Brian's Runners

LESSONS LEARNED Part 2 of 2

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Final Trade: CALM

I have thoroughly enjoyed this game and thank the people at Marketocracy as well as all the participants who played to the end. It has been entertaining and enlightening and has reinforced my belief that people who have the determination can learn to become good traders.

Becoming a great trader or even a good trader requires many hours of sustained effort and this requires words of inspiration. One source of my inspiration is a few lines from my favorite poem. They are reproduced below with one small change to the last line (apologies to Rudyard Kipling), see here for the full poem: www.eliteskills.com/c/2207.

"...If you can dream - and not make dreams your master;
If you can think - and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two imposters just the same;...

If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;

If you can fill the unforgiving minute
With sixty seconds worth of distance run,
Yours is the Earth and everything that's in it,
And - which is more - you'll be a" Person that's won!

Taking a cue from this poem my last trade will focus on one stock, Cal-maine Foods, Inc. (CALM). Its price move is dependent on a very dangerous catalyst. Its quarterly earnings report is due on 12/28/07.

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LESSONS LEARNED Part 1 of 2

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WOW!! The performance of the top Marketocracy SLO portfolios is truly spectacular. While only a select few have reached double digit growth rates, over 200 participants have beaten the market. Many thanks to all of the SLO participants as I have enjoyed being able to read your blogs and review your portfolios and have learned a great deal.

Many of the top portfolios include solar related companies. In September I wrote about whether value or growth would be the next bubble and I chose growth stocks in general and semi-conductors and retail in particular. The semi-conductor stock I invested in was VSEA, a supplier of equipment used in the manufacturing of semi-conductors. I should have chosen a semi-conductor stock related to the solar industry as they zoomed higher shortly after I wrote that blog article. Congrates to those of you who recognized that solar-related companies were the next new thing. The market has rewarded you. VSEA declined below its stop loss and was sold and has declined 8.6% since then.

I never made the connection to solar power because I have never seen a solar panel product that could effectively compete with old line "solar" energy sources. I am referring to wood, coal and oil. After millions of years of development they have become very effective storehouses for solar energy. Fortunately these storehouses are relatively plentiful and accessible for our use in generating electric power.

Converting solar directly to electricity is rather difficult and has never been cost effective in competing with the old line solar storehouses. This was of course beside the point as these companies (STP, SOLF, SPWR, YGE, FSLR) have exploited new applications not served by the old energy sources. In addition, they have taken advantage of government incentives that accelerated solar power adoption. Clearly it is not necessary to successfully compete with existing solar storehouses in order to participate in the next economic bubble.

The stock screen I created was designed to filter out any stocks with above average P/E ratios. The solar companies have P/E ratios ranging from the low 80's to over 600 and so never showed up on my screen. However, three semi-conductor stocks did show up: NVDA, POWI, and INTC. These generated growth of 10% to 45%. Not as spectacular as the solar stocks but not subject to the risks of bubble stocks which can deflate rapidly. However, this may not be the best strategy in a 6 month contest.

In my last blog I used the adjusted MSN stockscouter screen to add to my investments in LIFC and VOCS. The screen also identified DECK as a potential new investment but I did not invest as I concentrated on technology related stocks. All three stocks have gone up but DECK was by far the best (up about 20%).

Finally, one last look back at my original portfolio. It has had a gain as high as 15% and is currently at about 6%. This is not spectacular but it is in the top 100 of the SLO participants and beats the following indexes (measured from 6/29/07 to 11/14/07):

DOW -0.51%
NAS +1.25%
S&P500 -2.35%

In addition, my adjustment to the MSN Stockscouter Screen to eliminate those stocks that generated P/E's above their 5-year average had some positive effect as compared to the MSN Top Ten portfolios chosen at the beginning of the following months:

July, 2007 -5.51%
August, 2007 +2.65%
September, 2007 -7.66%

Unfortunately I was unable to hold on to my original portfolio including the semi-conductor stocks mentioned earlier and my current portfolio is about break-even. This is due primarily to a lack of persistence and poor trading execution. Many of my trades that hit their stop loss should have been re-entered as they established new trends. I am reminded of a story by a trader who gave up on an investment after suffering through ten buy signals that all subsequently failed (hit his stop loss). The 17th time was a charm as it began a trend lasting over 12 months and would have turned his previous losses into profits. If you have taken the time to develop a strategy and a system to implement the strategy, stick with it. Never ignore a buy signal, even if its for a stock you recently sold at a loss.

In summary the adjusted MSN Stockscouter screen worked well identifying stocks that outperformed the market but my trade executions were not always timely. This suggests that even an in-the-public stock screen can be used effectively if applied with discipline.

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VALUE TRAPS AND THE EYE OF THE BEHOLDER

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The market correction has taken back the small gains that existed in my portfolio and then some. It wasn't a total surprise since the market's intermediate uptrend was broken on October 18 and on October 19 the DOW, NAS, Russell 2000 and S&P 500 all declined by more than 1% on heavy volume. The last time this happened was June 20 but at that time the market recovered within a week and moved to new highs in July. The October drop looked like it might do the same thing. The market began moving higher on strong volume through the end of October. Then on November 1 these same indexes all dropped by more than 1% again and it became clear we were in a new intermediate downtrend. However, I didn't begin selling poor performing stocks from my Marketocracy portfolio until November 7 as I was preoccupied with my real portfolio.

My Halloween strategy has only one stock left, OHI as the other two hit their stop loss prices and didn't recover. As I sold stocks I also reviewed my adjusted Stockscouter screen for new candidates and added KRO and UTIW. However, I was losing confidence in this screen and when SLO asked about value traps I decided to review the subject.

As I understand them, value traps occur when the market does not confirm an investor's expectations. Investors fall into them when they are convinced they have information the market does not and invest in an asset expecting the market to discover this information within a certain period of time and move the value in the direction they expect, but the market does not cooperate. Since they are convinced it's just a matter of time they hold onto the asset becoming "trapped." Worse the market may actually move against their position, which makes them feel more trapped. This described my situation in the last two weeks. So how can I avoid the trap without abandoning value stocks?

The Scottish philosopher David Hume wrote: "Beauty is no quality in things themselves: It exists merely in the mind which contemplates them." Other writers restated this idea so many times it became a cliché: Beauty (or value) is in the eye of the beholder. This simple idea explains why there are over 10,000 listed stocks on U.S. exchanges, each owned by someone who beheld their beauty.

This idea also suggests that value is a popularity contest since only the stock with the most investor support is given the highest price. The successful value investor must find cheap but popular stocks. One method is to screen various indexes like the S&P 500 or the DOW 30 and wait for these stocks to "go on sale." Since they are in an index they are already popular or at least they were at one time. Screen for low P/E ratios, high yields and a PEG ratio less than 1. A screen like this would generate 30 - 40 stocks from the S&P 500. Then invest and wait for popularity to return

However, I never felt completely satisfied with this Beauty in the eye of the beholder approach. Only a handful of the 10,000 listed stocks account for most of the value. Which means there are a lot of eyes out there that have been mistaken about what makes a beautiful stock. So I was intrigued when I read in a book on Chinese culture by Boye' Lafayette De Mente that "To the Chinese, beauty is not in the eye of the beholder... In Chinese aesthetics, an object must accurately reflect nature in its pure cosmic state to be truly beautiful, and it is up to the viewer to develop the aesthetic ability to see, understand and appreciate the portrayal of the relationship." Few may think of a great stock investment as reflective of "nature in its pure cosmic state" but I like the sentiment that "it is up to the viewer to develop the aesthetic ability to see" beauty and value. Perhaps we can combine these ideas and find an inexpensive stock that has the factors necessary to become popular. The investor must identify those factors common to popular stocks, find the barest beginnings of these factors in currently unpopular stocks, invest and wait for the market to catch up.

Rather than abandoning my adjusted Stockscouter screen completely, I decided to begin with a list from this screen which includes a measure for cheapness. Then to determine if they had factors that might make them popular I reviewed the remaining stocks to see if they had taken five of the steps listed by Guy Kawasaki in his article in the November issue of Entrepreneur magazine (see the following site for the full article).

http://www.entrepreneur.com/marketing/marketingideas/article185590.html

1. Know Thyself. A company is not going to be crazy successful unless management knows what it stands for. Guy calls this "driving your competition crazy" and as an example of knowing itself offers Apple, Inc. Apple "stands for cool technology" and "will never represent" a service and support type of company.

2. Know Thy Customer. The holly grail of every marketing officer. Guy says "A good company listens to what its customers say they want. A great company anticipates what its customers need."

3. Know Thine Enemy. A company can't become super successful unless they understand the "strengths and weaknesses" of their competition. The best way to do this is to become your competitors customer. Then you can see what areas of customer need your competition is missing that you can fulfill.

4. Focus On The Customer. In order for a company to be successful they must focus on what they can do for the customer. They can best do this by "using the knowledge gained in the first three steps."

5. Turn Customers Into Evangelists. Guy says it best: "There are few things that drive a competitor crazier than an unpaid , thunderlizard group of customers who become evangelists for a company." And how does a company accomplish this? "Create a great product or service...see who falls in love with it...and take care of them." Think Apple, Starbucks, True Religion, Coach, Mcdonalds and in its day, Intel ("Intel Inside" printed on its customers products turns them into automatic evangelists).

If the companies behind your stock investments have taken these five steps, not only might you avoid value traps, you may have a ten bagger in your portfolio. For clues about whether they've taken these steps review their annual CEO letter to the stockholders. Does the CEO know what his company stands for and can he clearly communicate its mission. Don't forget to review their website and marketing brochures.

Based on this review I am increasing my investment in LIFC (www.lifecell.com) and VOCS (www.vocus.com) and may be adding DECK (www.deckers.com). For evidence that they have taken some of Guy Kawasaki's steps see their websites. Significant additions will be made only when and if the market returns to an intermediate uptrend. In the meantime cash is safest. The best way to avoid a value trap is selling at the stop loss which frees you from the losers and leaves you with the winners, and let your winners run.

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A HALLOWEEN STORY FOR INVESTORS

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"In the bosom of one of those spacious coves which indent the eastern shore of the Hudson..." So begins The Legend of Sleepy Hollow by Washington Irving. A story that involves fear, greed and the clever use of inside information. A story with a lesson for investors which has inspired my Halloween Investment Strategy.

Irving begins the story by lulling the reader with a description of the bucolic appearance of Sleepy Hollow, the natural beauty of the lush rolling hills next to the Hudson River, and the clearly prosperous farms in the valley. Then he injects a little uncertainty as he describes the people of Sleepy Hollow. "They are given to all kinds of marvelous beliefs, are subject to trances and visions, and frequently see strange sights, and hear music and voices in the air. The whole neighborhood abounds with local tales, haunted spots and twilight superstitions...The dominant spirit, however, that haunts this enchanted region, and seems to be commander-in-chief of all the powers of the air, is the apparition of a figure on horseback, without a head."

Into this "enchanted region" comes Ichabod Crane, a schoolmaster to the children and a music and dance instructor to the young ladies of the region. As schoolmaster he becomes "a man of some importance in the female circle" as he is viewed as having "vastly superior taste and accomplishments to the rough country swains" the ladies must usually contend with. Ichabod Crane is described as "exceedingly lank, with narrow shoulders, long arms and legs, hands that dangled a mile out of his sleeves" and a small head "with huge ears and a long snipe nose." Yet he was a man of letters, and "therefore was peculiarly happy in the smiles of all the country damsels."

Ichabod Crane used his knowledge profitably and was able to court the beautiful Katrina Van Trussel the daughter of one of the wealthiest farmers in the valley. Crane's greed becomes palpable when he visits the farm and realizes the rich life that could be his. Greed is essential if one is to develop that burning desire necessary to sustain a persistent pursuit of investment gain in the face of fear and uncertainty. Cranes burning desire rose to the challenge.

His competitor in this pursuit was Brom Van Brunt who was described as "a burly, roaring, roistering blade." In many ways he was the opposite of Crane. Confident in his physical abilities he struggled in his courtship of Katrina. His amorous toyings were described as "something like the gentle caresses and endearments of a bear." Van Brunt, like the other bashful country fellows was jealous of Cranes "superior elegance and address."

While many of the people of Sleepy Hollow seem "subject to trances and visions" the prosperous farms in the valley attest to the fact that many people must be down-to-earth farmers with a healthy amount of common sense. The farmer Van Trussel and his wife are described this way as is Brom Van Brunt. However, Crane is drawn to the fantastical story tellers and during his evening walks home after each community gathering his imagination subjects him to "...terrors of the night, phantoms of the mind that walk in darkness..." Van Brunt learns how easily Crane is thrown into an appalling fright by his own imagination and uses this "inside" information to scare Crane right out of the county. Van Brunt then wins the heart of Katrina and ultimately the wealth of the Van Trussel farm. To read this story go here:
>http://www.online-literature.com/irving/2846http://www.online-literature.com/irving/2846

The lesson for investors is not that you must hurl pumpkins at your fellow investors to scare them away from your "Van Trussel farm." The lesson is that your most formidable competitor is often your own fears. In the beginning of the story Crane fanned the flames of his burning desire by envisioning what his life would be like married to Katrina. This gave him the courage and energy to pursue this challenging dream. Even his fears were useful in protecting him from danger as he avoided direct confrontation with his physically superior adversary Van Brunt.

But the imagination that fired up Crane's burning desire to reach his goal also led him to stories of the fantastical. Stories of frightening terror about spirits and headless horsemen. Stories that were populated with imaginary ghosts that could not realistically hurt him. However, this fear grew to the point that he finally gave up his quest.

Van Brunt on the other hand was realistic and had a practical plan. He was undeterred by the ghost stories of the Valley which he knew were only to entertain and existed only in the imagination. When he observed the effect of these stories on Crane he used this information to good effect.

As investors we must find a way to minimize the impact our own demons have on our investing. One way is to pay little attention to stock market ghost stories. Stories about the terrors of October or of any other particular month of the year. While human behavior does repeat itself and thus so does market action it never repeats in quite the same way. And so we must listen and observe carefully the action of the market just as Van Brunt observed Crane's behavior. And then using what ever special information we might possess, make a plan and take action.

Another lesson this story suggests is that we should always have a Plan B. The market can change quickly and we need to be able to change with it. Or at the very least protect our capital when the market moves against our position. If Crane had courted other young ladies in the valley, or limited his indulgence in ghost stories, or never walked alone at night, he might have found success in Sleepy Hollow.

October's scary stock market history is actually quite limited according to the Stock Traders Almanac. The most memorable crashes occurred in 1929 and 1987. However, since the 500+ point drop in the DOW on October 27, 1997, October has been the best up month. In addition, history suggests two industries that have gained in value beginning toward the end of October through year-end: Semiconductors and Real Estate. While the general market has recovered powerfully since mid-summer, neither of these two industries has performed as well. The Semiconductor index is still trading below its 50-day average and both industries performance is looking a little scary.

Nonetheless, based on the objective historical data I will use this as the beginning of my Halloween strategy. Using the MSN Stockscouter I selected stocks in these industries with the highest overall score (10 is best, 1 worst) and then added the highest Ownership score (A is best E is worst). Since I have no inside information of my own I will piggy-back on the insider trades reported by the SEC. I eliminated those stocks with no insider buys in the past twelve months and ended up with the following list.

Download file

As you can see, several of these stocks have broken out beyond their buy points on above average volume. MPW is a REIT that was bought by many Marketocracy members last summer. Having risen 28% from its low it seems to have stalled in the $13 to $14 range. While some of the others have fallen back below their buy points, OHI, TUNE and CUZ look promising and will be purchased immediately. I will track the other stocks for the next two weeks and buy if any crosses above its buy point price on above average volume.

If none of these stocks breaks above its buy point or follows through on volume I will return to my original plan to focus on high tech growth stocks. In addition, I will set a stop loss price for each stock.

Happy Halloween!

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Ken, Don't Fight The FED

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One of my favorite stock traders, Marty Zweig was asked about his view of the FED and he said simply: "Don't fight the FED." Its the best advice I've ever heard.

Ken, your confusion about the FED action is easy to understand. Marketocracy is about voluntary transactions and associations to the mutual benefit of its citizen members. The FED is based on force and coercion to benefit government at the expense of the citizens. Two organizations could hardly be more opposite in their structure and their operating philosophy. In fact most private sector organizations are the opposite of the FED and so few in the private sector can easily understand the FED. The elegant simplicity of Zweig's advice takes this into account.

However, it is human nature to wonder why, so lets go a little deeper. The FED did not come into existance because of market demand. It came into existance because the government forced its creation. The government than granted it an absolute monopoly over the credit and currency of the U.S. Without competition to provide it with a rational market-based feedback loop, it quickly stumbled into the bubble of the 1920's and the depression of the 1930's. And dispite the fact that today its staff pour over reams of government generated data about the economy, the economy is too large and too fundamentally complex to be understood by a small group of people and certainly not by one person. So we continue to suffer through one bubble after another. In fact the idea that the market is too complex for one person but might be understood by many people working together seems to be the basis for Marketocracy.

So why does the government want the FED? One of its stated goals is price stability but it has never achieved this goal. Prices have fluctuated in an upward trend since the FED was founded in 1913, and this fact suggests thats OK with the FED. However, it has never wavered from its true goal - the manipulation of U.S. currency to the benefit of the government. And Ben Bernake(?) has shown he will hold fast to this goal. The practical effect of this is a long-term "controlled" inflation. An inflation that reduces the cost of government debt and increases the government's spendable funds, while decreasing the value of its citizens savings. A stealth tax.

In addition, by periodically changing the rate of growth of credit, the FED causes mal-investments. Investments based on the previous level of interest rates. And these investment "mistakes" must be liquidated so that investments oriented toward true market demand can continue. The FED's recent reduction in interest rates in response to the so-called "sub-prime" mortgage crisis will slow this process. It will allow some borrowers to continue meeting their obligations but ultimately the unsustainable values will defeat them. The problem is that investors will continue to be concerned that these problems have not been liquidated and so will change their investments to avoid the perceived risk. We may see an extended slow period in the U.S. real estate market and those areas closely related.

So how does this effect the investments I make? Don't fight the FED. I will invest in those stocks which benefit from lower interest rates but I will stay away from real estate related investments for now. History suggests that growth stocks respond the best to lower interest rates and I have focused there. In addition, since this rate reduction will continue to fuel inflation which benefits government I will favor those businesses serving government and its programs. I have recently adjusted my Marketocracy portfolio to include mostly small and mid-cap growth stocks in the healthcare, computer and communications businesses. For example, AMED serves medicare beneficiaries and EMC meets the needs of government data storage.

There are three stocks in your MSN Strategy Lab portfolio that concern me: GROW, FNM, and CX. While GROW may have well diversified portfolios, it appears that investors remain concerned that their may be sub-prime mortgage problems lurking in its portfolios. As I mentioned above, the resolution of this concern may take longer than expected due to the FED's rate reduction. FNM is a market maker for mortgages and again its future growth may be significantly delayed. Finally, CX provides building supplies and this market appears to have slowed significantly. All of these stocks seem likely to recover eventually, but the recovery may stretch into years.

It goes without saying that this is just my opinion and I have no crystal ball when it comes to predicting the market or any of its segments. I just try to not fight the FED, and follow the market.

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Ain't That Peculiar?

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Peculiar as can be...

I was reviewing my meager performance for clues as to why and I discovered that if I had left my original portfolio untouched, it would have generated a return of nearly 11% as of 9/27/07!! This wouldn't place me at the top of this game but it would place me in the neighborhood of the top 75 and that's a nice neighborhood. See here for my original portfolio:

Download file

So once again I am taught an old lesson...don't over-trade.

Traders in some of the other blogs are agonizing over selling decisions in order to preserve profit. New2trade talks about the psychological difficulty of selling which he overcomes by sticking to three basic rules. I have rules also, but I didn't follow them precisely. For instance I usually give a stock 6 to 8 weeks to show some growth unless it violates the stop loss price and doesn't recover within two days. This time I shortened the time frame to 4 weeks which resulted in more trades. If I'd been more patient I'd have more gain.

Now that the market appears to have confirmed the new uptrend I need to take advantage. I have decided to follow Scot Strickland's advice: "Time to get aggressive."

And that's really whats peculiar. I have discovered that too much trading can ruin a well thought out and carefully executed portfolio, and I have decided to get more aggressive and increase my trading activity. So I have re-run my adjusted MSN Stockscouter screen and will sell all stocks no longer on the list and add new ones that seem to be breaking out of well formed bases. Hopefully I will complete this by next week and then as Jesse Livermore advises, I will sit and wait.

Peculiarity....The essence of Trading.

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