How to make stop-loss work? Part 2: The causes

        

Earning Channel

 

After we wrote the first half of this article, we learned that Mr. Buffett had major changes in his portfolio. We’d like take this opportunity to urge MR. Buffet to do greater goods for the US. We will also discuss how ordinary investors could act on Apple and others.

 

Before that, let’s back to our topic: how to make stop-loss work effectively.

 

We believe the major cause for failing to execute stop-loss is that people bought stock with a wrong estimation, at a wrong time, in the wrong direction, and with the wrong mentality.

 

  1. Buy the wrong stocks

 

As usual, all our discussions are meant for ordinary investors.

 

What matters to ordinary investors is how much money we will make from the stock and not how much the company will make (eventually). Since the profits may first go to the company’s management team, its creators, or the preferred stocks’ shareholders, and not to us, ordinary investors.

 

However, judging future profitability and weighting against the current price is difficult. Let’s review three common pitfalls in estimating future profitability.

 

  • The P/E. Newcomers are often tricked by companies’ recent They tend to buy at the hottest time when a company has made a lot of money and is at its peak, and when the P/E is low. In other words, they undoubtedly bought at the top of a long monthly up-channel. Conversely, newcomers also often sold at the lowest point of the economy/business cycle, when the P/E is high or negative.

 

  • Dream Stocks. Dream chasers fantasize huge profits the company will soon make. They tend to ignore P/E whether it is very high or negative. They chase those with convincing stories, new technologies, new energy, new medicines, new business models, new lifestyles, or new government regulations. Unfortunately, most dreams are just dreams.

 

 

  • Overlords. The most enchanting and dangerous kind are the overlords. Buying them at the wrong timing could be extremely harmful. In their peaks, the overlords have dazzling earnings, near-monopoly status, and unbounded future. For instance, CISCO, Intel, Microsoft, and Walmart in 2000, and Amazon and Apple for now.

 

It is often dangerous to buy stocks when they are surging, especially when they already gained multiple folds. It is even more dangerous for overlords since for them, the surge or overpricing could last for months and even longer. But eventually, it couldn’t outgrow itself. When the time comes, the stock tumbles and the slope is often steeper than the surge. Big institutional players have already pocketed their huge gains. They have the money, skill, and procedure to turn around and short-sell to aggravate the fall.

 

Besides, overlords could wither and die, just look back the past 100 years of the US stock history. You can study their charts in the first chapter of “How to Make Money in Stocks” by William O’Neil.

 

Please also refer to:

“Can I buy Amazon? How about others?”

“Tesla and some of its suppliers, can I buy their stocks?”

The above traps capture those who study fundamentals but might not pay enough attention to the price movement.

 

These people seldom execute stop-loss, because they believed they are correct. And to their eyes, any fluctuation in the price is temporary.

 

These people normally have the misperception that when the fundamental is right simply buy and hold. The fact is, ordinary investors should always watch out for price movement.

  • At least, to reconfirm the fundamentals and to stay alerted. We are not experts, nor insiders. What we learned are from media, such as WSJ, Money Market, CNN money, CNBC, Yahoo Finance, Seeking Alpha, etc. The financial statements, that we get, are months behind the price movements. Sometimes they are fake.

 

Sadly, many more ordinary investors are even less diligent. They did not even study fundamentals. They do not want to study because they don’t want to hold themselves responsible. This kind of people prefers to listen to rumors or recommendations from brokers or anyone else for that matter. They do not execute stop-loss. They don’t know how to.

 

Some, who fight over a few ticks, they spent time and money on level 2 information. This kind of information, from our experience, is not only useless but a distraction of decision making. Unless you are a brilliant trader and a skillful programmer, chasing after a few ticks are futile. To one extreme, it becomes high-frequency trading, which we question its eligibility. It’s like the managers of a casino gambling inside their own joint. Volume moving is just sugar coating.

 

Ordinary investors who care about a few ticks are prone to flattening their losing positions. They seldom execute stop-loss.

 

For those who refuse to admit mistakes, they often go through the psychological cycle of anger, denial, desperation, and panic. They would not sell in the first three stages. They only sell when they are panicking, when they think the company or the world is coming to an end. That is, they do not execute stop-loss properly.

 

Those who do not execute stop-loss also fall more easily into a vicious cycle. When the stock starts to rise, they are in the disbelieving mode (still depressed). When the stock moves in the major thrust, they are in the skeptical mode (denial). They only buy when they are in a panic when they think they would be the poorest persons in the neighborhood if they do not buy. After they final got on board, they think this time is different. Since they bought at very high prices, how could they execute stop-loss?

 

  • The first step for effective stop-loss is:
  • Don’t buy the wrong stock.
    • If you are not sure if it is a good buy, don’t buy.
    • If you don’t know where to set a stop-loss, don’t buy.
    • If you can’t face reality, don’t buy any stock or ETF at all.
    • Practice, improve your skill and change your mentality.

 

Sad things happen more often in emerging markets, where investors couldn’t find enough stocks with sound fundamentals. The financial statements are often fake. Where a stock market is very much a gambling place. The saddest of all is that ordinary investors knew it was gambling, they jumped in and swam with the sharks and crocodiles, but they didn’t get out when things got hostile.

 

  • If you have to invest in emerging market, please take extra caution. The best protection or the only protection for ordinary investors is channel trading. Get in when there is a channel. Take profits when the price surges. Get out as soon as the channel is broken.

 

  1. Buy in the wrong direction

 

Why people buy when the price is on the way down? It often results from the two price points deeply carved in their mind: their own costs and the price at the previous top. This is a horizontal vision and not the way the price move. Price moves upward, downward, horizontal, or random, not just horizontal.

 

Personal cost is irrelevant to the price movement.

 

Next time, before you place an order for flattening, please ask yourself:

  • Isn’t there any other stock that can bring a better return?
  • How about selling the current position and buying others?
  • Maybe the underlining company or sector will go down for a long time, and it is, in fact, a good time to short-sell.
  • Ever if you think the company will eventually recover or is oversold, please wait for the confirmation of a bottom.

 

Please refer to:

“Bottom patterns and channel trading.”

“Painless preventing flattening and bottom fishing.”

If you often do flattening, that means you do not do stop-loss.

 

  • The second step for effective stop-loss is:
    • Don’t buy on the way down.
    • Don’t short on the way up.

 

“Don’t short on the way up” sounds intuitive enough. Why would anyone short on the way up? Isn’t it kind of stupid? But, then, why so many people buy on the way down?

 

A faster way to bankruptcy than flattening is to short-selling without sufficient practices.

 

Over the years of our services to ordinary investors, we’ve seen college professors and even professional industrial analysts got themselves into serious trouble by short-selling. They were often right on the fundamentals. However, they lack the experience in trading. This is due to the following factors:

  1. They think they are so right, the price could crash at any time. Must short now, or never.
  2. Enjoy being right than being rich. Try to fulfill their egos than their pockets.
  3. Don’t know how to establish a short position with proper risk management and stop-loss mechanism.
  4. Have the wrong perception that “prices lead the fundamentals”. In fact, quite often “fundamentals lead prices” when the price is near the top or the bottom.

 

  • The third step for effective stop-loss (for short position) is:
  • Don’t short, unless you are solid at fundamental analysis and experienced in channel trading.
  • Place extra caution in short-sell.
    1. Short only those with down-channels.
    2. Use static stop-loss, dynamic channel break-up line, and channel cover-point to protect your short position.

 

Please refer to:

“How to handle short-squeeze, DIY?”

 

  1. Buy at wrong timing

 

A serious investor may have noticed that Mr. Buffett often bought before the bottom, or sold before the top. That’s why he mentioned, “I often sold too early.”

 

Mr. Buffett applies these tactics for proper reasons. We can think of the followings:

  • His judgments on fundamentals are often correct.
  • The fundamental precedes the price when the price is near the top or bottom. This is contradicting to the old belief. From our analysis, the price indeed precedes the fundamentals, when the price is moving in a trend, upward or downward. But the price lags the fundamentals when it’s near the tops or bottom. It often not just lagged, but it could be oversold or overbought.
  • He needs to act before the top or bottom for the huge amount to fill his position.
  • His move could influence the fundamentals and the price movement.

 

Please remember, we, ordinary investors, are definitely not Mr. Buffett. We should wait for the clear signals for long-term tops or bottoms before we act. Otherwise, we could easily fall into bull traps, fake bottoms, or being short-squeezed. If you fall into these traps a few times, your self-esteem along with your asset could be destroyed. We can follow Mr. Buffett, but we should wait till the price moves in the direction he bought/sold.

 

Please refer to:

“Topping Patterns and Channel Trading”

 

 

  • The fourth step for effective stop-loss is:
  • Don’t act like a prophet! Wait for the confirmation of channel formation.

 

When we learned that Mr. Buffett had a major shuffling of his holding. There are a few thoughts we like to share.

 

  1. AMZN

We are very pleased to learn that Mr. Buffett’s assessment and action toward AMZN is similar to our recommendation in 4/7/17. We also think the Amazon is a respectable and amazing company. However, the price is too high and the company scale is too large. High price itself is a high risk for ordinary investors. To keep growing for a large company relies on the stability of the global economy.

 

For those who can afford it, our recommendation is to buy a small amount. However, please make sure you buy at or near the channel buy point. If you buy near the upper wall of the price channel, you might go through the unnecessary suffering of deciding whether to execute stop-loss when the price has a normal correction.

Please refer to

“Can I buy Amazon? How about others?”

 

  1. AAPL

As for APPL, the buying zone of Mr. Buffet is almost identical to the scenario we depicted above. Mr. Buffet and team bought in the range of a mid-term bottom. They increased their positions on every dip. And for the final increment, they bought when the weekly up-channel is formed.

 

AAPL #K shares Avg. cost Total cost $B 5/25/17 Mkt Value Gain %
114350 113.25 12.95 153.87 17.60 36%

 

We can see that Mr. Buffett already made some serious profits from this investment. And the timing was when people have doubts on the growth of iPhone, iPad, etc.

 

So, what should ordinary investors like us do?

  • If you have the stock – sell some and pocket the profit.
  • If you don’t have and want to buy – wait for the signal.
  • If you want to short-sell – Don’t.

 

Why sell some?

First, look at the daily chart. The current price movement already went beyond the upper wall of the daily channel. It is time to take profit. Then we zoom out to see a longer duration of the daily channel. This picture tells us that the price is still protected by the channel. No need to panic, don’t sell all.

 

To verify, we look at a larger picture – the monthly chart. The monthly chart forms a very good looking up-channel from 2009 till now. From the monthly channel, we confirm that it is time to take some profit, as the price is at the upper wall of the long-term monthly up-channel.

To make thing automatic, we use the action plan in Earning Channel to set the timing for us.

 

When we use the default settings, Earning Channel tells us

  • To make some profit at $146.98, the channel sell-point.
  • To buy back some at $118.12, the channel buy-point
  • To take major profit when the price surge and go beyond $179.25, the channel break-up line.
  • To clean position at $85.84, the channel break-down

 

Of course, you may have to wait for months to take the action, since this plan is based on a monthly channel. You can use daily channel or weekly channel to make your plan. Simply download Earning Channel and play with it.

 

3.Controlling Shares and Cash Reserve

We noticed that Mr. Buffett’s direct investment (ownership or controlling share) is nearly 80% of his total asset. That means he is more like a business tycoon than an investor now.

 

In addition, his cash reserve was $96.5B. This is in line with our suggestion a few months ago, that most stocks in the US are too expensive. We used channel trading to forecast SPY in 3/27, and astonishingly the prediction was accurate for the following weeks.

http://earningchannel.money/how-to-deal-with-spy/

http://earningchannel.money/spy-what-to-do-now/

 

4.The airline stocks.

Undeniably the US airline industry is now almost a monopoly game. And in the near-term future, the oil price seems unlikely to go back to when the fuel accounted for nearly half of the airline operational cost. So, Mr. Buffett spent $8.38B to buy the stocks of all big four airline companies.

5.The High-Speed Railway Network

We sincerely urge Mr. Buffett to spend money on building high-speed railway network for the US, not just earning short-term profits from the airlines.

 

We guess Mr. Buffett and his senior staffs seldom take public airplanes. They don’t know the ordeal ordinary people go through in taking domestic flights. Relying only on the airline for long distance traveling is not only inconvenient but inefficient. People who traveled to Japan, Taiwan, and now China would agree that HSR is not just convenient but also contribute to prosperity and equality.

 

Look at another example, Alibaba, and Tencent, two renowned Chinese companies. Would these two companies ever exist, if not for the incredible establishment of the networks for telecommunication, High Way, High-Speed Railway, and Airline in China in the past 30 years? Now China is extending the value to One Belt, One Road.

 

Looking back at the US. The current population is about 300 million. How about 50 years from now? Do we prefer the population to shrink? Do we expect ordinary people to not able to raise families and have children? Do we prefer to stop the intake of people seeking American dreams? How much more costly will it be to do it 50 years from now?

 

The High-Speed-Railway (HSR) network will more than pay for itself – unlike the wall.

 

Let’s take the Texas Triangle for example. If there is an HSR network from Houston to San Antonia-Austin-Round Rock, to Dallas, and back to Houston, how much land can be more effectively utilized? How many new jobs? How many new towns?

 

How about extending this to Chicago? How about one in the west coast and another in the east coast? And a few more from east to west?

 

How about extending to Vancouver and Montreal? How about down to Buenos Aries?

 

Build the roads, not the wall.

 

We strongly urge Mr. Buffett to help America greater and greater. We believe human decency and culture are what make a country great. If every time you take a fight you become a little bit meaner, the country will go down. Please help to enhance public transportation. We do not think highway along can take care of the problem, even with e-car and auto-drive. Airports, bus stations, taxi stands, and auto cars, should all be connected to the high-speed railway network.

 

We hope the above discussions and suggestions are agreeable and useful to you.

 

We don’t own any of the stocks mentioned and do not intend to have any position in the next three days.

 

Our goals have been to help ordinary investors.

 

We believe channel stock screening and channel trading are the most intuitive and effective methods for ordinary investors.

 

Earning Channel is a systematic implementation of channel trading. Please download and practice. You will become a winner in stock investment within a few months. You wouldn’t need to read tens of articles every day or watch if those TV experts happened to talk about the stock you are interested in.

 

Good luck!

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