Avoiding Value Traps in Today's Market
Submitted by Randy on Tue, 09/23/2008 - 19:56.
Tagged: Investing
When a stock’s price falls and corresponding valuation metrics like Price/Earnings and Price/Sales drop to attractive lows, bargain hunters tend to begin salivating like Pavlov’s dog. In fact, when MBIA and Ambac began to crumble late last year, well-known value investors like Marty Whitman lined up to buy stock at $20-$30 per share, only to see their investments crumble to the single digits.
Such situations are sometimes referred to as “Value Traps”, in that the stock appears to undervalued; when in fact, it is not.
And then current environment is riddled with potential value traps. Here are a few tips to keep in mind to help you avoid falling victim to one:
- Do Your Due-Diligence: If a stock appears to be cheap, investigate further to determine if there has been some fundamental change to a company’s prospects. If the sales forecast is weak or there is some other core problem with the company, then forget it and move on.
- Don’t Fight Market Momentum: There’s an old saying that suggests that a rising tide lifts all ships. The same is true of the market and stocks. If the overall market or a stock is trending lower, then it’s a fool’s folly to think that the stock will continue downward. Wait until momentum turns up before you buy. When checking momentum, look at longer term trend-lines such as 200 day EMA or 26-week relative strength.
- Avoid Low Prices or Low Floats: Institutional investors frequently have policies in place that require them to steer clear of stocks that are priced less than $10 or have very few outstanding shares available for purchase. Institutional buying can sometimes drive stock prices up very quickly, but buying a stock that institutions have to avoid can be somewhat akin to Waiting for Godot.
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Don’t Fight Market Momentum
Great post if even just for this one line "Don’t Fight Market Momentum" since I started relying on trading the trends 100% I have become a successful trader who sleeps good at night. Forget expert stock tips, trade the trends, only!
Again, great post!