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How to play the stock market

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Monday Morning, July 7, 2008

One of the things that I look at when I am trying to get an overall picture of the financial markets are technical indicators that give the sentiment of investors. What kind of thoughts, as a group, do people have? And it is very negative at this moment.

To try to get a feel of the mood of stock market investors, mutual fund managers, or even day traders, you can look at University of Michigan Sentiment Survey that comes out each month (I have no idea why they ask college students but this indicator has been used since the late 1940’s), the volatility index (VIX), which can be used as a contrarian indicator (1) of a pending turn in the market direction, and a variety of other technical indicators that tell us what stock market investors have been doing with their stock positions.

One area that I am watching for stock trading ideas or stock picks resides within the financial stocks. You might be asking, why would anyone be interesting in buying stocks in a sector that has been kicked, beat up, and one company was executed in March (BSC, Bear Stearns). Shouldn't we be selling short you might ask?

I make the most money in the stock market when I identify individual stocks or sectors that stock market investors or stock traders are selling out of at an increasing rate until ideally, they panic. (Panic doesn't occur too often). I've said for years to people that you want to try to gauge the maximum point of enthusiasm in investors to sell your current stocks (or sell short) and the maximum point of despair in order to buy.

It takes a lot of discipline and courage to do this because it feels like you are going against the grain where nobody else agrees with you. But to quote myself from a book I wrote in 1997, "You don't make a lot of money doing the same thing everyone else is doing at the same time."

Here is a quote I just ran across last week that is supposedly from Warren Buffet ..... "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." Warren Buffett

Just remember I said it first! (lol).

Getting back to recognizing when a stock or sector is ready to buy .... I think we are approaching that point with some of the financial stocks as a sector and a few of them individually are getting close to a technical bounce.

What you should be interested in are points in the stock price where the probability is very high that you will make money no matter what kind of stock trading strategies you are using from short term investing, to swing trading to intraday trading or buying and selling stock options.

The financial sector as a group still looks like it has more to drop but my guess is that BAC, Bank of America is most likely to be one of the first to turn up based on the technical indicators (more on that in another lesson). The current price is $21.17, target price next 2-4 weeks would be somewhere $26-27 but it still isn't ready to buy yet although I am watching it this week for a possible long entry for a short holding period of anywhere from 2 weeks to 2 months.

Earnings are scheduled for BAC in two weeks from today on Monday, July 21st, but not sure if it is before or after the market hours. Fund managers, hedgies (hedge funds) and traders are afraid their numbers are going to be worse than expected so that is the likely reason why it has been dropping so quickly this past week. I will be looking for a bottom in BAC in the next week or so, I am guessing that $20 will hold unless they announce some extremely bad news on July 21st but my hunch is the news is already reflected in the stock price now.

When the financial sector starts getting some buying, it is very conceivable to see 25-40% rebounds on the technical bounce AND many times, the managers and hedgies could jump on a small buying bandwagon in this sector.

The ideal situation is that you find the strongest stock (in every measure you use to evaluate) in a sector that corrects this hard, look for that stock to bounce upward first and the strongest. Eventually, we are going to see that people will "get used to" the bad news in banking and housing and start speculating on buying.

Take a note that GS, Goldman Sachs is considered the strongest in the investment bank group although Bank of America is considered a money center bank (or a retail bank). I keep hearing analysts stating that GS is the "gold standard" in this sector.

The following stocks were ones that I had sold short these past weeks in anticipation of its fall, which we saw very nice profits. PDO, FPP, ROYL, MXC. This set of ideas is over so don't buy or sell short any of them, just learn the pattern of the bullshort, which I teach very extensively in The Wizard Training Course. This was the second wave of short selling in this set of stocks that I did. This is a very advanced trading technique that I started developing in 1993 and have made very substantial money from. But don't load up the boat on these stocks, start with very small positions relative to your total portfolio or account balance in that one account.

There still are more stocks that are overpriced in this same sector, Independent oil and gas exploration companies. I am late to the party on these listed below shorts but there is still substantial profit potential still left in them. HK was a short today and I am looking for somewhere around $35-36 for a target price to cover the short in the next few weeks. Today's high was 46.42 and that would give a potential profit of about 30% left in them. Remember you are only trying to get part of that potential, maybe 1/3 to 2/3 of it.

GMXR, GMX Resources, hit a high of $78 today and dropped to $71.13, so this has started its correction similar to HK. I am looking for mid to low 60s so this doesn’t have quite the potential profit as HK but 20% is possible on the short side.

The last sector I wanted to discuss with you is the agricultural chemical companies like MON, MOS, POT, AGU, and SQM. There are others in this sector but this is what I have been watching and trading. SQM was a short idea at about $51.50 - $52 a couple weeks ago and hit $35.10 July 3rd. It went lower than I thought but the potential on this was 69% profit potential. I was late to see this stock by a few days but it did hit my target price of $40.

I see MON as a probable stock to rebound once this ag-chemical group rebounds. I am looking for this signal to turn upward the next few days with only a small 2-4 day trade of possibly 15% max. I would consider this a swing trade.

Remember not to get greedy and build too big of position sizes for any one trade or sector.

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