Thursday, July 22, 2010

How to catch the bottom?

It's hard to buy right at the bottom. From personal experiences, if I ever bought a counter right at the bottom - the elusive inflection point just before it turns up - it's just due to sheer luck rather than any godly skills in technical analysis or fundamental analysis. And because it's just luck, it's hard to replicate it consistently.

Reflecting from previous years in the market, I spent quite an amount of time and effort to learn the how to catch the bottom and sell at the top. Why the obsession over this? Don't the masters say that one must "Buy low and sell high"? Yes, they did, but they didn't say specifically that it must be the bottomost trough and the peakiest peak. Takes me some time to realise that... and I was wondering why I didn't come to realise it sooner. Silly mistakes made in the past are just that, plain silly. But at that moment of time, you wouldn't have the wisdom and experience to know otherwise. Optimistically, I take it as a learning process.

Knowing is quite different from doing, however. We all know that we have to lose weight but all the best laid plans set in the night before the morning jog will be laid aside when the alarm rings at 6am the next morning. Doing something requires more than just knowledge - it also requires a suitable dosage of motivation to start the engine going and another dash of determination to carry it through. But human beings being humans, there are always those who are good at starting things and bad at finishing them and vice versa.

Nah, there are perfect cubes around, like 8, 27, 64, 125...

Take the example of the very recent British Petroleum (BP). The oil leak incident at the Gulf of Mexico causes the share price to plummet. If you're interested in BP, and you're very convinced that the incident is just one-off (never mind the possibility of BP going belly up due to the sheer amount of compensation that is to come in the near future for the cleanup and claims), are you able to put down all your fears and buy it? Lingering at the back of your mind will surely be the formidable 'but' word - "the price is low down but...", "the oil leak is under control now but...", "the dividends are great at the price but....".

I think what I would do are the following steps:

1. Do a FA on the company in question. Read read and read reports on it and try to come out with a numerical value to the company, with the pessimistic scenario in mind.

2. Do a TA on it. Check for signs of bottoming and possible reversal signals before committing your capital on it.

3. Most importantly, start a chihuahua position on it, not a whale-size position straight away. A chihuahua position is just a small 'testing' point. Following the price after this initial position, you can choose the average up or down when the situation becomes clearer.

As a newbie in the past, I almost never follow point no. 3 - money management. Why is that? I was trying to save some brokerage fee by buying in one tranche rather than firing sparingly in several bullets. Don't the masters say, "More action, less wealth" or "Frequent in and out generates frictional cost"? Yes, but there's another group of masters saying that if you do a dollar cost averaging, your average buy price for the stock will be cheaper.

Aiya, so confusing...who to follow?


Jeremy said...

Dear LP,
Nice post you have, simple but sweet concepts of investing. I agree with your two concepts mentioned, firstly that there is no sure thing as catching a "bottomest" trough and peakiest peak.

I think FA and TA can help one to come close to this catch, but it cannot guarantee a sure catch. There is still some element of luck in catching the exact trough of a bear and peak of a bull just before major reversal. TA and FA only help one to decide better whether to buy or sell at a particular time, but it cannot eliminate the luck factor altogether. Why? Simply because the stock market is a random one.

Macroeconomics globaly can help one to decide whether an ensuing bear or bull is coming, but this may not be perfect sign to exact time of reversal in trends. And to add on, macroeconomics globaly can change suddenly also. So, there is no 100% perfect indicators for one to decide when is "bottomest" trough and peakiest peak.

So, can one still invest profitably if the element of luck cannot be eradicted totally? Yes. As you said, we do not hope to catch the "bottomest" trough to buy. For me, as long as I am in the midst of a bear market and I notice pessimism has build up to a large extent already by seeing stock prices of many companies depressed well below their intrinsic values, I will gladly start buying. I do not buy a lot of shares suddenly during bear market because I will never be sure whether I am catching a falling knife. Some say use TA to decide whether the trend is still falling. I say use your brains. TA is never 100% foolproof as one still needs to stop loss if the trade does not go according to what one perceives from the charts. Therefore, I believe in slow gradual accumulation during strong pessimism in bear market.

To be continued to next comment post.......

Jeremy said...

Continued from previous comment post........

Who tell one to be "gungho" (act smart) and "hug" the bear accumulating all at one shot? Please lah. Do not be a market fortune teller. I believe no one is able to be a market fortune teller to know when is the exact "bottomest" trough to accumulate all at one shot. Maybe one accurate prediction of the "bottomest" trough is still possible? Tell the same predictor to do it consistently for at least 5 bear markets in a row. If he can do it, I have nothing to say about the element of luck anymore. The same goes for predicting the exact peakiest peak.

Secondly, I agree with you largely to buy and sell in many batches and not all at one go. On one hand, one needs to be conscious of transaction costs of trading shares. On the other hand, buying or selling a lot of shares at one go increases opportunity cost. The same argument again, how sure is one that the time when you buy and sell in a large bulk is the best time to load up or offload your shares at the best price. The stock market is random. We can never predict for sure that the price of a company is getting lower and keep waiting in the case of waiting to buy in one large bulk. Similarly, we can never predict for sure the price of a company is getting higher and wait for a higher price to sell in one large bulk.

So, to resolve this psychological flaw of hope biasness, one can buy in many batches at suitable target prices one has determined based on TA or FA or any good "A", and similarly sell in many batches at suitable target prices. However, this being said, one still needs to be wary of frequent transaction costs. This is really a "frictional" cost to one's returns and "opposes" the profitability of investments.

So, one needs to strike a healthy fine balance between frequency to buy and sell and size of shares transacted. Is there an ideal frequency to trade or size of shares to be transacted? I do not know. Case by case basis. One can tell by his/ her track record in the market. So, the best way is to track one's performance in the market so as to see with eyes opened whether one is doing the right things as it will be evident from the returns generated from one's portfolio over a period of time.

Be it traders or investors, at the end of the day, results speak louder than anything else. If one has made consistent good profits over a long duration (in terms of years) by using one's own unique system and philosophy. Who can say that the profitable trader or investor is just being lucky and can tikam tikam his/ her way to the consistent profits over a long duration?

Sorry LP for me being so long-winded. Just my two cents worth.

Jeremy :-)

Createwealth8888 said...

Stock market is random for a while and continue in its direction a while and then become random again and soon continue in the same direction. Stock market is rarely random all the time.

AK71 said...

Hi LP,

You have written another article I can identify with. :)

There would be some people who want to sell away all their shares now, fearing a meltdown, keep their cash and wait. There would also be those who are keeping all their shares, believing them to be good investments, and would be buying more shares at lower prices to average down. In both instances, I would say, look to the technicals as we want to avoid selling at the lows or buying at resistance. We should not be afraid but we should stay cautious.

la papillion said...

Hi Jeremy,

Haha, your 2 cts is really worth a lot of money huh? Inflation is it? hahaa :)

Thanks for sharing your thoughts!

To both Jeremy and bro8888,

Hmm, I think it gets more and more random as you decrease the time frame. By that, I mean a 1 min time frame is more random than a daily one, and a weekly timeframe is more random than a monthly one. Longer time frames do follow a pattern.

la papillion said...

Hi AK,

Haha, I use charts for entry and exit too :) Thanks for posting your articles here as extra reading :)

PanzerGrenadier said...


Buying low and selling high (or selling high and buying back low) is the holy grail of investing, isn't it?

The more I am a market participant as well as observer, the more I believe the market is random with a huge dose of the herd instinct thrown in.

Making money involves typically hitting the right random bets now and then (with or without fundamental and technical analysis) plus being earlier to buy (or sell) before the herd.

The more I am exposed to Nicholas Nassim Taleb's books, the more I am inclined to believe that there is too much risk in the stock market to put most of one's investible savings into it. I am currently at 33% and don't envisage putting anything more than 50% at any one point in time for my own sanity and mental well-being.

Instead, I realise using some of my money to invest in learning a new language, acquiring useful skills (e.g. class 2B motorbike) licence is the way I'm investing in my own capabilities as an income generating asset :-)

Be well and prosper :-)

Createwealth8888 said...

Riding a motorbike is useful skill??? Sometime, the rider got killed not because they are less skillful. They got killed due to other drivers careless or reckless mistakes.

Anonymous said...

Great post! Totally identified with it!

la papillion said...

Hi PG,

I think we both realised that stock market is just a part of the bigger picture of life :)

Looking forward to more posts from you on retirement :)

la papillion said...

Hi financiallyfreenow,

Hey new guy :) Went to your blog just now - hey, keep it up!

PanzerGrenadier said...


Riding a motorbike is part of my plan of retiring to Thailand in my golden years :-) I don't intend to make money delivering Mickey Dees or Pizza Hut...hahah...

It's more to learn a form of transport so that I can ride a bike if I need to for transportation needs.

Be well and prosper.