CANSLIM & Momentum Investing 01 (May 08 - Jul 09)

[LenaHuat]

Read this sad story in the NYT 2day on "Golden Years Tarnished".
If only they had known abt "Cutting their losses at 8%".

http://www.nytimes.com/2008/11/13/business/13retired.html?_r=1&hp&oref=slogin

[iam802]

it will get worse...as these retirees representing the baby boomers...are going to start selling their portfolio slowly.

never ending redemption.

[millionairemind]

The big mo
Nov 20th 2008
From The Economist print edition

Why do share prices move relentlessly in one direction?

THESE days almost all stockmarkets seem to be falling inexorably. But in more normal times individual stocks are affected by momentum, which is the tendency for popular stocks to keep rising (and for unpopular ones to keep falling). When it comes to shares, what goes up does not always come down—at least in the short term.

The phenomenon has been noted in a wide range of studies and has often been exploited by fund managers, but it has puzzled academics for decades. It is hard to square with the idea that investors are rational. If it were easy to identify which shares were due to go up and which to go down by looking at their previous price movements, why would a rational investor be willing to sell the former group or buy the latter?

Explanations for momentum have thus tended to focus on the idea that investors are irrational. For example, they may be slow to recognise that the fundamentals of a business have changed for the better (or worse). A company may need to beat profits forecasts for two or three quarters before the market is willing to give the stock a premium valuation.

But a new working paper* by researchers at the London School of Economics (LSE) suggests that the momentum effect is still consistent with the idea that investors are rational. The paper’s main insight is that most investors do not buy stocks directly, but give their money to fund managers. This creates an agency problem: how do the clients know that the managers are earning their fees?

In the short term, it is difficult to distinguish management skill from luck. Because the index represents the average return of all investors before costs, some managers will beat the index while others will underperform. There is a natural tendency to assume the outperformers are skilful. So the underperformers will lose clients and the outperformers will gain.

The dotcom bubble was a case in point. “Value” investors (who look for stocks that appear cheap by usual measures) ignored the technology industry. They were dumped by clients who gave money to “growth” investors (who look for companies with a promising future) instead. By itself, that pushed up the value of dotcom stocks and made the relative performance of value investors even worse.

In the academics’ view, nobody was being irrational. The clients thought they were picking the best fund managers; the value investors were avoiding overpriced stocks; the growth managers were doing what they were paid to do. After the dotcom bubble popped in March 2000, the same thing happened. Value managers started to outperform, so clients switched their money away from growth stocks. This continued for several years.

By extension, the theory also explains why momentum effects can occur at the industry level. If there is one industry (oil is a case in point) with a low correlation to the market, fund managers will watch their exposure to it very carefully, to avoid the risk of underperforming the index. So if oil shares are doing well, managers will be forced to buy them, pushing up their prices even further.

What is trickier to explain is why the momentum effect ever stops. Academics have found a tendency for a reversion to the mean (outperformers start to falter, underperformers to recover) over longer periods such as three to five years. The LSE authors suggest that momentum effects eventually take prices to such extreme levels that the gains from betting the other way are irresistible. The tricky question is who has the cash to take advantage.

Take the bursting of the dotcom bubble. Value investors were losing clients and so were selling not buying. Growth investors had a mandate from their clients to buy tech stocks and thus had no incentive to switch. And the index-trackers just bought the stocks in the index.

Reversion thus requires a deus ex machina in the form of some superrational investor (Warren Buffett, maybe?) or, the authors suggest, fund managers using their own money, who can take advantage of the opportunity provided.

The theory does provide some insights into how momentum might work. But relying on the notion of rational investors seems to complicate matters. If investors are rational, and cannot be sure whether active managers have skill, why do they not just put their money in index-trackers? The idea that investors can occasionally become irrational seems both simpler and intuitively more appealing, especially in the light of recent events.

[millionairemind]

From IBD newsletter for CANSLIM practitioners.

Letter From The Editor
Investing Resolutions for 2009

Here are 5 proven — and profitable — resolutions for the new year:

#1: Target high-quality stocks with strong fundamentals, such as earnings and sales growth, and technicals, such as price and volume action. Those are the traits that may signal emerging leadership.

#2: Don't dismiss a stock just because its P-E ratio seems high. The greatest stock winners typically had high P-Es before their major moves, so you don't want to miss potential new leaders.

#3: Ignore opinions. Follow IBD's proven rules and let the market tell you which stocks to buy. That's been successful for countless investors.

#4: Stay on top of the market by reading The Big Picture each day. For decades, it's helped investors understand whether it's a good or bad time to be in the market.

#5: Keep all losses small. Always sell if a stock drops 7% - 8% below your purchase price.

[winston]

The Three Secrets to Uncovering Rocket Stocks

1) Rocket companies have rock-solid fundamentals... continuous revenue streams... surging profits... and operate in the highest-growth sectors.

2) Rocket companies are leaders in their respective industries. These companies are innovators, the one's developing breakthrough technologies, and world-changing advancements.

3) Rocket companies dominate their competition. With sustainable competitive advantages many of these companies are doing so well right now they're either buying-out or taking market share away from their competition, yes - even in today's brutal economy

[Aspellian]

Hi MM bro,

some burning questions i have on application of CANSLIM on spore markets. hope you can enlighten me....

- you mentioned that in spore there is no true leaders, just whack in a uptrend....

usually how do you go about doing so for spore market? Do you still practise CANSLIM,
ie. current/annual earnings - only best companies with outstanding earnings? but difficult as most companies are showing down earnings (esp. spore is an export country, so almost all companies affected badly)
- New stuff - new products, management, market, contracts etc etc
- supply&demand, shares outstanding etc
- Leaders - there's no IBD 100 for spore market, you mentioned no leaders (just whack!), so maybe this point not too important. probably more so eg. for 3 shipping companies - choose the strongest
- institutional investors (fund managers buying, then u buy?) but would it be too late?,
- market (more clear-cut, buy only when uptrend)

or do you just trade based on volume, irregardless of fundamentals, ie. you only practise M?

[winston]

Dear A,

As MM is not around, I will try to answer your questions:-

you mentioned that in spore there is no true leaders, just whack in a uptrend....

Normally, big movements are caused by the Funds. And the funds can only get in and out of index stocks only.

ie. current/annual earnings - only best companies with outstanding earnings? but difficult as most companies are showing down earnings (esp. spore is an export country, so almost all companies affected badly)

Please see my "AAR & TOL" thread. I think the first stage of the rally was because of the steep drop. The second stage of the rally would have to be based on Earnings. INTERVIEW-UPDATE 1-S'pore's Osim banks on China for growth
The Second Stage is where I think one would be using C and A of CANSLIM.

- institutional investors (fund managers buying, then u buy?) but would it be too late?,

No, dont think so..

Take care,
Winston

[millionairemind]

Hello A bro,

Paiseh, I was out to bring my son cycling.

W being the "LAO JIAO" here probably answered your question, better than I can ... he is super experienced. I am learning from him everyday. His musings on the TOL and AAR are always good reads

Just to add a few more points.

Singapore market is like a tofu market, goes up and down with the US market. No exactly day to day.. but overall trend is important.

If you like mid-caps, say Ezra (Musicwhiz's favorite stock), on follow thro' day, it was 51cts. Now it is around 1.30.

Always choose the strongest company in the sector that you are interested in. For eg. Wilmar would be the leader in the palm oil group, just like UOB is the leader among the banks.

When I say just whack, I was referring to the strongest companies as mentioned above and Winston is correct, major funds typically buy only index stocks cos' they have so much money, buying pennies will cause the stock to sky rocket.

When fund mgrs start to buy, they will leave clues in the price/vol action of your stocks. Similarly, when they sell, you will know too

I don't trade stocks with no earnings, stocks like lottvision or crap stocks like biosensors are punters favorite, I rather not touch them. Trading them is like crossing a traffic junction blindfolded. Some days you can get thro' and make some money, but one wrong move and you end up in the ICU

I hope this helps.

Cheers,
mm

[Aspellian]

Hi Winston and MM,

thanks for your comments.

Another novice question... sometimes Uptrend last for months on end (you wont know how long-even 1-2yrs??). if so, does it mean that if you missed out on the follow through day (eg. mid-march 09), you will have to sit on the side-lines and wait for next down and uptrend cycle?

<some thought - I will think its a personal risk appetite matter - still can buy but with a tight stop loss tactic.
eg. buy on dips, buy when price went back to 50DMA etc> please comment further

actually by going through the stock lists, the usual companies with more stable earnings will emerge... and among this, eg. as mentioned, UOB, Ezra or capitaland will be evident of leaders within the industry. This will help in avoiding toxic stocks that go up and down in the blink of an eye.

[millionairemind]

Hi A bro,

If you missed the follow thro' day, for STI, wait till the pullback to 10DMA and look at the stocks you have on your WL that is also pulling back to the 10DMA.

I found that the 10DMA works well when market is in a rally. Go plot the STI chart with 10DMA and you will understand what I mean. Of course, this is just a guideline , can fail sometimes, just like follow thro' day, works only 2/3 of the time.

For US market, not safe to pursue once it is more than 5% out of a buy point. Wait for pull back to the 50DMA for individual stocks.

Hope this helps.

mm