Buy Signals Sell Signals: Strategic Stock Market Entries and Exits pdfdrive com

Always remember: While there are many reasons to sell a stock there is only
one rational reason to buy a stock: because the buyer believes it will go up in
value and they can sell it for a profit in the future. The ‘future’ can be different
things to different people. For Warren Buffett the future may be ‘never’ and for a
day trader it could be in 30 minutes.
The only thing that makes stock market participants money is exiting a position
with a profit after price moves in their favor. Stock prices are driven by the
specific supply and demand of their stock, not by the underlying company’s
results. It’s the perception of the company’s current and future results that
interests buyers and sellers. A company’s stock price has to go through the filter
of all the market participants’ perceptions, opinions, and predictions about what
the current price should be versus what the future price may be.
Fundamental analysis is a long-term game that can last for years. Warren
Buffett’s success as the greatest investor of all time is not based on simple
fundamental value investing. The real key to Buffett’s incontrovertible record is
based on his ability to create the best margin of safety on his purchases. By
picking the right ones the majority of the time, holding a concentrated portfolio
of only his best picks, with an unlimited holding period, he has compounded his
returns for decades.
One of the keys to his success was acquiring the textile company, Berkshire
Hathaway. Initially an aging business model, Buffet converted it into a
successful insurance holding company whose insurance premiums could be used
to acquire healthy companies with great cash flow, and those with ‘moats’
around their business models that make it difficult for industry competition.

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His patience is legendary, often waiting years for a desired price. His buy signals
are often triggered by extreme fear, when stock is available at a large discount.
This value ratio creates a margin of safety that limits the downside risk even if
he’s wrong. His risk/reward ratio offers a significant gain if he’s right, and the
stock returns to a price that better reflects an accurate fundamental valuation of
the company. Warren Buffet rarely sells, but he will exit his holdings when the
business conditions are no longer favorable and there is little upside.
Very few people will have the patience, discipline, genius, and luck to be
anything like Warren Buffet. However, most people can trade simple price
action trading systems on a comfortable timeframe. If they use position sizing
correctly, they can handle the emotional issues that hinder the majority of other
traders and investors.
Fundamentalists can suffer from long losing streaks. Investors tend to have
larger drawdowns in capital and can give back years of returns very quickly
during bear markets and financial crises. A good trader will have tight controls
over losses, risk exposure, and drawdowns in their capital.
Conservative buy and hold investors have dealt more pain over the past 15 years
than most traders experienced with the 2000-2002 bear market, and the 2008-
2009 financial crises. Traditional buy and hold investors focused on retirement
generally set their buy signals for every payday resulting in a new contribution
into their retirement account. Young buy and hold investors not worried about
their retirement accounts look for buy signals all day, every day.
Buy and holder investors generally sell when they are rebalancing their
portfolios once a quarter, or annually when they sell their winning positions to
use the capital to buy positions that haven’t kept up, like bonds or other equity
sectors. Another time that they will start selling positions is when they get closer
to retirement, as they start to move their portfolios from stocks into lower risk
and more stable bonds.
Buy and holders expose themselves to unlimited risk with no stops because their
investing system is based in the belief that stocks will have good returns the
majority of the time over a ten-year period. This system seems to be more for the
benefit of the mutual fund industry than investors. A little later in this book, we
will explore some simple trend following systems that easily outperform buy and

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hold investing with half the drawdowns.
A poignant example of the disconnect between fundamental valuations and stock
prices is the Internet bubble of 1999 and 2000, before the price plunge of the
tech sector brought it back into balance. The NASDAQ 5000 was an irrational
price trend based on the idea that the Internet would change the world and
commerce overnight. The Internet has changed the world, but prices were about
15 years ahead of the fundamentals in even the best technology companies. Most
of the dot com companies were worthless, but they made millionaires out of
traders that traded them based strictly off price action exiting with their profits
when prices peaked.
Another excellent examples of a complete disconnect between fundamentals and
price action was the market meltdown of 2008-2009. Was Ford Motor Company
really worth $1? If Ford was worth $1 fundamentally and then went up to almost
$19, did the balance sheet reflect this? I was warning friends not to buy Ford all
the way from the $9 price level as it kept falling. I didn’t examine the balance
sheet, but I could see that the chart was in a downtrend, and it was obvious that
investors and traders were pricing in a possible bankruptcy of Ford.
Was CitiGroup really fundamentally valued at .97 cents in March 2009? Can
investors price in government bailouts with their fundamentals? A price action
trader would have used signals to exit before Lehman Brothers, Bear Stearns,
and the whole financial sector started melting down. Most fundamental investors
lost a lot of money in 2008 and 2009, with no exit strategy from individual
stocks or the stock market, and could only watch as a decade of gains
disappeared.
I have several problems with fundamental investing. When these investors buy
something based on the belief of what it should be worth, it looks even better
when the price goes lower and lower. It’s also difficult for fundamental investors
to know when to exit with a profit. While buy and hold investors in 2015 feel
pretty good about themselves for holding through 2008-2009 and getting back to
even, those that had sizable accounts from a lifetime of compounding didn’t feel
so good when they were down 50% of their portfolio in March of 2009 and
ready for retirement.
A good trader controlling their risk and position sizing will rarely have to suffer
through drawdowns that investors take during corrections and bear markets. As

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traders, we have exit signals that limit our losses. I had a profitable year in 2008
by following price action. A 50% drawdown in a brokerage account will
discourage most people from wanting to trade or invest again. This kind of
financial, mental, and emotional pain should be avoided at all cost.
While there are many legendary fundamental investors and fund managers that
have found success, there are also wealthy technicians that simply and
systematically trade price action. I think that the greatest opportunity for retail
traders and small investors is to let the big investors and other market