There is this notion that you have to make mistakes in order to learn. I do not know whether I generally believe in this but I truly hope to have learnt something out of my huge trading mistakes with Netflix. Then something good might actually emerge from me losing money. As I already indicated since I purchased Netflix in early December 2015 the stock lost 25% of its value. Today (27.01.2016) I finally and way too late sold my shares in this company. What had happened?
Well, first of all it has to be mentioned that I did not have any strong reason buying the stock in the first place. As the ignorant beginner I am, I did not analyze financial statements, the earnings prospects or any other indicator of the companies performance. I only knew that Netflix is a strong brand among people and especially the young (Netflix and chill?). The second thing I did was looking at the chart, seeing the incredible growth the stock has had in the last few years and then getting greedy and thinking that the past would equal the future. The rule I set myself was to sell if the stock lost 5% or more – well apparently that did not happen, did it? This is the thing that I hope I could learn with this trade – cutting my losses. Lets see whether that will work out better in the future.
From how not to invest to hopefully how to invest. In the following I´ll explain N, S, and L of the CANSLIM method.
In order for stocks to increase there should be something new. Something new could be a new product, new (preferably competent) management or new highs in the stock. Yes you heard right. O´Neil actually says that new highs are a good thing. He claims that between 1953 and 1993 95% of the best performing stocks belonged to companies linked to new products, new management, change in the industry or new price hights. When should a stock be bought then? Prior to buying the price should be at a new high or just coming out of a price consolidation. The paradox is that what seems too high often goes higher and what seems to low often goes lower.
Shares outstanding is of great importance because of the supply and demand aspect. The stock prices of companies with many shares outstanding seem to be harder to move and do not tend to advance as much as smaller capitalized stocks. 95% of the winning stocks analyzed by O´Neil had fewer than 25 million shares outstanding with an average of 11.8 million shares outstanding. Due to the this stock splits should be avoided. A positive indicator however seems to be the company buying back its shares from the public. This reduces shares outstanding and in this way increases earnings per share. The importance of this measure already has been emphasized in the last blog entry. Related to the supply and demand aspect is the trading volume of a stock. Trading volume should dry up during corrections and considerably increase on rallies (50%-100%).
Leader or Laggard
Laggard stocks and purchases out of sympathy should be avoided at all times. Rather leaders instead of laggards should be bought. For this relative price strength can be observed. This measure compares the price development over a specific period (6 or 12 months) relative to the overall market. The relative strength should be at least in the 70th percentile. The 500 best performing stocks of O´Neil´s analysis averaged a relative strength of the 87th percentile just before their major price moves. If the relative price strength has been deteriorating for at least seven month or there has been a sharp decline for four months attention should be paid. The stock may be of questionable performance in the future.
Next, Institutional Sponsorship (I) and Market (M) will be elaborated on.