Perception Rules Reality
Stockscores.com Perspectives for the week ending September 26, 2010
In this week’s issue:
Strategy of the Week
Stocks That Meet The Featured Strategy
What moves stock price? Information filtered by the psychology of the market defines the market’s perception of a company’s fundamentals. It is the perception of fundamentals that determines stock price, and it is changes in the perception that leads to changes in price.
There are many investors and market experts who base investment decisions on fundamentals alone. They apply scientific analysis to the financial reality of a company’s business to arrive at the value of their stock. If this logical value of the stock is higher than the price the stock trades at, the stock is deemed worthy of purchase.
This analysis process leaves little room for the artful interpretation of value. Fundamental analysis is either black or white, leaving little room for the color of reality.
What make the financial markets colorful are the characters, motives and moods that taint the process of logical deduction. A stock whose fundamental value is $20 may only trade at $10 because a large investor has lots of stock to sell, a group of short sellers may have the stock gripped in fear, or investors may simply not like the color of the story.
There is an art to predicting stock price change.
It is not enough to know what the fundamentals will be tomorrow, it is also important to know how the market will judge those fundamentals. It seems obvious that a company announcing positive news will go up in price, yet we as investors have often seen the opposite happen.
Investors will judge fundamentals not only on their merit, but also on how they relate to expectations. Sometimes, fundamental change will be ignored in favor of more pressing macro economic issues.
Suppose you are told that a mining company will announce the discovery of a significant gold discovery in two days. In anticipation of news, and based on your privileged information, you buy the stock. You are excited by the prospect of what will be easy money, to materialize when the news is made public.
Two days later, the news is announced and you watch the stock with excited anticipation. But instead of jumping higher and higher, it goes up for a couple of minutes, and then suddenly begins a free fall lower. Your expectation of quick and easy profit quickly and easily turns to loss.
You can not understand why, it seems to make no logical sense.
Here are some of the possible reasons why the trade did not work:
1. The stock market is not fair. The inside information that you received two days before the news was obtained by others weeks earlier, and the stock already priced in its value. Your stock has been going up in anticipation of news for some time.
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2. Expectations rarely live up to reality. Investors have a wonderful imagination, and the visions of those who were buying the stock in anticipation of the news pushed the stock beyond what the news was worth.
3. Without a reason to own, investors will sell. Many short term investors bought this stock in anticipation of news. When the news came out, so went the reason for owning the stock. Investors who buy in anticipation of news often sell when it is released.
4. The exit door is only so big. When a stock starts to do what investors don’t expect it to do, investors panic and all try to get out at once. This creates emotional selling that has no regard for fundamentals.
5. The tipster has motives different than yours. Believe it or not, the only person who cares about your money is you. Whoever gave you the “inside” information is only concerned about their money, and probably encouraged you to buy the stock because they already had.
6. Every stock correlates to the market. If the market is going down and pessimistic, buying a stock is like trying to paddle up stream. Some can succeed, but most eventually go with the flow.
Do not ever judge a stock through scientific analysis of fundamentals alone. You must always ask, what does the market think? How will the market judge this company? What effect will the mood of the market have on the perception of fundamentals?
Fundamentals don’t matter, only the perception of fundamentals is important.
This week, I ran one of my old and reliable Market Scans, the Stockscores Simple. This strategy seeks stocks that have Sentiment Stockscores of 60 or higher and Signal Stockscores of 80 or higher. I then inspect the charts, looking for breaks through resistance from periods of sideways trading.
I did this process this weekend and found the following:
T.BAJ broke to new multi-year highs on Friday with strong volume out of an ascending triangle pattern. Support is at $0.79 and Friday’s close at $0.94 gives this trade $0.15 a share in risk. The five year weekly chart shows the next area of major resistance to be $1.60, giving about $0.65 of upside for $0.15 of downside, making this a trade worth considering.
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Tyler Bollhorn started trading the stock market with $3,000 in capital, some borrowed from his credit card, when he was just 19 years old. As he worked through the Business program at the University of Calgary, he constantly followed the market and traded stocks. Upon graduation, he could not shake his addiction to the market, and so he continued to trade and study the market by day, while working as a DJ at night. From his 600 square foot basement suite that he shared with his brother, Mr. Bollhorn pursued his dream of making his living buying and selling stocks.
Slowly, he began to learn how the market works, and more importantly, how to consistently make money from it. He realized that the stock market is not fair, and that a small group of people make most of the money while the general public suffers. Eventually, he found some of the key ingredients to success, and turned $30,000 in to half a million dollars in only 3 months. His career as a stock trader had finally flourished.
Much of Mr Bollhorn’s work was pioneering, so he had to create his own tools to identify opportunities. With a vision of making the research process simpler and more effective, he created the Stockscores Approach to trading, and partnered with Stockgroup in the creation of the Stockscores.com web site. He found that he enjoyed teaching others how the market works almost as much as trading it, and he has since taught hundreds of traders how to apply the Stockscores Approach to the market.
This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.