Rule #1 Finance Blog

With Investor 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
.  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