Have you ever sold out of your position at a loss only to find the stock not only rebounding, but hitting your targeted price? If this has never happened to you, let me assure you, it happens all the time. A good chunk of losses in the market can be chalked up to fear.
Investors are scared to lose money. They’re scared to take risks. And what ends up happening is investors take big risks on bad investments…and they don’t risk enough on great investments.
None of this is to say that you should hold onto your position until it comes good. This stubbornness can take years, if not decades, to become profitable, if at all.
Let’s use the example of BHP Billiton [ASX:BHP]. If you had bought BHP just six, or even 10, years ago, your position would still be hugely negative. So it’s not about just buying and holding stocks.
You have to do your homework. Even finding out about what business cycle that company is in can be advantageous.
BHP is an obvious example of a company that is in a down phase of its business cycle. Whether BHP will ever reach above $40 again is questionable.
Therefore, do your research and find out how companies create money. This is the traditional value investing strategy. And it has worked for Warren Buffett for decades.
But let’s take a leaf out of the technical analyses handbook. Let’s look at how to find a stock whose prices has bottomed.
Trading stocks that have recently declined is popular among many investors, as they believe the stock will jump straight back up. This doesn’t always work out, but it’s almost like guessing where a stock might bottom out. And I say ‘guess’ because that’s exactly what it is.
But half the trouble with investing is getting in at the right price. For that reason, using historical data might not be a bad idea. Getting in at the right price is key to making returns; or for potentially turning double-digit returns into triple-digit returns for that matter.
Getting in at the right time might be an obvious thing to say. So how do we identify where the bottom is? Usually, the bottom is where big institutional investors, as well as professional investors, have their orders parked.
There are millions of orders at this price. If the stock trades down to this price, you will commonly see it jump straight back up. Why? Around this price, the stock becomes too cheap not to buy. It has traded below its intrinsic value, or what the market deems it to be.
But you must be careful. A large amount of orders isn’t always the sign of a bottom. Many times, orders will be parked at a certain price points just to rise again when the stock trades down. Once these orders are pulled it no longer creates a barrier for investors to feel secure.
And, as more orders are pulled, many other orders follow. Investors then get scared, selling out of their position for a loss. The price eventually bottoms, climbing back up to its original price. You find this happens a lot when trading Fixed Interest Rate Futures.
Traders would lean on large orders as it gave them confidence sellers would be eaten up by large buyers sticking to that particular price. However, if a bulk of those orders were pulled, then traders would quickly sell out for the fear of losing too much.
In sum, searching for a bottom could help your investing in the long term.
Let’s take a look at the Big Four Aussie banks. This year all four banks are down. The graph below shows the performance of Westpac Banking Corp [ASX:WBC] (blue), National Australia Bank [ASX:NAB] (green), ANZ Banking Group [ASX:ANZ] (yellow) and Commonwealth Bank of Australia [ASX:CBA] (red).
While all banks have traded up heading towards the backend of April, they are all still below their initial opening price for the year.
If you were eager to get into any one of the four banks, identifying the bottom might not only yield higher returns, but also result in fewer sleepless nights.
It’s actually not that hard to tell if a stock is sensitive to a certain price point. If stocks jump up immediately from a price point, you can bet there are plenty of buyers down in that area.
Let’s just use one of the Big Four banks, NAB, as an example.
This year, NAB’s share price hasn’t traded below $23.82 per share. In fact, NAB hasn’t traded this low since November 2012. But the black horizontal line on the graph above shows points in time at which NAB shares were trading at $23.98 per share. As you can see on the graph, share prices traded up twice when this price was hit. This might give us a hint as to NAB’s bottom might be.
As I said before, fear is one reason that might cause investors to lose money in the market. But extremities are part and parcel of stock market trading. Being too brash and confident has also been the downfall of many an investor.
In saying that, you should always ensure that you do your research before you invest in any stock.
Junior Analyst, Money Morning
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