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8-25-00 Page

This Week's Guidepost

Optionable Possibles vs. Optionable Rollers

1. Since we developed this site over three years ago the focus has been on rolling stocks. This is a simple, easy to understand strategy providing moderate market returns. Rolling stocks are a category of “technical” price patterns. Technical analysis is the study of price patterns based on the principle of supply and demand, of which rolling stocks are a magnificent example. However, our site has a different “fundamentals” approach from that of other rolling stock sites. That is, we place as much importance on the fundamental values of a company as on the technical price pattern. As we have scrutinized the many hundreds of stocks deemed “rollers” through the years, we’ve learned the following:

2. Rolling stocks do not roll at fixed buy and sell points for long (three to five rolls is the norm).
   • Sidebar: “Why do rolling stocks roll?” When we say that a stock “rolls,” we simply mean that the price moves up and down in some regular pattern, between a low value called “support,” and a high value, termed “resistance.” The idea is simple, buy when it is near the bottom, sell when it is near the top. But what we are looking at in the price chart are clues to the relationship between supply and demand.

   • My first experience with supply and demand occurred when I was in the sixth grade, in the late forties, when I built a concession stand with an orange crate and sold small bags of popcorn outside the movie theater in the small town of my birth. That was before goodies were sold inside theaters, at least in my town. I learned that if at night’s end I still had bags in my stand, I needed to drop the price another night to get some balance. That is exactly what causes the price chart to move and to create the technical patterns. You see, demand only occurs when the price is right! I can create demand, I can cause potential buyers to beat a path to my orange crate. I just lower the price until that occurs.

   • The other side of the coin is the supply side. Unless I can make money at the price charged, I will be unable to supply the popcorn for long. Ultimately, we will come to a price where both the seller and buyer are happy. That is the balance we seek. It is then a “win-win” transaction. But if either party is not satisfied, an imbalance occurs and some change somewhere must take place. It is this “seeking for a balance” in the market that causes the price patterns to move, causing rolling stocks to roll.

3. To help understand these technical patterns look at the chart below of the Dow Jones Industrial Average for the past five years and the time segments in the pattern labeled Bull, Bear, and Trading.

   

4. This chart of the Dow Jones Industrial Average shows “general” price patterns. When prices generally rise it is called a “bull market.” The “bear market” is the opposite, with prices generally falling. When the pattern is generally sideways, without much change over a time period, the market is said to be “trading.” Several segments are identified above, others are left for you to name. The term “generally” finds much use in these discussions, suggesting there are few absolutes looking at price charts. The next chart targets the most recent 7 months where we can see the “general” patterns repeat.

   

5. Trending markets are those periods where either the Bull or the Bear reign. Trading markets are the sideways patterns upon which the rolling stock strategy thrives. We chose the DJIA index to illustrate these patterns, however the same can be seen on individual company price charts. It is obvious that there will be periods of transition, from bear to trading, from trading to bull, from bull to bear, etc., where the market-type for each point on the chart may not be clear. As well, the closer we look at the chart, the less evident will be the type market. It is always easier to stand back and look at a big picture to see the prevailing patterns and trends. It is the forest that gets in the way of the trees. That is why it is so valuable to look at every price chart in both daily and weekly views. Often, the weekly view provides clues we miss just looking at daily price charts.

6. A price pattern is really just a clue to the state of supply and demand in the stock. Rolling stocks demonstrate this relationship in a dramatic way. For instance, when the supply/demand relationship is unbalanced, the price will move to correct that imbalance. It doesn’t take long for this to occur. When a roller moves to the height of its cycle, sellers move in to capture the profit, supplying shares, the supply side, which reduces the demand, causing the stock price to decrease. As the price decreases, buyers are attracted to these new lower prices, increasing the demand side, as they purchase shares at these low prices, fewer low price shares are available, increasing the demand. More demand, higher prices. And so it goes.
   Price goes up: sellers come out of the wings.
   Price goes down; buyers are drawn in.

7. If nothing changed, we would have continual rollers that would allow us to go sit on the porch and watch the money roll in. What complicates this simple scenario are the many multitudes of issues and considerations and investor/trader expectations and perceptions that play out every day. For instance, as the Fed meets to consider interest rate hikes, investor opinions and expectations hesitate, one way or the other. That clouds a clear supply/demand equation. As company earnings are reported, how close they come to analysts expectations will color the air for the perceived value of a stock. And it is the market perception of value that drives price and the supply/demand relationship. Accompany this with the fact that the real drivers of price are the institutional traders, who buy and sell in blocks of millions of dollars. They move money in and out of the market according to their perceived company valuations. As a group (representing ¾’s of the market dollar), they move into and out of industry groups in cycles, driving group values up and or down accordingly. And what does all this have to do with rollers? Simply, rollers obey the same market laws and principles as all other market players: Supply/Demand! See the discussion of Supply & Demand in the Technical analysis section of our book, Provident Investing.

8. The reason all of this works is there are literally millions of buyers & sellers in the wings looking for good deals, looking for an edge. That is “why” we have the market, a place for people, you and I, to exercise skills in getting ahead, bettering their (our) condition. Will some lose? Sure. That does not deter the masses from participating. And participate they do. So we have buyers and sellers, at the same time. Those who are buyers today may be sellers tomorrow, or even change mid-day. Or even buyers and sellers at the same time. Think about it. When we choose to enter the market, that means we’re ready to buy shares in a company. We start as buyers, later becoming sellers as we further increase our edge.

9. Market psychology deals with the human element in the trading scenario. People, you and I, are captive victims (participants) in this investment/trading market-place. We deal with human emotions (greed, fear, hope, joy, pride, stubbornness, ego, etc.) that affect how we act and react to market changes. Successful investors/traders use rational rules and objectives to guide their trades, not emotions. Many participants, however, are more afraid of missing the train than losing the ranch.

10. It is difficult to deal objectively with changes that take place in the market. Success requires specific rules that deal with the “If, Then” duo, rules that have been tested in the face of experience and trial and error, with some comfort that for us it worked “most” of the time. Because change occurs so frequently in the market, we must be willing and able to change direction quickly. Stubbornness is the villain here. We cannot let “discipline” be an excuse for stubbornness. Does that all sound like an oxymoron? Let’s try to look at if from another angle.

11. Change in the market: Two sides, supply and demand. If there is a demand for a stock, someone is willing to pay. If the shares are abundant, the buyer will not find a prohibitive price. As the supply become less plentiful, buyers must pay more. As the price increases, the buyers willingness to purchase weakens (less demand). The price can become high enough to kill the demand. That is, demand at what price? If I want a stock at “any” price, I’ll pay a bundle and find a deal quickly. If I want that same product only at price “A” or lower, it will take longer but usually I will find a seller who wants or needs to sell badly enough to sell at price “A.” The time window I desired may have lapsed, but that's life in the market.

12. In any event, when a trade occurs, there is both a happy seller and a happy buyer. This is the only way market trades occur. When we say there are more buyers than sellers, we mean the tendency is toward the buy side (demand) and less on the sell side (supply). However, for a trade to occur, there must be both a buyer and a seller. This means the sellers will make more concession to execute a trade than the buyer. Are they both happy? The seller would be more happy with a higher price, but it was high enough to satisfy his need right now. Even if he thinks “okay, I’ll make it up on the next trade,” his perception of value was sufficient at that time to let the trade occur. In every trade, buyers would be happier with a lower price and sellers happier with a higher price, but at that point in time, the two parties agreed to the terms.

13. This is why stocks roll. It is also why stocks do not roll long before something changes in the supply/demand relationship. With my orange-crate popcorn business, I maintained balance until my cross-town rival sold popcorn down the street with salt added. There was a perceived value difference, for which lower price meant nothing. Think about the multitudes of issues company owners deal with as they try to increase the value of their product/service.

14. That is all a long attempt to explain the dynamics of the auction mentality in the market place. We started this to reason together why we call the 100 optionable stocks each week “Possibles,” rather than “Rollers.” Simply this: In our experience, since we choose our 10 picks each week with good fundamentals, the “general” trend has been upward. When these rollers play out their trading pattern, they are more likely to move up than down. Many of our picks have done just that, broken out of the trading range into what Peter Lynch calls X-baggers, where the “X” is some multiple. We have even had some 10-baggers with our picks, primarily because of the emphasis on company fundamentals. The 100 “Possibles” have not been screened for fundamentals. That is left up to you. We provide models for your review with our ten picks each week. You may adopt similar screens. However, lasting success will come when you find methods that fit your own objectives and personality.

15. This is why we have chosen the term “Possibles” instead of “Rollers.” Why limit market success to rolling stocks when there are other strategies to fatten our wallets while working the rollers. In coming Guideposts we will discuss how to play both sides of the “rolling” street. Stay tuned.
    Understanding:

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