Hard lessons to learn

Up, I said

Enrolled in the School of Hard Knocks

What a difference a year makes! In August 2003, I was up 124% on the year. I was smugly saying things like, "It seems ridiculously easy to make money in the stock market." As they say, pride goeth before the fall.

This year has been a painful re-aquaintance with some of the harsher realities of the stock market.

Don't bet against the market

I have bought numerous stocks this year that looked promising at the time, for all the same reasons that produced such profitable results last year. But there's a big difference between years: Last year, the markets were rising over the course of the year. This year they have been falling. I think that one reason this year has been so hard is that even promising stocks have a hard time swimming against the tide.

2003 markets
2003 S&P 500 and Nasdaq composite indexes
2004 markets
2004 S&P 500 and Nasdaq composite indexes

Take profits when you can

My natural inclination is to find a promising stock, buy it, and hold on to it for a while to let it fulfill the promise. That seemed to work last year in an environment of rising markets, but it has been an expensive habit this year.

On far too many occasions I have watched promising stocks be battered by swings in the market as skittish investors react — over-react? — to every bit of news or speculation. "Renewed violence in Iraq" — down! "What will the Fed do with interest rates?" — down! "Oil jumps to $47 a barrel" — down! "Kerry nominated" — down! It hasn't really mattered. The market has just been in a hyperreactive mood. As a result, the DJIA can be up 100+ points one day and plunge 100+ points the next.

I have been loathe to use stop-limit orders and even the more robust "trade triggers" offered by Ameritrade because they often execute because of a trade at the extremes of the day's range. Clearly that has also meant that profits have slipped away.

Place the order and walk away

I've made a number of buys over the past year at a price that I recognized almost immediately as too high. I would place an order and then watch it. But if I had made a good pick, chances are I wouldn't be the only one, and I would see the price moving higher and think, Damn, I'm going to miss out if I don't raise my bid. To my chagrin, I have often seen the price fall later in the day back to about my original bid.

I've succumbed to the excitement of the chase way too many times over the past year.

If you're gonna jump, jump

Last year I would find a stock in one of my screens and think, Fine, I'll wait a couple of days and see if it's 'got legs'. That worked then. But then is then, and this is now. In this very volatile market a short-term trend may only last a week, if that. If you miss out on the beginning, you end up buying too high or having to pass entirely.

Take ShopKo Stores for example. SKO showed up yesterday in a screen for stocks in a new uptrend (ADX > 20, +DI > -DI). When I looked at the chart, it looked very promising, indeed.

SKO stock chart

• The stock had apparently bottomed in early May and had reversed trend.

• There had been a pull-back after the recent high of $16.09, but yesterday's close was above that mark.

• Yesterday's jump was on big volume, and the close bumped against the upper Bollinger band (green wavy line).

• The 50-day moving average is about to top the 200-day moving average, usually a very positive sign.

• The upward trend is strengthening — the ADX has crossed the threshhold at 20.

Considering all these things, I thought it was reasonable that I might get in at around $16, mid-way between yesterday's open and close. But when I looked in this morning, SKO was already trading at $16.50. I put in a bid for $16.45. Alas, that was too little and too late. The low so far today has been $16.29 and it has been as high as $17.46.

SKO 1-day chart
SKO 1-day chart in 5-minute bars

Even if SKO comes back below $17, it is trading beyond the upper Bollinger band, and statistically it is bound to come back toward the average. To buy at that price would, in all likelihood, be to ensure a loss in the very near future. On the long term, SKO could very well pull back and rise again, but in this market that's far from a sure thing.

So, what do I learn from this? I think the tactic for a stock flashing so many positive signals would be to place a trade trigger: if the stock trades above yesterday's close, buy at market. The risk in doing so is that you pay too much. The risk of setting a limit is that you miss out (as I did today). There's no sure-fire answer to this.

And yes, this lesson contradicts somewhat the lesson just before it!