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When purchasing a stock, you must first determine the probability of that stock returning a profit.
In other words, you must buy the stock based on an edge. An edge is establishing environments where you have more chance of returning a profit than a loss.
If you cannot define your edge, you do not have one. And if you do not have an edge, you will get eaten by someone who does.
Needless to say, having an edge is very much the foundation of sound investing.
The simplest way to determine an edge is to use technical analysis on the higher timeframes – monthly, weekly and daily.
If all three timeframes are in alignment, we have an asset that is very likely to be set up to return a profit.
Let’s look at Tesla Inc TSLA:
- An erratic performance history
- Down 67% from the high of November 2021 (bear trend)
- Trading below the weekly 200 simple moving average (bearish bias)
- Finding support at the $100 round number (bullish bias)
- Dropping in price and underperforming against the market (bearish bias)
Below is the weekly timeframe:
There are more bearish technical indicators than bullish ones.
Value investors will no doubt be licking their lips at the potential of buying a cheap stock, hoping for a swift reversal.
The challenge is landing in the classic ‘catching a falling knife’ scenario, where the stock keeps dropping against you once you have purchased it.
There will be many in this situation, having bought TSLA on its way down through 2022. Some will even compound their losses by buying more of a losing stock. Never do this.
The reality is this:
- Stocks that are dropping in price usually keep on dropping.
- A stock like TSLA will stay at these low prices for extended periods.
The recovery is slow and making a profit is inefficient. In fact, many in this situation simply want to get back to breakeven.
Let’s look at Arch Capital Group Ltd. ACGL:
This stock looks very different to TSLA.
- An excellent performance history (bullish bias)
- 50% up in the same time TSLA is 67% down (bullish bias)
- Printing new all-time highs (bullish bias)
- Trading above the weekly 200 simple moving average (bullish bias)
- In a bull trend and outperforming the market (bullish bias)
Below is the monthly timeframe:
All technical indicators confirm further bullishness as opposed to a reversal, meaning the odds of profiting are far greater with ACGL than with TSLA.
A reversal is likely to happen if the whole market turns, which is still a possibility. I am waiting on the S&P 500 to confirm further strength first before buying stocks.
However, if you put your attachment to TSLA as a brand name aside and focus purely on market structure and probabilities, ACGL is the stock that must make it into your portfolio when the time is right.
Looking at the S&P 500 at the start of the trading week, early signs are promising, but we still need to wait for confirmation with end-of-day closing prices.
The goal is not to be right but to make a profit.
If your goal is to be right, it is an emotional purchase which will land you buying the wrong stocks for the wrong reason. Exiting the stock will also be a challenge as you hold onto proving to be right. There is no longevity in this approach.
If you switch your focus to making a profit, you choose stocks based on probabilities. You then cut of the losers for a small loss and let the winners run and compound for a much larger profit.
It is all very simple, just not easy, especially if you do not develop that all-important investor mindset.
ACGL is my choice for today.
There is a reason why trend followers are regularly found at the top of performance tables, whilst value investors are midtable at best.
Featured image sourced from Shutterstock
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Image and article originally from www.benzinga.com. Read the original article here.