If you were paying attention to the big momentum plays this quarter, you could have pinpointed when the market was ready to turn lower.

Now, with short-term losses mounting, you might have the chance to spot the first buying opportunity by monitoring these very same stocks. When the momentum names begin to catch a bid, we could see the beginnings of an oversold bounce that would send stocks higher in the short-term…

During the first half of 2012, investors fully dedicated their efforts to Wall Street’s momentum darlings. These are the “hot stocks” in the midst of multimonth bull runs. Expectations run high with these momentum names. Valuations run even higher.

It is a ridiculous notion to wait for a correction (or even a pullback) before buying these red-hot stocks. After all, the share price will never fade. Or so the frenzied logic goes…

It’s probably no surprise to you that Apple was the de facto drum major of the momentum marching band. Apple shares shot up more than $230 between Jan. 1 and mid-April — when the furious momentum rally finally topped out.

Apple’s pullback — and the eventual pullbacks in several other overhyped stocks — was inevitable. Apple was displaying all of the classic signs of a blowoff top. The investing public was convinced shares could go nowhere but up. Analysts and the financial media joined the party with their own irrational expectations, including $1,000-plus price projections and declarations that any fund manager who didn’t own Apple should be immediately fired…

But just when the stock appeared to be completely unstoppable, shares abruptly reversed.

The selling wasn’t outright panic. As of this writing, it remains orderly. The market didn’t take an ax to the Apple tree. It only shook it a bit.

It’s how turning points are born. Shorts shake the branches to see if any weak hands fall from the tree. They’re after the low-hanging fruit. These are the folks who bought shares near the height of the rally. Their conviction is far weaker than that of the long-term investors sitting on substantial gains. So they sell. The selling puts enough downward pressure on the price to convince other longs to part with their shares.

Of course, disbelief prompts many buy-and-hold investors to hold shares of a falling stock much longer than they probably should. There are (and will continue to be) many investors who will stand by Apple — even if its decline accelerates. After all, Apple is a great company that makes interesting, in-demand products. But even if expectations from Apple faithful remain high, we doubt the stocks’ incredible performance during the first half of 2012 will be matched anytime soon…

It wasn’t just technology or high-priced stocks that caught the attention of momentum investors.

Smith & Wesson Holding Corp. (NASDAQ:SWHC) — which I recommended to my premium readers in December 2011 — was swept up in the rally that began on Jan. 3.

I didn’t somehow predict the buying frenzy would begin as soon as we recommended the stock. We knew Smith & Wesson shares had held up well during the height of the European crisis last fall. And we had multiple fundamental reasons for picking up shares when we did.

From a fundamental perspective, Smith & Wesson was improving its operations. Management had already started the process of unloading the company’s underperforming security division. Revenue and guidance strengthened as management concentrated on building the company’s core gun manufacturing business.

Gun sales were growing across the board. In fact, gun sales actually booked a one-day record the day after Thanksgiving 2011. The FBI reported a record number of background checks, adding up to nearly 130,000 gun buyers on the day. The old record was set in 2008 — at only about 98,000.

Stories highlighting record-breaking sales throughout the gun industry began to gain traction in the media shortly after our initial recommendation. Attitudes regarding firearms ownership were improving. More and more women were taking to gun ranges across the country. These tangible stories took hold with investors — and the trend that initially pushed shares of Smith & Wesson above $4 in December began to accelerate. A momentum play was born.

By early April, Smith & Wesson shares more than doubled, to $8. With the successes of high-priced momentum plays fresh in their minds, traders and investors jumped at the opportunity to own shares of this fast-moving stock.

But Smith & Wesson was not immune to the momentum sell-off. Shares gave back more than $1 in a matter of hours in early May as new concerns over the economy and eurozone surfaced. Shares have recovered somewhat. And we’re still hanging onto open gains of approximately 95%. But the warning bell has sounded. It’s time to be extra vigilant as skittish investors rush to raise cash during uncertain market conditions.

While the secret of Smith & Wesson’s potential is now more widely known, the stock has a much better chance at weathering the momentum sell-off than some of the more closely followed names on the market. Traders shook Smith & Wesson’s tree. But investors have stepped back up to the plate and bought back shares.

Only time will tell if the stock will consolidate and move higher from here. If Smith & Wesson and other momentum names catch a bid, we could get our first signal of a move higher.

Sincerely,

Greg Guenthner
for The Penny Sleuth

How to Time the Market with Momentum was originally featured in the Penny Sleuth.

If you don’t, you will probably lose money this summer. It’s as simple as that…

After a furious four-month rally, traders are selling stocks again. It’s a buy-and-hold investor’s worst nightmare. No sooner do stocks begin to move higher than the surge is cut short by volatile trading and fear.

No wonder so many people are walking away from stocks…

“Even though American stocks have doubled in price in the last three years, investors and traders large and small keep giving the market the cold shoulder,” declares The New York Times.

The fact is the average investor wants little to do with a stock market that has burned him one too many times over the last decade.

The numbers don’t lie. Trading on all U.S. exchanges has yet to recover since the 2008 financial crisis. Just last month, the average daily trades in American stocks remain about half of what they were before the financial crisis — 6.5 billion shares, compared with 12.1 billion. That stands in sharp contrast to the market shocks of 1987 and 2001. During these two events, normal trading levels resurfaced within two years of the initial crisis, according to The New York Times. Any way you look at it, the recovery in trading activity this time around has been painfully slow.

The Old Gray Lady isn’t the only mainstream news outlet latching onto this story. Even USA Today is chiming in. In early May, the paper forked over front-page real estate to a story about everyday investors shunning the stock market.

Are these front-page declarations that the market is a dead zone true contrarian signals? If so, is the market set to embark on a new epic bull run, due to the magazine cover indicator?

It’s possible. But from my vantage point, it’s simply too early to declare that the market is ready to charge sharply higher. It can be maddening to try to play these huge shifts in sentiment — especially when economic news and data both at home and abroad continue to unnerve investors. So instead of fixating on the stock market as a whole, I want to cut through the noise by focusing on the individual names that have the best opportunity to outperform their peers.

It’s no secret that we’re dealing with a tough buy-and-hold environment — that much we’ve already said. It’s why a carefully planned approach to small-cap investing is so important. More specifically, you should be concentrating on evolving your strategies to insure you will stay ahead of the market.

Ask yourself — What’s working right now? Which strategies will continue to work if the market moves lower — or when economic and market conditions begin to improve?

Obviously, staying ahead of the market should be the primary goal of every long-term investor. And I’m confident that with a little planning and foresight, we can continue to deliver market-beating results, despite uncertain economic conditions.

Here’s how a longer-term investor should be approaching the market right now:

Value: Many smaller stocks are expensive. You should turn to shares you can acquire at a substantial discount. During the first half of 2012, investors fully dedicated their efforts to Wall Street’s momentum darlings. These are the “hot stocks” in the midst of multimonth bull runs. Expectations run high with these momentum names. Valuations run even higher. But over the past month, these stocks have performed poorly. Avoid them. While the market’s trend is in flux, look for an extra margin of safety. These are the stocks with the fundamental backing to weather a storm of selling. Chasing the popular stocks with inflated multiples simply isn’t working in this environment

Timing: If the markets continue to fluctuate, timing your entries into new positions could be the difference between a losing trade and a great investment. You must use all the tools at your disposal to pinpoint ideal entry prices. If a stock’s chart isn’t backing up the fundamental story, move on to other options. There’s just too much risk in trying to guess when a crashing stock will stabilize. Unless you can target a low-risk entry point, walk away. Don’t try to catch falling knives.

Portfolio Management: When the market gives you opportunities to book profits, you take them. On the flip side, when the market warns you that one of your stocks might underperform, you should sell. What’s left is a lean portfolio containing the stocks that offer the best chance to lead you to profits. There’s nothing wrong with taking profits on a name you really like — even with the intention to buy it back when the dust settles.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Ways to Survive a Volatile Market was originally featured in the Penny Sleuth.

It doesn’t matter if you’re a long-term value investor or a short-term trader. When you’re dealing in stocks, timing isn’t everything — it’s the only thing.

As I was sorting through the mailbag this weekend, I found that many of your questions were about when to buy into a stock or a big investment idea. Today, I want to look at some of the potential trades and investments on your collective radar. I’ll analyze the charts and tell you if you’re looking at a solid buying opportunity — or a potentially disastrous trade…

Let’s get started:

What do you think of Cisco Systems (NASDAQ:CSCO) and Silvercorp Metals (NYSE:SVM)? Is now a good time to buy shares of both?

— S.R.

Here’s what Cisco looks like right now:

Yikes. Cisco is more or less a household name. But this chart is just awful. No one wants to own this stock — and with good reason. The company issued terrible earnings just last week — as evidenced by the massive gap down from $18.50 to $17.25. This gap will now act as resistance. So even though we’re seeing a decent rebound today to the high $16’s, I wouldn’t count on this stock recovering past the mid $17s anytime soon.

Any way you look at it, this thing is toxic. I would avoid it at any price.

Next is Silvercorp:

Here we see a very similar chart — minus the big gap lower. Still, a strong downtrend remains intact. Before you pull the trigger on an investment, draw a line connecting two or more peaks in the price. That’s where you’ll find resistance. Until your stock can break out of its downtrend, chances are it will continue to move lower…

Both of these examples could be considered falling knives. Neither CSCO nor SVM has indicated that it has put in a solid bottom. The important takeaway here is that an out of favor stock needs to time to consolidate after a move lower. Unless you see legitimate signs of life, the stock will probably see additional downside/sideways action before it begins to recover.

As far as questions go, I have one that may fall into your “it’s a bad stock, run away” category. Cameco (NYSE:CCJ), the world’s largest uranium miner. It got hammered after the accident in Japan, and I bought in about a week later. So, you can see what has happened since then. Personally, I still feel that nuclear power is an important cog in the energy machine, and I expect it to return. My question is: is that a rational view, and, if so, is it smart (for the long term) to even consider adding to the position?

— M.N.

Yes, you are expressing a very rational view. Unfortunately, there is nothing rational about the stock market.

Here’s a long-term look at Cameco:

I think you’re analysis is sound. Nuclear is and will remain an important source of energy. But this sentiment is not shared by the market right now. That’s your problem. While you are able to project a stronger future for nuclear energy, the market has yet to move past the events in Japan and the reactions that followed.

Solid analysis will occasionally produce substandard investment results. This is why timing is so important. In this case, you jumped back into nukes way too early. Think of it this way: the market continues to deal with the residual effects of the 2008 financial crisis to this day. And were’ only about a year removed from the nuclear crisis in Japan…

As far as adding to your position — I generally do not advocate averaging down. However, some longer-term investors are fine with buying more shares at lower prices in the hopes that the stock will eventually rebound. It’s more about your investing personality than anything else. As long as you can sleep at night without worrying about your portfolio, you’re probably doing something right.

Keep sending me your charts, questions and concerns to editor@pennysleuth.com.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Monday Mailbag: When to Buy Stocks was originally featured in the Penny Sleuth.

That’s because sitting next to Walgreens, in the same storefront that you’d expect to find a Hallmark or AT&T store, is a shooting range. No, the display cases aren’t filled with cell phones; they’re filled with handguns. And behind the (presumably bulletproof) glass are 16 lanes of climate-controlled shooting stations.

The location isn’t the only thing that doesn’t fit stereotypes. For some, the customers may be just as surprising…

There’s the lady in her early ’30s putting holes in the paper “bad guy” target 25 feet away — she’d never shot a gun before setting up in the lane next to me. Neither had the couple who rented a pistol to try for fun on a Wednesday evening…

Not everyone there was new to firing a gun. The corporate cowboy in a polo shirt and khakis — stopping on his way back from a day at the office — was showing up for a competitive shooting match taking place that afternoon. Don’t even try shooting here on a weekend unless you’re ready to stand around. The wait for a lane runs about an hour during peak times. In fact, you won’t find the range empty even in the middle of the workday.

“It’s like this every day,” said the range’s manager, looking tired. Clearly, business was booming a bit too much. “I mean, look around — it’s a Wednesday afternoon and this place is packed!” Around the country, the stories are pretty much the same.

Yes, the gun world is changing dramatically in 2012. While Black Friday 2011 was relatively tame by most retailers’ standards, it was a banner sales day for guns. The FBI’s NICS database (which provides instant background checks for gun buyers) got nearly 130,000 hits on Black Friday, the most the database had ever received in a single day. Not much later, December set a new record for the most hits in a month. And for the full year, 2011 turned out to be a record year itself, registering more than 16.5 million hits to the NICS database, a 15% increase from 2010.

Clearly, the trend of gun buying is still accelerating at a breakneck pace. But digging a bit deeper into the demographics of who’s buying provides even more interesting results…

It turns out women are driving some of the biggest trends in gun ownership. According to a Gallup Poll from October, 23% of women personally own guns, up from just 13% in 2005. That’s a massive increase in ownership by a group that has traditionally shied away from firearms.

We likely have the media to thank, in part, for the demographic shifts that are going on in the firearms business. Gun-centric TV shows such as Top Shot and Sons of Guns are giving publicity to gun ownership for recreation and protection. At the same time, guns are becoming a less politicized topic: While Republicans tend to be gun owners at a higher rate than Democrats, Democratic gun ownership has spiked in the last decade. Today, 40% of Democrat or left-leaning households own at least one firearm, the highest level in a decade.

That’s not to say that politics aren’t still central to the gun business. With an election year well under way, the National Rifle Association is already actively railing against the Obama administration. While it seems unlikely that a candidate on either side would tighten gun restrictions given the current pro-gun climate, the political message is still likely to do quite a bit to fuel the gun-buying fires this year.

Sincerely,

Jonas Elmerraji

Why You Should Bet Big On Guns was originally featured in the Penny Sleuth.

I’m talking about adding shorter, more time-sensitive investments to compliment a bigger idea. By playing the long-term and shorter-term facets of a trend, it is possible for you to take faster profits — all while waiting for as your investing trend to finally reach maturity.

Technology correspondent Patrick Cox has been following one of these life-changing trends from the very beginning. I’m talking about nutraceuticals. If you’ve been keeping up with this important story, you know that nutraceuticals are substances derived from foods that are either synthesized or purified, and sold for health benefits.

Nutraceuticals have been steadily gaining prominence for some time now. But new technology has broadened and accelerated growth in this small industry. And Patrick’s research indicates that the market is getting closer to widespread acceptance and use of these unique products.

“Those of us who have examined the science know that this is a world-changing technology. Ultimately, I believe it will prevail.” Patrick says.

Patrick has recommended two companies heavily involved in the nutraceutical sector to his readers. With these recommendations, Patrick is looking to ride the longer-term rise in the nutraceutical trend. The companies he has recommended are the best, most innovative forces behind the nutraceutical movement.

In short, Patrick believes the companies behind these substances could lead to the biggest market story in history.

“Things we thought were impossible are coming to pass on a regular basis,” he writes. “To prosper, we’ll all have to re-examine practically everything we thought we could take for granted…”

That’s why Patrick is searching for these transformation companies. He wants to find the firm that can one day become a household name.

Patience can be crucial when dealing with these kinds of investments. That’s why I encourage you to supplement your longer-term buys by finding the companies that stand to immediately benefit from the trend. Not only does this offer you the chance to book profits along the way to your ultimate goal, it also alerts you to important milestones in the life of your idea.

These positive signals are important. After all, when the shorter-term trends begin to align in favor of your longer-term ideas, you know you’re onto something…

That’s exactly the kind of angle we’ve been taking with our small-cap investing strategies. In the last several months, my co-editor Jonas Elmerraji and I have talked a lot about taking a “tactical” approach to buying and selling stocks in our portfolio. From our standpoint, being tactical means seeking out cheap stocks from a value perspective and then entering a position using various market timing techniques.

Of course, this strategy sometimes points us in the direction of a much bigger investment trend. This time, our paths have crossed with Patrick and his nutraceuticals. Our research has led us to a shorter-term play on the raw ingredients that go into various nutraceutical products. I’m talking about omega-3 fatty acids. Omega-3s have been found to defend against heart disease, alleviate arthritis, and improve brain and eye function — so it’s no great shock that this substance is in high demand from health conscious consumers right now.

This small-cap company’s products are used as everything from feedstock for animals and plants to key ingredients in high-priced nutraceutical for humans like you and I. And with both the timing and fundamental factors lining up in our favor right now, we were eager to jump on this stock for our premium readers.

While the time horizon for our investment in omega-3s and nutraceuticals might be considerably shorter than Patrick’s, we’re both after the same goal: to make considerable gains by riding a key health trend. By supplementing your longer-term approach with key behind-the-scenes players in any industry, you have an opportunity to book steady profits, even before the new household names see the light of day…

Best,

Greg Guenthner
for The Penny Sleuth

2 Different Ways to Play a Life-Changing Trend was originally featured in the Penny Sleuth.

But a rally is a dangerous time to be an investor. That’s because when everything’s moving up, it’s all too easy to buy into the over-hyped stock stories of the year and completely forget about fundamental value and technical strength — the two factors that actually lead to consistent investing profits. That’s why this year, you should be buying boring.

Let me show you real-world examples of why that’s true, using the Penny Stock Fortunes portfolio that Greg and I manage for our readers…

Rewind a few months ago to an unseasonably warm January morning in Charleston, S.C., when the mill workers at Charleston Kraft show up for their shifts. The mills sits about 200 yards off of the main road — down a private drive with a gate and palm trees at either side. The big blue building itself isn’t particularly interesting — your standard industrial operation — nor is the business. Charleston Kraft makes paper, the heavy brown stuff and cardboard stock used to make everything from beer cartons to the Happy Meal boxes at McDonald’s.

Boring factory. Boring business. Not exactly the sort of opportunity that most investors would jump at…

But behind those palm-lined gates was the key to one of the biggest-gaining stocks of the year. You see, Charleston Kraft was acquired by KapStone Paper and Packaging Corp. (NYSE:KS) in 2008, effectively tripling the size of KapStone’s business and providing a phenomenal value opportunity for investors who were willing to “buy boring.” By the time we recommended selling shares of KapStone back in June, shares had rallied 205.8% from our buy price — more than tripling the value of any dollar our readers invested.

KapStone was just one example of a boring stock that produced anything but boring returns in 2011. Five Star Quality Care (NYSE:FVE) was another…

Five Star operates senior living facilities spread throughout the country, a business that could hardly be described as earth-shattering or exciting. Five Star’s properties are nice. To be sure Greg and I took an in-depth tour of the firm’s facilities, in addition to an in-depth look at the company’s financials. Five Star facilities boast indoor pools, granite countertops in senior apartments and senior staff members who know residents by name. It was all very impressive. But the next Facebook Five Star was not.

Not that it mattered — we sold shares in 2011 for 94% gains.

There was no shortage of exciting stocks last year. In total, 2011 nearly doubled the number of IPO announcements that we saw in the previous year, and investors bought hyped-up names like LinkedIn (NYSE:LNKD) and Groupon (NASDAQ:GRPN) with both fists. But the “hot stocks” they talked about on CNBC last year weren’t the ones that performed the best — instead, it was the boring stocks.

All told, ignoring the hype and investing in boring names helped our public portfolio to beat the broad market cumulatively by nearly 38% over the last three years.

And we think that the results will be every bit as impressive in 2012, as investors start breaking their own rules and going after the “sexiness” of IPOs and fundamentally-weak movers instead of bargain-priced boring stocks. Don’t fall into that trap this year.

You’re not going to find the small, boring businesses touted on CNBC or in the Wall Street Journal this year – those names don’t get eyes on ads or sell subscriptions. But as we’ve shown again and again, they can generate substantial returns for your portfolio…

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why You Should Buy Boring in 2012 was originally featured in the Penny Sleuth.

It’s a fact: a majority of traders lose money. Many of these failures are new traders starting with $10,000 or less. They end up blowing up their accounts by chasing bad investments and using incorrect money management techniques. That’s why you need to understand a few basics before you get started.

Before I get into the details, I want to make something clear. I do not want you to think that $10,000 is an insignificant amount of money. It’s not. Most families could pay bills for months with less than $10,000.

But if you want to seriously invest the time and effort into actively growing your brokerage account, you will need several thousand dollars to begin. So, if you do not have $5,000-$10,000 saved right now, you need to get your finances in order before venturing into the trading world. Never risk money you will need to pay your bills or mortgage on a trade.

When you do have enough money set aside to fund a trading account, here are the three tricks you need to remember:

1. Don’t Overtrade

This first rule might seem too obvious. But hear me out…

Trading can be exciting — especially for a newcomer. There’s the thrill of your first big winner. Then there’s the panic of getting caught in a falling market. You might even experience the exhilaration of a losing position turning positive.

But if you are trading with a smaller account, you must keep a level head. Be selective! Only buy the very best setups. In short, do not overtrade.

Here’s why…

Let’s say you make three round-trip trades per week. You trade through a discount broker, so each round trip costs you $20 ($10 to buy your shares and $10 to sell). That’s $60 per week, and $240 per month.

Now, let’s say you have a solid trading month. You put $2,000 toward every trade, and half of the trades move in your favor. You then sell these successful trades for an average gain of $100 each. Let’s also say that you’re able to sell your unsuccessful trades close to break-even. This gives you a total of $600 in gains for the month.

But wait… don’t forget to factor in commissions. That leaves you with just $360 — cutting your monthly profits almost in half.

And remember, this number assumes you did not experience any losses. That means you would have to immediately sell all trades that dropped below your entry price. I’m painting an ideal picture — yet commissions are still a huge problem…

With a smaller account, you have to cut back on trading every favorable setup that flashes across your screen. If you concentrate on making one trade per week, you can cut your costs dramatically. You won’t be chasing trades that only offer 1%-3% potential upside. And you won’t be spending more than $200 on commissions every month.

By making just one round-trip trade per week, your annual commissions would add up to $1,040. If you’re chasing three trades per week or more, your yearly commissions would be at least $3,120.

With a small account, it makes no sense to pay your broker more than $3,000 a year. I would bet that even the luckiest trader’s gains would not be able to overcome these fees…

2. Avoid Big Risks

New traders inevitably lay down a huge percentage of their account on a “sure-thing.”

But when it comes to the stock market, there are no “sure-things.” Even well-laid plans can fall apart. That’s why you need to respect the market at all times. Properly planning how much you are willing to risk on every trade is one of the most important tasks of the successful trader.

Let’s turn to market technician and Sleuth contributor Jonas Elmerraji to find out the proper way to manage risk:

“There isn’t a set rule for position sizes,” Jonas says. “The chance that you’ll blow up your account if you hit a “cold streak” decreases dramatically as your risk approaches 2% or less of your portfolio.

“Keep in mind that I’m talking about risk — or money on the line — not total position size. So for a $10,000 account, for example, a trade with a 5% stop loss level would justify a $4,000 position at a maximum. You shouldn’t stand to lose more than 2% of your total account value on any given trade.

“Higher risk trades mean that you should be taking smaller positions. On the flip side, incredibly low risk trades allow more experienced traders to use leverage safely.

“The best rule of thumb is to stay within your comfort zone. On that $10,000 account, if a $1,000 or $500 position size is the most you’re comfortable with, follow your gut and ramp up to 2% as you gain experience.

“Too often, new traders base the size of their positions on how much the stock costs (How much can I afford?). Instead, you should be basing your position size on where your stop loss is (How much can I afford to lose?) — that’s how you can allocate your portfolio like a professional.”

3. Think Growth

When you begin trading with a smaller account, you must have patience — but also a sense of urgency. We’ve already discussed overtrading. But now, you have to get on track by trading the right kinds of stocks — the stocks that fit your unique trading plan.

If you’re beginning to trade, you’ve already developed a familiarity with the stock market. You have an idea of the setups you like. You know what types of trades fit your personality. You might like trading moving average crossovers, but not chart patterns. That’s fine. You have the basic experience needed to find potentially winning trades and execute an order.

Once you have a plan, you must stick to it! I can’t emphasize this enough. Do not be sidetracked by a compelling stock story in the Financial Times or a tip from a friend or your broker.

Remember, we’re talking about the stock market — a place where it takes money to make money. Your mission has to be clear: making money consistently. When your account gets bigger, you can allocate more money to trades — and maybe even branch out to new investments. But with a small account, you have to keep your eye on the prize. Putting money toward an interesting story or a stock you think might be significantly undervalued will only lock up that cash for an unknown amount of time.

If you begin to set aside portions of your account for these extracurricular ideas, you’ll only be robbing yourself of money that would otherwise put to work on trading your original strategy. Make a plan. Then stick to it. Once your plan is in place, use my three tricks to take your trading to the next level.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Tricks for Small Account Traders was originally featured in the Penny Sleuth.

I know this seems counter-intuitive. And I understand that the market at-large has consistently moved higher this year despite these analyst downgrades. But when analysts become negative, you have an opportunity to outperform even a rising market by picking up shares of Wall Street’s most hated stocks.

It’s difficult to believe the disconnect that we’re seeing right now. Wall Street’s cheerleaders have consistently dissed equities this year. So far in 2012, there has been only one day where we’ve seen more analyst upgrades than downgrades, according to Bespoke Investment Group. That means throughout earnings season, stocks have failed to impress…

But following analysts’ advice probably won’t help you make money — especially in the midst of a potentially important market turning point.

This isn’t just some gut feeling. In fact, there’s plenty of data showing that it pays to bet against analyst ratings…

We saw a similar scenario unfold when the market bottomed after the credit crisis in early 2009. According to Bloomberg, companies in the S&P 500 with the most buy ratings rose an average of 73% in the year after the index started to rise in March 2009. But the companies with the fewest buy ratings easily beat this group, rising 165% during the same period.

If you had simply bought the most hated companies in the S&P in 2009, you would have more than doubled the performance of the S&P by the end of the year.

Obviously, that was in 2009. The market was in turmoil and about to snap back from one of the biggest financial disasters in almost 80 years. These were unusual circumstances. Still, the stocks most in favor with analysts weren’t the most impressive market leaders. The same companies that these experts believed would have the best chance to outperform what was then a hopelessly broken economy fell short — giving way to the companies that these same experts believed to be destined for failure.

But even during a much less volatile time period, stocks that earned the wrath of Wall Street analysts beat the odds and prospered.

Looking at the same data from the 2009 study, you’ll find that betting against analysts also worked in 2010 — a year when the market was back on track and less vulnerable to wild price swings. S&P companies with the most buy ratings gained less than 9% as a group in 2010. But those with the fewest buy ratings rose more than 20%.

Different year, different market — but the exact same result. The hated stocks beat out the stocks with the most buy ratings on them by more than double.

Of course, I’m not advocating for you to just pick a basket of stocks with negative analyst ratings for your portfolio. But if your research leads you to a stock or group of new potential investments, always check what the analysts are saying. If your research runs contradictory to the Wall Street crowd, you might be onto something big…

Sincerely,

Greg Guenthner
for The Penny Sleuth

Double Your Market Performance by Betting Against Analysts was originally featured in the Penny Sleuth.

It’s downright impossible for a billionaire like Buffett to place a bet on the housing market. But an individual investor could see sizable gains in this beaten-down sector. And you don’t even have to buy real estate to get involved.

Instead, I’ve pinpointed a simple way for you to capitalize on the first signs of a potential housing recovery. Better yet, you can buy the small stocks in this group — while billionaire fund managers have to let the opportunity pass them by…

Before I get into the details, let me be clear: I’m not saying that the housing market is ready to boom again. And we’re certainly not looking an early 2000s-type run in home prices again anytime soon. In fact, many experts are predicting at least two years before the market truly regains its footing.

After all, negative news surrounding the housing market continues to command front-page coverage. It’s been all too easy for the media to pile onto the countless human interest stories in the most-affected regions of the country. Foreclosure horror stories, entire abandoned neighborhoods and abusive bank practices remain top stories in the financial and mainstream media alike.

On the surface, housing sector data does not look any brighter. The Case-Shiller index — which measures property values in 20 major cities — showed in its most-recent data that home prices dropped 3.7% year over year.

However, I am seeing several signs pointing toward improved conditions for the homebuilding sector.

Even Case-Shiller index co-creator Karl Case sees the silver lining in the numbers. Case told Bloomberg last month that the seeds of recovery have already been planted because homes are becoming affordable again. Add in record-low interest rates, and you have a reason to be hopeful about housing.

Cheaper prices are not just helping the average home buyer. Home builders have also used depressed prices to their advantage. Many have snapped up cheap land and prices that would have been unheard of just a few years ago, according to Investor’s Business Daily. They’ve also cut their costs and modified operations to sustain their businesses in a post-bubble economy.

According to The Associated Press, builders broke ground on a seasonally adjusted annual rate of 699,000 homes last month. This milestone puts the seasonally adjusted rate at its highest level since October 2008. These glimmers of hope for the housing market have ignited a stealth rally within the sector.

Right now, we are seeing the bottoming process play out. While it would be completely unrealistic to expect anything even close to housing bubble conditions reappearing, we believe there is opportunity in this space.

There’s value to be found in some of these beaten-down home builders. Even though conditions will remain far from perfect for some time, many of these stocks could find higher ground. The monumental bust that buried every single one of these stocks back in 2008 is beginning to wear off. It has taken more than five years for these stocks to stabilize — but it is happening.

What it all comes down to is expectations. Rather than dreaming of boom times, home builders are instead looking toward sustainable growth after years of decline. We can follow these expectations by tracking the National Association of Home Builders/Wells Fargo index of builder confidence.

The index hit 29 in February, rising for the fifth straight month. The last time the index increased for at least five months in a row was April-October 1995, according to Bloomberg. This improvement has gone virtually unnoticed — mainly because an index reading of less than 50 indicates that respondents find conditions in the housing market to be unfavorable.

In almost every category, home builders are seeing improvements. Sales expectations for the next six months advanced to its best reading since 2007. The same goes for buyer traffic, according to Bloomberg. This metric also recorded its best numbers in five years.

This is where my backdoor way to play the early stages of the home-building rally comes in. I recommend staking out the smaller, regional companies in the home builder supply sector. These are the companies that manufacture lumber products, vinyl windows, and doors. With business steadily improving for home builders, the suppliers in the best-performing regions stand to make early investors substantial profits.

Sincerely,

Greg Guenthner
for The Penny Sleuth

How to Beat Billionaires to Home Builder Profits was originally featured in the Penny Sleuth.

Heck, a well-placed trade ahead of earnings season can make a trader’s year…

But it’s not all excitement and anticipation during earnings season. There’s a flip side to that coin. That’s because while good earnings can pop shares higher, bad profit numbers can smash shares dramatically lower.

Quite frankly, it’s a lot like navigating a minefield!

All of that said, earnings don’t have to be a high-stress trading scenario for you. In fact, if you apply the right strategy, this time of the year can be very lucrative. Today, I want to show you three simple tricks that will help you take home bigger gains this earnings season.

First off, a bit of background. It’s important to mention that you don’t need to be a high frequency day trader to take advantage of the strategy I’m about to share with you. Even if you’re a long-term, buy-and-hold investor who spends more time looking at balance sheets and income statements than stock charts, this approach can help reduce your risks and put more cash in your portfolio.

With that, let’s dig right in…

Trick 1: Don’t Anticipate Earnings

The best way to avoid stepping on an earnings landmine is by not anticipating a stock’s earnings in the first place. That may sound like a bit of a letdown, but let me explain why this first trick is so crucial…

You see, a lot of newer investors get confused about the difference between trading and speculation. Put simply, trading is about exploiting advantages you can wring out of the market, whereas speculation is gambling. There’s a huge difference between the two — the biggest is the fact that under a well formed trading strategy you shouldn’t be capable of blowing up your account. As a speculator, you’re counting on random chance to make money.

99% of the time people bet on companies ahead of earnings, they’re speculating pure and simple. That’s why it’s a terrible idea to anticipate earnings.

I know that from experience…

A (long) while back, I was trading options on some large-cap stocks — names like Ford, Apple, and Citigroup — while I’d close most of my positions same day, one day I decided to hold onto Citigroup calls heading into the weekend as I waited for the setup to develop a bit further.

Unfortunately, while I was well aware of the market’s closure for a market holiday that Monday, I hadn’t factored it in when I originally set up my trading plan. Although I’d intended on selling the options ahead of Citi’s earnings (which would have given me a relatively nice gain), I got stuck holding the position and ended up closing out most of my contracts for a loss.

That’s a mistake I only made once. Don’t let it happen to you…

Trick 2: Look at Reactions

There’s more to a sound earnings season strategy than just sitting on the sidelines. In fact, you could actually make significant profits during earnings season.

Most people think that the biggest trading gains come by buying a stock ahead of earnings, then holding onto shares as they move higher. But that’s just not true — those are speculative gains, not trading gains. That logic is a lot like saying that the best way to strike it rich in Vegas is to hit a slot machine jackpot; it’s a true statement, but good luck actually pulling it off without going broke first.

Remember, we’re not speculators — so we’ve got to find an exploitable advantage. That’s where reactions come into the picture…

After waiting for a firm to announce its earnings numbers, you want to pay attention to how Wall Street reacts to the numbers. More specifically, how’d the earnings perform against Wall Street expectations, and how’s Mr. Market behaving as a result? (You can find analyst estimates for most stocks by going to major financial sites like Yahoo Finance.)

A stock that beats expectations and then rallies isn’t anything special. But a firm that misses earnings and either holds its ground or moves higher is a different story. That sort of unexpectedly positive reaction means that there’s some exploitable strength in shares. That could provide a good opportunity to be a buyer…

Trick 3: Rethink Your Analysis

Finally, after waiting for earnings to happen, then gauging reactions, it pays to put the puzzle together by rethinking your analysis. By that, I mean look back to the factors that made you interested in shares and decide how the market’s reaction to earnings changes your outlook.

Let’s say that you’re thinking about buying a stock because it just had a technical breakout. But you followed our first earnings trick and waited for the numbers to come out before buying shares.

Then, using trick 2, you noticed that even though earnings were missed, shares moved up a few points in the next session. That’s a very good sign.

Trick 3 involves looking back at the technical reasons you wanted to buy shares in the first place and making sure that the bullish earnings clues still jive with the stock’s setup.

If they do, you’ve got an especially strong buy signal on your hands…

Now, if you’re a fundamental investor, trick 3 may be as simple as seeing whether you’d still want to buy the company’s stock after it posted those lukewarm numbers. If your core reason for buying shares isn’t valid anymore, it makes sense to stay away. Earnings can turbocharge gains on a good name, but they can’t turn garbage into gold. That’s why it’s essential to rethink your analysis before buying.

When earnings season rolls around each quarter, that’s the exact process I go through on every stock I look at. By using these three simple tricks to trade earnings season, you can avoid the scariest risks in the market and pad your portfolio in the weeks ahead.

Happy trading,

Jonas Elmerraji
for The Penny Sleuth

3 Tricks to Playing Earnings was originally featured in the Penny Sleuth.