In the last few weeks, we’ve seen small caps take a battering while the US indices push onto new highs. Tesla (US:TSLA) motored (sorry, couldn’t resist) to new highs this week, becoming the latest company to join the trillion dollar club.
The Fear & Greed Index has risen to 71 compared to 33 this time last month. However, this does not feel the same in small caps. Many stocks have sold off on good news, and stocks that are delivering bad news to the market are cratering. Both Fisher James (FSJ) and IG Design (IGR) gave multi-year profit warnings, and saw their prices marked down at the open only to be sold off further.
Multi-year profit warnings are the best kinds of profit warnings. These warnings are so bad that the issues the company is experiencing will follow onto the next year – removing any hope of a swift recovery. This means that only a brave or foolish person, or a brave and foolish person, would be bullish on such bad news in the short term, and usually a profit warning will trade lower from the open.
That said, there are exceptions. If the news sounds terrible, but is actually expected, then sometimes the stock can rally on bad news because the bad news is not as bad as expected. This, however, is a rarity, and personally I would never go long on bad news unless I had good reason to believe the news was better than the market was expecting.
I’ve continued to make progress out of selling out of stocks. I use a simple question for this: “Would I buy it here?”, and if not: “Should I sell it?”. Bull markets are great for lazy longs but when it comes to battening down the hatches, I want my capital in high conviction names.
A larger cash position also means that you can take larger positions in your existing positions. This may increase volatility due to the smaller number of stocks (although most stocks are correlated to the market in some way) but the higher cash position hedges the trading account.
I like to imagine myself as a General, moving capital to where I have the biggest advantage. In military terms, where every commander wants to be is where they ‘cross the T’. If we imagine a T, you’d want to be at the top with most of your units attacking the weak flank of the single line. While there are no Ts to cross in trading, thinking about your account in both strategic and tactical terms is a good exercise. Where are you weak? What can you do about it? Should you retreat (sell)? Trading is a game of skill – those who are able to manoeuvre themselves through different market conditions stand a higher chance of surviving and prospering.
A turnaround opportunity
I was originally going to write up Shoe Zone (SHOE) for this column because it had tested 80p four times. I believed that if it broke out of that area then it would go on a run. Alas, it did on Monday morning, and so I had to scrap that article and start afresh. If it pulls back to retest the breakout sub 80p – I intend to add to my position.
Another stock I’m watching is Renold (RNO). This is a company that manufactures conveyer chains and machine components. It’s a turnaround stock where the chart has improved along with the fundamentals.
Chart 1 shows the decline of the stock over several years from the end of 2016 to the summer of 2020.
I’ve marked three arrows on the chart to show how a stock can false break out. Many traders will have believed that because the price was printing above the 200-exponential moving average (pink line) that the stock was now ready for a new uptrend. Not so. I like to check that the moving averages are pointing upwards rather than the price simply trading above it. This means that while I will get slower signals, it does remove noise and ensure that when I do get a signal that it’s more likely to be a genuine trend rather than a false move. We can see in the chart that at no point since the spring of 2017 was the 200 EMA pointing upwards.
Therefore, with this one simple trick, we could’ve avoided five years of pain, false promises, and the continual grinding down of the stock at more than 90 per cent drawdown from its high.
Moving across to Chart 2, I’ve marked two arrows where I’ve previously traded the stock. We can see that this chart is worlds apart from Chart 1, as we can see the moving averages start to trend upwards and rise.
The first arrow was when the stock was consolidating in a range in an upwards stage 2 base. When the stock broke out, I went long and closed this into the rally. It was a brief trade and the stock went much higher after I sold. That doesn’t bother me because a trade is a trade – it’s no good beating yourself up if you sold early. You’ll always sell too early and it’s better to do so than selling too late. Booking profits into strength is always a good feeling.
We can see in the second arrow the stock gapping up because of better-than-expected earnings performance. Again, this trade lasted a few days before I closed it out. For my third trade in Renold (and hopefully the hat-trick), I’m looking at the top line of resistance at 29p. Notice how each of my buys has been higher – this shouldn’t bother traders because you play the setup and not the higher/lower game. Ultimately, the stock setup matters more than the price. A good setup has a higher chance of running into profit whereas a cheap stock may get cheaper!
- You can trial some of Michael’s stock trading course at https://www.shiftingshares.com/online-stock-trading-course/
- Twitter: @shiftingshares
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