Trading Lesson of the Week

• September 16, 2024
• BLND | EVGO | RYTM

In This Week’s Issue:

• Market Outlook – Hitting Resistance
• This Week’s Market Minutes video – Stock Market Crash or Rally After the Fed?
• Trader Training – Use the 3 Cs to Pick Winning Stocks (NVDA vs INTC)
• Strategy – Sentiment Stockscores > 60

Market Outlook – Hitting Resistance

The markets have done well over the past week but are now bumping up against resistance ahead of the Fed decision on interest rates Wednesday. The market is now expecting a 0.50 point cut (63% chance) vs a 0.25 point cut (37% chance). While the market looks strong, I expect a pullback from resistance is likely in the short term. However, the longer term momentum is still positive and lower interest rates are good for stocks in general.

This Week’s Market Minutes Video – Stock Market Crash or Rally After the Fed?

Will the market crash or rally on this week's interest rate news? Stocks made a good comeback this past week and appear to be optimistic going into the US Fed announcement on interest rates. A simple technique can help predict what way the market will go and I share that with you this week. Then, my analysis of the stock, commodity, currency and bond markets and, finally, the trade of the week on a big Friday gainer, SMX.

https://youtu.be/XynEjWRpSd8

Commentary – Use the 3 Cs to Pick Winning Stocks (NVDA vs INTC)

I have done a video to complement the write up below, so you can see visually some of the concepts described below. Watch the video on YouTube at this link:

https://youtu.be/3dGO7UP-T10

Analyzing a stock, ETF or market can seem to be a very complex task. Yet, with a simple approach that I will explain here, you can do the analysis in just 10 seconds and be miles ahead of most investors who are lost in details that just don’t matter.

There are two common approaches to stock analysis – Fundamental and Technical. The former considers information about the company’s business and the latter considers the price and volume trading history of the stock. Both methods can be very useful but also very misleading. You have to apply each approach properly and very few are able to do that. The result is that most people do not consistently beat the stock market.

For most people, the approach that makes the most sense is to study the company’s business fundamentals. I have learned the hard way that we should not pick sides based on what makes sense to us but instead, choose the approach that is going to work best for us.

There is no doubt that a company’s business fundamentals drive the long-term performance of the stock. The stock’s price will trend upward if the company’s earnings potential is improving or down if prospects are looking worse. Understanding a company’s business, listening to the story and buying the stocks that seem to have the best business prospects makes sense to the most people. But this approach will not work for most people.

If you are a normal investor, there are two problems with analyzing the company’s fundamentals.

First, all publicly available information will be reflected in the price of the stock and therefore have no value in your analysis. If a company announces better than expected earnings, its stock will go up. If a company announces that it has discovered a new treatment for a disease, its stock will go up.

To use fundamental information to make decisions requires that you use information that most people do not yet know. You need to know that earnings are going to be better than expected before they are formally announced. You need to know about the new disease treatment before the company tells the world.

Second, even if you have access to information that is not widely known, do you have the expertise to know what it means? Are you an expert in every industry that makes up the public companies listed on the stock exchange? There are people, experts in their field, who can predict future price moves based on fundamental analysis. An oncologist will be better at identifying promising new cancer treatments before a plumber will.

But the plumber can still do better in the stock market.

What if I told you that there is an army of analysts who have access to the very best information, applying the very best expertise and who will do all the analytical work that you ask of them completely for free? Would you be willing to hire them?

Each day, millions of people make trades in the stock market, letting you know what they believe about a company’s future. Collectively, investors around the globe are doing the hard work to uncover the hidden gems in the stock market. They tell you what they know by what they do with their money. It is the most honest expression of opinion possible.

Their combined effort will give you a read on the general health and potential of a stock if you know how to interpret market activity. However, it is the actions of those with better information that presents the greatest opportunity. Again, with an understanding of how to read the trading activity of stocks, you can figure out what the smart money is doing too.

When an investor has information that they believe makes the stock worth more than what it is trading for, what do they do?

A rational investor would buy the stock and hold in anticipation of higher prices in the future.

Typically, the investors with the best information or expertise in an industry will also be large investors capable of making big investments in the company. A hedge fund with $10 billion can afford to do deeper research and make better fundamental decisions that the small investor with $10k. Since they make much bigger trades, their trading activity is more obvious to someone monitoring the price and volume activity of the stock.

The ability to pick stocks that outperform the overall market simply requires paying attention to what investors are doing with their money. Each trade represents the opinion of the people making the trade and the biggest, most well informed and qualified traders make the most noise in the market.

To understand the message of the market requires understanding the 3 C’s:

Who is in Control?

Think of the stock market as a war between buyers and sellers. The buyers believe the stock is worth more and the sellers think the stock is worth less. The side that is winning the war is the side you want to be on.

To know who is winning is simple. Look at the stock’s price chart and assess whether the bottoms are rising from left to right or if the tops are falling from left to right. Rising bottoms are a sign of optimism and indicate that the buyers are in control. Falling tops are a sign of pessimism and indicate that the sellers are in control.

To help with assessing whether a stock is worth considering, I created the Sentiment Stockscore indicator, available free from Stockscores.com. For longer term traders and investors (those who intend to hold the stock for months or more), only consider stocks that have a Sentiment Stockscore of 60 or better.

Do not buy a stock that is in the control of the sellers.

Are Investors Confident?

It is important to assess how much price is changing over time, which is called price volatility. If a stock has an increased amount of price volatility, it means that buyers are sellers do not agree about what the stock is worth. A stock that is trading in a narrow price range shows that the buyers and sellers agree about what the stock is worth; they are confident that the price is right.

This is important because a price jump from this low volatility, high confidence trading range implies that someone has new information that justifies the higher price. If buyers and sellers have agreed that the stock is worth around $10 a share and then, one day, it jumps to $12 a share, it is likely that some investors have new information that justifies the higher price.

Has There been a Surprise Catalyst?

This surprise price jump is the final C, the Catalyst for a new upward trend. Investors are out to make profits in the market and will not suddenly pay more for a stock unless they have good reason. It is the most well informed and sophisticated investors that cause the stock to break to the upside and, we as relatively uninformed investors, can simply follow their actions without knowing the reason for the price jump. We will learn about it in the future, when the information is widely known, and the price has risen to reflect the positive change in fundamentals.

Let’s consider two examples. First, a stock that has done poorly and was best avoided, and then a second in the same industry that has done extremely well.

Intel (INTC) first made a falling top and broke its upward trend line in January of 2024. It made a sharp downward move in the third week of January and then made another abnormal price break to the downside from low price volatility in April of 2024. The stock’s Sentiment Stockscore has been below 60 since early in the year while the stock lost more than half of its value.

nVidia (NVDA) is also in the semiconductor industry but it’s stock has done considerably better in 2024. It made an abnormal price break from low price volatility in the first week of January 2024. Prior to this price jump, investors demonstrated their optimism about the stock with the rising bottoms that had been building over the previous two months. The stock gained well over 150% over the following 6 months, with its Sentiment Stockscore over the 60 threshold for most of that run higher. The stock then made its first falling top of the year in July, it Stockscore fell lower and the stock has been a weak since.

You don’t have to know much about what a company does, how well it is doing or what’s its business prospects are. Instead, you can read the actions of those who have the best information and expertise and follow what they are doing. Start with an understanding of the 3 C’s, utilize the Sentiment Stockscore and take 10 seconds to look at the chart to determine if the stock is worth considering or not.