortal stock trader. After all, how many rich clerics do you know? The truth is that there are no divinely anointed stocks. There are no “good” stocks or “bad” stocks. There are only stocks that are going up, stocks that are going sideways, and stocks that are going down. It’s not hard to tell which is which.

The market gods are endlessly mercurial; they follow their own rules, not ours. The best we can do is watch the trends without emotion, set secular guidelines for ourselves, and get out of the way when omens of fire and brimstone appear.

Disclosure: China OTC Player and I both hold positions in ZSTN.