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.

Liquidity is one of the most overhyped of modern financial ideas. In the context of the stock market, all liquidity means is that you can buy and sell easily. Lots of liquidity means lots of trading volume. It means the bid-ask spread is narrower in a liquid stock than it is in one that is illiquid.

As it turns out, the best opportunities are often the most illiquid. In what follows, we’ll take a look at illiquidity as an investment strategy.

Markets are more liquid than ever these days, but that is not all a good thing…

Back in 1960, investors held their stocks for an average of seven years. No one complained about a lack of liquidity. Today, people hold stocks for on average for four-eight months.

The ability to get in and out of a stock quickly means you have lots of sloppy owners. As Lowenstein points out: “Those who expect to sell out quickly and cheaply are more likely to buy for speculative or foolish reasons and to act as uninformed owners in between times.”

An illiquid stock is, by its nature, more likely to attract a smarter shareholder base. This is simply because the people going in know they can’t get out of it as easily, so they are more careful about how and why they get in.

This may have something to do with the outperformance of illiquid shares.

Roger G. Ibbotson and Wendy Hu of Zebra Capital Management studied the performance of liquid stocks against illiquid ones. They found that illiquid stocks tended to trade at a discount to more-liquid stocks. “Investing in less-liquid stocks thus pays,” they write.

Moreover, they found that less-liquid assets tend to become more liquid over time, thus helping to erase that gap.

Ibbotson and Hu also note that investing in less-liquid securities as a strategy has an advantage in that it “avoids, or invests less in, popular, heavily traded glamour stocks and favors out-of-favor stocks, both of which tend to revert to more-normal trading volume over time.”

That’s all fine and makes sense. But you can really see it in practice by looking at portfolios investors construct.

Nick Padgett and Stephen Mack are the managing directors of Frontaura Capital. The fund invests in frontier markets such as Cambodia or Mongolia. I’ve never met them personally, but hope to someday. I was introduced via email by my friend Doug Clayton at Leopard Capital. They share their shareholder letters with me, and the latest one had an interesting observation on this liquidity idea.

Frontier markets can be very illiquid. It can take weeks, maybe months, to buy even small positions in Mongolian stocks on the Mongolian exchange, for example. This means frontier markets are cheaper, but not always. Frontier markets have some liquid stocks. And the valuation disparity between the liquid and illiquid is great. The most-liquid stocks can trade at the same price-earnings multiples as S&P 500 stocks like Wal-Mart or Intel.

“Thus,” Padgett and Mack write, “those willing to invest beyond the most-liquid frontier stocks could have a performance advantage, provided they remain patient and committed during difficult market periods, when less-liquid stocks may perform worse.”

As evidence of the disparity, consider the MSCI Frontier Markets Index. It is made up of the largest and most-liquid frontier companies. Padgett and Mack don’t own a single stock in this index. “Many of these stocks are good companies,” they write, “but they do not trade at the most-attractive valuations.”

At the time of their letter, Frontaura’s portfolio had an average price-earnings ratio of 6 with a price-to-book ratio of 1 and a yield of 5%. By contrast, the MSCI Frontiers Markets Index had a PE of nearly 11, a price/book of 1.5 and a yield of 4%. Frontaura’s valuations are cheaper in the less-liquid names.

I offer another exhibit of an absurdly cheap illiquid stock: Siem Industries.

This trades on the Pink Sheets under the ticker SEMUF. Siem is a holding company in the oil and gas, marine transportation and shipping industries. Siem owns pieces of Subsea 7 S.A., Siem Offshore and Star Reefers. Siem Industries is another stub play, as these three companies are all publicly traded.

The stake in these three companies is more than double the market cap of Siem Industries.

Siem Industries owns other stuff, too. It owns 100% of Siem Car Carriers, which owns ships that carry cars. It has a stake in a private equity fund that owns a variety of Scandinavian companies. It has stakes in a potash mine and an insurance affiliate. None of this is counted above.

The catch?

The shares don’t trade much. Over the last three months, the average trading volume was 945 shares. That’s a daily volume of about $60,000. And that overstates it. I checked over the last 16 trading days and found that on 11 of those days, no shares traded at all. Not a single share. On many days, you’ll see 200, 400 or 600 shares trade. As I write, the bid-ask spread is enormous. You pay $74 per share to buy and get $63 to sell.

That, I think, is the big reason for the discount. But this is not a situation that will persist forever. In the meantime, there is a whopping discount to the patient shareholder, and probably a rewarding ending.

Note: Siem Industries is not an official recommendation. I think it’s too illiquid for me to recommend here. Too few would get in on the trade.

In any case, liquidity as an investment strategy is a useful idea, as these examples show.

Sincerely,

Chris Mayer
for The Penny Sleuth

Liquidity, Crack and the Quest for Better Returns was originally featured in the Penny Sleuth.

Last year, it was the hype around LinkedIn and Groupon. This year, it’s Facebook. Chances are you’re gonna get suckered. On average, studies have proven IPOs underperform the market by 30% in the three years after going public.

Here’s just one example: LinkedIn.

If you participated, you saw the share price climb as high as $122 on the very first day, before settling to $94 and a quarter. That’s a big jump from the $45 entry price.

However, most individual investors couldn’t see those gains. Institutions get first crack at IPOs. Those who jumped in after Day 1 have seen days of major disappointment when the stock traded as low as $59 and climbed back to only where it was bought at. So much for all the excitement…

IPOs mean buying something the insiders no longer want at a price they’d never pay.

Let’s not spend our valuable time lurking about in these statistics in The Journal of Finance. I see far better deals out there in the public offering markets right now. Allow me to share with you the one class of public stock offerings that I think are worth your time and initial investment.

You probably don’t hear about these — even though they routinely beat the S&P 500.

From 2002-March 2012, an index tracking this class of offerings beat the overall market by 226%. Look at recent history and you’ll find companies like American Express, Home Shopping Network and Marriott Hotels directly involved in these deals.

But despite these incredible returns, these offerings get none of the “hype” of IPOs. That’s why I call them “Hidden Public Offerings” (or HPOs)…

They’re hidden because they just don’t get the press that IPOs do, but they’re a great way to exploit inefficiency in the market to help you outperform in your stock portfolio.

How Do Hidden Public Offerings Work?

When company insiders want to maximize the value of an asset they own, they may chose to do so by “splitting off” a section of their business into a wholly separate business. You can buy shares in that new business. This is referred to as a spinoff or Hidden Public Offering.

I consider spinoffs to be hidden because they don’t jump off the investment shelves the way IPOs do. Often, the asset itself is “hidden” on the balance sheet of a company; it’s not the main item that attracts present shareholder interest. Yet the asset will have a real value on the open market (often not the same value it holds on the parent company’s balance sheet). A spinoff helps “discover” the true value of that asset.

There are several benefits to the company (and present shareholders in the parent company) when a new business is spun off of the old. The parent company and its shareholders retain equivalent shares in the new company. They can buy or sell the new shares as they please. New investors can get into the new company at a price they might not have paid for the parent company.

How Can I Track Spinoffs?

If you want to track these stocks as a group, follow the Bloomberg U.S. Spin-Off Index. You can find it under the ticker BNSPIN.

But there’s no super-secret spinoff “tip sheet” that shows you what stocks are planning on spinning off assets in the next, say, 12-36 months. That’s why Mayer’s Special Situations exists, to point out such choice one-time events to readers as these Special Situations develop. It’s not as if I can say to you right now here are the spinoffs, here are the dates, the tickers, have at it! It takes time and research and sleuthing… That’s what a balance sheet detective like me does best.

I sniff out assets that could benefit in the case of a spinoff. I also do as much due diligence on the CEO and the big company directors and other insiders as I can. I’ll even ring a CEO up on the phone. He won’t be able to tell me if there’s a spinoff in the works… but many times, you will find the suggestion or hint of these kinds of value-creating shareholder actions in a public SEC filing or quarterly conference call.

Even if you did have an advance “peek” at the Hidden Public Offering list of spinoffs, you still need to vet out the candidates for investment. As with IPOs, not all companies are good bets to take.

My excitement for spinoffs depends on what price the new company starts trading at and the particulars of the deal. The form I need to see for that is the S-1.

One spinoff to watch out for is one in which the company is spinning off an undesirable legacy business that just might not have a future they want to be a part of.

A case like this is Loews Corp. (NYSE:L). I like Loews because I like the Tisch family, a dynasty begun in true American fashion just after World War II. The Tisch brothers paid out $375,000 for an old New York hotel with help from their parents. They went on to snap up hotels in Atlantic City and Manhattan. In 1968, they acquired Lorillard Tobacco, using that steady cash flow to fund other operations and, most importantly, smart acquisitions. By 1995, you could have found the Tisch brothers on the Forbes 400 list of wealthiest Americans, at $1-2 billion net worth. Loews, their main investment vehicle, continues to deliver solid returns to this day. If you’d put just $1 into Loews in 1959, it’d be worth over $1,622 today. And that’s not even accounting for the dividends Loews paid out over the years.

They follow three simple investing rules:

1. Always assess the downside.

2. Invest in assets, not management.

3. Our day will come.

Now, here’s why I mention it. You can use these same rules to decide why it’s no longer best to keep hold of a business you own. In Loews’ case, the thing to jettison was Lorillard Tobacco.

Lorillard used to be Loews’ cash cow, funding acquisitions during down markets when other assets (like drilling rigs or pipelines) were cheap. But those heady Mad Men cigarettes-in-every-meeting days are long gone. As the legislation changed in America, and as sick smokers started suing, Lorillard became something of a “surprise litigation risk.” It wasn’t a business I liked for Loews down the road, and I was very happy the day they announced they were spinning it off.

Forget IPOs. Luckily for us, we’re in the sweet spot of HPOs.

Joe Cornell, a 15-year veteran in the field and head of Spin-Off Advisors reveals, “I don’t remember the spinoff calendar being this robust. This is going to be the biggest year ever for spinoffs.”

I also think this year could be a record-breaker.

What kind of market are we talking about? Well, 2011’s spinoff values were double what they were in 2010. Back in 2000, the spinoff record was $265.5 billion. That’s the one to beat.

Sincerely,

Chris Mayer
for The Penny Sleuth

Hidden Public Offerings was originally featured in the Penny Sleuth.

This market is a minefield. You must prepare to deal with unpredictable prices, panic, and disorder. Ever since stocks began to sputter, investors have frantically jumped back and forth between long and short positions. Most of the time, the crowd has been dead wrong.

You cannot afford to be a delirious stock-chaser. In fact, your actions during the market’s most turbulent weeks will ultimately determine whether you will hang onto first quarter gains — or lose everything because of a few poor decisions.

MacNeil Curry, head of foreign exchange and interest rate technical strategy at Bank of America Merrill Lynch, offers the perfect explanation of the market’s mob mentality. “We lose our minds collectively, but we come to our senses individually,” he said.

These words of wisdom are especially true today. The market’s quick drop has punched unsuspecting investors in the face. Now, as we struggle to get back up and regain our senses, it’s important to use the market’s collective insanity to your advantage.

Here’s how:

Wait for confirmation before you act.

There is no prize for someone who guesses on a trend early. This rule is especially true when the trend is changing in the blink of an eye.

It’s never smart to guess on a breakout (or a breakdown) before it happens. You’ll be right sometimes, but wrong enough to offset any of the gains you booked when you got lucky. When the market is coming back to its senses, stocks will suffer from countless false moves. Breakouts will fail. Or a stock will break above a key moving average and then promptly fall below it the very next day. Indecision reigns supreme right now. Many traders will shorten their time horizons, meaning they will take profits almost immediately after a trade turns green.

That’s why waiting for confirmation is so important. If you’re attempting to trade a breakout, wait for the stock to retest the breakout zone and move higher before buying. Once the traders with shorter time horizons have been flushed out of a trade, additional buyers stabilizing the stock and sending it higher signal that the breakout was real. A retest of the initial breakout is additional confirmation that resistance has turned into new support. Buyers are willing to pay higher and higher prices for the stock, allowing the new trend to develop.

Avoid crowded trades.

Twitter has become a fascinating hub of stock market opinions. Every day, millions of market watchers share trade ideas, brag about their winning moves, and argue with those posting dissenting opinions. It’s the perfect place to go to see how investor psychology shapes the markets.

Take Apple Inc., for instance. As the most popular publically traded company in the U.S., Apple elicits strong opinions from longs and shorts alike. On Twitter, these opposing forces battle in real-time. At any given moment, you can unearth thousands upon thousands of tweets about Apple stock. It’s an epic argument with no end in sight.

The Apple saga came to a boil yesterday just before the closing bell. The stock had dropped in ten of the previous eleven days. Shorts positioned themselves for a weak earnings report, while longs scooped up shares at a discount from recent highs. So when Apple announced spectacular numbers last night, the squeeze was on. Shares immediately rocketed double-digits, trapping shorts and rewarding anyone who bought before the bell (at least for today).

However, Apple is one of those stocks traders should have avoided — long or short. There’s too much attention on the company and too many predictions and speculation as to where the hottest stock in the world will finally land. It’s a crowded trade that has become more of a gamble than a safe bet.

When everyone’s eyes are glued to a stock, it’s best to stay away. The obvious play can easily turn into the wrong play. A far as I’m concerned, betting long or short on a crowded trade is gambling. Any surprise information can cause wild price fluctuations. If you’re caught on the wrong side of the coin, you stand to lose big.

When in doubt, stay out.

My final tip may seem simple. But it’s one of the most difficult pieces of advice to heed…

If the trend is volatile and sideways, it’s usually best to say on the sidelines. Remember, cash is a trade. When you are in a cash position, you’re effectively betting that market conditions will change to a strong up or down trend at some point in the future. It’s a strategic, defensive move. You don’t always have to be “in” the stock market.

One of the main reasons investors buy into stocks at the wrong time is because of fear. They are afraid they will miss out on a new trend if they stay on the sidelines. But more often than not, always taking either long or short positions is not always best for your portfolio. And if you do end up sitting on your cash for several weeks, you will be better positioned than many of your trading peers. You won’t be stuck paying commissions on several stopped-out trades. You’ll also be mentally refreshed and ready to take advantage of the market’s next move.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 “Turning Point” Trading Tips was originally featured in the Penny Sleuth.

Somewhere a real estate man with dirt under his shoes and drywall dust on his shoulder must’ve had a hunch that skyscraper booms happen just as things go bust. But it took an economist to put it down on paper and create an index.

In 1999, economist Andrew Lawrence did just that. He created the Skyscraper Index. It showed that the tallest skyscrapers sprouted just as business withered.

Its ability to predict collapse is surprisingly accurate…

In a 2005 paper, economist Mark Thornton took a stab at vetting the index. He wrote that “the Skyscraper Index… does have a good record in predicting important downturns in the economy.” And most recently, Erste Group Research released a report in March that calls the track record of the Skyscraper Index “impressive.”

Here’s how it worked in Dubai. The Burj Khalifa took the crown of world’s tallest building from Taiwan’s Taipei 101 in 2007 — just before the onset of the global financial crisis. Here the Skyscraper Index worked perfectly. (And Taipei 101 itself fits the theory of the index too. Construction began in 1999, just before the tech bubble reached its peak.)

Some of the index’s successful past signals:

• The Singer Building (1908) and the Met Life Tower (1909), both record-setters, began before and were completed after the Panic of 1907 — which Thornton calls “one of the sharpest downturns in American economic history”
• The Chrysler Building (1930), and then the Empire State Building (1931), heralded the Great Depression
• The World Trade Center (1973) and Sears Tower (1974), were both completed amid the 1973-74 economic crisis
• The Petronas Towers in Malaysia (1998) began construction on the eve of the Asian Crisis.

The Erste Group also points out that three of the four highest skyscrapers in Europe were finished in Madrid as the Spanish property bubble was set to pop. There are more examples that fill out the theory, but you get the idea. What first appears to be a fun plaything suddenly looks very real.

What does the Skyscraper Index say today?

It is flashing major warning signs over China and India. A Barclays report in January — written in part by the aforementioned Andrew Lawrence — shows that most of the skyscrapers currently under construction are in China and India.

China has more than half of the world’s 124 skyscrapers under construction. In the next six years, it’ll double its collection. Barclays notes, “China’s skyscrapers are not only increasing in number… but the average height of the skyscrapers that it is building is also increasing.”

In India, only two of its 276 skyscrapers are more than 787 feet tall. However, in the next five years, India will have 16 more. One of these is India Tower, which will be the world’s second tallest when finished.

Barclays comes to the bitter but inescapable conclusion:

“The writing, so to speak, would seem to be already on the glass curtain walling. For if history proves to be right, this building boom in China and India could simply be a reflection of a misallocation of capital, which may result in an economic correction for two of Asia’s largest economies in the next five years.”

Looking further out, the Skyscraper Index flags little Azerbaijan. Yes, Azerbaijan. The small country sits on the crossroads of Eastern Europe and Asia. Size is no impediment to putting up skyscrapers of mind-numbing height. As Erste reports, “The world’s highest skyscraper is currently in the planning stage in Azerbaijan. The Azerbaijan Tower will be 3,444 feet high and thus overtop the Burj Khalifa by 728 feet.” It is set on an artificial island — one of 41 — in the Caspian Sea. The country aims to be the “Dubai of the Caspian Sea.” Construction begins next year and is set for completion in 2019.

Oil and gas account for half the country’s economy. Might the builders of the Azerbaijan Tower be taking high prices for oil and gas as a given? “One could interpret this situation as a long-term warning signal for the oil price,” Erste guesses.

To me, the Skyscraper Index is another caution flag to add to the mix. China’s and India’s booms fuel the need for steel and oil and copper. It is a time to be extra careful investing in these themes.

Sincerely,

Chris Mayer
for The Penny Sleuth

The Skyscraper Index was originally featured in the Penny Sleuth.

I’ll admit, treasuries aren’t the most exciting investment out there. That’s why they’re typically relegated to people like me — professional investing nerds — most retail investors don’t go talking about the latest t-bond series they bought; stocks are more interesting, easier to relate to, and they historically generate much bigger gains than treasuries.

But treasuries can give investors major hints about where the stock market is going. That’s why every stock investor needs to pay attention to treasuries from time to time. Let me show you how…

Let’s start at the beginning. The term “treasury” is a catch-all word to describe debt issued by the U.S. government — when Uncle Sam needs to borrow money, he issues treasuries. Because lending money to the U.S. is essentially considered risk-free, treasuries don’t pay a whole lot. In fact, treasuries have lately offered up investors negative real yields thanks to the impact of inflation; so why would anyone want to buy them? We’ll get to that…

As an investor, it’s critical to remember that anything you invest in doesn’t live in a bubble. You probably already realize that your investment in a single stock can be impacted by what’s going on in the market on any given day. Well, the stock market can be impacted by what’s going on in other markets on any given day.

The reasoning is simple — the thing that all the major asset classes (bonds, stocks, and commodities) have in common is who their market participants are. In other words, if I’m a sophisticated investor, I have the option of investing in a combination of stocks, bonds, and commodities. Because all of the money is coming from the same place (my brokerage account), the markets are interrelated. There are a few other reasons why markets are interrelated, but for our purposes today, the flow of funds from stocks to bonds (and vice versa) is the most important one.

So, back to why the heck anyone would want to buy treasuries to earn a negative return…

People buy treasuries because they’re a safe place to park cash. That means that when people buy treasuries at current rates, they’re willing to essentially pay for the privilege of staying away from “scarier” assets like stocks and commodities. It’s a move that reeks of desperation…

But it’s one that tells us a lot about the stock market. After all, if people are so desperate to get away from stocks that they’re willing to effectively pay the government to hold their money, you know that investor anxiety is a real problem. And for most of 2012, it has been.

Treasury prices have been sitting at historic highs for months now, without any real signs of backing down. We know that’s a bad thing, right? After all, if treasuries are high then that tells us that people are still extremely anxious about stocks, and money is still being withheld from the rally that Mr. Market’s been enjoying for most of 2012. That’s not the type of behavior we’d expect to see during a rally. Worse yet, extreme investor anxiety levels mean that stocks could get knocked lower much more easily than if there was more buyer participation taking place in stocks.

But something changed in the last week or so. The chart below shows the relationship between the S&P 500 and 10-year treasury notes:

That recent pullback in the orange line means that treasuries are finally getting sold off in favor of stocks — a very good sign. It’s only the first step though — there’s still a lot of money in treasuries right now. The flip side to that coin is that there’s a lot of money that could move into stocks and help support this rally. Expect more selling in treasuries to make current treasury owners question whether they should be switching that money to stocks right now…

Yes, treasuries are too boring for most investors. And obviously, treasuries aren’t a very good place to park your money when stocks are rallying. But, as I’ve just shown you, watching the treasury market can give you a significant leg up on what’s going on in the stock market.

I’d recommend occasionally checking on how treasury prices are moving compared to stock prices. You can see both charts together by clicking here.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why Treasuries Point to Gains in the Stock Market was originally featured in the Penny Sleuth.

Along with his half-sister, he performed in a dance number with Bob Hope and Judy Garland. That appearance helped ignite what would become a very successful career in show business. By 1956, the duo became one of the most popular dance acts in the world.

But this story isn’t about dancing. It’s about one of the most successful amateur investors of his generation — who just happened to be a popular professional dancer…

His name was Nicolas Darvas. As a young college graduate, he escaped Hungary with a forged visa during World War II. Putting his degree in economics to good use, Darvas began to dabble in the market in the early 1950s — right when his dance career was taking off.

But he didn’t mint his millions until 1957, when he was worlds away from Wall Street. Here’s how he did it…

Darvas spent considerable time perfecting what he called his “box theory.” Essentially, he would track a stock’s weekly movements and record (or “box”) the trading range. He would buy names that interested him when they successfully broke out above his boxes.

The technique Darvas used is very similar to other early forms of stock charting. Keep in mind this was the 1950s — long before stock charts were readily available at the push of a button on your computer. If you wanted to chart the price of a stock, you had to do it yourself.

News also moved slower in the 50s. And since Darvas’ dancing career kept him overseas for years at a time, he was consistently behind on the financial headlines.

Darvas actually credits his distance from Wall Street for much of his success. During his travels with his dance troupe, he relied on his broker to mail him copies of Barron’s so he could keep up with his stocks. Then he would send telegrams from his hotel when he wanted to buy or sell a position.

Because he was overseas, Darvas wouldn’t receive his newspapers until they were already out of date. The news was stale by the time it got to him — so he ignored it. This allowed him to focus on his box theory without the distraction of the news cycle influencing his thought process.

By isolating himself from the financial news, Darvas was able to grow his brokerage account to more than $2 million in less than two years.

However, when Darvas eventually returned to New York, he was not able to replicate his results. Word of his success has spread. And his constant contact with newspapers, brokers, and other investors took its toll. He simply couldn’t execute his trading system with the distraction of endless financial news and stock tips.

To regain his edge, Darvas again isolated himself from the Wall Street crowd. He quit reading the news again — and even went so far as to have his broker tear out the weekly stock prices in Barron’s to send to him. That way, he wouldn’t be tempted to read any news items about his potential trades.

The experiment worked, and Darvas went on to write several books about his trading experience, most notably How I Made 2,000,000 in the Stock Market.

It’s a fascinating story and a great read — one that still applies to you, even in the age of the internet, smart phones and instant news and information. The fact is, news consumption can greatly affect your trading and investing. I would even say that it could be damaging your returns.

Sleuth contributor Chris Mayer recently considered reducing his news intake. He cites an essay by Rolf Dobelli, a Swiss entrepreneur, titled “Avoid News.”

“Dobelli makes the case that news makes us distracted, wastes time, kills deeper thinking, fills us with anxiety and is toxic to our mental health. His analogy: ‘News is to the mind what sugar is to the body,’” Chris writes.

“News is mostly irrelevant,” Chris continues. “Dobelli says to think about the roughly 10,000 news stories you’ve read or heard over the past year. How many helped you make a better decision about something affecting your life? This one hit home.”

Think about how you research a new stock or trading idea. What’s the first thing you do? If I had to guess, I would say that you fire up your computer to see what the financial media or bloggers have to say about the topic. It’s an understandable impulse. After all, we want confirmation that our ideas are valid. But is it really helping you think critically?

In his essay, Dobelli recommends ignoring newspapers, TV news and internet news. And he says to delete the news apps from your iPhone.

So how will you be able to keep up with the world after you kill your personal 24-hour news cycle? Here’s a list of alternatives Chris has compiled:

• Read the shareholder letters of successful investors. I like reading Steve Romick at FPA, for instance. I also enjoy the shareholder letters of the Third Avenue family of funds. There are many others. Read any research such investment houses share

• Spend little or no time trying to guess where you think the market and economy will go. Instead, focus on finding good deals and winning teams of entrepreneurs and investors that you can invest alongside

• Listen in on the conference calls of your favorite companies and investors

• Check the stories and prices on your stocks once a quarter

• Read books written by successful investors. Then read them again. Some of my favorite authors include Martin Whitman, Seth Klarman, Peter Lynch, Ralph Wanger, Benjamin Graham and Joel Greenblatt. I’m sure I’m leaving a bunch out, but you can put together a truly awesome library of successful investors for little money

• Read books that deepen your understanding of markets and how they work. Read Louis Lowenstein and James Grant, for two of my favorites.

“Print it out. Turn off the smartphone. Stop checking email for 25 minutes,” Chris writes. “Be forewarned: It might just change your life.”

Best,

Greg Guenthner
for The Penny Sleuth

Kill Your iPhone – and Win With Stocks was originally featured in the Penny Sleuth.

Today, I want to show you three indicators you can use to spot the “end of the financial world” — and how you can position yourself to profit from it.

No, I’m not suggesting that the floor’s about to fall out from the market right now (in fact, my premium readers know that I’m cautiously bullish at this moment), but I am suggesting that since the crowd mentality is looking for gains this month, it makes sense to have a contingency plan for your portfolio.

Looking for signs of a financial meltdown isn’t exactly the equivalent of wearing a tinfoil hat in the real world. U.S. stocks have seen massive draw downs shake market performance a dozen times in the last few years alone. But by knowing what to look out for, you can actually profit from the next rough patch in the financial world.

Financial meltdowns don’t just happen. Before the S&P takes a nosedive and the talking heads start panicking on CNBC, there are telltale signs that point to the problems that are about to unfold on Wall Street. It’s just that no one pays attention to them.

That may sound hard to believe. After all, why would someone just ignore a warning sign hitting the stock market? The biggest reason is that financial markets are ruled by crowd mentality — and the crowd is always wrong at key turning points.

The only way to avoid falling into that trap is by constantly thinking about “what if” contingencies that could arise. It’s one of the cornerstones of contrarian investing…

But it’s not enough to think, “What if the market folds now?” To take advantage of a collapse, you’ve got to focus on the specific indicators that send you a red flag — as well as the market moves you’ll take to position yourself accordingly.

1. Rates Fall Lower

Right now, interest rates are sitting at historic lows. That’s proof positive that investors are still anxious about investing about stocks in 2012 — lots of people are happy to forego meaningful returns just to avoid seeing their portfolio move lower. It’s a situation that folks in the industry like to call “return of capital rather than return on capital”…

But as low as rates are, they aren’t in panic mode yet. That happens when 10-year treasury yields slide below 2% for a sustained period (they’re safely at 2.02% as I type) and very near-term treasuries go negative.

Too many people — professionals included — fall into the trap of thinking of treasuries as “fixed income instruments”. They look at factors like inflation and government debt ratings to make projections on treasury prices. That’s all well and good when times are fairly normal, but that goes out the window during a crisis.

Instead, think of it this way: when the yields treasuries pay out go negative, it means that people are so terrified of stocks that they’re willing to pay the government for the privilege of lending them money, just because they know they’ll get their principal back. That’s a scary scenario to be in the market during — we came close during the latter half of 2011, but it didn’t happen. You can keep track of treasury prices right on market data sites like Google Finance.

2. The TED Spread Increases

In the doomsday scenario, treasury yields are likely to fall hard as investors buy up risk-free assets. But not all interest rates are going to fall. The TED Spread, an indicator of the riskiness of financial institutions is likely to rise as banks start to run into liquidity problems.

Logically, that makes sense — with investors eager to avoid risk and put all of their cash in treasuries, banks are going to have to pay a higher premium to get ahold of cash…

While the spread has fallen dramatically since the start of the new year, it’s proven an effective indicator of risk in the financial markets. It’s the second piece of data to keep an eye on. You can watch the TED Spread on StockCharts.com by clicking here…

3. Gold Prices Rise

The final nail in the coffin is rising gold prices. An increase in gold prices is a technical signal that investors are running from risk assets in the stock market but that they’re still willing to buy somewhat risky diversification in the form of gold.

You see, gold isn’t really a metal — from a macroeconomic standpoint, it acts much more like a currency. By seeing gold prices rise when treasury yields drop and the TED Spread rises, you’ve got confirmation that gold is primed to benefit from the financial storm, just like it did in 2008 and 2011.

Putting It All Together

So, let’s put it all together. Let’s say you’re taking your monthly contrarian look at the markets and you notice something… 10-year treasuries are yielding less than 2%; the TED spread it hitting new highs; and gold prices are breaking through new highs as well. In that situation, you’ve got a potential scenario for a financial meltdown. The antidote is fairly simple:

Buy gold, hold treasuries, and sell stocks.

Why that combination?

Investors are going to buy gold and treasuries as an “anti-stock trade”. If you own treasuries at that point, that’s great — you’ve probably already enjoyed some capital gains in them, and they’re worth keeping. But gold has much more potential to deliver high percentage gains by the time our indicators are throwing out a red flag. At the same time, stocks are going to be the most hated asset class of them all, just like they were in the third quarter of 2011; it makes sense to unload the worst offenders from your portfolio at that stage.

Spotting the end of the financial world isn’t easy. It goes against human nature to turn against the crowd and take a contrarian viewpoint of the market. But investors who follow these three simple indicators can avoid major losses and collect big gains the next time a crisis rolls around. Plan to take a contrarian look at the market at least once a month to stay ahead of the game…

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Profiting From a Market Meltdown was originally featured in the Penny Sleuth.

That’s an understandable reaction. Futures are volatile, and they’re fraught with hypothetically unlimited risk. Futures have been known to wipe out multi-millionaire professional traders… so, it’s no surprise amateur investors prefer to keep their distance from them. But they’re also one of the best tools you have to predict what’s going to happen with stock prices.

Today, I want to show you how you can easily use futures to see what’s about to happen in stocks, as well as what’s on the horizon for the economy…

First off all, let’s start off with a definition: A futures contract is an agreement between two parties to exchange a specified asset at a pre-determined date for a pre-determined price. Futures have been around since the days of Aristotle, providing a way for farmers to lock in the prices of their crops ahead of time, erasing some of the uncertainty of their harvest.

If a farmer wanted to lock in a good price on his wheat crop, for instance, he could pre-sell all of that wheat to a baker with a futures contract, and avoid unforeseen price swings in the wheat market. The baker benefits too, because he’s able to lock in his wheat costs for a loaf of bread this year.

Futures are still used by major growers, but they’re not limited to soft commodities (stuff you can grow) anymore. Today, there are futures available for everything from stock indexes to interest rates to orange juice…

But I’m not suggesting that you start trading orange juice futures like Eddie Murphy and Dan Aykroyd in Trading Places. Instead, I want to show you how you can use these financial instruments as a prediction tool.

Because futures are available for financial indexes, such as the S&P 500 or the NASDAQ Composite, we can get some early insights about where the market is headed. You see, futures trade outside of normal market hours — while you have to wait until 9:30 Eastern for the NYSE to open for regular trading, futures on major stock indexes are trading almost around the clock. That means that futures prices can give you a preview of the day’s open hours in advance…

This morning, the S&P 500 opened down approximately 0.5%— but investors who were looking at futures this morning got a preview of today’s price action several hours in advance. In the real world, that sort of advance notice could be enough to tell you whether today’s going to be a good day to take on a new position, or whether a stop loss level is going to get knocked out. Having the extra time to prepare for a trade can be crucial.

To be sure, futures aren’t the only option for investors looking to get a preview of the day’s price action — pre-market trading can offer a similar glimpse at individual stocks’ likely behavior. Even so, because futures tend to be more liquid than most pre-market names, they’re a better indicator of what to expect.

Futures aren’t just good short-term predictive tools for stocks — they’re also a valuable way to preview economic data such as inflation.

Remember, futures got their start as a way to price commodities. Today, when people talk about the price of oil, gold, cattle, or timber, they’re typically talking about futures prices. Because commodities are directly related to inflation (increasing commodity/raw material prices means that you’re paying more for the goods you buy), they can be a good indicator of what’s going on with inflation…

So, if futures contracts for oil, timber, and silver are rallying, chances are that those increasing prices are going to get passed down to consumers and increase the rate of inflation. For income-focused investors, that’s an important observation; after all, high inflation eats away at the real yields you’re getting on stocks and bonds. (Of course, the opposite is true too.)

From stock prices to inflation, futures are the tool that can give you extra insights into the market. So, how do you actually use them?

While you can’t yet get futures data on popular sites like Google Finance, futures prices aren’t hard to find. If your broker offers futures trading, then they’re the best place to turn to get real time futures pricing data. Otherwise, a number of websites offer delayed futures prices for a number of different instruments (Bloomberg’s futures page is one example. StockCharts.com also offers free end-of-day charting for a number of different futures products here.)

Your preview of the market’s action may be as simple as opening your trading software, or logging onto your favorite financial site. It’s an effortless way to get advance notice if a major trading day is shaping up.

Whenever you’re planning on making a trade, I’d recommend sitting down early that morning and checking out what’s going on with E-mini S&P 500 Index Futures (if you can’t spot them right away, the ticker is usually ES or /ES depending on your data provider). If futures are pointing to an unusual open, you’ll have that much more time to plan your next move.

Even if trading futures isn’t your cup of tea, this tool can still provide a substantial amount of information to any investor. Whether you’re looking for a preview on inflation or just a jump on the morning’s open, you should add futures charts to your trading toolbox.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Preview Stock Prices Using Futures was originally featured in the Penny Sleuth.

But an announced price raise in the company’s cheapest content streaming and disc-by-mail package has attracted harsh criticism from users across the internet. Many customers are even threatening to cancel their subscriptions.

So, is this the beginning of the end of Netflix’s popularity and dominance of the movie rental biz?

Not likely.

But before I get into exactly why Netflix should continue to grow its business, let’s take a closer look at the price hike that’s created so much negative attention.

The change is in Netflix’s cheapest service level. The original plan allowed customers to stream movies over the internet and rent one DVD at a time through the mail. For $9.99 a month.

Netflix has now nixed this plan. They are forcing customers to pay $7.99 per month for a streaming-only service. And then another $7.99 per month DVD-by-mail service.

Keep in mind that most newer releases are not yet available for streaming over the internet. If a customer wants to see a movie that came out within the past couple of months, he would have to receive it by mail. So someone wishing to have the same access as the old $9.99 plan would have to fork over almost $16 per month now – that’s a 60% increase.

Despite such a drastic change, I doubt the higher priced plans will dampen Netflix’s long-term success.

Consider this: Netflix has spent the last decade squashing the competition. Alternatives are few and far between. Remember Blockbuster? Netflix crushed its entire store-based business model. Sure, Blockbuster has DVDs by mail now, but no streaming service. Despite the lack of new releases in its streaming library, Netflix still enjoys little serious competition online.

Redbox, owned by Coinstar Inc. (NASDAQ:CSTR), could be considered a more formidable competitor when it comes to new releases. The company’s automated movie rental boxes are convenient and cheap (as long as you don’t hold on to the disc very long). But again, there’s no streaming option here either.

The new releases issue is where much of the frustration lies. Customers are craving new, constantly updated streaming content— yet there’s nowhere to get it. This is the hurdle Netflix will eventually have to clear. But it’s nearly out of the company’s hands. According to the Wall Street Journal, “many studios’ films are tied up by long-term deals between the entertainment companies and traditional distributors like Time Warner Inc.’s HBO.”

A mass exodus from Netflix seems unlikely at this point— especially since customers have few comparable options. The initial shock of the price increase will eventually dissipate. Consumers will reluctantly fork over the extra money, just like they do for the much-maligned cable and satellite providers. Entertainment commands a distinct importance in American homes— and and extra $7 isn’t going to be the ultimate deal breaker.

Sincerely,

Greg Guenthner
Penny Sleuth

The Beginning of the End for Netflix? was originally featured in the Penny Sleuth.