FAQs: From Investing Tools to Indicators

A couple of years ago, before we began writing the Cabot Wealth Advisory, someone in our office came up with the idea of sending out a free monthly email that answered many of our subscribers’ most common questions. We named it Ask Cabot, and it proved to be a learning experience for us, and beneficial for many readers as well.

Unfortunately, as time went on, we didn’t receive as many general investing questions as we’d hoped. And, to be fair, we also got busier with our paid publications, which demanded more time and effort. So we halted Ask Cabot, and began Cabot Wealth Advisory, which is produced more frequently but discusses a wider range of topics.

Then something ironic happened: We began getting a slew of questions! Our Cabot Wealth Advisory is reaching so many current and future investors that our email inboxes are being filled with good, sound investing questions.

Because of this, I wrote a “FAQ Issue” of Cabot Wealth Advisory last November 10 (you can read it and all our past issues in our archives at http://www.cabot.net/Issues/CWA/Archives.aspx ), and I got plenty of positive feedback on it. It’s been four months since then, so I figured I’d give it another shot. If enough subscribers like it, Tim, Paul and I can do it on a regular basis. Consider it Ask Cabot reincarnated!

Realize that the questions below are generally not about specific stocks; we’re happy to answer those questions with direct emails. These are questions and comments that can help all investors better understand not just how we invest, but also some important principles that will quickly improve your skills. So, without further ado …

Q: You just recommended XYZ stock a couple of weeks ago … and today you’re advising to sell it. How can you change your opinion that quickly; I thought it was a great company!

A: As Paul Goodwin (analyst and editor of Cabot China & Emerging Markets Report) has written a few times in this space, you need to have three things for a successful stock–a good story (i.e., good future potential based on a unique product or industry upswing), good numbers (particularly strong sales and earnings growth and big profit margins) and a good chart (telling you deep-pocketed investors are accumulating the shares). Paul calls this the SNaC system–Stories, Numbers and Chart–and it’s a useful acronym to remember.

The most fluid of these three pieces is the chart–the story and the numbers don’t change overnight, but in rare instances, the chart can (either positively or negatively). Most investors refuse to change their minds that quickly, but our studies show that a rapid change in the price of the stock–especially if it comes on earnings news–usually leads to more movement in the same direction. So if your stock collapses soon after you buy it, your best move is almost always to get out. Yes, it’s painful … but stubbornly sticking with the stock usually causes only more pain over time.

Q: I’ve been looking at Baidu (or Google, or Apple, or any other past leader) and business remains great. Yet the stock is down significantly. Isn’t it a good buy?

A: This question is closely related to the one above. The answer is generally no, and the reason is that a stock is not the company. A stock can fall sharply and persistently even if sales and earnings are growing quickly. That’s especially true in a bear phase for the overall market.

Like I wrote above, you need not only a good story and good numbers, but a good chart as well. One without the other two is far less reliable. We do think last year’s big winners have topped, and while the occasional exciting rally will take place, you’ll be better off looking for new leaders.

Q: When will this market stop falling?

A: This is a very popular question these days. But the title of our Cabot Market Letter three weeks ago was “Forecasting Sells, Interpreting Pays,” meaning that, while predictions of the market will sell newspapers, the best investors simply interpret the market’s action day by day, week by week, and stay in gear with the trends.

Thus, we don’t have any guesses about when the morass will end, although we have seen some signs that a bottoming process is underway. Our biggest prediction is that this bear phase will NOT be like 2000-2003; that was a once in a lifetime event that followed years of huge returns. This past bull move was relatively tame, and we’re already four months into the downturn. So the next bull market could begin at any time.

Q: Recently you’ve profiled a bunch of strong commodity (gold, oil, gas, coal, etc.) stocks in Cabot Top Ten Report. Yet you’ve also continued to tell subscribers to hold plenty of cash and only buy small positions. Why not just go heavy into those areas that are working?

A: Here’s the thing about a downtrend in the overall market: It’s going to exert pressure on every stock and every group at some point. Now, that doesn’t mean an oil or gold stock won’t rise over time–many of the picks in Top Ten have put on solid performances–but it’s likely to be a three-steps-forward, two-steps-back kind of advance. And a choppier upmove means the timing of your buys and sells must be precise.

Thus, you certainly could ignore the market and just focus on the leading sectors. But, even though those stocks look great right now, it doesn’t mean they won’t suffer a sharp sell-off in the days ahead. Said another way, it’s hard to have a huge amount of long-term conviction in anything while the overall market is trending lower.

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Q: The CEO of XYZ stock, which you just recommended, just sold $2 million of his shares last week. Should I still buy the stock?

A: I wrote about this last November, but it’s such a popular question that I wanted to cover it again. Simply put, insider actions (either buys or sells) have never proven to be a great indicator of future price performance one way or the other. Sure, sometimes a stock tops out after the insiders dump shares, but just about all of the big-winning stocks in history have experienced plenty of insider selling as they rose to scintillating heights. What really matters is what institutional investors think of the stock–which is why we watch the chart.

Q: You’ve been talking about a possible bottoming process in the market, but with housing sales declining sharply, manufacturing reports looking awful, and inflation measures beginning to tick higher, how can the market move meaningfully higher?

A: All of the problems listed above are economic fundamentals, which are not good leading indicators of market performance. Remember, the market looks ahead three to nine months, so if anything, the market is a leading indicator of the economy, not the other way around. Think of it this way: If investing were as simple as reading the economic indicators and investing based on what they said, we’d all be rich! But that’s not going to happen.

The market will definitely bottom when the news is bad, and the outlook seems poor. We don’t know many people predicting great things back in March 2003, when our indicators gave us buy signals just as the bull market kicked off (the Cabot Market Letter’s Model Portfolio was up 50% that year). So it’s important to filter out the bad news and pay attention to the market itself.

Q: I’ve been using charts more, but am curious about your opinion about the various stock-based indicators like MACD, RSI, Stochastics, and so on.

A: Very good question. To be honest, I like to keep it simple–my charts just look at a stock’s price history, volume history, a couple of moving averages (especially the 50-day moving average) and the stock’s relative performance (compared to the market). All those “indicators” you mentioned are basically short-term overbought-oversold measures, which don’t carry much weight with me.

That’s not to say they’re totally useless, but if you’re looking for intermediate- to longer-term profits, you want to know whether a stock is under accumulation or not. And MACD, RSI and the like don’t help you determine that.

Q: List your top rules (or tools) for investing.

A: They are: Cut losses short (definitely rule #1 for growth stock investing) … Search for strong sales and earnings growth (especially triple-digit sales growth) … Search for revolutionary products with major benefits (First Solar and Crocs filled the bill in ’07 and were our two biggest winners) … Heed the message of the overall market … Never average down … and Be prepared for all contingencies (always have an exit plan ahead of time, just in case).

Closely following those would be: Never try to buy at the bottom or sell at the top (if you try to do it, you’ll just lose more money) … Stick with stocks that are liquid to avoid gut-wrenching volatility (usually at least 600,000 shares traded per day or more) … Only put more money to work after your past purchase or two is showing you a profit … and Be humble–making money in stocks is tough, so don’t kill yourself over one or two bad trades, and be thankful when you hit a big winner.

That’s all I’ve got now. Let me know whether you enjoy the FAQ format (no worries if you don’t, just be honest), and let me know whether you have any questions or comments.

All the best,

Mike Cintolo

Editor’s Note: Michael Cintolo is editor of Cabot’s flagship publication, the Cabot Market Letter. The publication has everything a growth stock investor needs–a clear, concise and concentrated Model Portfolio (no more than twelve stocks at any one time), proven market timing (which has helped the Portfolio remain defensive since mid-November) and sound buy and sell signals for its individual stocks, so you can keep the profits you earn. It was ranked the #6 Letter by Hulbert last year, and since the start of 2007, the Portfolio is up 29%, while the S&P 500 is down 6%! Over the past five years, the Portfolio is up more than 17% annually, trouncing the indexes and nearly all mutual funds. To see first-hand what the Market Letter has to offer, click the link below.



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