The first number, 1400, was the number of stocks Peter Lynch invested in when his fund size was $14B.
The second number, 343%, was the turnover rate at the first year when the fund size was $20M.
Peter Lynch is a great person in investing and in the kindness of sharing his experiences and methods with all of us.
However, people like you and me are probably not as smart as him who can look beyond financial statements. We also would not have the ability to visit companies and conduct meaningful survey; we can’t pick up the phone and call CEO’s; and we definitely will not have CEOs waiting outside to talk to us.
Therefore, Peter Lynch advised ordinary people to invest in 5 stocks.
But, please remember that holding 5 stocks was not how he made money for his fund. He bought and sold a lot of stocks. The turnover rates for the first three years of his management were all over 300%. The first year he hold 41 stocks. 13 years later, his team invested in 1,400 stocks.
He mentioned the key to his success was flexibility. Whenever he found a stock that could be more profitable (to him not necessarily the underlining company) he replaced the one that is least profitable.
We think that Mr. Lynch tried to protect us who do not have a lot of time or proper methods to work with. But for many, the interpretation of holding 5 stocks turns out to be holding 5 stocks for life. This approach may not make you rich, instead, it may make you poorer than putting money in the bank, because only a few companies can stay prosperous for a long time, or if you buy the stock at high price and low value. If you want to become rich in stock investment, you need to study and be flexible like Mr. lynch did.
So, let’s try to interpret what Mr. Lynch taught us and see how a simple tool can help us.
With 5 stocks in position, you need to watch (ready to trade) for 10 stocks. “The part-time stock-picker has time to follow 8-12 companies (let’s simplify it to 10), and to buy and sell shares as conditions warrant.” “Buy the right stock at the wrong price at the wrong time and you’ll suffer great losses.” So, you hold 5 stocks in long position, and watch out for the right timing for the other 5 stocks that you follow. Yes, wait for the right timing to trade and to replace the least profitable one, like Mr. Lynch did only in smaller scale.
But, when you follow 10 stocks, you probably need to study 100 stocks. “If you study 10 companies, you’ll find 1 for which the story is better than expected.” “The person that turns over the most rocks wins the game. And that’s always been my philosophy.” However, as a part-time ordinary guy, how can you study 100 and follow 10? And then how to decide the timing to trade and to replace the one that is least profitable in your portfolio?
There is a simple method that can help us. This method is to use price-channel to quickly narrow down the candidates and to find the optimal timing to trade.
Earning Channel is an automated implementation of using channel to find what to buy and when to sell.
Let’s reiterate what is a channel before we continue.
- A channel is a specific form of a trend, with at least two peaks and two dips, and the resistance and supporting lines are as close to parallel as possible.
- A channel indicates, in the period of time, people (little guys as well as institutions) think and act alike and are not in panicking.
Now, how to pick stock and trade? Let’s follow a few lessons.
Lesson 1: “In the long-term there is a 100 percent correlation between the success of the company and the success of the stock.” When a stock’s price forms an ascending channel in the monthly chart, it often means the company has done well for quite a while.
You can find stock with monthly channel using Earning Channel in the Typical-channel or DIY channel. Without setting other criteria, you could find about 300 stocks that forms monthly channels. Many of those are 10 baggers from 2009 till now.
To do so using Earning Channel,
- In typical channel, select strong up channel 60 (the default shows stocks with daily channels for a duration of at least 60 days). The number of stocks in up-channels and down channels also reveal the current sentiment. For short term traders, or when you are entering your trading zone, you can choose 30 days instead of 60.
- Chose “month”, it finds about 300 stocks in Dec. 2016. That indicates the market has been strong.
- To narrow down, you can put in fundamental or price and volume concerns. For instance, you can use P/E or PEG to check if the stock is overpriced. Earning Channel offers major criteria in pull down menus for you to choose from.
Let’s take a look at a few of the stocks with monthly channels. You can see that many of them grew 5x of even 20x. Several of them even broke the monthly channel upwards. Many more others are near the top of their monthly channel. We think there is overconfidence or greed in the air.
If we look at the definition of stalwart (big, stable, and can survive major market correction or economy down turn), and the definition of PEG (PE/Growth). In Peter Lynch’s guidance, most stalwarts should have PEG around 1, and PE should be less than 20. In today’s market, you almost could not find any. This also indicates the market is too hot, or the monetary policies and tax policies favor super rich and financial institutions and these guys don’t know where to put the money. So, for common people like you and me, we need to be very careful and very choosy when we see the market has been hot for too long.
For buy-and-hold, you would want to buy stocks with or is forming monthly channel. The proper timing to buy is at the supporting line (the lower line) of the monthly channel, not at the resistance line (the upper line). Notice that many of the stock are at the upper wall of the channel, and many even broke-up.
Let’s repeat, “Buy the right stock at the wrong price at the wrong time and you’ll suffer great losses.” said, Peter Lynch. Echoed by Dr. Elder “When the prices hit the upper envelope, they are overvalued. They can continue to go higher, but I’m not buying. I’m a value trader. I aim to buy below value and sell above value.” Echoed back by Mr. Lynch “It pays to be patient, and to own successful companies.” So, even though there are many stocks with monthly channels to choose from, be very choosy at this moment. Don’t buy at the wrong price and at the wrong time.
It also does not pay to second guess the tax policy or monetary policy. Follow rule 19. “Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.” Don’t buy, simply because you guess the policy is going to push the market higher, and the P/E going from 40 to 60, or 60 to 80. That is insane. That falls into the mental stage of “This Time It’s Different” or “I am invincible.”
If you seek hard or have patient to wait for the next cycle, then you can find good candidates to buy-and-hold. You can also build up the position in a safer manner by increasing along the forming of channels. This approach will enlarge your gain and reduce your risk.
Lesson 2: The secret is flexible, there are always some stocks that are under value. Mr. Lynch said he traded back and forth among oil, insurance, and consumer stocks in an amazing speed for a period of time after 1997 August 2nd. How did he do that?
Using Earning Channel we may be able to achieve similar effect by finding and following stocks with weekly channels. Buy at the weekly channel-buy-point and sell at the weekly channel-sell-point. It is now a band trading opeartion and not buy-and-hold.
After you are familiar with Earning Channel and know the business cycle of the company or the industry, you can make profit with band trading. When you master the skill, you can do so with three stocks, similar to what Peter Lynch did. The effect will be like the following.
Notice that, the effect is similar to enlarging the channel width, but keeping the same range of fluctuation. Which means you enlarge your profit, but control your risk relatively to the scale of band trading one stock.
Lesson 3: The optimal timing.
When you are ready to trade, you put the stock into the action plan of Earning Channel.
- First you define the channel.
- Decide your trading scale and strategy, for buy-and-hold, band-trade, or short-sell, using monthly, weekly, or daily channel.
- Decide the channel boundaries, using the default one or manually adjusting to the one you like. For manual adjustment, Earning Channel also offers peaks and dips of the wave to facilitate your judgment.
- Decide the channel buy line, sell line, and break-up, break-down line.
- Earning channel issues you an alert when the price touches break-up or break-down line. These are the situations to take profit or to stop loss.
- For buy-and-hold or the band-trade, Earning Channel issues an alert when the price bounces back to the channel buy line – a channel-buy-point, or to the channel sell line – a channel-sell-point. (The first time the price touches the buy line, the price may keep going down. The second time means the price move back into the channel. This time it is channel-buy-point.)
We believe the skills of exploiting the merits of channel will benefit you a lot, either in seeking stocks that will bring your profit, or in the proper timing to trade, so that you will not scare yourself in selling too early, or holding on to the stocks and never sell.
For beginners you can try to seek for good stocks to buy as long as the channel is not broken and you buy at the channel buy point. For those who already gained a lot since 2009, now it’s time to stay alert and ready to take profit. One should consider taking some profit when there is a break-up in monthly channel.
There is no guarantee a channel will continue. However, finding a channel and following channel trading principles will greatly increase your odds in making profit and in reducing risk.
Channel buy-sell offer you the first line of defense, break-up and break-down offers you the second line. In the coming article we’ll discuss more on how to use these lines to better protect you in case the market crash, or when you can’t buy what you want, and can’t sell what you need.
Hope this discussion is useful to you.
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