Tesla (TSLA), me and momentum investing

Why should a company fundamentals-driven investor have a problem with momentum investing?

Two reasons:

–momentum investing is a reactive strategy, and

–one that focuses on the past price movement of the little pieces of paper (or electronic impulses) that trade in the secondary market.

In contrast, fundamental investing is a predictive strategy based on the idea that the price of the paper/bits will ultimately be determined by the value of the underlying company.  Among fundamental investors, value investors believe that the key is the worth of the company as presently constituted (but perhaps running more smoothly than it in fact is).  Growth investors think the key is in early recognition of novel and unexpected profit positives that will fully emerge only in the future.

 

What kind of a thing, reactive or predictive, is my formula for TSLA of:   buy at $180 and sell at $250?  In a sense, I’ve got some fundamental underpinning.  My back-of-the-envelope figuring suggests nothing is likely to happen inside the company Tesla over the next couple of years that could possibly justify more than a $250 price.  And I’m willing to sell at that price even though the stock is still exhibiting positive price momentum.

But how did I get the $180?

What I’ve really done is to take a chart of the stock and draw a line that runs through the lows of the past four years or so and to conclude that this line forms the bottom of a channel (with something like $250 as the top) that TSLA has been navigating itself through since late 2013.  Yes, at $180 I have better potential for upside than I do at $250.  But that’s more a fact about arithmetic than a deep insight into corporate operations at Tesla.

In sum, then, the fundamental underpinning of at least the buying are pretty lame.

So I guess I have to say that there’s a healthier dose of momentum in my fooling around with TSLA than I might like to admit.  On another non-fundamental note, though, this ensures that my California son and I stay in regular contact.

trading a stock: what to consider

the cardinal rule

Last week I mentioned that for you and me trading–as opposed to investing–should only be for a small portion of our portfolios.

How so?

Our biggest, perhaps only, advantage over professional investors comes from knowing a few things better than most other people and in being able to adopt a longer time horizon than pros who are worried about quarterly performance.

When we decide to trade, we give up those advantages.  The main reasons for doing so are that we’re currently in a period of unusually high volatility and because we can probably find one or two stocks to study to the point that we know the short-term movement patterns as well as anyone else.  Having something to do to fill up the day is a far distant third reason to trade.

finding a stock to trade

fundamentals should be at least stable

Our idea is going to be to buy and a low point, sell at a high point and then repeat.  We don’t want to be involved with a stock where the business of the underlying company is deteriorating, because this diminishes the chances of the stock ever going up.

trading range

When we find a candidate, the first thing to do is to get a chart of the stock price over the past several years.  On it, make one line that goes through all the short-term high points, and a second that goes through all the lows.  This will typically form what technicians call a channel , within which the stock will trade and whose upper and lower walls will mark turning points between which the stock will bounce.  The move from lower wall to higher wall and back could take a month or it could take six.  The assumption we make, as the basis for our trading, is that this pattern will recur.  Buy at the bottom, sell at the top, and repeat.

Channels can either consist of two horizontal lines or have an upward or a downward slope.  In my experience, the chances of a breakout to the downside are much higher if the channel has a downward slope.  Avoid downward sloping channels.

ranges don’t last forever…

…although a given stock can trade in a well-defined channel for years and years.  So we have to be alert for a breakout from the channel, either to the upside or the downside.  Upside breakouts are little more than an eventual fact of life for traders, and a key reason not to try to trade the entire position in a core holding.  Downside breakdowns are a greater practical concern.  Finding companies to trade that have strong fundamentals and are in uptrending channels is our best defense against this.

 make a plan in advance:  (my) rule of thirds…

If we’re going to try to trade a stock that has shown a past pattern of trading between 10 and 20, there’s no need to buy/sell at precisely the presumed high/low and all at once.  My personal preference would be to buy a third of my intended position at 12, another third at 11 and the final third at 10 (assuming the stock cooperates).  I would plan to sell a third each at 18, 19 and 20.

…and stick to it

We all tend to get caught up in the moment.  At least I do. Let’s say the plan is buy at 12, 11 and 10–and sell at 18, 19, 20.  If the stock drops to 9, don’t buy more.  If the stock gets to 19.5, don’t decide to hold out for 25.  Sell at 20.

trading is not for everyone

I find it entertaining.  But it can be time-consuming.  Some people have a knack for it, some don’t.  Remember, too, that trading can be a bit like bowling or golf.  Other peoples’ public success stories are most likely not true and complete.

 

 

 

 

trading your own portfolio: general outline

preliminaries

size

Let’s assume I have a $100,000 portfolio.  I probably have a core of 85% in index-like products of some sort, with the remainder in, say, five active positions.  Each would be 3% of the portfolio, or about $3,000 each.   I would probably try to trade one of them.  In other words, this kind of trading should be a side show in investment strategy, not the main event.

trading commissions

If this is the amount I want to trade, I can’t possibly do this in a traditional brokerage arrangement.  I’ll be destroyed by commissions.

what can’t be traded easily

I may not be able to do this with some mutual funds or ETFs, which may limit the frequency with which I can buy or sell shares.  They may simply not honor trade requests, or may put them through and then impose financial penalties.  Either way is unpleasant.  So individual stocks are best.

liquidity

If the portfolio is $1 million, then the amount I’d be trading, using the arithmetic above, is $30,000.  If it’s $10 million, it’s $300,000.  At this last level, there may be some thinly traded stocks where getting in and out immediately will be a problem.  My preference would be to avoid stocks like that.  So the universe I would be willing to trade in narrows as the portfolio becomes larger.

taxable or IRA/401k?

Successful trading will likely produce short-term gains.  Arguably, they’d be best recognized in a non-tax or tax-deferred account.  On the other hand, there’s the tradeoff that doing so loses the benefit of taking a tax loss if a trade ends in tears.

Personally, what little trading I do is in a taxable account.  For me, this reinforces the idea that trading is not a structural pillar of my investing but more like embroidery around the edges.

More tomorrow.

 

trade your portfolio? …why not?

trading your portfolio

Trading your portfolio can be a couple of things.  It can mean finding one or more stocks you own for the long term but that have periodic ups and downs.  You try to add to positions when they’re down, with the intention of selling the extra when prices are unusually high.  Or you can take a stock that is unusually volatile that you have little long-term interest in and try to buy at low points and sell at high.

Professional portfolio managers, with the possible exception of hedge fund managers whose main (only?) skill is trading, usually don’t trade their portfolios.

professionals don’t

How so?

–For a professional manager with, say, a $5 billion portfolio containing fifty positions, average position size is going to be $100 million.  There may not be enough daily trading volume in any given stock for short-term buying and selling to make a meaningful difference in overall results.

–I used to think that truly excellent trading, which I had through the trading room at my last job, could add 100 basis points to my portfolio return in a year.  Certainly no more, maybe less.  My job, on the other hand, was to try to add 300 basis points to the return on the index through good selection of sectors and individual stocks.  It made no sense for me to take my mind off 300 basis points–and risk losing them–when the highest payoff I might get for spending a lot of time on trading would be 1/3 of that.

–The skills are different.

–Pension clients actively dislike portfolio managers (again ex the hedge funds they irrationally adore) who trade a lot.  They monitor turnover ratios, that is, the annual dollar value of buying and selling activity as a percentage of total assets.  They simply won’t consider a new manager whose turnover is much higher than the average, not matter what the long-term record.  So successful trading is a good way to drive clients away.

 

you and me

None of that affects you and me, though.  And the stock market has been crazily volatile in recent times.  Why not try to take advantage of battling trading computers that are creating strange ups and downs?

No, this is not for everyone.  There are risks.  Still…

More tomorrow.

 

 

 

the January effect

Mutual funds and ETFs typically have an operating year that ends on Halloween.  They do their year-end tax selling in September and October.

Other taxable investors, like insurance companies and you and me, have tax years that end on New Years Eve.  So  we all do our year-end tax selling in December.  We sell stocks we have losses in.

Smaller-cap, low share price, limited liquidity speculative stocks, which are mostly the domain of retail investors, are particularly hard hit during December.  Part of this is the volume of selling; part is marketmakers who are loathe to take on inventory and who can sense anxious sellers, dramatically lower their offers.

what it is

Just as there’s most often a November stock market rebound from mutual fund/ETF selling, there’s also typically a January rebound from December tax selling.  This is the January effect.

It has two parts:

–the losers from the prior December rebound.  Again, this is partly that new buyers appear, attracted by now-lower prices, partly that marketmakers respond by raising their bids.  Low share price speculative stocks normally lead the parade.

–investors of all stripes tend to defer sales of stocks where they have gains until the new calendar year rolls around.  This is also income tax-related.  If for no other reason than some investors want to trim the size of their winning positions, the prior year’s big gainers typically open the year poorly.

how long it lasts

The January effect usually lasts about two weeks;  some years, however, it goes on for most of the month.

this January?

This January my guess is that energy stocks, which have sold off heavily throughout 2015, will show at least a temporary rebound.  My worry about them, other than that current financials aren’t yet available, is that the seasonal low point for demand is still ahead of us.  That’s normally in late January-early February.

It may also be that the stars of 2015, like Amazon and Netflix, will take a step backward.

It will be interesting to observe how the new month starts out.

what comes after a double bottom?

A double bottom marks a significant reversal in market direction.   There are two possibilities:

–after a bear market, meaning a nine-month to year+-long market decline caused by a recession.  (This is not the situation we’re in now.)  The market typically bottoms six months or so in advance of what government statistics will eventually say was the low point for the economy.  It does so partly on valuation, partly because the first anecdotal signs that the worst is over are beginning to be seen.

The market then begins its typical sawtooth pattern of upward movement, forming what technicians call a channel.  This is an upward sloping corridor whose ceiling is formed by progressive market highs and whose floor is similarly formed by progressive lows.  Initially, the slope can be quite steep.  Day to day, the market makes progress by bouncing along between floor and ceiling.

–after a correction, meaning a decline of, say, 5% to 10% in market value that occurs over several weeks and which, in effect, adjust market values back from stretched to the upside to levels where potential buyers see the potential for reasonable gains over a twelve month period.  (This is our current situation, in my view.)

Generally speaking, the same upward channel forms.  But the slope may be very shallow.  In fact, until new, positive, economic information emerges, there may not be much of a slope at all, so that stocks move more sideways than up.  Nevertheless, in the case that the channel is almost completely horizontal, periodic successful testing of the bottom established at the end of the correction reinforces the idea that downside risk is limited.

double bottom

As regular readers may have discerned, I have a complicated view of the value of technical analysis, which is the attempt to derive useful investment information from studying the volume and price trends of individual securities and/or entire markets.

In the US of the 1920s, technical analysis was king.  That’s because there were no real standards for reporting of financial results by companies (some of which switched accounting standards the way most people do shirts to show themselves to the best advantage) at that time.  Nor were there legal bars to prevent syndicates of wealthy investors from creating artificial enthusiasm by manipulating individual names up and down in bucket shop fashion.  Basically, technical analysis was all there was.  In my view, subsequent legislation mandating minimum auditing and disclosure standards, and outlawing syndicate activity, have rendered much technical work obsolete.

By the way, I also find much of technical analysis to be useless/incomprehensible.  Take head-and-shoulders movements as an example   …or the Dow Theory.  But my main objection remains that technical analysis is a century-old tool that has been superceded by fundamental analysis of audited and SEC reported financial results.  It’s like riding a bicycle in a NASCAR race.

Nevertheless, even fundamental analysts fall back on technicals in times of panic, which is, after all, completely about sentiment with no room in fear-gripped minds for fundamentals.  And there are a few indicators that I think are very helpful in gauging sentiment.

One of these is a double (sometimes triple) bottom.

what a double bottom is

The idea is to figure out the index level where selling that is driving down a market/stock either exhausts itself or meets potentially strong resistance from buyers.

bottom occurs when downward movement stops and reverses itself.  Often this happens on higher than normal volume.  Sometimes the final down period is marked by a steeper than normal decline.  The level of the low may also be closely related to a prior significant low.  At times, however, none of these confirming signals are present.  The important thing is that the marke/stock stops falling and begins rising again.

Four to six weeks later–not any sooner, but occasionally even later than six weeks–the market/stock stops rising and declines again to the vicinity of the prior low.  If the market/stock then reverses course and begins rising a second time, it is said to have tested and confirmed the prior low.  In most cases, this double bottom signals the end to the down phase.

Sometimes, the market repeats this process and forms a triple bottom.

 

From a psychological point of view, the fact that the market/stock falls to a significant low but repeatedly fails to break through that low creates and strengthens the belief that this is a point where significant resistance to further decline will occur.  The more the low is successfully tested, the stronger this conviction grows.

relevance for now?

The S&P 500 made a low of 1867 on August 25th.  This is very close to the closing low of 1862 (intraday:  1820) on October 15, 2014–and another low (1816) on April 11, 2014.  The index reversed course on all these occasions, this time reaching 2020 on September 17th.  The S&P then declined to 1882 on September 28th.  The market then reversed course again and has been rising since.

So far this looks like a classic double bottom–the first low, the four-week interval, the confirmation of the first low, all linked to prior significant lows.  We’ll only know for sure as we see trading unfold over the next few weeks.

In the present case, the formation of a firm bottom for the market would also be evidence in favor of the idea that investors are willing to separate clearly the (weak) commodities-related sectors from the (strong) rest of the market and are not prone to let the former infect the latter.