Early Not Always Better in the Stock Market
Getting Started with Chart Reading
The Next LED Superstar?
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One topic I like to write about every few months (partly
to remind myself) is the principle that, in the stock market, early is not
always better. Of course, this is
the opposite of the usual wisdom (the early bird catches the worm, and so on),
and it also doesn’t jibe with most investors who (over)react to every wiggle in
To these investors, it’s all about being early–after
all, if the market has bottomed, it’s better to buy on the first or second day
up than the eighth or ninth day up, right? In this limited example, yes; obviously, having identified
the low, you’re better off buying as close to the low as possible.
The only problem is, correctly identifying the low point
is nearly impossible to do in real time.
If we’re talking about the general market, for every sustainable,
multi-month low, there are dozens of days that are false lows, after which the
market keeps on slipping. In other
words, the only way to get in at the very bottom is to bottom fish during a
downtrend … but if you do that, you’re going to be wrong many times before
you finally catch a low. And the
end result will be lost money!
Thus, the first lesson of “don’t be early” is
to always wait for confirmation of a new uptrend (or downtrend, for that
matter). Market timing is not
about being the first to get in at the bottom or out at the top; it’s about
correctly identifying the trend and riding it as long as it persists. Yes, that means you’ll never buy at the
bottom or sell at the top. But it
also means you won’t die a death of a thousand cuts (by continually trying to
pick the bottom) or ever miss out on a major move in either direction.
I’m writing about this topic because of its implications
for buying individual stocks … something that is very timely given the
current market environment.
A few years ago, I was trying to buy early like most
investors. Now, I was never trying
to pick a bottom, but if the market had a few good days (including a good gain
on a volume thrust within a few days of a low) I would usually put on a couple
of small positions and see how they did.
I would do this even if our own intermediate-term trend indicator, the
Cabot Tides, was still negative.
Now, realize that these volume thrusts tend to work
pretty well at identifying a low, and they tend to come a week or even two
before the Cabot Tides give a bullish signal. Thus, you’d think my results would be enhanced by buying a
couple of stocks at this earlier stage, right?
went back and studied my trades, and here’s what I found: There were numerous stocks I bought on
the volume thrust that turned out NOT to be leaders. They looked good initially, but eventually, they petered out
and lagged the market.
Also, even among the stocks I bought that WERE leaders of
the new advance, most didn’t make immediate upward progress. There were a few exceptions, but the
vast majority bobbed and weaved for a while before kicking into gear. Finally, of course, there were those
times when the Tides never did turn positive, so most everything I bought
turned out to be a small loss.
All in all, the study showed that, on balance, buying
before the Cabot Tides turned bullish wasn’t helping my results … in fact, it
was slightly hurting them! Waiting
for the Tides to turn positive–it usually takes two or three weeks after a
significant low point–allows you to a) home in on the true leaders of the
advance, and b) take out a little extra insurance that the rally is the real
What about today, you ask? Well, even though I’ve been highlighting a couple dozen
potential leaders to subscribers, I’ve mostly been cooling my heels, waiting
patiently for the Tides to give a green light. For the most part, that has once again been the right
move–while some leaders have lifted off in recent days, few have really made
big moves (especially after Monday’s reversal lower) and some have pulled back
into their bases. If we get a Tides
buy signal in the days ahead (we’re close), my guess is that there will be
plenty of good opportunities to make money.
The Cabot Tides appear in our flagship newsletter, Cabot
Market Letter, which I’m the editor of. Subscribe today to get the Cabot Tides
latest reading, along with that of our other two market timing indicators and
recommendations for the market’s top growth stocks.
Switching gears, I wanted to write briefly about getting
started in chart reading. I’ve
found that most investors make a few mistakes early on that can be easily
The first mistake is that some investors try to become
jacks of all trades … and end up being masters of none. What I mean is that novices will focus
on way too many indicators and time frames. First they look at the RSI Index and the Slow
Stochastic. Then they add on the
MACD. Then add on 5 different
moving averages (including exponential and simple moving averages). Then they add on Bollinger Bands. Yikes!
This is just way too much information, most of which will
be too short-term and too contradictory.
You should approach reading charts like you should approach learning to
golf–you don’t go out and hit every club two or three times. No, you focus on a couple of irons (or
maybe your driver) and try to develop some consistency with them. Then you work on some other clubs. In other words, it’s a step-by-step
With charts, I can tell you that, to this day, I only
have four things I look at regularly–price, volume, two moving averages
(25-day and 50-day simple) and relative performance lines (how a stock is doing
compared to the market). That’s
it. Now, I’m not saying my way is
THE right way to look at charts, but I just want to show that it’s usually
better to have less on your chart.
So keep it simple, especially in the beginning.
Another mistake to avoid is that you should never assume
that charts are going to do something they can’t–predict the future with
certainty. Realize the chart is
simply a current look at a stock (or sector’s or market’s) current supply and
demand situation, not a crystal ball.
Yes, examining charts can help put the odds in your favor, but there are
no sure things in the market, and a chart’s picture can change quickly.
In total, chart reading is a skill you need to learn if
you’re going to be a successful growth stock investor over the long haul, and
keeping things simple, and realizing what charts can do (put the odds in your
favor) and can’t do (predict to the day what will happen) will help you get off
to a good start in your education.
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As for the market, I already mentioned that we’re on the
verge of a new buy signal, and if we get one, I’ll be putting some money to
work. However, right now is one of
those times when I don’t have a super-strong conviction about what’s likely to
On one hand, the market has built a decent-looking bottom
during the past few weeks, and there are a few dozen potential leading stocks
with good growth stories that resisted the market’s May-June correction.
On the other hand, the broad market and even the charts
of the major indexes are in rough shape, and this latest upmove has come on
super light volume; even the biggest volume day (last Tuesday, June 15) saw the
Nasdaq’s total volume 12% below average.
So it’s hard to really have faith that big investors are piling into
So what do you do?
First, you follow the system–as I said, if our Cabot Tides turn bullish,
I’ll be putting some money to work.
However, I think taking a gradual approach is the best course of
action. That means buying two or
three small positions … maybe half your normal investment, dollar-wise.
Then, over a few days, if the market is acting well and
your stocks are making you money, you can buy a little more, either of your
current holdings, or new purchases.
After two or three weeks, if all goes well, you’ll be heavily invested
in some strong stocks. Of course,
if the rally peters out (failures usually occur quickly and violently, so it
won’t be hard to notice), you won’t get heavily invested; you’ll stop buying if
your stocks aren’t showing you a profit.
One tiny company I’m keeping my eye on is Rubicon
Technology (RBCN), which isn’t a household name, but is helping to lead the way
forward in the LED industry.
Here’s what I wrote about the firm in Cabot Top Ten Report earlier this
“If MEMC Electronic Materials was the raw material
supplier (silicon) that benefited greatly from the solar and chip boom of the
2005-2007 period, then Rubicon looks like the winner in supplying raw materials
(in this case, sapphire substrates) for the current and upcoming LED boom. The
company is a leader in producing these substrates in the Western hemisphere,
and is the world leader in larger sapphire wafers, which the industry is moving
toward (and which have significantly higher barriers to entry than smaller
wafers). The stock is strong today because demand is miles ahead of
supply–LEDs in notebooks, networks, LED monitors and TVs are using more and
more LEDs, and the industry is racing to expand capacity to meet that demand.
That, indirectly, is pushing prices for Rubicon’s wafers up; prices roared
ahead 20% sequentially in the first quarter, and management sees higher prices
going ahead. Revenues have soared the past couple of quarters and the firm just
booked its first profitable quarter in two years. Eventually, this industry
will over-expand and prices will fall … but management believes that’s at
least a couple of years off. In the meantime, we see major growth ahead.”
Since that time RBCN has broken out powerfully from a
choppy base, successfully completed a share offering and, importantly, has
refused to give up ground during this week’s slide in the market. The stock is relatively thinly traded,
but business is picking up in a big way, and if the LED trend continues for a
few more quarters, Rubicon will have a bright future. I think a little could be bought around here, or preferably,
on a pullback toward 30.
All the best,
For Cabot Wealth Advisory