After more than thirty years in the financial markets I have made my shares of mistakes but have also learned many things on how investors or traders can stack the odds in your favor.
The financial media is full of analysts' lists of what will be the best stocks or ETFs for the year. Some have inquired why I don't publish a list each year.
At the start of a bull market you will often find a number of stocks that have completed basing patterns that span a year or longer, which when completed makes them strong candidates to move higher over the next year or more.
In 2009, Neflix Inc. (NFLX) was such a stock as it had been trading between the 2004 high at $39.77 and the 2004 low of $9.25. The monthly chart shows a broad trading range, lines a and b, with key resistance at $40.90, which was the April 2008 high.
The relative performance broke through its resistance, line c, at the end of December 2008 as NFLX closed above its 20-month EMA. The following month, the OBV moved above its WMA (line 1) and NFLX completed its bottom formation at the end of March 2009 as it closed at $42.92.
When a market has been rising for almost four years it is much more difficult to find stocks with long-term bases. Even though I do concentrate on monthly and weekly charts, they generally spot trends that last four-six months, but not always a whole year.
Given the volatility of the stock market in the past two years, market picking a list of stocks to hold for the entire year is a waste of time as very few stocks stay in sustained up trends for an entire year.
This chart of the Spyder Trust (SPY) shows the various swings that occurred in 2012. From the beginning of the year, the SPY rose 11.5% to the April 2 high before dropping 11.2% into the June lows as the SPY came all the way back to just a 0.3% gain for the year.
From a risk management standpoint, giving up over a 10% gain is a bad habit to develop if you want to make money over the long haul. I feel that these lists can often encourage investors to make some of the classic investing or trading mistakes, which drastically reduces their chances of success. In this article I will propose five rules that if followed in 2013 will increase your chances for a profitable year.
Caterpillar Inc. (CAT) was one of the 10 Best Stocks for 2012 that was featured on CNNMoney. Most of the lists come from fundamental analysts who make their recommendations based on their estimate of the company's earnings or other fundamental factors that they expect will drive the stock price higher for the whole year.
The analyst who recommended this stock commented that (CAT) "has a 2% dividend yield, but that's really just a side benefit. The company's five-year average P/E ratio is 16. Were it only to rise from its current 10.1 multiple to 13 (assuming it hits its projected 2012 earnings), that would mean $117 a share-a 31% total return."
(CAT) closed 2011 at $90.60 and while this analyst did give a price target, quite a few do not. In the majority of cases they will also not give a suggested entry level or stop. This is one of my key complaints about these yearly top stock lists.
The weekly chart of Caterpillar Inc. (CAT) shows the 2011 close, (point 1) at $90.60. On the first day of 2012, (CAT) opened at $92.77 and a stop under the December low of $86.29 (such as $85.92) would be the tightest that seemed reasonable. This would have been a risk of 7.3%.
In 2013, be sure you calculate the risk of every new trade before entering an order. Too many ignore the risk of just a few of trades each year, which can seriously impact the performance of your whole portfolio. For 2013, concentrate on risk.
(CAT) rallied for eight weeks and made a high of $116.95, which was very close to the analyst's $117 target. At this point, the position had a 26% gain. As it turned out, that was the high for the year, as by July (CAT) had dropped to a low of $78.25. If you bought at the year's opening price, you then had a loss of 15.6%. (CAT) closed the year at $86.81, which was a loss of 6.4% for the year.
Of course, I feel that fundamentals are often a lagging indicator and a stock can drop 20% and still be a growth company. Technical analysis can help you time your entry, as well as a price level where you should buy or sell.
Regular readers know that I spend quite a bit of time determining an entry level and while I sometimes miss buying a big winner by a few cents, occasionally I also buy a market low. There are quite a few stocks that I do not write about because the risk/reward profile is not favorable.
I use a number of technical tools to determine when and where to buy. For example, I use starc bands to tell me when not to buy and when to wait. As for entry levels I use a combination of pivot point analysis, Fibonacci as well as simple tools like the 20-period EMA. As most of you are aware, in an uptrending market, pullbacks to the 20-day EMA often provide a good entry point.
In my review of some of the "hot lists, I have found very few that recommend a specific entry level. If you are looking to buy one of the highly recommended stocks for 2013, you must determine your own entry level. Concentrating on the entry level could pay off big in 2013.
United Technologies (UTX) was the most recommended stock in 2012 and the percentage change chart shows that it had a wild ride. (UTX) closed 2011 at $73.09 and gapped higher at the start of 2012 as it opened at $74.91. Just three days later, (UTX) traded to a low of $73.62 for two consecutive days. This was below the 20-day EMA at $74.19, which could have been a reasonable buy level
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A stop would need to be placed under the November 25 low of $70.41 (line b) at around $69.88. This would have been a risk of 5.8% ($74.19 - $69.88/$74.19). The weekly chart (right side) shows that the 20-week EMA at $75.76 was slightly violated in late January, which could have been another entry point. This would have allowed one to use a tighter stop under the December low of $71.60.
One should never make an investment without knowing how much you are risking and where you will get out if you are wrong. The top ten lists do not include stops, and in 2013, be sure you place a stop order in the market at the same time you enter a buy order. Never move it lower and don't make the mistake of not having a stop.
The % change chart shows that by March 15, (UTX) was up over 17% for the year but as the candle chart on the right shows, (UTX) reversed the following week and closed below the prior six week lows. Three weeks later (line 2), it violated the support at $80.98, line c, and began a nine-week slide. (UTX) eventually dropped below the year's opening price as it hit a low of $70.71.
The support on the % change chart, line a, was broken a week earlier (line 1) as the gain for the year fell below 9%. Over the years, I have known quite a few traders and several with quite deep pockets, but very few would ride a 17% gain to a loss, By early June 2012, (UTX) was down 5% for the year.
At the start of August, (UTX) was back into positive territory once more, peaking with the market on September 14 as it was back to a 10% gain for the year. By the middle of November, it was flat for the year. It did manage to reward those who stuck with the position all year with a gain of 8%, or including dividends, just over 10%. This was still less than the performance of the Spyder Trust (SPY).
For (UTX), you had good technical reasons to close out your long positions in April as the stop should have been raised to under the March low of $81.71. This would have protected a 10% profit since it had dropped 7% in just a few weeks
In 2013, you should protect your profits when you have them by adjusting your stop when a market moves in your favor. Never ride a good 8-10% profit into a loss. I also favor scaling out of long positions if my first upside target is reached.
In those lists I have examined I have found very few analysts who follow up on their recommendations more than a few times during the year, and as I mentioned before, they do not use stops.
These lists can often be used as an excuse by investors or traders to not do their own research as some just blindly follow the advice. Make no mistake, profitable investing or trading does take work and one of my goals has always been to educate, not just give recommendations.
Therefore, if you are following their fundamental advice, you need to do the necessary research to assess whether their fundamental argument makes sense or not. Compare to the conclusions of other analysts and also look back at how accurate their fundamental analysis has worked in the past.
Also, you should critically evaluate the work of technical analysts, including their reasons for buying or selling a stock. Did the analyst correctly identify an up or downtrend? Was their support or resistance level right? What about their stop or did they hold on too long? This will allow you to assess their strengths and weakness and act accordingly.
This research should not only cover the specific investment but also the analyst recommending it. In the past, has the analyst adjusted his recommendations throughout the year? Also find out how his past lists have performed and what kind of drawdown his recommendations may have had during the year.
Also assess the analyst's longer-term view of the economy or stock market. If the analyst is looking for a major market decline during the coming year, why would you want to buy and hold a stock they are recommending?
Therefore in 2013, become your own analyst and do your own research. Find a methodology that makes sense to you and then track it for awhile.
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Of course, the major Wall Street analysts also have their own lists of most and least favored stocks as I discussed recently Wall Street's Pick and Pans. I wanted to conclude this article with a review of Schlumberger Ltd. (SLB) and an explanation of why I do not currently find it attractive.
The weekly chart of (SLB) shows a broad trading range, lines b and c, which has been in effect for most of 2012. There is strong resistance at $78.47 to $80.78, the highs in 2012. The long-term downtrend from the highs in 2007-2008 is now at $92.
(SLB) rallied the first week of 2013 to close back above its 20-week EMA and its quarterly pivot at $71.32. This is a positive sign. It has near-term support at $66.85 with more important (line c) at $61.73.
The relative performance still shows a pattern of lower highs (line d) and lower lows, line e. The RS line needs to break through its downtrend and above the high from the fall of 2012 to suggest it is starting to become a market leading stock.
The on-balance volume (OBV) is currently below its weekly WMA and well below the resistance at line f. A move through this resistance is needed to suggest that it has begun a sustainable new uptrend.
If you find the relative performance and OBV analysis worthwhile, you might want to track (SLB) on your own and let me know if you see a change in its trend.
Remember for 2013, follow these five rules and I think your performance will improve.
- Focus on the risk and calculate it for each investment.
- Critically determine your entry level and don't chase any market.
- Use a hard stop on all positions.
- Protect your profits by raising your stops to lock in profits.
- Do you own research and learn to become your own analyst.
Given the current market outlook as we end August, the focus on risk becomes even more important as September is typically a very difficult time for the market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.