Category: books

• 95% of big winners had a major new product / service, new management, or important change in their industry
• Buy on the breakout.  The stock should be close to or actually making a new high after undergoing a price correction and consolidation.  Consolidation can last from 7 – 8 weeks (normal) to 15 months.  As it emerges from this base, it should be bought just as it is starting to breakout.
• Avoid buying more than 5 – 10% off the base

• Low float is better than big float
• Large % ownership by top mangement
• Today’s hot product will find sales slipping in 3 years, so management must be an entrepreneurial style
  • Not many layers between CEO and customer
  • small medium companies
• More than 95% of companies had fewer than 25M shares during their greatest period of eps improvement.  Avg was 11.8M and median was 4.6M between 1970 and 1982
• 3 to 1 and 5 to 1 stock splits after huge run ups make institutions sell (this doesn’t seem relevant)
• Comapanies buying their stock in the open market
• Reducing debt to equity over last 2 to 3 years
• Small cap with less liquidity and no institutional sponsorship / ownership should be avoided.
• Trading volume should be light on corrections and increase significantly on rallies (50% to 100% more)

Ch 5 ‘L’ Leader or Laggard

• Most people buy stocks they are familiar and comfortable with, like an old friend.  These will be the slowpokes rather than the leaders in the stock market.
• Buy the leading security in the industry you want to get in among the 2 or 3 best in a group
• Relative strength > 70 mean it outperformed 70% of the stocks in a comparison group over the last 6 – 12 months
  • Avg for best performing equitites between 1953 and 1993 rated 87 before major increase began.
  • Investors Business Daily has these numbers
• Look for charts in a bull flag or trading range and buy near the top of the range, but not more than 5 – 10% out of the range
  • …this doesn’t seem like a good idea
• Once a general market decline is over, the stocks that bounce back to new highs first will generally be the leaders.

• At least 3 – 10 mutual fund sponsors, corporate pension funds, insurance companies, large investment counselors, hedge funds, bank trust dept, education institutions.
• Certain mutual funds are better than others, so these will help define your quality of sponsorship
• Over owned by institutions may mean the largest moves are over

• Learn to interpret daily price and volume chart of general market averages.  You want to be on the correct side of the trend of the market, or 3 of your 4 positions will lose money.
• Market top
  • General market tops are later than individual stock tops
  • poor market rallies and rally failures in the SPX will occur
• Discount Rate
  • When it is successively raised 3 times usually marks beginning of recession, when it is lowered usually signal end of bear market
• Wait for adam eve bottom
• Stages of stock market
  • Economic indicators bottom AFTER the stock market, thus are a poor choice for stock market returns
  • Big money is in the 1st 2 years.  After this expect occasionally 8% to 15% drops
  • Railroad equipment, machinery, and other capital good industries are late moves in the business / stock market cycle
  • Bull markets begin when institutional cash positions are higher than normal and end when cash positions are lower than normal

• After each qtr focus on the relative returns of each investment in your portfolio, not the price you paid for it.
• When you buy a stock if it is down 7 – 8% from your purchase price you should cut your loss.  However dont sell your winners if they are down 7 to 8% from their highs.  You must give your winners room to run.
• Don’t avg down, don’t worry about how many potential “turkey’s” you had.  Your “red dress” has now turned into a “yellow one”.  Get rid of that “yellow dress” and go find the “red dress”
• Self confidence
  • holding losers makes you less confident.  If you cut your losses quickly and with discipline, you make the hardest decisions without wavering.
  • There are no good stocks, they are all bad – unless they go up

Ch. 10 When to sell and take your profit

• Most good investors / hedge fund managers sell on the way up.  They dont buy at the low and sell at the top
• Jesse Livermore
  • Pyramid and buy more as it goes up.  You want to make a lot of money when you’re right, and cut your loss quickly when wrong
• Revised profit plan
  • sell 20% profits (except with the most power of all stocks.  If it goes up 20% in < 8 weeks, then hold at least 8 weeks.  If it is still very strong, you will want to hold for 6 months)…Take your 8% loss
  • buy exactly at the breakout pivot buy point, do not pyramid 5% beyond the buy point
• Selling pointers
  • Buy at the right time.  This will solve half your problems
    • Buy off a proper base structure, do not chase or pyramid when the price is too extended past your buy point.  You will be able to sit through most corrections
  • Beware of big block selling.  The best stocks can have sharp selloffs for a few days or a week.  You shouldn’t get shaken out in a normal pullback
  • If the price is extended from a proper base, its price closes for a larger increase than on any previous up days, watch out! this climax is at or very close to the peak
  • Ultimate top may occur on the heaviest volume day
  • Big investors like to sell on big run ups when there is liquidity
  • new highs on low volume means there is temporarily no demand for that level and selling may soon overcome
  • after and advance, heavy volume w/o further upside price movement means distribution
  • Look for clear reversal days (low at the previous days low after an up day on several days.)
  • Sell if a stock breaks badly
  • Consider selling  a stock if it takes off for a good advance for several weeks and then completely retraces the advance
  • When qtrly eps increase slowly or decline for 2 consecutive qtrs, in most cases sell
  • Consider selling if there is no confirming strength by another important member of the same group
  • If a stock declines 8% from its peak, check if it is just a normal pullback.  If it declines 12% to 15%, you may want to sell
  • If a stock has made an extended advance, and suddenly makes its greatest 1 day drop since the beginning of the move, consider selling if confirmed by other signals
  • When you see heavy selling near the top, the next recovery will either follow through on weak volume, show poor price recovery, or last a short number of days.  Sell on the 2nd or 3rd day of the poor rally.  It will be the last good chance to sell
  • Sell a stock if it closes the end of the week below major lon term uptrend line or breaks key support on overwhelming volume
  • Number of up days vs down will change will change after stock starts down
  • Wait for 2nd confirmation of major changes to market avgs.  Don’t buy back stocks you just sold because they are cheaper
  • Learn you mistakes by plotting past trades on charts
  • Sell quickly before it becomes completely clear a stock should be sold.  Selling after an obvious support level break could be a poor decision.
  • In a few cases you should sell a the trend channel line overshoot
  • Sell when your stock makes a new high in price of it’s 3rd of 4th stage
  • Sell on new highs off a wide and loose erratic chart price formation
• When to be patient
  • Have a line on ur chart below your buy point where you must sell if price is touched.  Raise this as the prices move below the low of the 1st normal correction.  Don’t move too close because any weakness will stop you out.  If your stock increases 15% after purchase, move the sell line up to less than 5% below pivot purchase
  • Objective is to buy the best stock with the best eps at exactly the right time and hold until you’ve been proven right or wrong.  Give 13 weeks after your first purchase before you conclude that it was a faulty selection (if not stopped out first)
  • Any stock up 20% should not be allowed to drop into a loss.
  • Always pay attention to the general market.  If the markets are topping, most breakouts will fail
  • Major advances take time to complete.  Dont take profits during the 1st 8 weeks unless there is serious trouble or there is a rapid run up on a split.  If the stock shows 20% gain in 4 or 5 weeks, it is capable of a 100% to 200% move.  Only go for these long term moves after you are up for the year
  • Try to hold through the 1st correction if you already have a profit
  • Investors who can be right and sit tight are uncommon.  It takes time for a stock to make a  large gain

Ch 11 – Diversify, Invest for Long Pull, Margin, Short

• Portfolio > 3M should have 6 to 7 stocks.  Most people should have 4 to 5.
• No well run portfolio should have losses carried for more than 6 months
• Use margin after you have experience and you’re young and still working.
  • Margin should never be 100% all the time, you must carefully choose when to use margin
  • Never add cash to meet margin call.  Sell the position
• Real Estate – buy it at the right time
  • Dont buy in:
    • Area that is not growing or deteriorating
    • At inflated prices after several boom  years and just before a severe economic setback in the economy or geographic area where the real estate is (major industry layoffs or closing of a plant).
    • Mortgage is greater than the rent
    • Frequent natural disasters

• Cup and Handle
  • 7 to 65 weeks, peak to low point is 12% – 33%
  • Shouldn’t correct more than 2.5x the general market
  • Handle is 1 to 2 weeks and has a price shakeout, volume should be very low on the pullback phase of the handle
  • Should consolidate above 200dMA
  • Handles that don’t properly shakeout (10% – 15%) are prone to failure
• Pivot Point
  • Line of least resistance should be broken with volume at least 50% > normal.
  • If you try to buy before this point, the stock will never get to the buy point.  If you buy 5 – 10% after you are too late
  • Objective is to buy a the right time before the move, not the cheapest price
  • Not necessarily the old high, could be a trendline from the old high
• Double Bottoms
  • Likes when 2nd bottom is lower than 1st to get a shakeout
• Flat Base
  • Usually after a run up from cup w/ handle, saucer, or double bottom.  Moves sideways for 6 – 7 weeks and does not correct more than 10% – 15%.
• Tight Flag
  • Occurs after 100% move in a short period of time
  • Corrects sideways w/ no more than 10% – 20% decline.
  • Only occurs a couple times / year
• Overhead supply
  • After a run up and significant pullback there is now overhead supply.  When the stock moves up again, you have to be able to tell where the overhead supply is using the charts

• Investors Business Daily ‘New America’ Articles show new companies
• Find stocks in the top 80% of all performers
• Look for large volume flowing into stocks
• Review leading industries.  S&P classificiations of industries is not correct, you should use revere

• There are many more industry sub groups that are actually related than those categorized by S&P.  You should use these sub groups to find the performance rather than the industry group.
• Only pick industries of the future
• A stock’s weakness can spill over to the rest of the group, so be aware
  • especially the best stock in the sector
  • avoid buying stocks unless there is one other important stock in the same group that shows strength and attractiveness
  • this doesn’t apply to companies that are completely unique (he gives Disney as an example)
• Follow on stocks
  • If oil prices rise, oil stocks go up, but so do oil service stocks.
  • When new efficient jet aircraft took off, airline stocks did well.  So did hotel stocks.
• Cousin Theory
  • Suppliers of the main group will do well
  • Boeing sold new jet lines, and its Monogram (sold toilets for airplanes) did well
  • Fleetwood (RVs) helped Textone because it supplied vinyl clad paneling and cabinets
• Defensive stock cues
  • If you see increased buying of defensive stocks after a couple years of bull market, it may indicate a near top.
    • Gold, Silver, Tobacco, Foods, Grocery, Electric / Telephone Utilities
  • Prolonged weakness in the Utility Average could also forecast increasing interest rates and bear market ahead
  • Look at $spx, $util, $tran in stock charts
• Stocks require a wall of worry, doubt, and disbelief to climb
  • Generally masses are wrong, so are investment managers
  • Stock market is about 8 to 9 months ahead of economic indicators
  • Fed, Tax Policy, and Interest rates are most important

• Most investors do not use a good selection criteria
• Miserable results will follow buying on the way down in price
  • Even Worse is to avg down your buying than average up
• Low priced stocks (< $10)are low because they are inferior in the past or something wrong happened recently
• 1st time speculators want to make a killing too fast without doing the necessary study and preparation
• Don’t buy on tips, rumors, stories, or advisory service recommendations.  People are willing to risk their money on what someone else says instead of knowing for sure what they are doing themselves.
• Investors buy 2nd rate stocks because of dividends or low P/E ratios.  Dividends are not as important as EPS.  Low P/E is most likely because it is inferior
• People buy company names they are familiar with.  Many of the best stocks will be newer names you won’t know well but could and should know if you do a little studying / research
• Most people don’t know anything about the market, so their advice is probably worthless
• 98% of people are afraid to buy a stock that is beginning to go into new high ground, pricewise.  It just seems too high to them.
• The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable.  They could get out cheaply, but being emotionally involved and human, they keep waiting hoping until their loss gets much bigger and costs them dearly.
• Investors take profits too easily and hold their losers, they exact opposite of correct investment procedure
• Investors worry too much about taxes and commissions.  Key objective is to make a profit.
• Dont focus on short term options.  Don’t sell naked options.  Focus on longer-term options
• Just use market orders, you are going for large gains not 1/8 and 1/4 of a point
• Most investors who are unable to buy or sell have no plan because they do not know what they are doing.  You need a plan, a set of principles
• Most investors cannot look at stocks objectively.  They have favorites, are always hoping, have personal opinions rather than paying attention to the opinion of the marketplace
• Investors are influenced by things that are not crucial – splits, increased dividends, news announcements, advisory recommendations

• preparing for the market day
  • The closing bell signifies the start preparation for the next day.  Adjust watchlists, add / remove opportunities, review your trading day with complete honesty
  • Review economic calendar for important economic reports.  Exercise great caution on fridays that release unemployment report
  • Avoid information overload
• Support / Resistance
  • Can be a price that cannot be crossed, or elasticity that can be stretched but not broken.
  • Swing traders earn their livelihoods as they find and execute setups along S/R lines
  • cup and handle, triple top / bottom breakouts
  • consider the benefit of contrary entry on classic S/R moves
  • a trend line break only means the current trend is over, most likely leading to a range bound market
• The Charting Landscape
  • Use 3D chartings (look at charts one period higher and lower than current chart to confirm)
  • Trading indicators/oscillators are only useful after identifying price / volume bars patterns.  They serve as a confirmation that your price observation was correct.  If the oscillator does not confirm, then do not take the trade, unless you’re very experienced
• MA Ribbons
  • Use MA’s for intraday, and EMA for daily or higher.
  • expect choppy actions when the MA’s criss cross out of order.  Use the standard 20, 50, 200 for daily, use 5, 8, 13 SMA for 1min, 5min, and 60min charts
• Candles – Most reliable when near the outside of BB
• Chart Polarity – Identify the current environment bull, bear, neutral on every chart time frame
  • Expansion / contraction -bars tend to expand rapidly into a climax through rallies and selloffs.  then congestion sets in and volatility drops as bar ranges contract along w/ ROC.  Often an impending price move is signaled by this, and many math indicators will be in neutral zones.
    • These are high-reward, low-risk entry points and entry permits a fast stop loss
  • Short covering – Consider closing positions when the market prints a wide range bar that departs substantially from routine price action, but does not occur at a breakout point.
• Building Watchlists
  • Keep a core group of 50 to 100 stocks, and follow them on a tick by tick basis.  Also review their charts on a nightly basis.  Put them in different groups.  If this is too big, cut it down to 20 to 30.
  • Out of the 2000 liquid, moderately priced stocks, use a scan to filter your trade setups.
  • Setups that look good the day before, must also look good as the market opens.
  • Don’t trade the most liquid stocks (INTC, MSFT, DELL, CSCO) .  They’re notoriously hard to trade

• Bottoms –
  • Double bottom, but with 2nd bottom >= to current bottom.  Usually 2nd bottom will be higher than first, but will occur more slowly.  Often resistance occurs where the center top is, and price consolidates before breaking out.
  • Rounded Bottom – Wait until momentum clearly shifts toward positive.  Best used to identify break markets that wash out and gear up for a bull leg.
  • Big W pattern – double bottom, and price retraces between 62 and 38 fibs before completely retracing.   Often congestion develops once pattern has fully retraced.
  • Stop set at first bottom.
  • Very hard to time bottoms.
  • H&S bottom must be perfect – neckline must line up, shoulders must be same price, breakout must pierce known resistance(MA / gap) on high volume
• Breakouts –
  • Sharp breakout gap on heavy volume.  If not high enough volume, gap will quickly fill.  Non-gapping, high volume surges provide a comfortable  breakout floor but support is less dependable.
  • Dip Setups – Moderate strength often setup good pullback trades.  Uptrend faces considerable obstacles and should force frequent dips that mark good buying opportunities.  Identify profitable resistance zones in advance.  Look for price to shoot past the top BB and this should provide a turning point to natural support.  Enter at support.
  • Price surge on MACD / ADX, and vertical rallies erupt.  Dip setups won’t work.  Shift to a lower time frame to find small support pockets.  Volume peaks as a smooth wave of increasing volume which draws to a climax often culminating with a price spike.
• Rallies –
  • Elliot Wave Theory.  Target the 3rd wave, it is the most powerful.  Use 3D charting to find multiple overlapping waves (ideally two 3rd waves)
  • Price will reach into broad resistance and it should gap over resistance.  RSI and other strength indicators should be in the middle of their ranges
  • 4th wave corrections setup the final 5th wave.  Both aborted waves and parabolic rallies occur in this wave and brings in a sense of invulnerability.
• New Highs –
  • Let accumulation – distribution guide.  When it is lagging, price will move up in stepped ranges before surging upwards.  Other issues will go up vertically immediately on breakout if acc-dist confirms
  • Use bottoms to congestion, for the measured move after a breakout.  Low to breakout to expected move is about 1.38.
  • Use MACD histogram rising on price pull backs to enter long
  • Avoid short sales until price and momentum peak.  Picking a top is a loser’s game.  Short after momentum drops but prices stays high in a rangebound market (SPX rangebound?)
  • Parabolic moves cannot sustain themselves, slow steady rallies last longer
  • First major break of a trendline signifies end of the trend.  This just means it is possibly rangebound.  Exit positions until conditions favor rapid price gains again.
• Tops –
  • H/S patterns and double tops occur when crowds slowly lose their faith.  Volume should decrease in the 2nd shoulder, this increases odds of neckline break;
    • Stay away from ascending H&S neckline breaks, descending is fine
  • Healthy trends find support at 62% fib before continuing.  100% retracement violates the primary price direction.  Allow for whipsaws at all fib levels since they are well known.
  • Shock events can kill enthusiasm
• Reversals –
  • Descending Triangle
    • BB contract, scalpers are pushing around the stock, momentum is fading
    • Use upticks to enter short sales and counter any weak bull response.  As horizontal support fails, sell stops trigger below support and price declines rapidly
  • Double Tops – Often this is the exactly opposite of the Adam / Eve bottom pattern
    • The more violent the sell off at the first top, the more likely it is the top cannot pass the support of the last high
    • Buying interest wanes as price does not support new highs
    • Swing traders can sell short into the 2nd rise of the double top if the exit when price violates first high
    • triple tops should rarely be sold short because accumulation has built up (daily MFI 30)
• Declines
  • Volume repeatedly surges through waves of selling pressure while false bottoms print and quickly fail.  Violent covering rallies erupt to shake out poorly time short sales and offer hope to wounded longs.  Price carries past rational targets, panic builds, and then a bottom is formed.
• Price Breaks
  • All time high is different than retracing old numbers.  No built-in supply of losers exists within tha time frame.  During these momentum markets, swing traders, may need to enter near highs rather than pullbacks and manage risk without close support under positions
    • 5min and weekly pattern – tight flag a the top of an expanding price right after a breakout (reverse wedge?).   Congestion at the top of the range generates strong demand that attracts the needed greed.
  • Breakouts / breakdown attract dumb money.  Insiders initiate whipsaws after each volume surge to shake out weak hands.
• Trends –
  • Volatility, bar width, and volume all decline as a range bound market nears its conclusion.  This empty zone(EZ) allow for a low risk entry where a small move against the position signals a violation

• Got Wall Street research and a broker and tried following their tips but it didn’t work either.

• Mortgages his house to invest in a stock he thinks is going up, and it goes down about 20%.  He almost goes broke.  Then he slowly starts developing his theory.

• Stocks trending up move in trading ranges (boxes).  Once they move from one range to the next they shouldn’t fall back into the previous trading range.  If that happens you should sell.  The range he uses is based on the daily chart hi and low.  Ranges appear to be 5 – 10 day, and every stock has their own characteristics.  Time frames were not necessarily important.
• The boxes on the chart should stack up to form a pyramid in time.
• It is normal and beneficial for stocks to have swing lows because it shakes out weak hands and enables the next jump upwards.
• Lessons:
  • You will only be right about 50% of the time
  • must look at stocks w/o emotions or attachment
  • must reduce risk as much as possible
  • He would buy on breakouts with stops in the previous range
  • Look for high volume on the breakouts that hold (large % of the float)
  • Keep stop below the box (it looks like he kept it about $1 below)

• He travels around the world for his career and he can only get Barron’s weekly articles and a few stock quotes from his broker.  This teaches him that he can ignore most of what is going on and still pick decent stocks.
• He makes ‘Cause of Error’ tables that show the stock, price bought / sold and the cause of error.  These tables became one his most important tools.  He describes this like driving a car.  You may have knowledge how it works, but you need to develop a feel for how hard to press the accelerator / brakes, and what a is a safe distance to trail the preceding car.
  • Errors: bought too late, stop – loss to close, overlooked weak market conditions, bought on decline, wrong timing

• Technofundametalist view – He would select stocks based on technical action, but only buy when he could give improving earning power as the fundamental reason for doing so.
• Takes a 20 year view of industries for those whose future he could expect revolutionary new products that would sharply improve the company’s earnings.
  • At this time the industries were electronics, missiles, rocket fuels (which were very small cap stocks)
  • stocks go in and out of fashion ever couple years, just like women’s styles
  • Find stocks that would be hoisted up because they stirred people’s imaginations of the future
    • Not interested in the company’s products, and didn’t want to know in case the extra info would inhibit him.  Only care about whether the company belong to a new vigorous infant industry and whether it behaved in the market according to his requirements.
    • Watch these stocks weekly
• During this bear market he noticed that most companies who didn’t fall as much had earnings trends that pointed sharply upwards.  The capital was still following the eps improvements.  He would only look for improving earnings power or anticipation of it.
• That was the position for which I had now trained myself for five years.  My Canadian period taught me not to gamble; my fundamentalist period taught me about industry groups and their earning trends; my technical period taught me how to interpret price-action and the technical position of stocks – and now I reinforced myself by piecing them all together.

Ch 9 – My 2nd Crisis

• Gets a office on wall street at a brokerage and then loses his touch because he is too close to the quotes.  Loses 100k in 1 month from the 500k he made
• He moves to France and instructs his broker to just give him the daily quotes, and he will read his weekly financial paper to get new ideas
  • Also, my brokers must never quote any stock to me, except the ones I asked for. They must not tell me about any new stock because that would immediately come into the rumor class. I would pick new stocks myself, as I had always done, by reading my weekly financial paper. When I saw one that interested me and seemed to be preparing for a rise, I would ask for quotations. I would only ask for one new quotation at a time. Then, as I did before, I would study it carefully before deciding if it was worth going into.
  • After a month he starts to get his ‘feel’ for the market back

• If pre-select investment areas that put you ahead of the game before you start, the most important work is already done.  You’ll be picking and choosing from an already outstanding menu, and your choices are less likely to result in indigestion
• Spinoffs:
  • Stocks of spinoff companies, and shares of the parent companies significantly and consistently outperform market averages
  • Spinoffs in SP500 companies often will be subject to a huge amount of indiscriminate selling because the funds that own the new companies are too large to be concerned with the new smaller company
  • The largest stock gains occurred in the 2nd year after the spinoff
  • Reasons to own a spinoff:
  1. Institutions don’t want it (and the reasons don’t involve investment merits)
     • Host Mariott would be spun off with huge debt and unpopular real-estate assets(hotel market was terrible at the time).  Because the situation looked terrible, most people would be discouraged from additional research on the new stock
     • Host Mariott would be 15% of the 2B market cap of its parent company, which would make it too small for most of the original shareholders to want to own
  2. Insiders want it
     • Are the managers of the new spinoff incentivized along the same lines as shareholders
     • Will they receive a large part of their potential compensation in stock, restricted stock, or options?  Is there a plan for them to acquire more?  When all public documents have been filed, look in this area first
     • Host Mariott new CEO would be Stephen Bollenbach, who was the architect of the spinoff and had successfully helped Donald Trump turn around his failng hotel / gambling businesses
  3. A previously Hidden investment opportunity is created or revealed
     • Typically a great business or statistically cheap stock is uncovered as a result of of the spinoff.  In the Host case, tremendous leverage was the result.
     • The tremendous leverage would magnify returns on equity if it turned out to be more attractive than it initially appeared.
• • Digging for research involves reading multi-hundred page corporate documents and mountains of SEC filings, like Form 10
    1. Identify where you think you will find opportunity in the documents
    2. After you’ve identified a spot that has opportunity, then start digging
    3. It takes between 6 – 9 months after the initial disclosure of a spinoff to occur.  In the Host case it took over 1 year
  • • Form 10
      • Look through table of contents to identify areas you actually want to review
      • Pro forma statements – show what the company would be making if it was a separate entity
      • Economic interests of insiders
      • ‘Business of the company’ – Strattec 10F ‘based upon current product commitments, the company believes ford will become its second-largest customer during fiscal 1996’  The companies statements did not include any business related to Ford.  Since the current 2nd largest customer did about 16% of business, Ford would be responsible for about 16% more.
  • A spinoff that involves a parent company divesting a highly regulated industry may provide a prelude to a takeover because it makes the target a more attractive takeover
• Partial Spinoff
  • Only sell a partial amount of a division
    • If shares are distributed to current parent company shareholders, it is generally better than an public offering
    • By knowing the parent company market cap, and after the spinoff is complete, the child company market cap, you can figure out what the rest of the businesses in the parent company are worth
  • After analyzing the parent company there may be opportunities to purchase the existing business cheaply.
    • Sears needed to spinoff AllState and Dean Witter.  After their spinoff, Sears $27B in sales was worth only $1.5B in market cap
• Right’s offering
  • Gives you the right to buy shares in a newly spun off company, usually when the parent company needs additional capital
  • Look for oversubscription privileges and the motives of the insiders

Ch. 5 – Bankruptcy

• Common stock is almost always a terrible investment in bankrupt companies
• Bonds
  • All types of bonds
  • Bank Debt
  • Trade claims – claims from the companies suppliers who didn’t get paid for goods, materials, or services provided before the bankruptcy
  • Typically these holders get securities in the new company after it emerges from bankruptcy, bonds or common stock
• The opportunity comes from analyzing the new common stock by reading the disclosure statement.  This filing is made with the bankruptcy court and can be obtained directly from the company or SEC filing ‘registration statement’.  Disclosure statement is better because it provides management’s future projections and past complications.
  • A study showed that these new distributed stocks outperformed the market by 20% during the 1st 200 days of trading.  However, it was the stocks with the lowest market value that performed the best
  • Only buy good businesses – strong market niche, brand name, franchise or industry position
  • Buy companies that were overleveraged due to a takeover or LBO
    • Product liability lawsuits from a discontinued or isolated product line
  • Slumming – cheap compared to similar companies because analyst dont’ cover it, nobody knows about it, or bad stigma
    • Ex: Charter Medical still pretty leveraged after bankruptcy but management were trying new things to make up for lost revenue.  It ended up working and stock tripled, but then didn’t go any higher.
• Knowing when to sell:
  • Trade the bad ones, invest in the good ones.
  • If you bought because of a corporate event, once it is widely known, it is time to sell.
  • If the business is still difficult, but lots of analysts start speaking positively of the stock, sell it.
• Corporate Restructuring: Selling or shutting an entire division that is materially relevant to the entire company
  • Companies close or sell major division to stanch losses, pay off debt, or focus on more promising business lines
  • Often times, the division being sold was masking the company’s other businesses.
  • Two ways to profit, 1. after it is announced, often there is time to see what will happen.  2. Finding a company ripe for restructering

• Recapitalization
  • company repurchases a large portion of common stock in exchange for cash and/or securities
  • The left over stock is called a stub stock and many have returned 5x to 10x
  • Ex: $36 dollar stock, company recaps by giving $30 in bonds to common stock holders that carry 10% interest.  Earnings before were $3.  Pre-tax earnings were $5.  After recap, earnings are still $5, but $3 is paid out as interest.  Remaining $2 is taxed at 40% = .80c and remaining $1.20 is distributed to shareholders.  Stock was trading at P/E of 12 pre recap, and will trade at about 8 after.
    • Assumed growth of 20% before recap.  Growth of 20% in eps = $6.  EPS = $1.80 * P/E 8 = $14 from about $9.60
  • Recaps rarely happen now, they were more popular in the 80s.  However, you can emulate the leverage by buying LEAPS and warrants
• Options market tends to be undervalued during these special situation events.
  • During a spinoff, a call option can be split into 1 share of each of the two companies.  Since after a spinoff shares generally rise, this is not always taken into account with options models.

• Look in the WSJ, IBD, Outsanding Investors Digest(LEAPS candidates), Turnaround LEtter(orphan stocks from bankruptcy and restructuring stocks), value oriented funds (look up their picks that are related to special situations)
• SEC filings for the most interesting stocks from above: 10K, 10Q, Schedule 14A (executive stock ownership, sock options, overall compensation)
  • Extraordinary Events filings:
    • 8K – acquisition, asset sale, bankruptcy or change in control
    • S1, S2, S3, S4 – S1 -> S3 are registration statements for companies issuing new securities, S4 is for securities being distributed through merger or bother business combinations, exchange offer, recapitalization, or restructuring.  S4 sometimes combined w/ a proxy statement where shareholder vote is required
  • Form 10 – spinoff distribution
  • Form 13D – owner of 5% or more must disclose holdings and their intentions regarding the stake is for investment purposes.  If the purpose is for exerting control or influence, this filing may be a sign of an extraordinary corporate change
    • 13G is if institutional holder only is holding for investment purposes
  • Schedule 14D-1 – tender offer statement.  provides useful background info on a proposed acquisition.  You can get these from the information agent listed on the ad announcing the offer.
  • Schedule 13E-3, 13E-4 -E-3 is a going private transaction, E-4 is the tender offer statement when a company is buying back its own shares and disclosures are more extensive than usual, so read these carefully.

• The reasons traders would give for their actions are irrelevant. Most traders don’t know why they did what they did because most traders don’t plan their trades, thus eliminating any connection between themselves and the results of their trades. Most traders act spontaneously and impulsively and then ascribe the rationale for their behavior after the fact. Most of these after-the fact reasons are either justifications for what traders did or excuses for what traders didn’t do
• If you want to learn to predict price movement, you don’t need to pay
  attention to reasons. What you need to do is determine how the majority of
  traders perceive the external conditions in relationship to either their fear
  of scarcity, or their fear of missing out, or both

• In other words, we pass on our ignorance, as well as our wisdom, without
  knowing at the time the difference between the two. And what was passed on that
  was dysfunctional will be regarded as the truth just the same as the wisdom.
• You can wish and hope that the market will come back, or you can cut
  your loss and make yourself ready to take the next opportunity. To be able to
  cut your loss and be ready to take the next opportunity requires that you
  change anything in your mental environment that would cause you to avoid
  confrontation and consequently wish and hope. The less cause you have for
  wishing and hoping that something will happen, the more you will know that when
  you get that certain feeling, it is a true intuitive impulse, and the more
  confidence you will have to follow it.

• If, for example, a market has been making consistently higher highs and
  higher lows, to determine what is likely to happen next, ask yourself the
  following questions: 1. What kind of price action will sustain the buyers’
  beliefs that they can make more money? 2. When are sellers likely to come into
  the market in force? 3. Where are old buyers likely to take profits? Where are
  old sellers likely to lose faith in their positions and bail out? 4. What would
  have to happen for buyers to lose faith? What would have to happen to draw new
  buyers into the market? You can answer all these questions by identifying
  certain significant reference points where buyers’ and or sellers’ expectations
  are likely to be raised and where they are likely to be disappointed if they
  don’t get their way.

• First and foremost, you may need to change your perspective or the focus
  of your trading. Until now your focus may have been to make money. If this is
  so, you will need to change your perspective to “What do I need to learn
  or how will I have to adapt myself to interact more successfully?” You
  need to stay focused on mastering the steps to achieving your goal and not the
  end result, knowing that the end result, money, will be a by-product of what
  you know and how well you can act on what you know. There is a tremendous
  difference between focusing on money and focusing on using your trading as an
  exercise to identify what you need to learn. The first will cause you to focus
  on what the markets are giving you or are taking away from you. The second
  perspective causes you to focus your attention on your ability to to give
  yourself money. With the first perspective, you are placing some of the
  responsibility onto the markets to do something for you. With the second
  perspective, you assume all the responsibility.
• Predefine what a loss is in every potential trade. By
  “predefine,” I mean determine what the market has to look like or do,
  to tell you that the trade no longer represents an opportunity, at least not an
  opportunity in the time frame in which you trade.
• Execute your losing trades immediately upon perception that they exist.
  When losses are predefined and executed without hesitation, there is nothing to
  consider, weigh, or judge and consequently nothing to tempt yourself with.
  There will be no threat of allowing yourself the possibility of ultimate
  disaster.
• To help you learn how to be with the flow of the market, I pose a series
  of questions that are designed to keep you focused in the “now
  moment” to determine what is true about the market. 
  • 1. What is the market
    telling me at this moment? 
  • 2. Who is paying up to get in or get out? 
  • 3. How
    much strength is there? 
  • 4. Is momentum building? 
  • 5. Can it be measured relative
    to something? 
  • 6. What would have to happen to indicate the momentum is
    changing? 
  • 7. Is the trend weakening or is this a normal retracement? 
  • 8. What
    would show that? If the market has displayed a fairly symmetrical type of
    pattern and that pattern has been disturbed, then it is a good indication the
    balance of forces has shifted. 
  • 9. Are there any places where one side will definitely
    gain dominance over the other? If that point is reached, it still may take
    sometime for the other side to be convinced they are losers. How long are you
    willing to give them to stampede out of their positions? 
  • 10. If they don’t
    stampede out of their positions, what will that tell you? 
  • 11. What did traders
    have to believe to form the current pattern relative to the past? Remember that
    people’s beliefs don’t change easily unless they are extremely disappointed.
    People are disappointed when their expectations aren’t fulfilled. 
  • 12. What will
    disappoint the predominate force? 
  • 13. What is the likelihood of that happening? 
  • 14. What is the risk of finding out in a trade? 
  • 15. Is there enough potential
    for movement to make the trade worth the risk?
• If you can’t determine the significance of any particular high or low or
  any other significant reference point for that matter, then you have to ask
  yourself if it is worth the risk of finding out? How much room will you have to
  give the market to define itself before it is evident that the flow of the
  market is not in the direction of that trade?
• Keep in mind that since the market is in perpetual motion, it puts you
  in a position of having to make never-ending assessments of the current risk in
  relationship to the current possibilities for reward. To do this effectively,
  you will have to learn to observe the market as if you were not in a position.
  This perspective will free you to take whatever action is appropriate for the
  situation instead of hesitating, hoping, and wishing that the market will make
  you right.
• Which, of course, is always going to be less than what is possible from
  the market’s perspective. If we are perceiving much less than what is
  available, then we are out of touch with what is possible from the market’s
  perspective and setting ourselves up for a painful forced awareness. To be
  objective you have to make “uncommitted assessments of the
  probabilities.” Which simply means that you have no commitment to any
  particular outcome. You just observe what is happening in each moment as an
  indication of what will probably happen next. Here is what objectivity feels
  like, so that you can recognize when you have achieved it. 
  • You feel no pressure
    to do anything 
  • You have no feeling of fear 
  • You feel no sense of rejection 
  • There
    is no right or wrong 
  • You recognize that this is what the market is telling me,
    this is what I do 
  • You can observe the market from the perspective as if you
    were not in a position, even when you are 
  • You are not focused on money but on
    the structure of the market

1. Small real body at the lower end of its daily range and a long upper shadow, color not important
2. Real body that gaps away from previous real body
3. Wait for verification that a reversal is taking place by looking for a gap in the reversal direction outside the real body