The Safe & Consistent Short Term Trading Strategy: Buying Great Companies on a Pullback
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If you wanted to make moderate returns you would have given your money to a financial advisory firm. That’s how I first started years ago. However, my returns consistently under-performed the market. I received a call from my financial advisor once or twice a year to review my portfolio and he would suggest changes. I was in the standard “safe bet,” low return cocktail; mutual funds, large cap, medium cap, bonds, treasuries, emerging markets, cash etc… my adviser did not buy value. It seemed to be a strategy of diversify, under-perform, and wait. My advisor certainly did not buy when the price was attractive. He simply threw money into whatever he already had me invested in. That’s why I decided to manage my own money. As of writing this I am up 148% for the past 12 months.
People nevertheless give their money to financial advisors for a reason, they don’t know what they’re doing. And neither did I when I first began managing my own money. Fast forward a few years and I see people making the same mistakes I did when I first began. And though I am not a financial professional or certified advisor, I am nevertheless committed to helping others by detailing what has and has not worked for me. Once again let’s stress the fact that I am not a certified financial professional. I am simply an amateur investor, as I am sure you are, if you are reading this.
This entry will discuss what I consider the safest, surest, and quickest method of growing your portfolio value. It does not advocate throwing your money in all at once, but assuming that the security will drop granting you the opportunity to buy into the red and average down. It takes advantage of the ebbs and flows of the market, taking into account market maker manipulation, and adhering to the classic principles of buying low and selling high. It may or may not be the best investment strategy as markets change and develop. It may not be the best investment strategy for you. But at the moment of this publication, its my favorite. Below you will find the step by step methods I use to turn a safe, quick, and consistent profit.
WARNING: IF YOU HAVE A BROKER THAT CHARGES YOU FEES FOR EVERY TRADE THIS STRATEGY MAY NOT BE FOR YOU.
1. Finding attractive securities
2. Things to Know Before Buying in
3. Finding an Attractive Buy in Price
4. How to Buy in
5. The Psychology of Holding
6. When to Sell
1) FINDING ATTRACTIVE SECURITIES
1. Finding Attractive Securities: If you have read my write-up on Due Diligence then you likely know what qualifies as an attractive security. Ideally, you’d want relatively undervalued, high performance, and low risk securities. This means a low P/E ratio, consistent good earnings, and over-performance in their sector. Preferably the company should have good expectant guidance (a good outlook) for the future. If you invest in securities that meet these criteria you won’t mind bag-holding if the trade turns against you. Chances are big investment firms will eventually take note and buy up shares of such a company. Chances are such a company will undergo analysts upgrades. Chances are such a company will enjoy boosts from good earnings.
Something else you may want to consider is heavy institutional investment. My picks are usually unpopular securities that meet a good portion of the aforementioned criteria, but with a heavy institutional investor presence. I find these securities insanely easy to predict and awesome to buy on a solid pullback.
1. Buy Value: i.e.Securities with a Low (Not Negative) P/E P/B. Perhaps Trading relatively close to their Book Value Per Share: Why? Because if you notice securities are undervalued so too will traders and institutions.
2. Buy Companies with Consistently Good Earnings: Why? They say that past performance isn’t indicative of future results. But it’s a damn good indicator! If a company has smashed earnings 4 times in a row and it does not appear to be slowing down, then it is likely traders will want to pile in in the weeks leading up to earnings.
3. Low Risk: i.e. stay away from companies that have a history of scandal, financial insolvency, or aren’t turning a profit. Additionally stay away from penny stocks! This method does not work well for penny stocks.
4. Do not Forget to Factor in Debt and Free Cash Flow (FCF): A company may have a low P/E or P/B, but if the company’s debt is increasing at a faster rate than than their profit, or the free cash flow is trending lower from quarter to quarter, a Low P/E or P/B may be misleading. As a snapshot, consider looking up the debt to asset ratio. Remember that the valuation of a company is not only considered by their assets and income, but their debt, potential growth, and FCF as well.
5. Consider Little Known Companies: Some of my most profitable trades came from little known companies that retail traders generally do not follow.
6. Other things to Consider: Have a look at the float … that is number of shares in existence. The smaller the float the more volatile a security can be. Additionally look to see if the forward P/E is smaller than the trailing P/E. If so this is good news and analysts expect the security to grow. If there is a dividend see what the dividend payout ratio is. This will help you gauge if the company can afford their dividend so you aren’t blindsided by selling if they change things up. Also use market indicators to see if the sector is hot or not. A sector enjoying or expecting to enjoy favorable economic conditions trades much better than a sector that does not. Economic Colanders and the ability to do some Industry Research can come in very handy. Don’t forget to check how their competitors are making out financially, particularly if they report earnings before your company does.
NOTE: Yahoo Finance under the ticker’s “statistics” section is a good place to find all of the above information and more. However you will also want to see other references as well. Different references update company financials at different times and may differ from one to the other. For a list of other resources that include Yahoo Finance CLICK HERE.
NOTE FOR WEBULL PHONE AND TABLET APPLICATION USERS: Try the following. 1) Log in and go to your main screen. 2) click on “More.” 3) Scroll down to “tools” and click on “Screeners.”4) Click “Create New Screener.” 5) Scroll down to “Financial Indicators” and click “P/E.” Adjust the P/E to your desired setting (I use 5-20 because I’m hunting for relatively undervalued companies). Then go back to the financial indicators and click “EPS.” Set your EPS to the desired setting. From there you will get a list of likely undervalued companies to research. By clicking on them you can look at the 3 month or 1 year chart and see if they beat or missed expectations during previous earnings. Additionally when you look up a company on the quote screen and click the financials tab you can you can scroll down to the “Peer Comparison” section and see how the company ranks among others in its sector. You can additionally click on P/E or EPS, and a number of other categories and see which companies are relatively undervalued. Once you find one you can once again go the quote chart and see how it performed during previous earnings.
2) THINGS TO KNOW BEFORE BUYING IN
2) Things to Know Before Buying in: Before buying in you must come to the realization that retail doesn’t own the market. Large institutional investors and Market Markers do. When a hard earnings date is announced for a promising company, these are the folks that may short the security to incentivize selling pressure for the purpose of buying more for the ride up to earnings. If you have paid attention to earnings date announcements I’m sure you’ve noticed that some securities pull back hard. Additionally you may have seen a company undergo 100% earnings beat and dump soon after. The culprit is typically institutions & Market Makers combined with a number of traders who opted to simply ride the pre-earnings pump before dumping the stock. This is not a conspiracy theory. A large investment firm is dealing with many millions to many billions of dollars. If they were to simply take a position outright they could pump the price beyond what would be attractive. In doing so they would realize a smaller gain or perhaps no gain at all on their investment. Instead they find an attractive security and “make a market.” They’ll short the security low, cover the short position on panic sellers, and slowly build their position back up. This is important to know for a number of reasons; namely so that you understand that unwarranted deep selloffs are the perfect time to buy, not sell.
Yet another thing you must realize as a trader is that most trading in the market is overwhelmingly done by algorithms. Roughly 80% in fact. This too is not a conspiracy. This is in part why you find reliable lines of resistance, support, and why you can rely on various moving averages as indicators. The algorithms are mostly run by institutions and programmed to buy or sell based largely on lines of support, lines of resistance, and various moving averages.
1.Institutions Own the Market: Retail traders have little effect on the overall trading price of a security.
2. Institutions Regularly Manipulate Securities: The price often goes down or up as market makers “make their market.” Unwarranted sell offs of good securities/companies are often market makers attempting to drop the price so as to buy for themselves on the cheap. This is normal. We cannot expect institutions to buy at market value and drive the security higher than what is warranted. They will do whats good for their interest. Therefore we ought not to complain about it, but use it to our advantage!
3. Algorithmic Trading Accounts for Most Trading: This is in part why lines of resistance, support, and moving averages are solid indicators.
3) FINDING AN ATTRACTIVE BUY IN PRICE
3) Finding an Attractive Buy in Price: You may have done your research, your analysis, or due diligence, but this does not mean you should simply jump in. Sure the company may seem relatively undervalued, but how is the security trading as compared to the past 3-6 months? In most cases you do not want to buy in on a peak or relative high as compared to previous months trading. Stocks both increase in value and pull back for a number of reasons. There is nothing new or unusual for a sector to pull back on macro or geopolitical implications. Bad news comes out all the time; companies get sued, CEO’s do something stupid, contracts are lost, the Federal Reserve releases bad news, unemployment applications can be higher than anticipated, and the FDA can reject a trial application. I therefore recommend jumping in on a pullback of little to no consequence.
Security pullbacks of good companies that are generally orchestrated by market makers (institutions) are a perfect example of a pullback of no consequence. You already know that institutions own the market. Why not take advantage of it? Instead of fighting the institutions, why not make the institutions work for you? After-all, they have the toughest job; they need to figure out how to invest many millions to billions of dollars at a reasonable buy in price without pumping the security so high that they cannot profit on it. As a result they must manipulate sharp pullbacks to induce selling and buy back up to the previous price to acquire shares. Just as a Remora fish attaches itself to a shark for the free lunch, so too should retail investors take advantage of institutional investor induced pullbacks.
Institutions are known to manipulate the price frequently over the cycle of a security. I assess that they often so this when a company announces an upcoming earnings date. While retail may think this is a good time to enter, as of late I’ve seen many pullbacks of excellent companies when they announce upcoming earnings. By assessing recent lines of support relative to the pullback, you can come close enough to finding the bottom for a solid entry point. Additionally institutions can send a security into a downward tailspin after excellent earnings. Sure, the analysts on CNBC will come up with a number of excuses as to why this happens, but barring any truly reasonable explanation the analysts are just speculating. I assess that the most likely reason a company can smash earnings, and with no warning signs at all, it severely pulls back the following day, is simply because the market makers are impressed and want to drive the price lower to buy more. Particularity when they know the ratings agencies will likely upgrade the security to “buy,” “outperform,” or “overweight” in the near future!! Once again by assessing recent lines of support relative to the pullback, you can come close enough to finding the bottom for a solid entry point. Finally there are times where the algorithms assess that the security is overheated and induce a sharp pull back. Hopefully this happens after you’ve sold for a 10-20% profit. In many cases the security price may approach close to the previous dumps support levels. If it does its a good place to buy in!
IMPORTANT NOTE: These market maker sell offs can last for one or two weeks. They can even trade sideways for a while after. The price will not usually increase until they decide they have covered their short position and acquired enough shares to justify the pump.
EFFECTIVE TIP: Once you’ve valued a security and established an attractive buy in price set your alerts to notify you when the security dips to acceptable buy in levels. This way you will be alerted to possible profit opportunities in the future.
1. Just Because a Security is Undervalued DOES NOT Mean Buy: Use a combination of value and review the past lines of support. Also assess as to whether you expect the market makers to short the security.
2.Be an Institutional Parasite, Buy on Pullbacks of no Consequence: Let the institutions work for you. Enter when market makers decide to drop the security for the purpose of buying more! Trust me when I tell you that the reason they’re dumping it is to acquire more stock and, even more so, that they expect to make a profit on their investment!
3. Keep an Eye on Important Dates. Announcements of upcoming earnings and post earnings where the results were outstanding are great times to see if a security will dump to your buying advantage. If so let them dump, wait a few days, then slowly buy in. Once you’ve realized bottom do not forget to set your alerts somewhere near the support level. Sometimes after a solid pump the security price can revisit support giving you yet another entry point!
4) HOW TO BUY IN
4) How to Buy in: I always recommend slowly buying in and I never recommend establishing a 100% pre-planned position at a pre-planned price. You will be surprised at how low market makers can drive a security under instances of low selloff volume … even on really great companies. Moreover the macro-economic situation can turn against you, and this means folks pulling money out of an ETF that your security may be a part of. Such a scenario can lead to an intensified pullback. Instead, judge how much of your portfolio you are willing to allocate to the trade. Never allocate 100% of your portfolio to one trade! Establish an initial buy in of 10-20% of what you’re willing to invest. Then buy more for every 1-3% the security continues to dip. This will significantly lower your cost basis, increase the size of your profit when the security returns to normal trading levels, and provides a great level of bag holder insurance; meaning if you end up holding bags, you will do so for less time than you otherwise would had you simply established a block position. Moreover you must understand that you will never be able to accurately find the bottom, however with this strategy you can get damn close!
Sometimes this strategy may run afoul. You can misjudge how low the security will dip, and run out of money that you planed to allocate to the security while its still dumping. It happens to us all. Its often why I never have more than 50-75% of my portfolio invested at any given time. I maintain a large 25-50% cash position for just the instance that I need to average down further than I planned. This happens more than I would like to admit. It can mean the difference between bag-holding for months to bag-holding for a a few weeks longer than you expected. However, once the price of the security returns to your cost basis you can sell your excess shares (The shares you weren’t expecting to buy) for a small profit and re-allocate the money to either averaging down more (if necessary), or holding it in reserve for another position you may be building.
NOTE: I recommend always buying into the red, never the green. This means to save the money you plan on using for your position for when you are 1-3% down, never when you are 1-3% up. If the train leaves the station early, then let it leave and enjoy the profit you have. There are always other securities you can invest in with the rest of your money.
EXAMPLE: For newer traders I believe an example of averaging down may be instructive. Please understand that this is just an example and there are a number of ways to do this:
Lets say you’ve found a company that beat earnings for the last four consecutive quarters. It has a solid P/E multiple of 16 indicating that it is relatively undervalued in its sector. You judge the company to be low risk, well run, and reliable. You also assess that the macroeconomic situation is favorable. You think to yourself “investors will anticipate excellent earnings for this company.” Finally, the company releases news that they will be announcing earnings and you notice a multi-day sharp decline in trading price. You assess that the market makers want to buy some more shares before earnings in three weeks. After a 7% dump you decide its time to hop in. You judge that you want to allocate $5,000 to this trade.
1) On Monday you buy in at $20.00 for 50 shares of XYZ for a total cost of $1000 (20% of what you want to allocate to the trade). (Price $20.00/Average $20.00)
2) On Tuesday you noticed the stock dumped 3% more and now trades at a price of $19.40. You buy 50 more shares costing you $970. You now own 100 shares at an average cost of $19.70. Though you’ve lost 3% of your initial trade ($0.60 cents per share), you now only need the price to increase $0.30 cents per share to break even. (Price $19.4/Average $19.7)
3. On Wednesday the stock decreases another 3% to $18.818. You decide to pick up 50 more shares of XYZ which will cost you a total of $940.90. You now own 150 shares of XYZ at an average cost of $19.406 and you’re down nearly $89.00. Though the stock has decreased 6% since you’ve initially invested, you now only need it to increase about 3% to break even. You’ve only allocated 60% of your position thus far. (Price $18.818/Average $19.406)
4. By Friday the security dumped another 1.5% to $18.536 per share, $1.46 lower than your initial investment on the first day. It seems to be slowing so you decide not to wait for it to go down 3% and just buy another 50 shares. The transaction costs you $926.80 and your new average is 200 shares with an average of $19.19 per share. Though the security has dumped 7.5% since you took your initial position, you only need the security to go up 3.41% to break even. (Price $18.536/Average $19.19).
5. Next Monday it is a week and a half until earnings. When trading opens up you realize that the security is up 4% within the first hour of trading. You are in the green but you do not sell. Over the next 4 days the security either increases, trades sideways, or slightly dips, but you remain in the green. 48 hours before earnings are announced you sell at the price of $21.00 netting you a profit of $362.00. In a little over two weeks you made a profit of 9.5%. You never allocated all of the money you wanted to invest, but you should be happy enough with that return. You move on to find another security.
This strategy is often why you will realize selloffs a day or two before earnings. Playing thorough earnings can be risky. However if you are going to play through earnings consider selling 50-75% of your profitable position before earnings, and the remaining 25-50% after. Remember, the dump before ramp up to earnings in not the only sell off you can take advantage of. Sometimes securities dump after, granting you the opportunity to hop in before a probable analyst upgrade. Remember the following when playing the excitement around earnings or any other expected catalyst after an unwarranted selloff: Dumb money gets in a week before or less, smart money and institutions get in two weeks before or less, so beat them both.
IMPORTANT NOTE: The scenario above was simply an example. This is not how it always happens. Sometimes there isn’t a sell off before expected earnings. The scenario above is completely fictional. You can sometimes lose money, you can sometimes average down beyond your comfort zone, or you can get stuck holding for a while if unexpected bad news come out. In either case so as long as you buy value, buy reliable companies, and buy companies that consistently beat earnings, you wont mind bag-holding as much as if it were a penny stock. In this strategy the odds of breaking even or making a profit are in your favor.The same goes for dips that happen after excellent earnings.
1. Buy in Slow After an Assessed Pullback: Average down every 1.5-3%. Never assume you should go all in because you are “at the bottom.” Averaging down increases your profit potential and provides protection from long term bag-holding.
2. Do Not Buy into the Green: If you immediately realize a profit just let it fly. You can find other securities. Use the money you have for averaging down, not increasing the chance that you will lose your initial investment.
3. You WILL Make Mistakes and Misjudge the Chart: The number of times I have been able to estimate exactly how a security would trade in the future in my lifetime is zero. If your security
5) THE PSYCHOLOGY OF HOLDING
5. The Psychology of Holding: I am ill equipped to talk about the emotions and psychology of holding. But I am equipped to tell you how I feel when I implement this strategy. Perhaps I can also tell you the lessons I’ve learned. You can see them below.
1.If you cannot delay instant gratification, then you will never make the kind of money you want. This strategy assumes you WILL experience red days. In fact is counts on it! If you are liable to see red and give up within a day or two, or even a week, this is not the strategy for you.
2.You will start to doubt your position when the trade turns against you. Trust your analysis!
3.You will want to average down sooner than you need to. For example you will want to average down at 1% when you planned to at 2%. Stick to your original plan! You will be surprised how far market makers can tank a security.
4 You will be misled by dips that swing at the end of the day. You will deduce from these swings the following: “If I had only averaged down more I’d be green right now and could sell part of my position for a small profit.” Stick to the original plan. They don’t always swing!
5. You will want to make your position larger than necessary pursuant to bigger gains. Do not do this! All it will take is one bit of bad news on an over-allocation into a single company and you will be left with no money to average down and a giant bag.
6. You will want to hold on to your excess shares acquired by averaging down as a result of unexpected selling pressure when you realize a slight profit. Remember that it is better to have that money to average down further if necessary, than to need to average average down but do not have the money.
7. You will be tempted to buy into the green. DO NOT!
6) WHEN TO SELL
6. When to Sell: Knowing when to sell is often harder than knowing when to enter. We all want more profit, and traders can be hesitant to sell when they see a significantly profitable swing. While there is certainly nothing wrong with holding for a quarter or two, if you are only in the position in the short term there is nothing bad about a probable 5-15% gain! Sure, the security could pump more, and sometimes will. However in my experience after a significant pump they tend to correct and trend down to retest previous lows. Remember the algorithmic traders and take into account how earnings affect the P/E multiple. The more of a bargain the security seems as a result of earnings the more likely the security will increase.
7 Example: The chart above is that of Summit Materials (SUM) from early Jun to August 29th 2020. I began a position on July 30th after the stock sold off amid beating analyst EPS estimates by 100% on July 21st. I assessed that this company met all of my criteria or close to it. I bought in at 200 shares at $15.50, another 200 shares at $15.35, another 200 shares at $15.15, another 200 shares at $15.05, another 200 shares at $14.90, and another 400 shares at $14.85. I only really wanted to allocate 1000 shares for this trade but I had 1400 shares at an average price of $15.093. It is important to note that this security had not yet recovered from the COVID-19 sell off in late February and I was perfectly willing to hold for longer than I turned out doing. The security traded as low as $14.72, meaning at one point I was down $522.00. The security traded way lower than I thought it would and I bought 400 shares more than I expected. However I trusted my analysis. The security bounced ABOUT where I expected it to and within the first three days of the rebound I was already in the green. I sold my excess 400 shares at $15.15 for a small profit of $24. I could have assumed it would continue up but at least now I could average down more if the security dipped again. Fortunately due to the 100% EPS beat JP Morgan upgraded SUM to “Market Outperform.” From there the security skyrocketed. I sold my remaining shares on August 7th for $17.00. So in a little over a week I made $1934. The stock continued to go up but I did not get greedy. I could have certainly made more as it pumped an additional $1.12 to 18.12. Nevertheless I charted the lines and set my alerts for $15.50 in the event the security pulled back again. It did. And I bought back in at $15.24. I still hold the position as of August 29th 2020 and I’m currently enjoying a profit of $224.40. Thus far the Market Makers and their Algorithmic trading platforms are performing exactly as expected.
SUM (Summit Materials)
Q2 EPS: Surprise of 103% Revenue $631 million 07/21/2020
P/E: 17.55 (Sector Average 25.00)
Debt to Asset Ratio: 64.44%
Market Conditions for Construction and Paving: Highly Favorable due to Low Fed Rates
Other Factor 1: Has not yet fully recovered from COVID-19
Other Factor 2: Upgraded by JPM to “Market Outperform”
Other Factor 3: Hurricane Season (Higher Construction Demand)
8. Conclusion: Finding relatively undervalued and consistently reliable securities, with a history of beating earnings, with growth potential, that are on a manufactured pullback of little consequence, is not hard. By taking advantage of these pullbacks you can remain safely and consistently profitable multiples beyond the meager returns of those who hand their money over to outside financial advisors. With a little patience and discipline, consistent gains are not outside your reach. The above strategy is much less stressful and way more reliable than investing in penny stocks, and yet with the benefit of small pump penny stock gains. Of course it is not enough to meet the simple criteria listed above when choosing securities. You will need to do your Due Diligence to include peer comparison and assess market conditions. No investment strategy is 100% and the market always finds a way to surprise us. However I find that solid securities trading at a bargain are less susceptible to outside surprises than securities that are overpriced. Once again this may not be the right investment strategy for you. I however find that I am consistently profitable utilizing this method. God bless and safe trading!
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IMPORTANT DISCLAIMER: I am NOT a registered investment adviser, broker dealer, or member of any other association for research providers in any jurisdiction whatsoever and I am NOT qualified to give financial advice. Investing/Trading in securities, particularly microcap securities, is highly speculative and carries and extremely high degree of risk. The information, analysis, and opinions listed above are my own and may not properly reflect the underlying conditions of a company or security. You should do your own Due Diligence. If you trade based on anything I have written YOU ACCEPT FULL RESPONSIBILITY AND LIABILITY for your own trades and actions and hold the author of this publication harmless. If that isn’t clear enough DO NOT TRADE, ACT, OR INVEST, BASED UPON ANYTHING I WRITE OR RECOMMEND. There, we should be solid now.