CATALYSTS

  • Posted by
  • on November 26th, 2009

Stock prices are moved by catalysts. There are four major types of catalysts.

1)      Liquidity: low cost of borrowing makes the investment in most asset classes quite alluring. An inflow of money makes price to go up. Rising prices bring joy and confidence to the soul of the masses. Higher confidence leads to higher risk appetite, which usually brings even more money into the stock market. This is a catalyst based on greed and vanity.

2)      Earnings’ related catalysts. If it is not about current earnings (beating estimates), then it is about future earnings (raising outlook above street’s expectations) or potential for future earnings (FDA approval, collaboration with another company, takeover rumors, announcement of new product, regulatory changes that could affect the whole industry). This is a catalyst based on momentum. The key here is market reaction. Reaction no news is more important than news itself.

3)      Valuation: I am simply not smart enough to define the intrinsic value of a stock; therefore I leave that job to the Warren Buffets of the world – people, which pocket is deep enough to survive prolonged periods of market irrationality. Who am I to say that certain stock should be traded at 18 times next year earnings or 28 times next year cash flows? Don’t get me wrong. There are plenty of smart people, who are constantly able to find stocks, trading below their intrinsic value and know how to profit from them. A big bow to them. For me their work is 50% science and 50%s art and gut feeling (experience). This is a catalyst based on common sense, but don’t forget that in trading the obvious rarely happens, the unexpected constantly occurs.

4)      Fear: of missing out on a big move or fear of getting short squeezed; fear of losing more than can afford to lose; fear of accepting that you were wrong.

I often look at the charts of stocks that make big moves in short time frame. How often? Every day, hoping that I will find out as many common patters in the beginning of those moves as I can. In hindsight, everything looks so easy. “I should’ve bought here and sold here and I would’ve made quick 10-15%”, but taking the proper decision in real time is always much harder than expected. Such fast moving stocks often experience violent corrections along their climb higher. Only the few with strong stomachs, enough experience and sound risk management behavior survive. How to overcome the fear of losing and act quickly when an opportunity presents itself? Risk smaller portion of your capital. A portion that wouldn’t hurt your confidence or sound judgment if you actually lose it. If you are risking 1% of your capital and it happens that you lose it, you only need to make 1.01% on the next trade to break-even. Can you do that? Absolutely. Then why you are afraid to take on new trading ideas, produced by your method? If you’re not able to sleep, then you are risking too much. If you are trading too often, then you are not risking enough. And one more thing. No one can buy at the bottom and sell at the top. If it happens, it is due to pure luck, not skill. Gradually build positions in equity that you like and gradually take profits when you exit.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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