How to Trade Stocks Online Trading Primer Part 2. 'Stock Tips'

This is part 2 on a 10 part series about how to trade stocks online. Feel free to email this post to a friend or re-post.

We've all been there. You are at work standing by the water cooler and Dave from Accounting is telling you all about some hot stock. He's standing there blowing hot air at you about how this is going to be the new thing and now is the time to get in on it on the ground floor. You then go home and open your email and you see a few emails touting some stock or another. Maybe you were at a website a year ago that you were kinda impressed with, left your email, and now some guy is emailing you 4 times a week on stocks, filling up your inbox. Or you go to the mail and find a 6 page flyer on a stock that is ready to explode with expert testimony, graphs and charts including descriptions of how this stock is going to be the next big thing with the contracts that it is about to land.
Lets say that you are smart enough to skip all the above. You keep your head above the water and you only engage in smart investment research. You watch Bloomberg. You read the Wall Street Journal. You watch Cramer. (You read articles like this at www.the1045report.com)
And then you realize something: every time you get into a stock based on the recommendation of one of the above resources, the stock seems to start dropping in value. Then when you go back and look at the trade, you notice that there already was a run up in the stock price by the time you got the news to go ahead and buy this stock for whatever reason.

It Comes Down To The Big Boys VS You

In the stock market, information is power. And advance information before the rest of the crowd gets it is ultimate power. Do you think because you saw something on the internet sitting at home in your pajamas that you are one of the first people to see it?

Its human nature to be part of an exclusive group. That's how humans throughout history have gotten a leg up in life, to separate themselves from the rest of the pack and take the best things that life has to offer by being part of that exclusive group that has engineered special access to these things that everyone else does not have access to. Think Harvard, think Skull and Bones at Yale, Think Princeton, congress and the halls of power. Do you think that its any coincidence that men who have served posts at the White House later get cush positions of power as 'honorary' board members at major corporations for millions a year? Its the inside deal, the special deal. The deal allowed for the privileged few, regardless of how you got there.

While it is definite grey area, and maybe even bordering on illegal, people on the stock market floor and major fund players and big fish at financial corporations get the information on things hours before you do, hours before the information shows up on the AP/Reuters wire and it has already been acted upon. As a matter of fact, the big boys are already starting to sell by the time you get the info and are getting in to buy. That's why when you see something hot in the news then turn on your computer to get in, you will see that the stock has already reacted to the news for a while and has already been climbing.

Pros have slowly over the last 50 years been working on information systems that will give them the news first before the rest of the public and the public wires. They see it as, without this advance start, what are we even doing? They see it as a right, not a privilege.

Flat Out Scams

I remember in June 2013 I got a several page brochure/prospectus in the mail called "The Ken Williams Hard Asset Report. It was a slick color multi page folded mailer with charts, graphs and expert opinion pushing a small oil penny stock. Here are some snaps of what I saw when I opened this up:

As you can see the entire purpose of this brochure was to convince you that this oil stock was about to explode and how BP and Exon and Mobil were going to be a part of this and how you do NOT want to miss out on this action because getting in RIGHT NOW was going to make you rich. The magazine claimed it was giving you a rare inside advance tip. So this got you all hot to quickly get your money in POLR before it exploded right? I threw the mailer to the side for about 6 months and forgot all about it, then found it again. I decided, 'hey, lets see what actually ended up happening with this stock.':

The above is POLR for 2013 and 2014. As you can see, the scammers picked POLR as their penny stock that they were going to push, and they got in early, say in Nov 2012 when the stock was worth pennies, and then they got on the phone and started pushing it. They then started a big mailing blitz using mailing lists of people who have previously signed up for stuff on the internet or had previously made a mail purchase of something to do with the stock market. As these scammers were pushing this stock on the phone and sending out mailers, the stock started to rise as people were sold and started buying it. The peak of this stocks price was about the time I got the mailer, then the scammers sold at 5 and 6 dollars per share up from several pennies and made possibly millions, then the price collapsed back down to pennies leaving everyone who got in towards the end holding the bag. Pump and Dump.

This happens with unsolicited emails that pop up in your email from people you don't know pushing stocks or people you don't know calling you on the phone pushing stocks. There were two movies done about this, one called "Boiler Room" and more recently, "The Wolf of Wall Street", which were basically companies that made like call centers pushing crap stocks pumping up the price and making the people working the center rich based on a stock that actually provided no intrinsic value other than temporary hype.

If you are going to follow a stock picking service, follow their picks for a while before putting any money in it. That's the only true way to measure their performance. And don't fall for a sudden switch in services. Follow the specific service that you want, and then when you are satisfied that that service does and will make money, then go ahead. Be careful of your money allocation, and take it slowly.

We are hard wired to follow the crowd

We are all wired to suddenly start running when we are in a crowd and we suddenly see everyone start running. Chances are if everyone moves at once, you will feel an irresistible urge to start running as well. The reason for this is evolution. When we were cavemen and suddenly everyone started running, that usually meant that a natural disaster was suddenly in  progress or a hungry sabre toothed tiger suddenly sprang out of the bush. If you stood around trying to figure out what was going on and why is everyone suddenly running, you would have become lunch. 

So the people that stood around were taken out of the gene pool. And the people that moved as one with the crowd kept there genes in play, eventually coming down to you.

This also manifests in crowd behavior in the markets. When the market is roaring like in the late 1990's, the crowd is all clamoring to buy, people can see no end to the market in sight, it even affects the commentators on all the main cable programs. When the stock market is crashing, people all run to sell, which causes the markets to crash harder, which makes people panic and start selling yet more. This is why the market has implemented trading brakes, or a time out to curb the panic selling in a crash by turning the machines off for a hour, half day or even the rest of the day.

Contrarian Traders trade against the crowd..and make all the money (or a good part of it)

Contrarian Traders make quite a bit of money trading against the crowd because for the most part, the crowd is wrong. For example, Contrarian Traders recognized the house buying frenzy as a bubble in 2003-2004. Credit was too loose. People were buying houses with almost no money down with shady sliding scale financing. Everyone was getting into it. The crowd saw money laying on the table and no one wanted to miss out on it, homes were appreciating so quickly. This was the signal to Contrarians to wait with their cash reserves. When the housing market crashed hard in 2008-2009, the value of these homes plummeted a good 30%+. Then the Contrarians came in with their money and snapped up these discounted properties and when the market bounced back in 2012-2013, the houses re-inflated in price, and the Contrarians sold for a profit.

This same principle can also be done in the stock market, virtually every day with information that is public to everybody. Then why doesn't everyone do it? Because of the siren call of the crowd. People are reactive, looking around for the next trend to pile on, for the next momentum play to get with, 

Contrarians look for several pre set situations that they know people will react to and pre-arrange the deck and sit there and wait like a fisherman for the crowd to predictably react. 

For example, what I do is trade against the crowd in a manner that I covered above using a trading window of 2-3 days to 2 and a half weeks.

With a 2-3 day to 2 and a half week window, you can stack the deck in your favor by going against the crowd.Lets look at some specifics at what I do:

A) 2-3 days:  Go to the Yahoo finance page and look up the Earnings calendar, and look for stocks that report quarterly earnings that day 2-3 days in the future. Now look at their analysts expectations. If they are all low, and in the red, then go to stockcharts.com and check to see if the stock has been steadily climbing in price for the last week and a half leading up to earnings. If it has, and the analysts expectation is crap, and 3 out of the last 4 quarters there has been negative earnings surprises, this means that the crowd is wrong, the stock is going to report bad earnings, and the stock is going to drop. To go against the crowd, I would purchase a stock put on this stock (providing it is optionable) 2 days before it reports, and then the day of its earnings announcement, the stock will most likely drop and the put will jump in price. You then sell the put on the earnings date for a profit. The crowd is almost always wrong, you are profiting by going the opposite way of the crowd.

B) 2-2 and a half weeks: Go to the Yahoo finance and look up the Earnings calendar and go out 2-2 and a half weeks. Go on down the list and look for stocks that have great analysts expectations with numbers that are in the black, and high. Look at their last 4 quarters. If 3 out of the last 4 quarters there has been earning surprises to the upside, then there is a good chance that this stock is going to do the 2 week climb leading up to earnings. Purchase call options at the money either for the current month if at the beginning of the month or the next month out. 2 days before the stock announces, sell your options for a profit after the stock climbed up. You want to sell two days early because trading insiders on the stock room floor start to leak the news out ahead of time and this can manipulate the price of the stock and cause it to start dropping early if the news is bad thus eroding our option price.

In doing the above you will have to analysis the market first by looking at the QQQ charts first to determine which way you think the market is going to be going. If you have analysed that the market is going to be dropping over the next several days, you want to go with option A above. The market will aid your put drop, its like a beach ball (your stock) being carried on the wave of the ocean (the stock market). If you think that the market is going to be going up for the next 2-3 weeks from your analysis of both the daily and the weekly charts for the QQQ (weekly is more for long term forecasting) then use option B above. The market will go up and drag your stock up with it, helping your call option to rise with it.

There are further nuances that I use with the Contrarian method that I will cover in a later post in this series, but serves us here in this capacity to make my point on how to trade with publicly held information without getting stomped by the big boys.
By trading in this Contrarian style, you can constantly make money with publicly available information by setting up your trades ahead of time while not competing with the big boys in the slightest. The big boys will be looking to strip the crowd moving as a whole of their money, they wont be concerned about you moving the wrong way in the crowd. Very few people trade that way.
What kind of money can Contrarian traders make? Look up Contrarian Trading on Wikipedia. You will be surprised at what kind of bank those people make.

Until the next installment of the series,

Mark