Sunday, July 10, 2005

Shorting Stocks, the Bubble, and Lucent

I just finished William O'Neill's primer on shorting stocks, How to Short Stocks.

Shorting a stock is simply betting its price will go down.

During bear markets, this is how hedge funds make money, along with a panoply of other trading strategies.

The most important thing I got out of this book?

Stocks move in groups.

He gives some obvious examples, as the air travel boom in the 60s that precipitated the rise of hotel stocks and the recent Internet boom in which the fiber-optic-planting companies were reaping all the benefits of a world aimed at "wiring up."

Remember Lucent and Cisco, the telecom darlings ever American just had to have in his or her portfolio?

Well, we all know what happen to those stocks.

The market tanked in March 2000, wiping out 7 trillion dollars worth of assets.

Lucent, the popular AT&T spinoff, went from $60 to $3 after the telecom sector experienced a meltdown due to excess capacity.

Lucent was also charged for aggresive accounting practices.

I have a client who is so enamoured with Lucent, she refuses to sell it even today, thinking it'll go back up to its high.

I still laugh every time I think about her.

The book is mostly filled with charts and tell-tale chart formations that signal market or company specific tops, such as the head and shoulders, double top, and railroad track rally formations.

He drives home the argument that fundamentals don't mean shit, as a managing director at an investment bank I once worked at so eloquently put it.

This same guy had made boatloads of money in a down market simply by shorting two stocks -- Yahoo and AOL -- when the bubble was ready to pop.

After he told me that, I started studying charts on my own, night after night.

The power of charts is that they tell shrewd and patient investors what the institutions -- the bad boys who move stocks --think about a given stock.

Charts reflect what the so-called smart money is going (or isn't going) after.

If, for example, company XYZ is hitting new highs on light volume, demand has withered up and a correction is imminent.

The Joneses down the street are buying the stock (probably after seeing a report on CNBC), but the elephants like Fidelity or Vanguard are not.

Message at the end of the tunnel?

Follow what the institutions (who account for about 75% of a stock's movement) are buying, not your neighbor.

And read charts.

Looking a chart of Lucent would've saved you from getting your tits blown off.

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