Investor Psychology: How to Profit from the
52-Week High
By Greg Guenthner
July 27, 2010
Beware anytime you hear someone say something remotely resembling the
following:
“This stock is cheap right now — there’s no way it could go even
one penny lower.”
At any given moment — even during the most frantic bull markets — you
can find cheap stocks. Some are cheap because they should be; avoid
them at all costs. They’re what we call “value traps.” That is, they
appear cheap on the surface, yet are actually at or above what most
investors would consider fair value due to various circumstances
involving the macroeconomic picture or the company itself. On the
other hand, you do occasionally come across stocks that present some
type of hidden value that just happens to have gone unnoticed by the
market.
Over the long run, value traps and legitimately undervalued stocks
provide investors with distinctly different returns. In the short
term, however, you can count on these two types of stocks to behave in
very similar fashions…
That’s right: The stock you think can’t get any cheaper inevitably
will go down before it finds its way back up — if it ever does. That’s
why confident investors will average down a position if there has been
no material change to the investment thesis. (Note:
Sometimes, I’ll average down on my longer-term investments. In fact, I
recently re-recommended a long-term play to
my premium subscribers…)
But what about stocks forging new highs? It’s this same type of
thinking that keeps most investors from succeeding. When your average
investor finds a stock that posts new highs week in and week out,
he’ll inevitably wait and end up missing the entire rally. The reason?
This stock is up way too much. It can’t keep performing this way
forever…
Inevitably, the investor in our scenario ends up waiting for a dip
that never comes, or completely misses the stock’s run.
The truth is that new highs are a great way to find stocks for
shorter-term trades. The path of least resistance is up. And more than
likely, the trend will continue and good news will follow the rise in
price.
Consider this classic Market Wizards interview with William
O’Neil protégé David Ryan. Ryan discusses how a stock setting new
highs has more of an “open running field”. With these short-term
performers, market psychology takes over—and Ryan knows from
experience that you have to know how other investors are thinking in
order to come out on top…
“… No one ahead of you is at a loss and wants to get out at the first
opportunity. Everybody has a profit; everybody is happy,” Ryan said.
That’s how winning stocks retain their strength and continue to push
to new highs— while those on the sideline watch in disbelief, thinking
that the stock could not possibly go any higher.
Of course, a rally has to eventually end. And there are techniques we
can use to determine if and when a stock making new highs is actually
becoming overbought. I’ve written about the difference between
low-volume pullbacks and corrections before, so I won’t bore you with
a long, drawn out lesson. Just remember this: Fight the urge to look
for other options when you see a stock making new highs. It could be
your best opportunity to profit in this market.
Sincerely,
Greg Guenthner
P.S.: Like I said before, when markets are fickle,
averaging down can be a good way to lower your cost basis on a smart
long-term investment. I just re-recommended a trade to my premium
readers that’s already starting to gain steam. To get a glimpse at my
entire “$200 Retirement Blueprint” portfolio,
just click here now…
