There’s been a clear trend developing this earnings season. It’s not an old one, but it has to do with one of my Ten Commandments of Trading.
Following this trend and my Commandment is nailing some opportunities this earnings season.
It’s a trend or pattern that companies like Netflix and Microsoft have already shown us over the last two weeks.
I did a full breakdown on this pattern of being ‘priced for perfection’ early last week. if you missed it – check it out here.
It’s also a pattern that I’ve been tracking for more than 20 years.
I’m talking about the market’s reactions to earnings results. More specifically, reactions with respect to the market’s expectations.
It seems overly simple, but this contrarian approach to earnings is uncovering some amazing opportunities.
We’ll get to two opportunities that are coming over the next few weeks, but first a quick look at the approach.
I’ve always talked about how I try to avoid crowded trades. Let’s talk about why. The following is “Number Two” from my “Ten Commandments of Trading”.
“Never run with the crowd. Avoid bandwagon stocks unless you’re driving. The best time to buy is when everyone is selling, and the best time to sell is when everyone is buying.”
Psychologically one of the harder commandments to follow, this is also one of the most effective in determining the best time to buy or sell a stock from an intermediate to long-term perspective.
It’s a running joke in the investment world that most investors buy high and sell low. The reason for this is that in most cases investors tend to buy at the peak of excitement for a stock, or the market. If you think of this objectively, that’s the worst time to buy.
Follow me on this….
Stocks are driven higher for one simple reason, there are more buyers than sellers. Forget about fundamentals, P/E Ratios and to some degree even technicals.
The bottom line is that a stock CAN go higher only as long as there are buyers out there that want to buy the stock.
Buying power is a finite resource on Wall Street. Once you understand this the rest is easy.
When investors have piled onto a stock’s bandwagon as buyers there is little to no buying power left to drive that stock higher. The simple term for this is a “bubble.”
When everyone is piled into a stock it’s only a matter of time before someone decides to sell. This causes a reversal as there are no buyers left waiting to get into the stock. From this point, it’s a case of the stock spiraling lower as the crowd begins to sense problems, adding to the selling pressure which is still at an imbalance against the potential buyers.
A relatively easy analogy that everyone usually understands is the idea of someone yelling “FIRE!” in a crowded theater. It doesn’t matter if there is a fire or not, everyone runs.
In our case, running from the theater is represented as selling the stock.
The bottom line, never be the last one in the theater or the last bullish investor to catch on to a stock that is already crowded with bulls.
The reverse here is also true. Let’s go back to the theater analogy. The first in the theater gets the best seat. It’s really no different with investing. The first one brave enough to buy when everyone else is selling gets rewarded the most.
If you understand that then you’ll be interested in what is going to be happening this week….
July 31 2023