Investment Opportunities - Types of Investments

Patterns for Profits Newsletter - February 6, 2008

When researching investment opportunities and different types of investments, it seems logical to look at good past performing investment opportunities. The bad thing about this practice is that past performance is not necessarily an indicator of the future. Chasing past performing types of investments, whether they are hot stocks, high-performing mutual funds, or index funds, aren’t always the best plan. For an example, let’s look at this scenario.

Types of Investments - An Example
Turning back the clock to the end of 1999, let’s look at a situation that emphasizes the point that using past success of investment opportunities can be a tremendous investment risk. With the end of 1999, you are looking forward to chasing various types of investments for 2000. You determine that in mutual and sector funds and after your analysis on the 1999 results you choose five:

Mutual Fund A, with its 329% growth in 1999
Mutual Fund B, with its impressive 314% increase
Mutual Fund C, which showed an amazing 280% rise
Sector Fund D, boasting a 1999 increase of 273%
Sector Fund E and its 249% jump in 1999

With increases like these, even a fraction of that success in 2000 will be very profitable for you! Unfortunately for you, the law of investment gravity held in 2000 and this was the results you saw:

Mutual Fund A was down 72%
Mutual Fund B fell 23%
Mutual Fund C was shut down and paid returns to its investors but only after a 60% drop
Sector Fund D experienced a 56% decline
Sector Fund E fell 64%

If you had owned these funds in 1999 maybe you would still be able to smile, but you were chasing investment opportunities based their past results and didn’t do any technical analysis to back up your decisions. If you had invested $10,000 equally among them, you now have $2,250 left! This example reflects real funds and their performances in both 1999 and 2000; the example also shows what can happen if you choose types of investments based only on their past performances, you are asking for an outcome like this.

How To Choose Your Purchases Without Chasing
This isn’t only a lesson about the dangers of chasing investment opportunities based on their past performance; this is really about using only one measurement before implementing your investment strategy. If you only use one measurement you are subject to all of its inherent risks without the protection you can get from others. A successful trader will implement a number of ratios in order to prepare for such important decisions.

What Else Do You Need?
This may sound like a broken record but this list of steps to prepare for a purchase is always the same and it doesn’t include chasing previously great types of investments. This list involves establishing a stock trading plan, performing technical and fundamental analysis and utilizing a charting and analysis system such as Japanese Candlesticks. By taking advantage of the strengths of these principles you are left simply chasing top investments, you are finding and proving them.

Conclusion
Choosing past performing investment opportunities alone is a dangerous method for trying to make money investing in stock. The markets can be very unkind to a trader who doesn’t spend the time required to find good types of investments. It is always better that you take the time to find good investment opportunities.

Patterns for Profits Market Watch

The Large Head and Shoulders patterns we mentioned were forming broke the necklines in the last couple of weeks. After a sharp selloff there was a sharp rally back towards the neckline area which led to a trend day down in the SP 500.

The markets may spend some time consolidating; the outlook appears to be possible lower prices to come in the coming weeks. The intraday swings have been very wide and we have been advising traders in our live trading room to use lower leverage and pick their entry spots carefully for any trades. The average daily range last January in the SP 500 was about 11.50 points. Although January has not quite ended as of this writing, that range has increased to 34.5 points. This means that the intraday bars on each time frame have expansion and what used to be one bar being 2-3 points, now one bar may be 7 points or higher.

Adhering to a money management plan is always extremely important, but with this extreme volatility traders need to be aware of both the additional opportunity and risk and trade accordingly.

The markets are in a downtrend and although there is opportunities short term trading both directions, watch for the longer term intraday setups in the direction of the trend.

Patterns for Profits Trading Tips

Exposure and Trading

The following excerpt is from the book, ‘Be The Pack Leader’ by Cesar Millan. I am a great fan of his and have used his techniques to train my German Shepard puppy, ‘Gartley’. I came across this part on fear in this book and could not help but notice the profound similarity to trading. I hope that you enjoy this as much as I did and find it helpful.

This excerpt is when Cesar Millan asks his friend Dr. Alice Clearman to explain how exposure works as a technique for dealing with fear.

“Exposure is all about reinforcement in the brain. Whenever we engage in a habitual behavior in response to something we fear, we reinforce that fear. If we are afraid of spiders and back away from them, we reinforce that fear. Imagine a great fear of spiders. You see one in the bedroom. You run out of the bedroom and get someone else to kill it. Or you spray half a can of pesticide in your room. Or you call a pest control company. I’ve known one person who refused to sleep in her bedroom for three months after seeing a spider there!

The way it works is that they become more and more anxious as they approach the feared object or situation. In the case of spiders, if I’m afraid of them and I have to kill one, I become more and more afraid as I approach it. Maybe I have a shoe in my hand, poised to smash the creature. My heart is pounding, my pulse is racing, I’m almost hyperventilating. I’m terrified! I get closer and closer, sweating bullets. I suddenly decide that I can’t handle it! I turn heel and flee from the room, calling my neighbor and asking her to come over and kill the thing. The moment I run away, how am I feeling? Relieved! My pulse slows and my breathing returns to normal. I wipe my brow with a shaking hand. Whew! That was close!

Look at what I did to my brain. I had increasing anxiety as I drew closer and closer to the spider. Then I decided I couldn’t do it. I fled the scene and I had an enormous sense of relief. That relief – that feeling – was a reward. I rewarded myself for fleeing from the spider. I’ve taught myself, quite literally my brain, that spiders are indeed very dangerous creatures. I know this because of the feeling of relief I had when I left. The result is that I actually increase my fear. I have made myself a little bit more afraid of spiders every time I exit.”

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Leslie Jouflas
Kelly Hill