By David Popper
If anyone thinks that the stock market is the road to easy money, they have not traded for long. Despite the hype presented by a myriad of promoters who hawk "top secret" methods to achieve easy wealth, traders know that no "system" is fool proof and every position must be monitored. Psychologically, trading can be difficult. Each and every day traders are presented with a new "fear of the day". The economy and the market are too complex to be perfectly good or perfectly bad. There is always a catch. There is always a reason not to trade, not to put your money at risk. I am convinced that the risk/reward principle (the greater the risk, the greater the reward) is the real answer as to why trading can be lucrative.
Last year, my trading partner, Tim, began keeping meticulous trading records. Besides recording his trades, he also recorded the "fear of the day". On a monthly basis, he would review charts, and observe what happened because of, or in spite of, the daily fear. This exercise has made us realize that there is often little correlation between the fear of the day and the market action. Over several weeks, most fears resolve themselves and any short term impact they have on a stock is nothing more than a short term divergence. As the Nasdaq rose over 80% last year, there was a reason not to trade a Nasdaq stock each and every day if you were to listen to CNBC. This is not to say that a trader should not pay attention to news. What it does mean is that there is difference between news and fearful speculation. Listening to analysts can paralyze a trader. It is better to listen to the markets themselves. The very best way to gauge the market is to observe the major averages and the leading stocks. If the major averages and leading stocks are setting up, it is time to trade - in spite of the fear of the day. Most bull markets are born in the midst of despair. If the major averages and leading stocks are breaking down, it is time to get out - in spite of the hope of the day. Most bear markets begin when euphoria and complacence abound.
Again, hype, whether it be positive or negative simply has no place in a trader's analysis. A better use of a trader's time is to spend it selecting stocks that have superior earnings, superior growth prospects and are participants in leading sectors of the economy. Those stocks should be purchased when it is technically correct to do so. It also helps if there is a motivating event upcoming such as a split, earning season or analyst meeting. A trader's time is better spent loading the deck in his favor than it is listening to the opinions of others.
What do I mean by loading the deck? By loading the deck I mean it is necessary to put every factor possible, whether it be fundamental, technical or sentiment, in your favor when executing a trade. For example, this week I have been looking at TQNT. TQNT fundamentally sports a 97 EPS rating according to Investors Business Daily. Technically, TQNT sports a 98 relative strength rating according to Investors Business Daily. Additionally, TQNT has formed a cup with a handle pattern and has just recently broken out. It is not very far away from its pivot point. Further, I expect market sentiment to operate in TQNT's favor. A recent analyst's meeting disclosed the fact that TQNT has been taking market share from PWAV. Additionally, TQNT belongs to the powerful semiconductor sector. News in this sector has been fabulous lately. Analysts have not been able to find enough good things to say about this sector in general, and TQNT in particular. Finally, TQNT is scheduled to split its stock 2:1 on July 12th.
Now all of the above do not guarantee a successful play. As we all know, the market can turn on a dime. Market risk is always present. Further, there is always the unforeseen disaster. Setting aside these possibilities for the moment, a case can be made that there are fundamental, technical and sentiment reasons to purchase TQNT. This is a play that is loaded for success at this moment. Does that mean I put all of my money in TQNT? Of course not. Does it mean that there are not plays that may be equally as good or better? Of course not. It just simply means that the market conditions for this issue seem to be favorable at this point.
Once a play has been identified, then you have to choose how aggressively you wish to play the issue. The most aggressive way to play the issue is simply to purchase short term calls. This, of course, provides the greatest possible return and the greatest possible risk. The second most aggressive way to play the issue is simply to buy the stock and hold it until the split. Third, you could buy the issue and write a covered call and achieve a reasonable probability of obtaining a 10% return by option expirations in July. Fourth, you could choose to write in the money puts or even choose to take an ultra conservative approach and write an out of the money puts. The return is less, but the risk is less. Fifth, you could trade the issue using spreads and hedge your downside risks.
The primary point I am trying to make is that the markets themselves and the leading stocks will tell you when to trade. It is best to put all odds in your favor when executing a trade. Your risk tolerance will influence how you choose to trade a particular issue. Analysts, speculation, fear, hope and greed should not play a role in your decision making process.