For most of this week we’ve worked on the November issue of Australian Small-Cap Investigator. We put the final touches to it yesterday morning, and sent the report to subscribers yesterday evening.
Part of the job of researching, analysing and writing about small companies is that you have to look on the positive side of things. You have to think about what could happen if all the company’s amazing ideas come to fruition.
Of course, you also have to understand the risk of investing in small-cap stocks. There’s a chance you could lose all the money you invest.
However, if you fully pay for your shares rather than using borrowed money, you can never lose more than the amount you invest.
The thing with investing in small-caps is that the odds are always against you. It’s never a 50/50 proposition. But, although you could lose your entire investment, there’s a chance you could earn many times the amount you invest.
That’s what makes the risk-taking worth it.
But not all analysis works that way. There are some analysts and investors who have a neutral attitude to the stock market. They aren’t looking to double their money in a trade, and they don’t expect to lose their entire stake.
Rather, they bet on short-term market moves, and they don’t care whether the stock market goes up or down…
In this month’s Australian Small-Cap Investigator we wrote:
‘But with revenues and profits falling, neither of this month’s stock picks can afford to do nothing.‘The issue is whether other, more nimble firms can innovate better than either of these two companies.
‘If either company gets the next step wrong, either by not innovating or by innovating in the wrong direction, then it could be curtains for them.
‘To sum thing up, this is a speculative turn-around situation. I’m better that these two […] companies have enough resources and new ideas to reinvigorate their businesses and return to profitability.
‘If they do then gains of 294% and 230% are entirely possible.’
Most of the time when you buy a small-cap stock you’re punting on a company that either has big ideas to become a much bigger company…or used to be a bigger company and needs to come up with a new plan to get back to the top.
This month’s Australian Small-Cap Investigator stock tips fall into the latter category.
But as we said, not all investing is the same.
Some investors aren’t looking for big game-changing events that could change a company’s fortunes. Some investors just look for shorter-term price trends.
The best example of that is the technical analysis approach taken by our old pal, Murray Dawes…
This is Why We Buy Stocks in a Falling Market
If you don’t subscribe to his trading service, you’ll know Murray from his feature articles every Wednesday in Money Morning.
Although Murray admits to having a bearish outlook on the markets, the reality is he doesn’t care which way the stock market goes.
That’s because he’s typically looking for the same risk reward on bought and short-sold trades.
For example, if he wanted to trade a stock like BHP (current price $33.58), he might look for a short-term $3-$4 move. Depending on whether his charts tell him a rise or fall of that amount is more likely, Murray will place the trade accordingly.
When you’re trading blue-chip stocks you’re typically not weighing up the odds of the stock going to zero against it going up 200% or 300%. Blue-chip technical traders are looking for smaller gains in a shorter period of time (that’s why they also tend to use leverage to magnify their returns).
How does that fit in with the current market? Is the stock market more likely to rise or fall?
Well, as a speculator in small-caps stocks we’re always looking to buy. We see small-cap investing as a gold mine of optimism, innovation and entrepreneurialism (and because it’s harder and riskier to short-sell small-cap stocks).
And because we only recommend investors allocate a small part of their portfolio to small-caps, if things don’t go to plan investors aren’t exposed to big losses.
But as we say, Murray has a more neutral approach to investing. If he thinks the stock market is going higher, he’ll buy. If he thinks it’s heading lower he’ll short sell.
So, just where is the stock market headed…?
The Stock Market Could Fall 29% in Weeks
Murray isn’t a big fan of making long term forecasts. He knows that events can make the stock market turn on a sixpence. So he prefers to look at short term movements and trade accordingly.
Even so, Murray’s analysis takes into account historical price action and how it relates to potential future market moves.
It’s when Murray looks at the historical price data that he sees some troubling signs.
One of those signs is the recent market action. The stock market hit a one-year high just a week ago. The problem is, after hitting that high point the market fell below a key level, what Murray calls the ‘top of the distribution’.
In layman’s terms, it means there wasn’t enough buying strength to keep the stock market at the higher level. As the buying dried up, the short sellers gained strength and pushed the stock market lower.
This fits into Murray’s longer term view that buyers will fail to prop up the stock market. And the longer this continues, the more likely it is to exhaust buyers, and it will be harder for the stock market to sustain rallies.
That will put short sellers in an even stronger position. That’s why Murray has another key level in his sights – the low of 2009…and it could happen sooner than you think.
If Murray is right and the stock market does head south, you’re looking at a fall of 29% from the current level. That will mean some big falls for Aussie blue-chip stocks.
Small-Cap Stocks Will Be the First to Gain When the Market Rebounds
Of course, a lot of things can happen. Even in a bear market you get periods of rising share prices. But if you’ve got a lot of money tied up in shares, it’s important to know the long term trend and the impact it could have on your wealth.
Anyway, we’ve asked Murray to share his thoughts with you, including the key dates when he believes the biggest move could occur. He’ll be in touch with you shortly.
Until then, we’ve already seen big falls in the small-cap market. So in a way we’re looking ahead of a stock market collapse and adding as many dirt-cheap small-cap stocks as we can to the recommended buy list.
That doesn’t mean small-caps will escape damage when the stock market falls. But when it recovers it can happen so quickly that many investors miss out on some of the biggest small-cap gains.
Cheers,
Kris
From the Port Phillip Publishing Library
Special Report:
Retire Rich, Happy and Free From Money Worries
Daily Reckoning: Currency Devaluation: While Europe Gets Sinned, Australia Sins
Money Morning:
Don’t be Fooled by Australian Housing’s Death Fart
Pursuit of Happiness:
The Right to Protect Yourself: Why the State Disarmed You
Australian Small-Cap Investigator:
Five Simple Steps to Picking Winning Small-Cap Stocks
