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D. This Week's Guidepost

"Market Risk #2"

1. Risk in the market place has long been linked to the volatility of a stock. Or, it is more risky to invest in a stock that moves up and down more dramatically, even while moving steadily higher with an increasing market. The technical indicator “beta” compares a stock’s volatility to that of the S&P 500 which is considered “The Market!” A beta of one means it moves exactly as the S&P, higher than one means it moves more dramatically, less then one less dramatically, and if it is negative, it moves in an opposite direction from the S&P. In this context, a low risk stock would be one with a low beta.

2. In recent years the overall volatility of the market has increased significantly, where very large jumps both up and down occur routinely. The idea of beta representing market risk does not carry the weight it once did. In our book, “The Provident Investor, a Guide to Rolling Stocks,” we discuss seven additional risks we must consider when making investment decisions: 1. Market Risk, 2. Interest rate risk, 3. Opportunity risk, 4. Cyclical risk, 5. Inflation risk, 6. Liquidity risk, and 7. Diversification risk. Each of these risks represent events that can occur over which we have no control.

3. How comfortable we all are when every thing is under control! It’s the oft repeated story of the sailor who can sleep when the wind blows. He has taken the necessary precautions, tying down everything that might blow away in a possible storm. Having done that, the potential risk is minimized. He is unable to control the storm but can sleep through the event because of preventive steps taken. He has managed the risk!

4. Let’s see how we can manage the several risks identified as we invest and trade in the market.
   • Choose stocks for trading with good fundamentals. The market will jerk us around with the volatility mentioned earlier. That is simply the nature of the beast. Our ability to sleep when the market blows is greatly enhanced if our picks are chosen with certain fundamentals criteria. Solid companies with a history of increased earnings will weather the storms and be there with the light of a new day. We cover these criteria in section II (Fundamental Issues) in our book and on the Pro-fundity web page Tutorials. It has been said that with rolling stocks, fundamentals are not that important, that we are just playing the natural rolls of volatile stocks. Of course that is true on individual issues, when we know a stock will continue to roll, when we know what the support and resistance levels will be, and when we know what the timing of the rolls will be. Unfortunately, those cases are rare indeed. Rolling stocks do not roll forever. Three to five rolls are the norm. Fewer rolls are difficult to take advantage of since by the time we identify them as rollers, they have stopped rolling. Wouldn’t it be better if we had some evidence the price would increase at the end of a rolling or trading pattern? That is what sound fundamentals can do for us.
   • We do vigorous homework and research on stocks we choose to trade. This information has become abundant and easy to access with the many business and investment web sites available. It is an easy task to increase the likelihood of success by screening out companies of questionable character. Message boards on the net can provide a valuable service. Some of the more useful sites are: clearstation.com, siliconinvestor.com, company.sleuth.com/index.cfm, iexchange.com. While there is a lot of noise on these message boards, they can provide fundamental insights worthy of the effort.
   • We watch the charts carefully, learning the value of technical indicators and their value in timing both buys and sells. There are several free charting services (e.g. www.bigcharts.com, moneycentral.msn.com) that will help us do this. TC-2000 is the best service for the money, in our opinion, with free software and monthly data-feed costs at about $30 per month. It is impossible to trade rolling stocks without heavy reliance on technical analysis and the use of price/volume charts.
   • We avoid placing market orders before the market opens. With the large increases in on-line trading, overnight orders to buy or sell at prevailing prices are more often unpredictable and out of line with prices later in the session.

5. These suggestions are the type of effort made before the winds blow to help our sleep quotient. Much of the concern we are now faced with deal with the general market condition. Is this a bear market? How severe? How long will it last? We would like to talk about “Bear Market Blues,” in our next guidepost. Stay tuned.
   Understanding:

   It is our intent to help our subscribers understand market strategies well enough to make informed decisions and understand the risks.

   TC-2000 tutorials are available on the home page.

   Be diligent...
   Take action!

   

   
   
   
   
   
   

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