'Don't Reach, Young Blood!' An Elemental Investing Mistake

Summary

• Over-exuberance, jealousy, and greed lead to overextended entry points.
• Overextended entry points often result in days or weeks of "dead money."
• Worse yet, overextended entry points often quickly become "underwater," causing many investors to lose confidence and sell at a loss.

The other day, while perusing some twenty-year charts and mentally kicking myself (what could have been, Apple (NASDAQ: AAPL) , what could have been...), it suddenly dawned on me that I've been investing for over twenty years. I've read a veritable library of books on fundamental and technical analysis (from PEG ratios to Gravestone Doji patterns), I've enjoyed the blissful rise of bull markets and suffered through ulcer-inducing bear market crashes, and doggone it, for twenty years I've been making the same [insert swear word of choice] mistakes over and over again! These beguiling, seemingly simple errors have taken a huge bite out of my profits over the years; indeed, without them I would probably be floating on my yacht, drinking an umbrella-adorned cocktail right now. Let's examine my most common investing mistake, with the hope of avoiding it in the future.

Overextended Entry Points

Without a doubt, my most common and frustrating mistake investing mistake is entering a stock that is overextended. The stock symbols have been different over the years, but the recipe for disaster is always the same. First, I come across a stock that has had an amazing run, one that has shot out of a base formation like the proverbial rocket and is climbing spectacularly. Greed and jealously bubble up in my veins. "How could I miss this stock," I say to myself. "Look at that amazing run!" Then, I research the company and learn its beguiling story. It's making an innovative new product or offering a revolutionary service. My heartbeat quickens. And then, I take a look at the fundamentals, and they are tremendous. Sales growing exponentially, earnings per share increasing rapidly, etc., etc.. I take a look at the chart. The price is well above its 50-day average, and its steady uptrend is starting to go parabolic.

Obviously, what I should do is put it on the watch list and wait for it to form a new base, or throwback to its 50 day or perhaps even its 200 day average. But all too often, the power of greed (the red devil on my left shoulder), overcomes my sense of reason (the angel on my right shoulder), and I buy the stock. "I've got to buy this before I miss the rest of its run," I say to myself, and I pull the trigger. Let me show you three examples: The first is a hypothetical situation showing an overextended entry point and how it pans out. The second and third examples are real trades that I initiated recently, revealing my poor entry points and their subsequent results.

First, let's examine an a hypothetical example from one of the more exciting turnaround plays in recent years, Advanced Micro Devices, Inc. (NASDAQ: AMD). Here is an incomplete chart showing an overextended entry point (the blue arrow marking February 22, 2017)

Courtesy of StockCharts.com

Over the course of ten months, AMD put together a spectacular run, rising from $3.5 to a jaw-dropping $14.5. Kicking himself for not getting in earlier, our hapless investor buys the new high in late February of 2017. He knows that the stock has been running up for months and has already retested its 50-day average multiple times, but he has heard that this company is the turnaround story of the year, and rumor has it that AMD's run is just getting started. Here's the rest of the chart:

Courtesy of StockCharts.com

For a few days, our overzealous investor is grinning smugly, as the price makes a new high at $15.5. His grin turns to sheepishness, however, as the price suddenly tops out and descends as rapidly as it had risen. Fortunately in this case, AMD appears to be forming a base and is poised to resume its uptrend, but his investment has been "dead money" for four months, if he has been brave enough to hold through the agonizing drop from $15.5 to $10. Perhaps not so fortunate after all...

My second example is a real overextended entry point that I recently made on a somewhat similar tech stock, NVIDIA Corp. (NASDAQ: NVDA). NVIDIA has been a phenomenal performer over the last few years, and after shrewdly purchasing some shares and then not-so-shrewdly selling them way too early, I was determined to get back in. After missing the gap up out of the descending wedge in mid May of 2017 that occurred after a strong first quarter earnings report, and after watching it continue to rise for a more couple weeks, I got impatient and bought a position on June 5th, 2017 (see blue arrow on the chart below), even though it was well-extended above its 50 day moving average, and even though it had gone up some 30% from its breakout point without any form of correction. I had listened to the NVIDIA conference call, I was excited about its future prospects in gaming and its collaboration with Tesla (NASDAQ: TSLA), and the impulsive side of my brain took over. The train was leaving the station, my impulsive side said, and I had better jump onto that last car!

Courtesy of StockCharts.com

The month following my purchase was a wild one, as the stock went up, suffered an ominous bearish engulfing day on June 9 when the Nasdaq sold off heavily, and then quickly corrected down to what should have been my buy point--the first near touch of the 50 day line (see green arrow on the chart below) on July 3rd. The Nasdaq correction and corresponding NVDA sell off spooked me, and as my profits disappeared and went into the red, I came extremely close to selling. Fortunately, the stock is recovering now, and I still have my shares, but my entry point error caused me a lot of stress and nearly caused me to unload my NVDA shares too early, AGAIN!

Courtesy of StockCharts.com

My third example is a stock purchase I recently made of Transportadora de Gas del Sur S.A. (NASDAQ: TGS), a natural gas service company in Argentina. Impatient to diversify my holdings (I was weighted primarily in tech.), and salivating at the steeply rising chart, I initiated a ridiculously overextended position on April 12, 2017 (see the blue arrow in the chart below).

Courtesy of StockCharts.com

Only a few days after my buy, the stock made a short-term top and returned to touch its 50 day average for the first time in five months, providing a much better entry point on May 9th (see the green arrow in the chart below). Instead of buying there and sitting on a comfortable 15% gain, My TGS shares have been "dead money" for three months, and I am just now at the break-even point.

Courtesy of StockCharts.com

Conclusion: Once you have determined a good stock via fundamental analysis, being patient and waiting for a proper entry point is crucial. A poor entrance point is often costly to your pocketbook, and just as importantly, to your self-confidence. Very often, a few weeks or even days after you buy an over-extended stock, it begins the natural process of throwing back to its 50d average, or starts falling into a new base, or worst of all, it tops out and begins a multi-month downtrend. At minimum, your investment is dead money as the chart slowly catches up with your price. At worst, you have bought at the very top of an uptrend, and you sell at a loss--small or large, depending on your ability to recognize and get out of a failed trade. Tempting as it may be, avoid buying a stock when it is overextended--no matter how glamorous its story. Buy it very close to a breakout point out of a multi-month base, or at its first throwback to its 50 day average. (Each subsequent return to the 50 day becomes more risky and more prone to support failure). Or, buy at the bottom of a consolidation formation at what your fundamental research tells you is a good price. Instead of kicking yourself for missing a stock's run and jumping on late, put it on the watch list and wait, or find something else. One of the wonderful things about the stock market is that their are literally thousands of stocks to choose from, each moving up, down, or sideways at its own pace.

To end with, I would like to share a humorous anecdote that has become a mantra that I repeat to myself when buying a stock. On YouTube, there is a hilarious series of basketball street hoop spoofs starring NBA all-world player Kyrie Irving. Heavily disguised in make-up, with gray hair and a gray beard and frumpy "old man" clothes, he takes on the persona of "Uncle Drew" and proceeds to teach the young whippersnappers a lesson on the court. At one point, a frustrated young player reaches in for the ball, and Uncle Drew scolds, "Don't reach, young blood," before going right around him and taking it to the hoop. When we find ourselves tempted to press the buy button on an overextended stock, we would be wise to remember Uncle Drew's words: "Don't reach, young blood. Don't reach."

Uncle Drew. School is in session... "Don't reach" clip is at 3:11. Source: YouTube Screen Shot.

If there is an interest, I would be glad to detail some of my other investing mistakes in future articles. (Goodness knows, there are a few more.) And, I am interested in hearing from you. What investment mistakes do you find yourself repeating? Please share them below.

Analyst’s Disclosure: I am/we are long NVDA, TGS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.