What Goes Up, Doesn't Need To Come Down

People actually attempt to apply the laws of gravity to stocks.  It so drilled into our heads, that what goes up, must come down, people try to apply this physical law to stocks.  A stock can go up, stay up, and then go up some more. 

The amount of terrible advice, and mis-information out there is astounding.  People suggesting to sell, or buy, for all the wrong reasons.  Like I've mentioned before, so much of this game is just keeping an open mind, not allowing yourself to get stuck on one piece of information, and discrediting the nonsense.

You'll hear people say,  "I sold because the stock had run too far", or "I bought because the price has been cut in half."  I'd say about half the people who invest in stocks, never calculate a PE ratio.  It's the only true way to value companies, yet some could care less.  You need to be always evaluating where you stocks are currently.  Just like we talked about in the "Dreaded PE Ratio", keep checking your stocks to see how they are valued.  As the price moves up or down, and as the companies earnings do, that PE will change.

This will sound funny, but these kinds of folks must prefer just to guess if a stock is over, or undervalued.  Wallstreet calls buying a stock after a big upwards run, "chasing".  It calls buying a company where the stock is declining rapidly "catching a falling knife".

The mistakes I see daily in this game are inexcusable.  I'm left stunned that someone who's supposed to be very intelligent, deciding a stock is a sell, for all the wrong reasons, while it's as clear as day to me, the stock is a buy. The reasons why people can be so incorrect on a stock's direction can vary greatly.  With so many factors, reasons for being completely wrong, are easy to find. 

The most glaring reason is the stock action itself.  When you see a successful company's stock, trending higher over a period of years, it's much easier to stay on the bandwagon.  You have been correct for years, all the other investors have been correct also, so who are you come in and spoil their party?  If you are right, and the stock has peaked, and will decline soon, you'll have hundreds of stocks owners telling you just how wrong you are. 

It works the same in reverse.  A stock that has fallen heavily over a period of time, the people that owned the stock and sold it, hate it, because they lost big bucks.  They will trash that stock until the end of time.  The people still in the stock, hate it also, because they are losing money big time.  Then's there's a select few, that have taken the losses, but still believe in the underlying company.   When a new buyer like yourself, come in and decides this stock has fallen too far, maybe the business prospects changed, or the valuation has gotten too cheap, understand that most people will call you crazy.

Going against the grain is necessary, and very profitable.  You need to be agnostic towards the stock, and company.  This is where good traders make their money.  Greed, Stubborness, Denial, are all human emotions, and when applied to the stock market, will lose you money. It counter-intuative, but it's usually when the naysayers are the loudest, that your buy, or sell call, will be the most correct.

Let me tell you why "Stocks Are Leading Indicators"...

Big Caps Vs. Small Caps

The word "Cap" is short for Market Capitalization.  Market Capitalization is simply the amount of shares a company has in their float, multiplied by their current stock price.  This number is supposed to give you an idea of a company's overall value, and size.

There's small caps, mid caps, and big caps.  All they're referring to, is how big and established the company is.  Most people who own, and trade stocks, use mostly big caps to do so.  These companies are established.  They have been around for years.  They have name recognition.  They have an earnings history.  They have a chart you can study.  They have big name CEOs.

Big caps are the easiest, and safest stocks to trade, for all the factors I just listed.  For a company like IBM to lose half of their share value would be completely shocking.  It would take a market crash at this point, or a complete business catastrophe, to ever get back to that level, and it the decline could take weeks.  By contrast, a small cap could lose half it's value in a day, pretty easily.

With small caps, a lot of time we're taking about companies who aren't currently making money.  You have to be extremely careful with companies that aren't making money.  If they aren't making money, they are burning, or spending it.  At some point, if that little company can't turn a profit, it will need more funds to survive.  They can add debt, if a lender is willing to lend them money, they can sell assets, or they can attempt to release brand new shares into the market.

Any shares issued by a company after they've had their inital public offering (IPO), are called a "Secondary".  When this happens, most of the time, it's a bad thing.  As more shares are added to the float, your current shares become less valuable, because there are more of them distributed.  The company is in a sense, selling more pieces of itself into the market, and they will recieve money back for each piece.  We'll talk about "Dilution" more in a future post. 

Understand, there is more risk in small caps, but there is also more profit to be had.  You would be surprised how many small and mid caps, go virtually unnoticed, even if they are doing a great job.  Quality small businesses do go largely unnoticed in this game.  Big money likes established names, and predictable earnings.  Much of the time, they completely ignore these smaller companies, even knowing they are good, and will wait until they grow more.  Basically you will find gems out there, and it will be easier than you think, because these small companies just don't get exposure.

Most people when they start this game make the huge mistake of allocating a lot of funds, to small cap companies.  The market offers all kinds of business' from very safe, to very risky.  I'd prefer the first stock you sink some real money into, is a reliable big cap.  You'll have more information to work with, and the stock will have less volatility.  You'll have a trust that this company will be around for a long time.

There's a huge difference between buying McDonalds, a big cap, with great earnings viability, and a dividend, and a small cap Chinese semi-conductor company, with no earnings, that trades on the Chinese stock exchange.

Let me teach you "Averaging Up And Down"...