Was that so bad?

Over on another thread, Ron and I have discussed trading vs investing, strategies and tactics, etc. Ron then asked, "... how about ANF and GOOG... Are you concerned about a correction of a 1/3 or more?"

Money management offers not only the answer, but is critical in the quest to achieve consistent success. This is due to two primary demons that plague each investor, especially at the onset of his or her career. These are:
1) Fear of the market;
2) Not trusting one's self to do the right thing.

The following snippet is from a reader across the table who gets it...

"Thank you for showing your trading discipline and leadership in your blog. It's great. I've found that in formalizing my own trading rules, setting goals, keeping a trading journal, studying my trades, setting stops, exit points, etc. etc., I'm doing much better and feeling confident about it. And, this is the clincher, my ability to understand what you're saying has greatly expanded. It's like that question that someone asked about position sizes for GOOG; like you said, simply, it was a money management problem. Being that I formalized my money management rules for myself I immediately understood the nature and substance of your reply to him. Sure, the greed percolates inside and you wonder if you should back up the truck. But when you hold it up against your trading criteria, then..."

When the investor achieves a minimum level of self-knowledge -- such as the Deipnosophist reader I quote above -- then he is one step closer to conquering those two demons. Another step on the path to consistent success is pattern recognition. For example, during the second half of March, while I warned that Apple/AAPL was a top, most investors instead screamed, "Buy!" The day last month (11 May) of the low trade (so far), I identified Apple/AAPL's correction had ended, and the building of the new intermediate term base had begun. Unfortunately, those same investors who said earlier to buy now see only parlous times. Go figure. (In fact, I have: it seems most investors are wholly unable to see past the obvious trend; for them, price movements appear chaotic, random. Why don't they - and all investors - invest some time learning to recognize patterns? It is so worth the effort.) The Apple/AAPL decline from high to low was approximately (your) 1/3. And as the base now builds I ask, "Was that so bad?"

Learn your fears, and then confront them. I had recommended Websense/WBSN, and all appeared mostly fine -- until yesterday...

[click to enlarge]

The circled area 1 betrays little relative volume during the price advance; although disconcerting, the lack of volume at this stage of its pattern is not critical. More disconcerting, however, was the new recovery high achieved intra-day yesterday (Wednesday) before the shares reversed, and closed near its low trade (see bar 2). This bar qualifies as a key reversal day - the high and low are outside the high and low of the prior three days. These two items are not the only bearish items but all are short term in nature; this pattern has yet to be despoiled. Nonetheless, as a direct result of yesterday's action, I immediately sold my shares this morning (Thursday) at $55.25, making ~5% for ~6 weeks worth of 'work'. For those who wonder, "What next?", I could create any number of scenarios, but will limit to the most bullish: the shares open down Friday morning, plunge into the $51-49 zone (with solid support at ~$51.50), reverse, and then close at a price higher than today's close. If that scenario begins to unfold, without hesitation I would buy back the position.

You wonder whether Google/GOOG, too, is ripe for a decline of "1/3". At this specific moment I see zero signs of a reversal in any periodicity. In the future, this spate of price weakness since its high at $300 will be seen as a mere speed bump. Do not misunderstand: Google/GOOG will correct by 30-50%, albeit not yet, as it still is in the throes of a primary move to higher prices -- punctuated, of course, by bases within the lesser periodicities. I must remind you, however, of the differing strategies of investing and trading; a trader should not hold during a correction of 30% or more, whereas the investor should embrace the inevitable and frequent 30-50% corrections. (Regarding Google/GOOG, I am an investor, which means...)

This process of investing (vs trading) is more than a matter of perspective and inner fortitude; I hold up as Exhibit 1 Johnson & Johnson/JNJ, the poster child for long term investing in growth companies. Take a good look at its long term chart (date back 30 years, at minimum); JNJ has suffered many, many 30-50% declines, and each was an opportunity to buy. Today the shares are within a hair's breadth of its all time high set mere weeks ago, and are a darn good buy right now. An investor (read: me) can hope that Google/GOOG might proceed along a similar path; if not for 30+ years, then for 5-10 years. We shall see.

Re Abercrombie &Fitch/ANF. The shares closed today at another all time high. Of course, this move could be explained away by the news that the AG Edwards analyst upgraded ANF to Buy from Hold with a $97 tgt. (How close that is to my price target! Is comfort to be found in the similar target from two analysts, one fundamental and the other technical?) The AG Edwards analyst sees continued good times ahead in terms of ANF's comps, earnings, and stock price. He says ANF is on a roll on the strength of a continued surge in denim sales and superb merchandising, and that strong comps will continue for some time. Although a decline of "1/3" could occur at any time, there is nothing in its current pattern and setup that says such a decline would materialize before this new primary move to higher prices exhausts itself.

I have studied the markets for almost 40 years. I have learned many items, including
1) That fear not only is irrational but debilitating;

2) That I might have zero control over the market, but I do have control over my actions;

3) That there exist four critical aspects when reading a chart: price, volume, pattern, and trend.

4) That we purchase shares to sell later at a higher price; we should focus our efforts to that objective.

5) That declines of 30-50% occur frequently, with almost cyclic regularity; they are not to be feared, but embraced. Use them, as trader or investor, to time your entry.

6) To purchase quality, never dreck. (Dreck has a smaller pool of interested buyers.)

7) That we get what we pay for: cheap stocks are cheap for a reason, expensive stocks are expensive for a reason.

One method of dealing with volatility - or the fear of volatility - is to down-size the purchase; whether you acquire your positions via a $-basis or a share-basis, cut by the level that feels comfortable for you and yet allows you to participate. There are other methods of money management, learn them. All aspects of investing -- fundamental and technical analysis, money management, and self-knowledge, etc -- manifest as a piece of the puzzle, a tile in the mosaic. In the end, we grapple more with ourselves and our fears than we do with the market. While suffering a decline of 30-50% is not recommended, that is small change compared to the unlimited psychic damage we each can inflict upon ourselves. The losses on that path are far more damaging... and far more costly.