Friday, July 23, 2010

How I Lost Money Once and I'm Now Learning To Get It Back

The Summer Investors were allocated $1000 each by David Neubert for an informal portfolio advising competition amongst ourselves, so I will explain my stock picks. I have actually been watching a few stocks for a couple of months now, so I already had an idea of which ones I wanted picked out.

First, how do I choose my stocks? Well, ever since I started trading and investing I've been told to "buy what you know". I know technology pretty well, so I first started out trading Apple (AAPL) since I'm a huge fan of them. I was trading options, which I will explain in a later blog post, and I hadn't a clue what I was doing other than the mechanics of buying and selling. I didn't know how to value a stock, read a chart (much less know what kind of chart to use), research a company's financials, nothing. I just knew Apple is awesome and they were constantly growing on a macro scale, so I'll throw some money at them. Bad mistake. The markets ended up slumping and I lost almost all of my money. I was incredibly frustrated with myself, so I decided to actually learn how to become a "day trader" (I chuckle at that expression now). In retrospect, I look at my loss as an expensive education.

To do this, I had to ask myself, "How do people do this and make money every day? What do they do specifically to make a living off of their trading?" I had no idea where to find out, so Google and Wikipedia were my first sources. I searched and searched and searched until I finally realized that the brokerage I was using actually had a little bit of educational information. I read continuously on how to chart a stock, what determines the value of an option, how they react to market volatility, etc. I finally began to grasp the basic concepts of investing and trading. Now, I'm interning at Kapitall and learning tons more.

So, what do I look for in a company/stock to decide whether I should trade or invest in them? First, I check the chart to see how they have been trading. If it looks like the price of the stock has been strongly and steadily climbing over the past year, I take note and move on to my next criteria: financials. I check their income and cash flow statements to make sure they are making a steady growth in revenue, cash, and assets over the past few quarters. The best way to determine the cash value of the company is the Cash Equivalent for the ending period (Year End, Quarter End) on the cash flow statement. The Net Cash From Op Activities shows how much actual cash they've made from their operations. If that shows steady growth, along with an increase in revenue from the income statement, I move on to read more from the chart.

The company looks good financially, so how is it trading in relation to its recent past? Chartists have terms called "resistance" and "support" that refer to the stock's recent peaks and lows. They are basically imaginary lines that the stock bounces in between until it eventually breaks free from them. The resistance is the line representing peaks and support is the line representing lows. When resistance is broken, it often becomes the support and when the support is broken, it usually becomes the resistance. Then the respective missing line is reformed after time. Above is an example of a stock trading between the resistance and support and at last breaking the resistance. I loosely expect this stock to now form a new resistance and use the old as support.

How would I time buying this stock? Well, I would have bought today since it stayed above the new support until the markets closed. I expect it to continue to climb as long as the markets don't fall. What if it dropped below resistance, though? I would have waited until it finished dropping over the next few days next week and bought it when it showed that it was going to climb again. You can tell when the stock will begin to change directions by watching the buying and selling volume. The price will start to climb when more people start buying the stock, and the price will drop as more people sell the stock. It will react to the basic economic principle of supply and demand. You can try to guess when it will change directions by watching the volume of either buying or selling starts to lower. If there is large buying volume and then it starts to lower, selling volume will begin to increase, and vice versa. My rule of thumb is to try buy the stock as the selling volume slows dramatically and the buying volume increases dramatically.

So, what stock did I informally advise Neubert to buy? One company I've been watching for a while (and the graph above is of) is called Ariba Inc. (ARBA). They are an intranet- and internet-based data storage business. They showed strong revenue and cash value, so I bought it today during the market closing rally and made 0.23% in about 30 minutes. I'm hoping it continues to climb all next week until the company releases its quarterly earnings report. If it beats analyst's expectations, the price will likely jump up even further.

-Danny Guttridge

DISCLAIMER: I have informally advised David Neubert on this company. After consideration, he has decided to purchase this stock, which he is keeping in his personal account. This is strictly advice for a beginning investor like me, and the opinions I have do not necessarily reflect those of Kapitall.

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