Phil Town
Phil Town

Laura left this comment very recently:

I'm having a heart attack today because I bought into Chicos (CHS) when the arrows said to "buy" and I have been watching it in gross detail everyday. I felt good about it closing yesterday at 37. I woke up this morning and it has taken an enormous nose dive and all of the signals have gone to sell. It's killing me to sell right now because I have faith in the wonderful company and I would lose a lot of money. I'm violating Rule 1! If the big guys move so slow, how can this kind of nose dive occur so quickly without any bad news! Anyone can help with advice?


ARGGGHHHH!!!!  This is not good!  Losing money and getting caught in a big drop just isn't fun.  So first, what went wrong, and second, what to do about it?

Laura bought in using MSN Money tools.  Had to because if she was using Investools and a 30-Day MA the third "green" signal never showed up.  What she was looking at was both the MACD and Stochastics telling her to get in, but only the 10-Day MA said get in, too. 

So what's wrong with using the 10-Day MA in this case?

Here's where just a little experience with the tools will really help you -- so, Laura, if you are not experienced, what are you doing using real money????  Didn't I tell you to trade virtually for a while until you get good at this thing?  You don't fly a plane after reading a book and you don't invest real money right after reading a book either. **

So gang, a reminder: Don't Lose Money!!!!  And to do that we need a bit of experience in using the tools.**

Let's look at this situation deeper:  Why not the 10-Day MA in this case?

Because a quick look at CHS tells you that the stock price is moving down like crazy over the past two months.  If something is wrong in the business that you don't know about, the Big Guys can burn you over and over by creating brief bull runs in the stock and then dumping into it.  This is called a Bear Trap -- set by the guys who want to get out and need buyers.

While you can get caught using longer term MA's, the 10-Day is particularly susceptible because it moves to positive signals so much quicker than the 30 or 50.

So the way to use MA's when a stock is crashing is to use slow ones like the 30 or even the 50.  Since MSN Money doesn't give you a 30 day MA, you'll have to either extrapolate between the 10 and the 50 or use the 50.

Should I have warned you about this in the book?  Yeah, on hindsite, I would put in a bit to insist you use longer term MA's on wonderful businesses that have crashing stock prices.  Next edition.

Meanwhile, too many of you are jumping in there on tech signals with real money without taking the two months or so of virtual investing.  You need to test this out for a while to get the hang of it.  So go do that now.  Practice first and don't violate Rule #1.

Back to Chico's.  They just announced April sales up 18% from last year, a new record, but same store sales were 5% instead of the 8% the street expected and the earnings figures are coming in at $0.28 instead of the average expectation of $0.30. Since Wall Street is all about what have you done for me lately and not much about the long term expectations, the stock crashes on the news even though the company is doing great.

So let's look at the Sticker Price and see if we love the biz:

If you plug in 18% as the future growth rate and use a 36 PE (2 x the growth rate) you still get a $49 Sticker Price, well above the current $30.  There is a lot of head room even with low expectations.  That's good news.

Now the question is, should Laura stick with this or bail?  Depends on her way of trading.  If she is very comfortable with CHS as a business, given its Sticker, this price isn't likely to last.  But she better understand the business well, I think.  Short of that, she doesn't have a choice.  She has to sell it and get out even though she took a beating.

So gang, first lesson here is to not try to buck the general trend of the stock by using a quick MA.

The second lesson is to be sure you really do your homework on the first and second and third M BEFORE you buy the stock so that if there is a crash, you can figure out whether you are a buyer at the lower price or a seller, regardless of the signals.

Now go play!

Phil Town