Investing Performance:

In Search of Entry Points

High Performance Investing Date: 15 October 2018

Improving investor performance comes with the price of consistency. Ralph Waldo Emerson may consider, "A foolish consistency is the hobgoblin of little minds", for improving performance it is critical. To increase wealth, we must create policies and procedures as part of a larger investment process. This enables review of the decision making that went into the positions we start, end or hold. Aspiring to deliver 10alpha,planning, discipline and review of our decision-making are the enablers.

Finding higher probability entry points is no different. We have a process we use that is the result of several years of honing. It can still be improved. More importantly, as market dynamics change, we must change some details of the underlying procedure.

There is no real 'special sauce' to this process: a mash-up of a bunch of traders' processes would ultimately lead you to something similar. The really important part is for the investor to have the discipline to follow it and take the time to appraise results.

Let's take a run through the process using Adobe as an example.

Strategic Review

Analysis must begin with a strategic review of the market. Ours has not changed though yours may have. We remain confident that the market is bullish, that we'll end the year around 3000 on the S&P 500 and that we do not have the foresight to tell when the recovery from this correction will happen.

We are also prepared to change our mind in a New York minute. And, we have a portfolio level hedge on to buy time for turning the ship.

Geopolitical issues are ripening; oil prices are volatile; tariffs are the sword of Damocles for small and large business alike; we are into earnings season without much excitement and President Trump is doing the Michael Jackson moon-walk on the economy blaming the Fed.

Our view could change on dramatic political changes at the mid-term elections; impeachment gains momentum; shooting war breaks out; President Trump bows to the pressure to back off on tariffs; or Kanye West goes Democrat.

Sector Review

Adobe is in the Technology sector. Our view is that this is the highest growth sector available with the least risk.

Given the volatility in the Tech sector, this may sound odd. The other great growth industry is BioTech; volatility there outstrips Tech though the occasional rewards seem nice. From a risk perspective, that variability in outcomes makes Tech the better choice.

For many investors, having a significant part of their portfolio in high growth has rewarded them nicely for quite some time. They are accustomed to it. And, frankly, not much has changed in the sector other than investor opinion.

Equally, hedge funds and institutional money are heavily reliant on the sector for performance. With Tech representing some 26% of the S&P 500; any Alpha will require Tech participation.

So, we'll take the view that Tech is fine, will recover and deliver a bullish contribution to our portfolio.

Here is a chart of ADBE showing daily candles with 200, 50 and 20 day moving averages. It also includes the Ichimoku Cloud and Fibonacci series from the most recent low in December of 2016.

ADBE Daily Fibonacci Entry
Point Selection

Equity Review

Price action of a given equity will be impacted by the Market, Sector and its own Company performance. There are a lot of opinions on what the ratio of impact might be. Our view is that it is mostly about relative impact without trying to pin a number on it.

Most often, the Market has the larger relative impact. Equities struggle to run counter to the overall market. Those that do so likely have something special going on that is worth looking into.

The Sector has the next largest impact and the action is the same as the Market: equities will struggle to run counter trend and if they do, a second look at why could identify something special.

The Equity has the least impact of the three most of the time. Special cases are so numerous it may well be that the exceptions proves the rule. Earnings, senior leader departures, stupid comments by CEOs (getting Zucked and Musked), SEC investigations, social media outbursts, food poisoning, merger talks, etc. And the list goes on.

Long term momentum

We know of nothing special happening for ADBE. The most recent analyst posting was RBC reaffirming its outperform rating with a target of $288, perhaps a 20% move over the next year. so, we remain comfortable with its momentum and expect it to recover at least as quickly as others in Tech.

200 day moving average

ADBE has just bounced off the 200 day. Recall from our discussion on Calling the Bottom that trends and moving averages need to be drawn with a very fat pencil. This is the case of close is good enough, just like hand grenades and nuclear weapons. Stocks know nothing about any of this techno-babble but the big boys have an army of 'quants' making a case for action. Nearly all put a lot of weight on the 200 day.

20 day moving average

The 20 day is an indication of shorter term sentiment. It is clear from the chart that is has yet to turn. Some people also use On Balance Volume to see if the stock is being accumulated or distributed.

Ichimoku cloud

The Ichimoku Cloud is a useful construct, well worth adding to your tool box. It displays a view of support, resistance, momentum and trend in a single view.

For bullish positions, look for rising price action into or above the cloud. Above is higher probability than when the price is in the cloud.

In our case we are below the cloud and really cannot say that the price is showing a legitimate rise.

Price action

Stable stocks rarely go up or down in a straight line. Instead, they tend to make a move, consolidate or pull back and then make another move. Consider that it is people, or algorithms written by people, making decisions that move the price. Nearly everyone likes to invest something and then watch to see what happens. As the stock moves fewer new entrants show up.

We are really looking for a situation where there have been pull backs yet the overall trend is higher highs and higher lows. Or on bearish positions, lower highs and lower lows.

For ADBE, we want to improve our probability of choosing when to enter by identifying whether we are on the red or green path as depicted in the chart. The only way to do that is to have at least 2 higher highs and we can consider entry on the second higher low.

For each additional higher high/lower low pair, the probability of choosing the new higher low as an entry point being successful increases. Essentially, the trend is your friend.

Unique events

Always be on the lookout for unusual events, even if they are scheduled. Changing CEOs, CFOs, earnings, even dividend payouts can affect both the stock price and the Implied Volatility. While there are many special techniques for profiting from events, that's a story for another day.


Here is the result of our check list:

Check list:
Market: positive
Sector: positive
Momentum: long term momentum favorable
200 day: above the 200 day moving average
20 day: turned up
Ichimoku Cloud: above or rising through Ichimoku cloud
Price action: 2 higher highs and second (or third, fourth, etc.) higher low
Events: more than a month to earnings or other events

Clearly, the time is not ripe for ADBE. Any decision otherwise is irrational and effectively guessing.

Looking at the chart, we may not get our entry point until ADBE rises through 260. Those with a 'Fear of Missing Out' (FOMO) inclination will dislike this greatly. Realize that the remaining upside is over 30 points. Giving up the 20 increased our probability of success by quite a bit.

Additionally, our first entry my only be 1/8th of our planned position. It is important to take several shots and this is why portfolio capitalization is so important, as described in Portfolio Size.

Today, there is nothing to say that we don't have an equal chance of rising to $290 or declining to $209. An equal chance is not what we are after.

Meanwhile, the talking heads will be pushing for more investment: '... a unique opportunity', '... a healthy pullback, take advantage', etc. All those comments may be true but it is the timing component that is missing. Creating hype is to their advantage as their rice bowl only gets filled when you are invested.

Those who have knowledge, don't predict. Those who predict, don't have knowledge. --Lao Tzu, 6th Century BC Chinese Poet