5 Mistakes to Avoid for the Rest of 2015
05/14/2015 6:00 am EST
Some just starting out in the stock market can blindly fixate on the opinions and headlines out of the financial media without doing their own research, so MoneyShow's Tom Aspray shares five mistakes for traders and investors to avoid for the rest of 2015.
As I suggested before the 2014 holiday season in A Six-Point Checklist for a Profitable 2015, taking time away from the markets is essential for the mental health of all investors and traders. It doesn't matter whether you are a professional trader or a beginner, watching the markets 24/7 without a break will inevitably dull your analytical abilities.
In that trading lesson, I reviewed some of the technical approaches that I have found to be the most reliable over the years. The goal was to reduce not only the number of losing trades but to avoid those trades or investments that could seriously damage your portfolio. Everyone has some losing trades and incorrect market forecasts but the explosion of available financial data on the Internet has created new problems for many traders.
One of the biggest mistakes you can make in the financial markets is to make any investment decisions based on what you hear on the financial TV networks or read on a financial Web site. It is important to understand that the producers at the financial stations gear their daily programming to get immediate attention. Have you ever noticed how put buying segments come near market lows?
Therefore, they will have an analyst discussing the imminent depression when the market is down sharply, but follow that with a super bull the next day if the market is sharply higher. It is no wonder that new investors are afraid to get in the stock market.
My analysis of the stock market began in the late 1970s, and in 1982, I began my professional career as an analyst. My research of past bull and bear markets had convinced me that major trend changes do not happen overnight. It was also evident that rigorous analysis of the data would help you identify when the economy or stock market was turning.
Since 2010, the rally in the stock market has had to overcome a rather consistent barrage of skepticism. In April 2014, I published this chart in my Week Ahead column.
I wanted to point out how the bearish commentary often reached extreme levels near the end of a market correction.
Before the major lows in 2010 and 2011, the S&P 500 and NYSE A/D lines both made a new high which was positive for the major trend. This made a new recession or bear market extremely unlikely.
Then, in May 2012, the market corrected sharply as many were concerned about a split in the EuroZone as many thought Greece would be forced to leave. Many are now voicing the same concern over their debt crisis.
The market also fought the skeptics throughout 2013 (The Most Hated Stock Market Rally in History) as each earnings season was viewed as a potential disaster, even when stocks continued to move higher.
Just before the October 2013 earnings season, one well known analyst proclaimed, There's A Decent Chance Stocks Will Crash. His two concerns were that stocks were expensive relative to earnings and that earnings were much higher than normal. Huh?
The Dow Industrials hit a low of 14,700 just seven days later and reversed sharply to the upside. Just six days after the lows, another analyst wondered Will Earnings Season Kill the Stock Market Rally? Of course, the market finished the year on a strong note.
Did anything change in 2014? Not really, as in the last half of the year, the stock market had several wide swings. As I have noted, the lows since last August have also been accompanied by a number of bearish articles.
NEXT PAGE: Are There Any Good Resources for Finding Stock Ideas?
Some who are just starting out in the stock market sometimes can blindly fixate on these opinions without doing their own research. This is why following the advice of someone in the financial media without doing your own analysis will be a serious mistake for the remaining half of 2015. This is especially true when it comes to those that are calling for a major change in the trend of the economy or any market.
At the early August low, the negative sentiment was quite high as one headline proclaimed The Stock Market IS Still Trending Bearish. This was in contrast to the technical readings as the NYSE A/D line had made a new high in July, so therefore, the decline should have been viewed as a correction not a major top.
The plunge from last September's highs was accompanied by heavier selling than I was expecting. But the warning of a recession was contrary to the real economic indicators like the Leading Economic Indicators or ISM data, which was still strong.
Of course, a headline that came out in January of this year issued that some warned of a bear market because the stock market was weak over a seven day period. Everyone is still waiting for the bears to arrive.
The point is that if you see something on TV or read a column that starts you thinking about changing your market view or your portfolio; take a deep breath. Then wait at least a week, and in the interim, ask yourself some hard questions. Also, review the past commentary of the analyst which will help you better evaluate the validity of their analysis. (I have 2029 articles on MoneyShow.com.)
In October of last year, I spoke to a few investors that had just heard a bearish presentation that focused on why the Ebola crisis was going to be very negative for the stock market and the global economy. Unfortunately, I know of several who reduced their commitment to the stock market back in October.
I pointed out to these gentlemen that, historically, events that cause sharp market declines when the market is in an uptrend do not last very long. Such events in a downtrend market will just help to reinforce the downtrend.
Many get their trading ideas or investments from articles on the Web, TV, or one of the financial newspapers. Many of these sources do not give specific entry levels or recommend a stop to use on either new long or short positions.
The second mistake to avoid for the second half of 2015 is to never add a new position before determining where you will place your stop and then using it. This will allow you to determine the risk on the position, and if you consistently risk too much (8%-10%) on any one position, you are likely to be in trouble.
There are many good resources for finding stock ideas and I have often found the fundamental research in Barron's to be quite good. Like many services, they often provide their analysis on how high a stock might go but not where or when to buy. Stops are rarely provided on either their long or short recommendation.
They do provide good data on their recommendations to subscribers (link here), so I wanted to use some of their 2014 recommendations to illustrate some simple steps that could have been taken to filter their recommendations and to illustrate the mistakes to avoid over the remaining months of the year. Once you have determined where your stop will be, and that the risk is acceptable based on the last closing price, there is another step you should take before you buy.
NEXT PAGE: How to Not Buy Too High
In order not to buy too high, I suggest that you look at the price of the stock that is recommended and determine how far the price is from its 20-day EMA. On February 17, 2014, they recommended CVS Health Corp. (CVS), which had closed the prior Friday at $69.16 and the 20-day EMA was at $67.24.
The close was 2.8% above its 20-day EMA and the stock opened the next trading day at $69.73, which was 3.7% above the 20-day EMA. The closest stop was under the weekly low of $65.66 so the risk was just over 6%, but would have been 5.3% on a flat opening.
This was not a low risk buy as I generally try to buy no more than 3-4% above the 20-day EMA. When a stock is significantly above its 20-day EMA, you are generally buying too high as a pullback is inevitable. This entry technique was discussed in more detail in a previous trading lesson, Avoiding High Risk Entries.
These two steps will help you avoid two common mistakes. As the chart indicates, it actually was a great time to buy. However, it is important to realize that you will have several opportunities to get in a strong stock. This is a reason why all serious investors or traders should keep a written watch list.
CVS peaked at $75.55 at the end of March, 2014 and traced out a flag formation (lines a and b) from early March until early May. Prices tested the March lows in both April and May of last year allowing for a low risk entry in the $74 area with a stop under $71. This would have been a risk of 4% and CVS rallied to a high of $98.62 in late 2014.
Of course, another problem is that Barron's rarely provides any sell advice, so without a stop, it can get pretty ugly. Apache Corp. (APA) was recommended on June 21, 2014 as it had closed at $100.09, which was 5% above the 20-day EMA at $94.96.
The tightest stop would have been under the quarterly pivot at $94.30 or the November 2013 high at $93.90. A stop .05% under the pivot would have meant a risk of 6.2%. The risk and entry point analysis suggested that one should probably wait before buying Apache Corp. (APA).
APA pulled back below the flat 20-day MA as it made a low of $96.74 on July 15 and closed at $97.26. This close was below the 20-day EMA at $97.78 and it looked like a normal pullback. A stop under the June 9 low of $93.33, say, at $92.90, would have meant a risk of 4.4%.
After a rally to new highs at $104.21, APA again corrected back to the support in the $97.27-50 area, line a. In this chart, I have included the OBV, which had stayed flat during the prior move to new highs. Since the position had been up just over 7% on the recent highs, a prudent step would have been to move the stop to just under the monthly lows at $96.
In early September of last year, APA dropped down to a low of $94.89 as the support, line a, was broken (point 1). Over the next three days, it rallied back to its declining 20-day EMA (point 2), giving anyone who was still long an opportunity to get out.
NEXT PAGE: Don't Forget About Grabbing Partial Profits
Once you are fortunate to be in a stock or ETF that is moving sharply higher, don't forget to grab some partial profits on the way up. Visteon (VC) was recommended in Barron's on March 22, 2014 after the stock had closed the prior Friday at $85.67. The 20-day EMA was at $84.04 and a reasonable stop could have been placed under the February 27 low of $82.43 (line c).
The risk was, therefore, around 4% and the close was just 1.9% above the 20-day EMA. VC had a wide range the next day of trading as it gapped sharply higher at $87.30 on the opening but traded during the day as low as $83.32 before closing at $85.87.
One could have either used a limit order at the prior day's close or have bought 50% at a limit of $85.67 and another 50% position at a lower level. This, so called, Barron's boost is a problem as market buy orders on the open can push their stock recommendations sharply higher on the open. Use limit orders.
Despite that volatility, the stock stayed above the stop and by May was in a solid uptrend. It made a high on July 7 of $100.79. At that point, the open profit was 17.6% and the steepness of the rally indicated it was a good time to take some profits. Now, I have found that a stock can often rally 12-15% from a good entry point before stalling or reversing course.
There I will often recommend taking a 12-15% profit on half or a 1/3 of the position. In the case of VC, it corrected back to a low of $94.23 in late July before resuming its uptrend. Once the July high was exceeded on August 21, the stop could have been raised to just under this low.
VC eventually hit a high of $109.41 on September 10 as it traded above both the daily and weekly starc+ bands. The reversal from the highs was scary as it dropped 24.3% in just five weeks, which dropped VC below the level when the stock was recommended. Those who sold half of the position above $100 and were stopped out of the other half at, say, $93.90, still had a profit of over 13%.
Those who stuck with the position-as per Barron's-committed the fifth mistake that everyone should avoid whenever possible. That is turning a 10% or greater winner into a loser.
This can happen on a short-term basis when a stock rallies sharply on news or earnings just after you buy it. But the real mistake is when you are in a position for a month or so, only to watch it gain 15% from your entry before it drops and stops you out with a loss.
In summary, here are the mistakes to avoid for the rest of 2015:
- Never make a major portfolio or a substantial change based on something you read or watch without first doing your own research. Spur of the moment investment decisions generally do not turn out well.
- When considering a stock recommendation, decide first where your stop should be and calculate the risk based on your proposed entry level. Always use stops and limit orders.
- Compare the entry level to the 20-day EMA to see if you are buying too high. Don't buy if it is more than 4% above the 20-day EMA or place an order closer to the 20-day EMA.
- Sell part of your long position once you have a 12-15% profit and then raise the stop to the entry price or higher.
- Don't ride a position to a 10% or greater profit and then turn it into a loser. Raise your stop at that point to protect yourself against a loss.