market data vs market scenarios

March 4, 2010

For the moment sticking with stocks as the investment concept (as distinct from bonds or stock derivatives, etc) for the investor of course at first, basic decisions have to be made. These basics would include, especially for a Canadian, what currency to use - typically Cdn or US depending on the relative outlook between the two - and from that, which market and what individual company from among those thousands you choose - which sector, what characteristics it has that you have been looking for. Where to look and what to look for, we can touch on another time. There are lots of important subset characterisitics here. In the end, you narrow it to a few and make your choice. Now you consider an entry point, begin to act and ultimately develop your position. OK, so here we are.


If it wasn't thought out beforehand, at least at this point we might need to do more than hope it goes up, remembering that hope is never to be mistaken for a plan. We need to develop a scenario for the destination it needs to reach in order to fulfil your requirements. Lets say that the research that led to the choice suggested that over the next 3 to 4 years if things worked out reasonably for the company, for its industry or the economic sector that it depends upon or works within tp succeed -for instance, consumers for retail; transportation and industry for energy; housing, credit cards and autos for finance; sovereign debt, currencies and savings for gold) doubling looks achievable.

This presupposes you have now become pretty familiar with the analytical tools, charts and how to read them (I prefer the Japanese candlestick type), that are currently available to D0-It-Yourself investors. Even if it turns out to actually reach your goal, you can't see an actionable path in detail from here. What's happening in your life and what are you prepared or interested in enough to do? Do you sit like Warren Buffet back when he was 40? Do you have some investable funds coming in every month to buy with on dips along the way? Maybe you don't have decades to coast. Worst would be no long-term horizon together with no further money coming in.


These differences all change how you will look at that imaginary trend line (OK, you can draw it in so its a real line, but its still not a reality). What you DO know for sure is, it will not get there in a straight line. And within that certainty lies both opportunity and danger.

So lets call that "macro" line an initial price scenario. Again, there should be some concept as to why it ends where it does both in price and the date. At this point, the more aggressive (needy?) of our investors will start to think about how they could optimize the returns along the way - and in the process help achieve the overall target if not improve on it. Recognize that starting up this micro or short-term management path working around a core position, will also mean putting in more time to do the work. In a period of activity this could resemble day-trading, but is not. A true day trader will always close out and be flat at the end of the day and picks stocks using different primary or initiating criteria than those above (usually a momentum player).

OK so now our charts, plus real corporate news cycle expectations, may call for a trading exit from some part of our holding at a certain calculated price point (time to event is less distinct or important unless you're expert in market cycles). What percent should be sold will depend on your judgement of how much time the stock will spend at the price (are you shooting for the maximum expected or a reasonable average close to that expectation?), the liquidity of the stock (is the amount you will want to sell significant in terms of the number of shares typically traded in a few minutes, hours or need to be spread over a longer time frame) and are you looking for a specific sum. Typically the amount will be related to the expected cost of buying back a larger position at a lower cost than where it was sold. If it works out that getting more stock becomes risky, settle for the same number of shares plus an improved cash balance. How great is the volatility in a typical trading day? The more the volatility the faster execution you may need and the price of accuracy will be really important. Do you think the pullback will be adequate in price and time to realistically be worth the round-trip risk?

For our purposes here, we are ignoring the concept of stop-loss positions below the market. That needs some blog space of its own. However, in this scenario I have often used several orders, scaled progressively up in price and share size placed ahead of the market. Even if modifying the price of an existing order while in play, a faster execution will often occur compared with a new order placed at the same time. The same technique can be used below the market, particularly during the buy-back of a vacated position when speed at reversals can be really important.

Having this kind of stuff in your head can help when new information comes unexpectedly. Yesterday, a stock already up but still a definite core hold, slipped more noticably on its watch chart than normal for the time the change took. I went directly to my newslines and found a 2-hour old quarterly results notice I had not been expecting yet, released just after the open. The news was rather neutral for the strength of the previous price action. That enabled me to judge that although the stock was sharply off from its high of the previous close, the price range I could execute in would provide a very satisfactory return above the mean trend and my cost. I immediately sold 60% of the core position, an amount I had previously decided. The market clearly reacted poorly to the news - largely due to a generally weak attitude in the natural gas sector - and the stock continued to slide afterwards. With 2/3 now in cash, a high base level had been protected. From a well-purchased position, selling on good news is often - but not always - a temporary good move.

This morning the reverse happened. I had been expecting some kind of constructive announcement by this company before the open next Monday, but not beforehand. However, while checking as usual for late-breaking news on my holdings, moments before the open I found 2 identical wire service briefs that were quite positive. Within seconds I moved cash and placed a buy just as the market opened. I could see seconds later that it had not executed. I had underpriced my bid by 1c. I immediately adjusted and re-sent. The order executed at the revised price during the moment it took to bring up the results screen. In mid-afternoon an official e-mail announcement arrived from the company that was fuller and even more constructive. The stock closed at a new high 15 minutes ago. This positive result would not have happened had there not been a plan of what to do already in place. Actual data modifies action and always trumps the plan.