This stock is an example. A base period started in August 2010 at a low of 3.67. The subsequent high of the base has been 7.57 in 2011 and more recently 7.18 in 2013. The opportunity is to buy as close as possible to the low and sell near the high. Thus if you could buy in the $4.00 area or less and sell in the 7.30 area, you would earn 82.5%. It is possible that you could repeat this trade again and again.
This is a simple strategy that has worked for many years over and over again.
What about the risks?
There definitely are risks. Stocks may breakdown and even go out of business.
How can you mitigate the risks?
• Select stocks with limited debt. Make sure current assets are significantly greater than current liabilities. Eliminate companies under investigation or defending sizeable law suits.
• Select stocks with a long base period of at least 11 quarters. The study, Non Random Profits reported that since 1936 there have been very few stocks with an eleven quarter base that did not increase in price.
• Diversify, do not put too much capital in any one stock.
• Use risk control. If the stock declines 15% below the low of the base, SELL and buy back again at 50% below the low of the base.
• If you find a number of channeling stocks in the same industry group, your odds of success based on prior history is very high.
Make sure the risk reward ratio is appropriate. Measure the amount of loss you might incur if the stock declines 15% below the low of the base. Compare this amount to the amount you would gain if you sold near the high of the base. Your risk to reward ratio should be 1 unit of risk to 5 units of reward.
This strategy requires a great deal of patience to wait for the right buy price and to wait for the appropriate sell price.
I am writing to you about this today because the stock market is nearly fully priced. It is likely opportunities will be available to buy channeling stocks at the right price when the market is under selling pressure. This strategy has worked over a long period of time in bull and bear markets alike.
If you have not already read Non Random Profits, you can learn a lot more about cycles in stocks, industry sectors and market indexes.
In fact the profit opportunity discussed in this article is only a part of the much greater longer term opportunity in these stocks.
If you use stocks which trade for a higher price you may be able to sell put options with a strike price at or below the low of the base. This way you collect an immediate income. If the put is exercised you buy the stock at the right price, without using up your patience. If the stock never gets down to your price you simply keep the income. This way you get paid immediately and your strategy is in effect right away.
This is not personal advice. Please consider the suitability of these ideas for your own particular use. All equity investments involve risk. Past performance is no guarantee of future return.
Let me know if you would like to discuss your ideas or if you would like more information on any areas discussed here. You may call me at 860-963-0722 or click on the red button and make an on line appointment.