If you’re like most investors, myself included, the most fun in trading is hitting the order entry button and making the trade. At that moment we see only the upside, and it’s exciting. Until it isn’t. Then, it’s remarkable how quickly excitement and optimism can turn to disappointment and dejection when the trade turns against us. What went wrong and why didn’t we see it coming BEFORE we hit the Trade Now button?
The answers came to me as I listened last week to a Successful Investing Coaching session with instructors Brian D’Amico and Todd Shaffer. It was excellent! Brian and Todd analyzed attendee’s stock ideas, explaining why it’s okay to be picky, and why it pays to be patient and not make the trade just to be trading. Stock after stock they would say, “I don’t like this”, or “I don’t like that.” Let’s look for a better one.
They seemed to be reversing the usual approach to stock selection by looking first for any reason NOT to make the trade, and thereby setting a high standard for any stock they would consider buying. Eventually they would find one they couldn’t find fault with.
After listening, I came up with a list of my Top 7 Reasons for not making the trade.
- Bad Market Timing. It’s tempting to jump in when a stock is shooting up, but if market conditions are unfavourable, too often you’ll be buying right at the high, just before a bad market brings the stock crashing back to earth. VectorVest’s market timing signals range from very fast with the Primary Wave and Green Light Buyer to much slower with the DEW and Confirmed Call signals. Choose the timer that works best with your temperament, time-in-trade expectation and investment goals, and then stick to it. Above all, no matter how tempting, don’t make the trade when the overall market is falling.
- The Stock is in a Downtrend. A stock may be up for a day or two and rising off what you think is a bottom, but if it’s still technically in a downtrend, hitting a series of lower highs and lower lows, that’s a good reason not to buy. Instead, favour stocks that are in reasonably smooth, rising uptrends from bottom left to top right on a one-year graph or longer.
- It’s Too Volatile. With a stock you own, VectorVest teaches a warning sign of potential trouble ahead is increasing volatility. So, why then would you buy a volatile stock? There’s a good reason why one of Dr. DiLiddo’s favourite chart patterns is a flatline or consolidation with low volatility followed by a breakout. If a stock is moving up, down and all over the place with no rhythm or direction, there’s a greater chance that any breakout will be false and short lived.
- Too Far Above Its Moving Average or Trendline. Beware of a stock that has gone up too fast and too far. It’s riskier at that point because stocks that are extended naturally tend to revert to their mean. That can be the 40-day Moving Average, a Support zone or a lower trend line in a channel. Instead, look for stocks that are breaking out from periods of consolidation, sideways trading or a normal pause during an uptrend.
- There’s No Liquidity. Stocks that are not actively traded are more difficult to get in and get out at reasonable prices. The bid and ask can be wide, causing you to pay too much when you’re the buyer, and not getting the price you want when you’re the seller. Best to just avoid them.
- The Industry Group is Lagging. You might find a stock that looks promising, but for some reason the industry group is weak. In the same way a rising industry group can lift even the weakest stock, a falling industry group can drag down the strongest stock. Favour a robust industry group where the RT Ranking is rising and price on the industry graph is above its 40-day MA and rising.
- Earnings Are Falling. This is the absolute non-starter for Brian and Todd, and so should it be for you. Consistent and predictable earnings is the engine that drives the stock price higher, and the opposite is also true. Look for stocks where EPS is rising all the way to the right edge of a one-year graph or longer. If it isn’t, don’t make the trade.
Billionaire investor and Warren Buffett’s partner, Charlie Munger, said, “You don’t make money when you buy, and you don’t make money when you sell. You make money when you wait.” Charlie Munger knows THE IMPORTANCE OF NOT MAKING THE TRADE.