Thursday, April 16, 2009
(Cont'd from above)...

Jim (cont'd):   

Now, I want to talk about something that could be even more important… perhaps the scariest part of investing… tops… people never like to talk about tops, not on Wall Street, especially not in the financial media… when things are good… boy do we ever hate to talk about a top… sure the bears will get all ominous and talk about impending doom endlessly…. but they do… good or bad, it is always the most dangerous thing in the world right… the media might try to make negative forecasts… how much do they love to do that… it is what I call recklessness couched in the language of prudence… but you hardly hear talking about a top… particularly when it is developing… see it does not benefit the Street to talk about tops… the very idea flies against the conventional wisdom… all the time you are told, and I am often denigrated because I disagree with this… and frankly, I love the denigration, but that is because I am strange.

You are told to buy and hold… oh, go and buy an index fund… yeah, that will do it… because you cannot do your job picking stocks… look you know that I think this stuff is garbage… I believe in buy and homework… casticated for that view, oh please… and one of the biggest reasons for that is the existence of tops… buy and hold presumes that they do not exist… that a stock is just endlessly going higher… as if it is some sort of magic projectile… how would you have felt if you took the conventional wisdom and you bought and held the standard S&P 500 index fund thru the crash of 2000... pretty terrible I bet… but if you had been able to spot that top, you could have sold and escaped some serious pain.

Let’s be clear, what exactly is a top… it is where a stock or the whole market reaches some price that is too high and then comes tumbling down… if you try to ride out a top, you could or will lose all of your gains and then some… think 2000... these things hurt… they are a key reason that buy and hold does not work… and I have said before that they are the bane of investing… they chop your money… they kill it.

So how do we see them coming…. and get out before the top hits… here is how I look at tops… we know that they are going to happen first of all… they are part of the firmament… sooner or later every stock, every market reaches a point where it can go no higher… and in fact it starts going a whole lot lower… it might take years… we know this will happen because it has happened historically without fail… if you own a stock, and that stock keeps chugging along going higher and higher… at a certain point you know that you have got to get out… you have got to ring the register… you know a top is coming… that a top has to come… but you cannot get past the emotion of the thing.

Who wants to sell a stock that has been a proven winner… a real money maker… one that you just can’t seem to shake… nobody, that is who… but you have to when you see a top coming… and in order to do that you need to be honest with yourself… to admit that there will be a top from the moment that you buy a stock… and you better be looking for it… that is not how the Street usually approaches tops… for a lot of the institutions, probably your broker too, this sell, sell, sell… is a dirty three words… it is just a temporary breakdown, some mild turbulence… maybe things will turn around tomorrow… yeah, sun tomorrow, okay… but tomorrow never comes.

When I first got to Goldman Sachs, I remember asking my co-workers when I should tell a client to sell… I wanted to give them an exit plan… all of the gray beard would tell me… when the stock gets downgraded, that is when you sell… who wants to sell after a downgrade… after a stock has already hit its top, after it has come down… not Cramer… but how do you know when that top is coming… I will tell you the biggest clues to spot a top before it does its damage… first in this segment and then after the commercial.

One of the best ways that you can tell that a stock, especially one that has had a lot of momentum, is played out… is when the bears start disappearing… when all of the analysts who cover the stock have upgraded… when there are no or very few sell, sell, sells left… when everybody is here… buy, buy, buy… you have got to reconsider… that is a great sign in a momentum stock that you are about to run smack into a top… the reason… there are no bears left to convert…. no sellers left to turn into buyers… everyone is in the pool… no people left standing on the sidelines left to convert either… everyone who wants the stock owns it already… no one can come in and buy it higher… and that means that the buying will stop soon… with no more buying, you have got a top… time to sell… time to ring the register.

The second reason to abandon a stock… even when you know and like, not love, remember these are just pieces of paper… is competition… you might not want to believe that competition matters… especially if you have got a history with your stock… but I am begging you to be objective… the only way that you can tell that the competition is about to come in and destroy your companies business… is being vigilant… the price of profits is eternal vigilance.. it is not enough really to do homework on your stock, you need to monitor the whole section… you need to make sure that there aren’t any up and comers ready to come in and gobble up the market share, and send your stock hurdling down… I would say that a solid 70% of the tops that I have seen were caused by competition… yes, raw competition coming in from where you least expected it… competition as much as anything else is the reason that it is imperative that you spend one hour per week doing homework… it is a huge drag… it will safe you money… otherwise, I can practically guarantee you that you will get blindsided… isn’t it funny, the only guarantees that I can offer on the program, are that you are going to lose money if you don’t do the work… that I can guarantee you… your stock will top and then you will lose money.

The bottom line...

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