Three Steps to Successful Stock Trading

Back in 1931, Humphrey Neill, who later became famous as the Vermont Ruminator, but was then vice president of Wetsel Market Bureau, Inc., wrote a book called “Tape Reading and Market Tactics – The Three Steps to Successful Stock Trading.” It was published by B.C. Forbes Publishing.

In 1970, it was reissued by Jim Fraser of Vermont, and last year it was reissued again, by Marketplace Books. You can get it on the Internet for about $10.

The copy I pulled off my shelf last week is from the original edition, second printing in March 1931. It was first owned by Lester Vernon Parmelee, who signed his name both on the flyleaf and inside the back cover, and affixed his bookplate, complete with the Parmelee motto, Beatus Qui Patitur, or “Blessed is he who endures,” inside the front cover.

A little research reveals that the Parmelees settled Guilford, Connecticut, in 1639 (and some endure there today), but that Lester was born in Los Angeles in 1896 and died in 1966. He never married.

My father bought the book used in 1951, apparently for $5.00 (the price penciled on the inside cover) and affixed his own bookplate, and though he retired from Cabot four years ago, his valued books remain here in the office, enriching those of us who are still willing to learn their secrets.

Three Steps to Successful Trading

So what are the Mr. Neill’s three steps to successful stock trading?

The first step is familiarizing yourself with the methods of the institutions that move the market.

The second step is learning how to interpret the actions of both these groups and the investing public.

The third step (and hardest of all) is achieving mastery of yourself; of the “temperament, emotions, and the other variables that go to make up human nature.”

We write about all three of these issues frequently, but we don’t spend much time on the first; we simply accept that institutions have the power to move the market.

We do spend a lot of time interpreting their actions, reading charts to determine whether stocks are under accumulation or distribution or just simply ignored.

And we spend even more time on the third issue, working to teach you, the individual investor, that the greatest obstacles to success lie in those variables that make up your own human nature.

The biggest obstacle of all, of course (if I’ve written it once, I’ve written it a thousand times) is the inability to cut losses short.

Humphrey Neil said it way back in 1931; “The one thing which retards success in trading, more than any other, is the unwillingness of many of us to accept losses, cheerfully and quickly, when we realize that we have misjudged the action of the market.”

Today, unfortunately, the market that was teasing us toward a re-entry last week has dashed our hopes. The moving averages that had just begun to give buy signals have been whipsawed; Friday’s big 316-point Dow drop has pushed them back to the negative side. Thus we continue to counsel that you maintain a heavy dose of cash.

If you did any new buying last week be certain to keep any losses small. He who sells and runs away lives to buy another day.


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China Medical Takes a Dive

Which brings us to China Medical (CMED).

I wrote glowingly about the stock last Thursday, after the firm released a terrific third quarter earnings report. Revenues grew 75% to $36.3 million, while earnings grew 46% to $0.60 per share, beating analysts’ estimates by $0.14.

But after the market closed, management revealed, in a conference call, that revenues this year were not expected to grow quite as fast as previously expected.

In response (and in concert with the plummeting broad market), CMED fell 8 1/2 points–on big volume–to 46, for a drop of 15%.

Now, in my defense, I did write, “Short-term, CMED looks a little high to buy here, but long-term, the future is bright.” So I hope you didn’t buy.

And I don’t think you should buy now, even though the stock is cheaper. Today, the sellers are in control, and there’s the risk that this first bit of “bad news” will lead to more. So CMED comes off our watch list and we move on.

In retrospect, I was wrong. But it’s no sin to be wrong; the only sin lies in staying wrong, in arguing with the market. CMED’s story has changed, the market has signaled its judgment, and we accept it.

Now, I know from experience that some investors will have trouble accepting that. They will say that I should have known; I should have done better research, etc. My answer is that deep research does help when you’re investing in undervalued stocks and undiscovered stocks … but it doesn’t help when you’re investing in growth stocks that are already under accumulation and being followed closely by thousands of other growth-oriented investors. In those cases, the action of the stock is paramount; today, CMED’s action says we should move on.

But where to?

Stocks Hitting New Highs

One thing I like to do when the market falls apart, as it did last Friday, is see what stocks are holding up well … even better, what stocks are hitting new highs.

A quick screen after the close Friday revealed 37 stocks hitting new highs. Only 16 were liquid enough for our taste (liquidity implies more stability of trading) and only 14 of these were trading above $10 (the higher price lowers risk).

Here they are

Agrium (AGU) Calpine (CPN) Choicepoint (CPS) Concho Resources (CXO) Darling International (DAR) Echostar (SATS) FTI Consulting (FCN) Kinross Gold (KGC) Newfield Exploration (NFX) Petroquest Energy (PQ) Sandridge Energy (SD) Southwestern Energy (SWN) Stillwater Mining (SWC) Syngenta (SYT)

I already know many of these, and a little study of both charts and fundamentals enabled me to familiarize myself with the remainder.

So, from the top.

Agrium, of Calgary, Canada, is in the fertilizer business, which is in excellent shape. The company has good fundamentals and the chart reveals a long-term uptrend.

Calpine is an energy company that emerged from bankruptcy a month ago, so its chart doesn’t have enough real history for interpretation. The sector is healthy and the post-bankruptcy status is attractive mainly because it gives the company a stigma that causes many investors to avoid it for a while, leading to fewer selling pressures.

Choicepoint is being acquired by Reed Elsevier for $3.6 billion.

Concho Resources is a Texas oil and natural gas company that came public in August. Its chart is healthy and its fundamentals attractive.

Darling International is a Texas company that turns animal byproducts and used cooking oil into tallow, protein and yellow grease. Margins are increasing and the chart’s long-term trend is up.

Echostar Corp was spun off from Echostar Communication in January so its chart is quite young. The firm makes the set-top boxes that process satellite TV signals.

FTI Consulting is an old favorite, a company that does well when times are tough. It provides forensic services for companies in trouble: litigation, accounting, expert testimony, restructuring and more. The long-term chart is up and the fundamentals are good.

Kinross Gold is a Canadian gold miner with operations in Brazil, Chile and Russia. The long-term trend is up.

Newfield Exploration is a Houston-based oil and gas company. Growth is rather slow, but the chart has just built a long 29-month base and if this breakout works the stock could make a nice run.

Petroquest Energy is a small Louisiana-based oil and gas explorer and producer. The main trends of revenues, earnings and the chart are all up.

Sandridge Energy, based in Oklahoma City, also is finding and producing oil and gas. It just came public in November, so its chart is young, but all trends look good.

Southwestern Energy is a big Houston-based oil and natural gas company, already owned by 250 institutions. All trends look good.

Stillwater Mining, of Montana, mines, processes and refines platinum and palladium. The long-term fundamentals are messy; the firm lost money in both 2005 and 2007. But the break above old resistance at 19 means the stock could make good progress from here.

Syngenta, of Switzerland, leaves us back where we started, in the fertilizer business. Long-term trends of revenues, earnings, and the chart are all good.

For independent-minded investors, that’s the start of a decent watch list. Energy stocks are obviously leading the way today, but you should be careful where you buy (if you buy); they may be due for a rest. More important is that the broad market’s rally has failed, a sign that you should continue to harbor lots of cash until the market’s health returns. In the meantime, diligent research can pay dividends in the future.

As one of Jim Fraser’s buttons says, “Proper Prior Preparation Prevents Poor Performance.”

Editor’s note

FTI Consulting, Kinross Gold and Southwestern Energy have all been featured in Cabot Top Ten Report in recent weeks and subscribers to that publication will get updates on them in every issue until they are sold. Cabot Top Ten Report, for the record, was the first Cabot publication to feature big winners like MasterCard, Intuitive Surgical and Archer Daniels Midland, and you can count on it to bring you the leading stocks of the next big market uptrend. To get started with a no-risk trial subscription, simply click the link below.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory

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