April 3, 2008
Current Share Prices
I find the stories about the California Gold Rush era fascinating because at few other times across the course of human history, could a person of modest means potentially achieve great wealth. Though the quest for gold was not always easy for the 49ers, and not all of them achieved wealth, once they literally “staked their claims,” each person had the same opportunity to achieve instant riches as the next. The Gold Rush was the great equalizer.
Finding great stock trading opportunities is, in a way, like the 49ers’ quest for gold, in that anybody– whether young or old, rich or of modest means, male or female– has a chance to create wealth for him or herself. But finding a shinny nugget at the bottom of your pan is one thing, while finding those select stocks that have the most explosive upside potential is quite another.
Today, I know why trading a stock just as it breaks out can lead to explosive gains, and I know the thrill of watching a quality stock quickly swell my portfolio, but this was not always the case. In fact, I tried out just about every other stock trading strategy first, because I found studying stock charts tedious and confusing. Which stocks should I concentrate on? What should a stock’s chart look like? What moving averages should I use? Which oscillators are the best?
You would think that as an executive at a financial television channel, I’d have the inside track on slick ways to trade the market, wouldn’t you? After all, I regularly rubbed elbows with some of the most influential stock market gurus on the financial seminar circuit. There was only one thing. Each individual was busy selling his or her own unique stock trading strategy. As I bounced from trying one trading strategy to the next, I began to realize that many of these techniques did not work as predictably as I had expected.
At one point, I even turned to penny stocks thinking they were the way to make big money in the market. After all, 5,000 shares of a stock made you feel like a pretty big investor. But in the end, even a $1.50 stock could become a .75 stock overnight, on some little ripple in the company’s game plan, and poof! Half your grubstake…gone! And, since penny stocks are usually so thinly traded, it took a “month of Sundays” just to execute a sell order. Meanwhile you watched as your sell order single-handedly brought the stock’s value down far below what you were hoping to get for it.
The shortcomings of many of the stock trading strategies I tried only made me more determined to find a more predictable way to make money in the stock market. My epiphany came while turning the first few pages of a book on stock charts that had been sent to our television station by the publisher. The book had been sitting on a bookshelf in a corner of my office for some time collecting dust. The book? Analyzing Bar Charts For Profit by John Magee.
Magee was talking about how the field of technical analysis developed, beginning with the early moving averages developed by Charles Dow dating all the way back in 1884. As I read, three things occurred to me.
1. First, some very smart people had been hot on the trail of finding a system of using charts to anticipate stocks’ movements for a very long time.
2. Second, charts represented the only visual, factual record of a stock’s movement that was not filtered through some financial news analyst or stock market guru.
3. Third, and most important, it actually seemed plausible to make reasonable assumptions, based upon certain charts, as to when a stock was nearing its greatest potential. Could I have finally found the “holy grail” to stock profits I had been searching for?
Of course, nothing is ever as simple as it seems at the outset, and quite frankly, the study of charts took me far deeper into technical analysis than I ever had intended to go. Yet somehow the quest for a more definitive way of knowing when to buy high-potential stocks had grabbed hold of me, and wouldn’t let go until I had some hard and fast answers.
I read every book on charting techniques I could lay my hands on. At night, armed with my charting software, I’d download a list of stocks and stare at their charts trying to discern what they were telling me. William O’Neil’s “How To Make Money In Stocks” helped me to better understand the relationship between a stock’s daily price action and its volume. Slowly, after what seemed an eternity, I began to spot the chart patterns.
Of course gaining knowledge about technical analysis is one thing, and putting this knowledge into practice is quite another. Here again, there was no shortcut. No abbreviated course. No quick cure. I had to rigorously trade stocks based upon my assumptions about a stock’s chart. I’d hear seasoned traders say this is a process that takes about four years of frustration, elation and often, disillusionment. They weren’t kidding. Once I emerged from this “birth of fire,” I had a newfound respect for the market forces. Gone was any pretense of cockiness or self-pride. I felt almost as if I had achieved a kind of “warrior status.”
In the end, I learned that trading stocks just as they broke out was simply the most dependable way to make money I had ever been exposed to. There wasn’t any guarantee, there were still surprises, and not everything worked out exactly as planned, but when a stock’s time had come to break out, there just was no quicker way to make money.
These days, I usually begin my search for stock market gold by scrutinizing a company’s fundamentals and choosing the best of the best. Why? Because a leading company has an established track record for executing a successful game plan, and is less likely to surprise you with negative news. Believe me, with all the varying factors that you have to contend with in trading stocks, you at least want to have your best players on the field. Why would you want anything less than your top quarterback in the Superbowl? The same thing applies to stocks. Does the company have successive quarters of earnings increases? How does the company stack up to others in terms of its “relative strength,” or price stability? Is the company in a strong industry group? Is the stock under accumulation by mutual fund companies?
Then I look at the stock’s chart. Here’s where things start to get exciting, because breakout stocks form certain time-tested patterns just before breaking out. “Time-tested” does not mean foolproof, but from a cup-with-handle, double-bottom, flat base, or other types of chart patterns, you can begin to discern the telltale signs of pent up demand. The stock may drift sideways, or slightly downward as if it is disinterested in going any higher. Meanwhile, it’s daily volume drops to a whisper. It’s almost as if the stock is sleepwalking. A lot of traders take this to mean there is no interest in the stock. Nothing could be further from the truth.
One day, the stock seems to turn on the afterburners, and you see this explosive burst of volume that exceeds anything the stock recently seemed capable of. You silently watch in awe as this stock breaks through its resistance/buy point and then heads skyward. Then, as you watch your profits mount, you sit back in your chair and allow yourself a brief moment to reflect on the thrill that the 49ers must have felt, because in your own way, you’ve just hit paydirt. For more information visit www.StockConfidential.com
Copyright ? 2005, Paul Johnson
About the Author
Paul Johnson’s knowledge of technical analysis has been honed through thousands of hours of studying stock chart patterns and rigorous daily trading.
In addition to being the publisher of Stock Confidential, Paul has authored a number of stock trading e-books. For more information, visit www.StockConfidential.com .
Everyday, there is a new EBay or Microsoft or Dell company that files for an IPO and that will make the early buyers of its stock very wealthy in several years. The trick is how to find them and invest in them safely. Sure a General Electric or Microsoft could possibly have a bump up in share price in one year of 30% or 40% with the release of a phenomenal product or service, but the chances of earning 70%, 100%, or even 300% in one year with large cap companies is quite slim. But it’s not so with small and micro cap stocks. In fact every month, there will be another micro or small cap stock that nobody has heard of that will make loads of savvy investors rich.
So the key is how do you play riskier stocks like this? There are five rules you should always follow. In Part I of this series, I’ll review rule number one.
Rule Number One: Do your homework.
When you find a micro or small cap stock that excites you, make sure you do your homework before making the decision to buy in. Always research the float of a small stock. Why is this important? For a number of reasons. Let’s consider this scenario. You research a small stock ABC that you really like. You discover that ABC only has $10MM of outstanding shares, a float of $5MM because insiders hold the other $5MM, and average daily volume for the past three months of $3.7MM. Well you could be in for a very bumpy ride given the fact that daily volume is averaging 75% of the float (total amount of shares owned by the public). This discovery alone may make you reconsider buying the stock.
Furthermore, if stock ABC has recently had its initial public offering (IPO), then you must absolutely find out when its lock-up period expires. Usually, insiders are restricted from selling off their shares for six months after an IPO. Let’s look at our hypothetical stock ABC again, assuming it is now four months after the IPO. Many times, share prices of companies start falling about two months before a lock-up period expires in anticipation of insiders selling off their shares and flooding the market with volume once they legally can do so. If stock ABC is trading relatively flat and there is no added demand right before insiders unload their stock, an overnight doubling of the stock’s float is bound to dilute the stock price, and possibly do it very rapidly. It’s simply supply and demand at work. There is now twice the supply of stock on the market without any increased demand.
However, let’s look at the flip side. Let’s consider a company XYZ that has $20MM of outstanding shares and a float of $17MM. Positive news surrounding company XYZ has steadily driven its stock price higher, right up until the point the lock-up period for insiders expires. Let’s assume, even though prices have been climbing steadily, that the insiders still decide to cash out and sell off $2.5MM of their shares immediately. Because this company’s float is so small and demand is high, release of additional shares may create a buying frenzy that will drive prices up even more rapidly.
So to summarize rule number one, always do your homework and know everything you possibly can about the stock you are buying. As I’ve demonstrated, in one situation a small float may hurt a stock’s price while in another situation, a small float may tremendously help the stock price.
I’ll review the remaining four rules in the remaining articles of this series.
? 2006 Global Market Opportunities
About the Author
John Kim is the founder of Global Market Opportunities. He has over thirteen years of experience in finance and financial services with two Fortune 500 companies. To learn more about how to identify small and micro cap stocks that significantly beat the market indices, click the following link, Learn to Invest Money and Achieve Financial Freedom
