“Don’t make things simple. Make them simpler.”
– Albert Einstein
Investing is neither easy nor difficult. Some people make it extremely complicated and get lost in the fog. All you need is to stay with one method and discipline.
We present our own market philosophy below. Our method based on our market experience and simple common sense.
THE MARKET REALITY
PURPOSE: The primary purpose of the stock market is to anticipate and discount the future. We believe that in the long run the market is usually right in its interpretation of economic data. We take advantage of the “discounting mechanism” of the market by focusing entirely on the market’s interpretation of economic facts and we restrict to the minimum our own judgment. We never ever fight the market. The market is the ultimate reality.
PRICE: The basic economic law of supply and demand drives prices up or down. Price is the market’s language. We believe that by analyzing price we are able to “read the market” and profit from it. We examine the fundamental forces that drive the market up or down in an indirect way – through price movements.
TREND: Everyone who accepts the fact that there are bull and bear markets is simply saying that prices move in trends. This most important characteristic of market behaviour is what allows us to make money. Investing is all about identifying trends in their early stages and staying with these trends as long as they last.
WINNING INVESTOR REALITY
TIME: Our main focus is on intermediate-term and long-term market activities. We believe that in the short-term we are dealing with random forces, which reduce our ability to control our investments. Our time frame definitions are:Short-term: a few days to 6 weeksIntermediate-term: 6 weeks to 4 monthsLong-term: 4 to 16 months.
TREND: Our main purpose is to identify a trend in its early stage and stay with that trend as long as it lasts. We believe that big money is made on big moves. The main tools that help us to identify a new trend and monitor the health of that trend are moving averages (MAs), trendlines, relative strengths and trend stage characteristics.
STAGES: A crucial task when working with trends is to identify the stage of a particular index or stock. The primary trend of the stock market always starts and finishes at the extremes. What do we mean by that? The real bottom of each bear market is characterized by extreme valuations: (1) stocks are extremely undervalued relative to their historical averages; (2) economic conditions are highly unfavourable; and (3) the sentiment towards stocks is negative. The opposite is true at the end of the bull market: (1) Valuations are at an all time high (we usually experience bubble conditions), (2) the economic conditions are near perfect and (3) everyone owns stocks. These market characteristics act as a map and help us to observe the end of the trend.
In addition to the market, individual stocks also experience their own stages. There are four phases of a main cycle for each stock. These are:
Stage 1: The Accumulation Phase – After a long decline, the stock starts to stabilize, despite negative news, financial problems and severe downturns in the Industry. While fundamental analyst continue to predict further declines, the stock remains in a narrow trading range, as the professionals take up all the supply.
The 40-week MA loses its downside slope and starts to flatten out; the accumulation action is all taking place close to the MA; the stock is trapped in a trading range where buyers and sellers have equal power. The stock may cross above and below the MA a number of times. Volume usually dries up.Our policy is to wait and closely observe the stock.
Stage 2: The Advancing Phase – this is the time to own the stock. Fundamental news is more favourable; the company introduces a new product or has a new management; earnings start to improve.The stock breaks out from the trading range on high volume and moves above its 40-week MA (which at the same time or shortly after turns to the upside.) The price usually moves away from the MA, but comes back to it from time to time, only to move away again. All swings and corrections take place above the stock’s rising 40-week MA. The most important characteristic of this stage: the MA is clearly trending higher.
Stage 3: The Distribution Phase – after a long advance, prices start to stabilize; the company is a Wall Street’s favourite; fundamental news is excellent; earnings are at an all time high; and the stock is widely owned. Despite these positives, the stock remains in a narrow trading range as the professionals supply all demands.The 40-week MA loses upside momentum and starts to level out; relative strength shows signs of weakness; volume is high; the stock stays within a trading range; and price action revolves around the MA. The stock may move above or below the MA several times.This is the time to sell.
Stage 4: The Declining Phase – at the beginning of this phase everyone believes that the decline is only a correction; fundamentals are still favourable.The stock moves below its 40-week MA which itself turns down; relative strength declines; and the stock breaks major supports. Price moves away from its MA but comes back to it from time to time, only to move and stay below again.
Our policy is to never own the stock in this stage.
CYCLES: Cycles acts as a map. They tell you the rhythm of the market and point to favorable and unfavorable investment periods.
TECHNICALS: Fundamental analysis tells us how rational investors should behave while technical analysis tells us how actual investors do behave. This is crucial to understanding the usefulness of technical analysis.Let’s remember: the market has its own perspective of fundamentals and this perspective is comprised in the price. That’s why technical analysis focuses entirely on the price movements, believing that price will always respond to the most important, fundamental force. Technical analysis alerts us to economic change, allowing us to act before those changes take place.The real usefulness of technical analysis comes from its long-term trend component in the price data; we follow it, and with patience and discipline we make money.
EXPECTATIONS: We believe that every investor should be prepared for the unexpected and the only way to do this is to build a scenario opposite to the consensus. We use sentiment indicators in order to perceive the expectations of others.
DIVERSIFICATION: Yes, we suggest diversification but only to a limited extent. We prefer to hold recommend a few stocks and monitor them closely, instead of a multitude of them.
EXPERIENCE: We believe there is no substitute for experience. We survived a many bear markets; we know how the bull markets behave. We learned from our mistakes and from our successes.
PATIENCE: We treat investing as a business. Our goal is to make money for our subscribers in a consistent way. We do not gamble, we suggest investing only when all odds are on our side. We do not make recommendations all the time. When the time is unfavourable for stocks, we stay away. We do not compete with others. The only benchmark for us is the market. We wait for the best opportunities. We do not suggest risking money for the sake of the game.
DISCIPLINE: Our philosophy of investing is not perfect. We are not perfect. We understand that we are in a business of making mistakes. We cannot be right all the time. That’s why the key to survival is money management: cut losses short and let profits run. William J. O’Neil in his book “How to make Money in Stocks” writes:
“The whole secret to winning in the stock market is to lose the least amount possible when we are not right.”
This is essential. We cannot emphasize it enough. If you are wrong, admit it and get out. Many times in our work you will read: We are wrong! YES! We admit when we are wrong. We do that because this is the key to being successful in this business.
SUMMARY:WE BELIEVE THE MARKET IS THE ULTIMATE REALITY.
WE FOCUS ON THE INTERMEDIATE AND LONG TERM.
WE ARE TREND FOLLOWERS.
WE ARE PRICE RESEARCHERS.
WE ARE CONTRARIANS.
WE CUT LOSSES AND LET PROFITS RUN.
WE DO MAKE MISTAKES AND…. WE ADMIT IT.