Moving Trains, Falling Knives, Death And Super Crosses

by: Mycroft Friedrich

An investor should never rely on just one method in analyzing stocks, but should try to verify investment decisions by using a variety of different methods. Much of my success as an investor has come from using free cash flow analysis. I have been able to establish a solid methodology for identifying strong companies selling at attractive prices for purchase.

I have never really had a problem identifying what to buy or when, but have always struggled with when to sell. Therefore I have spent the last couple of years backtesting various methods of technical analysis and this led me to create my own system which I call SIA-Charts. SIA simply stands for statistical indicator analysis . A couple of years ago I introduced my Statistical Indicator Analysis (SIA) here on Seeking Alpha which you can read about by going here and since then I have improved my SIA-Charts significantly and will now show everyone how the new updates work.

SIA shows you good entry points on when to buy, but the four key points to look for that make up the title of this article will show you when to hold, when to sell and even more importantly when to add to a stock position that you already own with confidence. Over the last three months I have backtested all four key points successfully enough to where I now feel confident in implementing them in my client portfolios.

I have named two of the four key points I look for after a famous saying on Wall Street that rings very true in my own work. That saying is "Never try to catch a falling knife or step in front of a moving train". What this statement basically means is that when a stock's price starts to collapse you need to be very careful that you sell and get out of the way so "the falling knife" doesn't do some serious damage to your portfolio. On the other hand when things are going well you should be content in holding your winning positions and let them run as long as you can, as large gains are lost basically in many cases because one sells too early. This "stepping in front of a moving train" explains that selling too early can really reduce your performance over time.

This all sounds simple enough, but the hard part is implementing it and then doing so successfully and consistently, because you never really know when to hold and when to sell. That is until now, as I feel my SIA-Charts explain how to do so. I found the following to be true in most cases:

1) 1) "The Moving Train" = When the 50 day moving average is above the 100 day moving average the underlying stock price tends to go up over a long period.

Here is a chart of Apple (NASDAQ:AAPL) that proves that just following this simple rule could have allowed you to hold over a multiple year period and make a lot of money with confidence:

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As you can see in March of 2009 Apple's 50 day moving average broke above its 100 day moving average and thus triggered our "Super Cross" and has remarkably stayed above it ever since. One would have definitely made a lot of money following this rule, by not stepping if front of the Apple moving train. I have named the point where the 50 day moving average breaks above the 100 day moving average "The Super Cross" for in Super Cross motorcycle racing, riders have to deal with large hills that they have to overcome while facing stiff competition. This is very similar to how companies must battle on Main Street and Wall Street to produce ever increasing earnings, compete against their competition while beating analyst's estimates every step of the way. As long as a stock continues to impress it continues to rise but when they don't then point #2 happens.

2) 2) "The Falling Knife" = When the 50 day moving average drops below its 100 day moving average the stock price tends to go down over a long period.

A stock that competes with Apple is Research in Motion (RIMM) and we will use it as our poster boy for our falling knife point.

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Back around the first quarter of 2011, when the stock was trading around $60 a share it experienced a "Death Cross". When a company is having problems, people "in the know" start noticing and they slowly start to sell the company's stock and it eventually gets to the point where the 50 day moving average breaks below the 100 day moving average and then in most cases all hell breaks loose and everyone runs for the exits. Selling usually continues as the pain continues to increase for those holding out until they finally have had enough and capitulate and end up selling, which continues to cause the knife to fall further. Here is a SIA-Chart of Nokia (NYSE:NOK) that shows the same thing happening to its stock that happened to Research in Motion.

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As you can see owning Nokia has been a house of pain for anyone who owned it over the last few years. Recently I was looking to buy it around $5.50 as the new Nokia 900 was being released in the United States using Microsoft's (NASDAQ:MSFT) mobile operating system and I thought from a qualitative point of view that it would be a big hit. Thank God I discovered my falling knife indicator in time, as that's what saved me from pulling the plug and experiencing a massive short term loss for my clients. I am still in shock with how poorly Nokia has been managed, but when you go negative on your margins, then the falling knife increases as everyone is running for the exits at the same time.

Those who like to go short as well as long the market can also use my SIA-Charts methodology by going long one name in an industry and short another. Anyone who went long Apple and short Research in Motion and Nokia would have achieved a triple crown victory and had an amazing year.

Sometimes you can get really lucky and find a "Super Cross" and then a "Death Cross" in the same stock, so you can ride it all the way up and then short it all the way down. Netflix (NASDAQ:NFLX) is a perfect example of using SIA-Charting in implementing such a strategy.

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Back in February 2009 you had a "Super Cross" occur and then had a massive run up, which then ended towards the middle of 2011 when NetFlix had a "Death Cross" occur as the 50 day moving average finally broke the 100 day moving average and "Hell came to breakfast" for the stock. Recently the stock movement has shown a hope of starting a Super Cross again but as the short term chart below shows that the falling knife is still falling:

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In my own work I first do the qualitative and quantitative analysis on 1000's of stocks and then I buy what I see as incredible companies, but once I own a stock I now let my SIA Charts tell me how long to hold and when to sell. I learned this the hard way as I bought Netflix when it was $41 and then sold it at $119 in less than a year, which was a tremendous gain in anyone's book. But watching the stock then go to $305 afterwards was a house of pain and even though I had a tremendous gain in the stock, I left a lot on the table.

Now that I have my SIA-Charts, my quantitative and qualitative analysis is truly strengthened and my results in the future should be much improved. I am an old dog in this game as I have been investing since 1974, but the secret to my success is never being satisfied and I am constantly trying to improve on my craft of research, because the world is constantly changing and the way people invest is also changing. We are now competing against hyper trading computers and massive hedge funds who use insane levels of leverage in their operations as do investment banks like Goldman Sachs (NYSE:GS) and J.P. Morgan Chase (NYSE:JPM) who at times make such massive moves that they themselves move markets with just one investment. With SIA-Charts I feel the small investor can now compete successfully against the big guys and I am proving it successfully everyday in my work for my clients.

Disclosure: I am long MSFT.

Disclaimer: Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. The information contained in this article represents the opinions of Peter "Mycroft" Psaras, and should not be construed as personalized investment advice. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.