Between my last article and this one, administrations in Europe and the U.S. have set up what are called “infinite quantitative easing” or “perpetual easy money.” I believe that over the next couple of years these monetary policies will help to drive up the price of gold and silver, but both will be volatile. At some point, inflation will kick in and administrations will likely have to put the brakes on these economies.
I think we will have an opportunity to make money from volatility, but only for a few years.
If you’re a long-term buy and holder stock investor, maybe flip the page. However, if you are a more active investor, buying low and selling high are key parts to making money with volatile stocks.
There are three sell signals I try to follow to make volatility work for me. I won’t be so bold as to say that every sell signal works perfectly every time, but from what I see, if all three sell signals gang up on a stock and say “sell,” perhaps I would be wise to listen.
The best part is that most of the information you need to make good decisions is free.
1. Down eight per cent
In the late 1990s during the tech stock bull market, I read William J. O’Neil’s book How to Make Money in Stocks. He wrote that if a stock is down eight per cent from your cost, you should sell.
When you’re down eight per cent, that stock needs to rise back up 8.7 per cent to get back to your purchase price so you can break even. If you wait until that stock is down 20 per cent from the original price, it will need to rise 25 per cent for you to break even.
As you might guess, it’s a lot easier for a stock to rise 8.7 per cent than 25 per cent.
Critics of this strategy say we might get whipsawed, that good stocks usually recover and if we sell we don’t know when to buy back again.
Selling when a stock is down eight per cent is a very simple strategy that requires no charts and no sophisticated knowledge, just a simple calculator.
On September 26 I sold 1,000 shares of Cameco (CCO) because it was down eight per cent.
2. Daily price crosses moving average
When the daily price is lower than the 10-day moving average, it’s an indication of a downward trend. I developed this sell signal on my own after giving back big bucks.
The strategy would not have worked well during the 17-year bull market that ran from August, 1982 to March, 2000.
But these days, even though stocks have generally gone up from their March 2009 lows, many stocks are still below water, and many move up and down a lot more than in the past. In other words we are in a volatile market, not a definite bull or bear market.
Sure, CNR has gone from $40 to $90 but those are few and far between. Fortis (FTS) dropped to around $22 during the bear market and now is over $32 and does not move much. Pipelines: same thing. The shares recovered and have generally kept their value.
Maybe you don’t need sell signals if you own a bunch of utility stocks that have regulated profits and usually rising dividends.
But even high dividend paying stocks might run into a wall one day when interest rates rise and big money starts selling high dividend paying stocks.
With stocks like Silver Wheaton (SLW), the stock dances with the price of silver and over the past two years. Selling when the daily price of SLW crossed the 10-day moving average and buying again near market lows would have made a person more money than the stock is worth. That would be called farming volatility.
The key would be to sell when the daily price stops going up, rolls over and crosses the 10 day moving average. Waiting just a few days would likely be okay, but most of the time when these volatile stocks start to drop they drop hard.
If I had sold CCO when the daily price crossed the 10 DMA going down, I would have sold at $22 or even $21.50. That’s a lot better than $19.30.
When there is downward movement in a stock you can sell the shares, except many fear being whipsawed. You can buy puts on the stock — the put goes up as the price of shares goes down. If you’re wrong, all you will lose is the premium you paid to buy the put.
3. Double tops or heads and shoulders
A third very reliable sell signal first shows up as a new and quite high price. Stocks that make a double top normally go up high, then drop and then go back up but stop rising just about the time the price is just below the old high.
That second high price might be a few days or a few weeks after the first high. Normally it is quite distinct and quite easy to spot.
When the price comes back up to that second high it’s quite easy to think that it will keep rising.
When it doesn’t rise above the old high, many shareholders will start to sell. Non-believers might just hold on and hope the price goes back up. And it might. But it might not.
In his book Encyclopedia of Chart Patterns, Thomas N. Bulkowski studied enough stock patterns to put a statistic to them. For example he shows in a table that when a stock shows a double top there is a 92 to 93 per cent chance that stock will drop from 23 to 27 per cent.
My silver stocks, like SLW, have often dropped far more. In fact, several times during the past two years as SLW peaked and rolled over, the shares dropped from say $38 to $25. That is a drop of 34 per cent. Sure, the price has come back up but that sort of drop can ruin a new investor’s attitude and the value of his or her portfolio.
Talking about Natural Gas: $natgas had a double top almost six months apart in 2011 at around $4.60. In April 2012 the price touched down to under $2. The price did drop to $2.22 in early 2012 and then jumped to about $2.70. Then the price went to under $2 in April, 2012. On a chart, that $2.22 sure looks like the left hand shoulder of an inverse head and shoulders.
The price has clawed its way back up to around $2.70 and then dropped to $2.25. On a chart that sure looks like the right hand side of an inverse head and shoulders.
The natural gas industry was good at finding new wells. Then the price dropped and the industry got very good at shutting down or capping wells. Now, I believe the natural gas industry has developed a supply management system for natural gas and those capped wells will not be turned on until the price goes up and the industry decides to let more natural gas onto the market. Plus, a lot of shale gas wells don’t produce very long.
The latest drop in price has been down to just below that $2.22 level. In technical terms the price of $2.22 or so was a resistance that was tested twice and the price dropped. Now that price could easily become a floor.
Natural gas shares might be cheap, but this may be the reason for that. Under accounting rules, if natural gas companies find that their reserves are a lot smaller than they once thought, they might have to write down values or cut dividends. I would be careful.
There is one more sell signal that is a bit harder to see — seasonality. Many stocks move with the seasons. The precious metal stocks drop from February/March to June. After June or July, jewelers begin to buy gold and silver ahead of wedding season, Christmas and Chinese New Year. Once harvest is done in India, when farmers have a good year they pay off their bills, set aside some money for groceries and buy gold or silver with the left over money. That creates a bull market for precious metals.
If we believe that the price of silver for example will drop going towards June, and the commodity and the stocks have had a double top or head and shoulders pattern, we now have two pretty solid reasons to sell a stock or the commodity.
The same thinking can be applied to other stocks and other commodities.
Rotation rotation rotation
In this volatile market many investors are quite ready to lock in profits and move on to another stock that has been ignored or beaten up. I call this rotation. Stack that on top of or ahead of seasonality and again we might have two reasons to sell a stock: selling when the daily price crosses the 10-day moving average going down works well with these volatile stocks.
I’m also practicing selling high and buying low.
In late August I sold 1,000 shares of Standard Resources (SS0) at just under $14 after the stock earned $2,000 (16 per cent) in a few months. I also brought 300 shares of Potash at $40 and change, just a dollar or two above a common bottom. I sold calls with a strike price of $42 for September and collected 26 cents per share. Then the shares were exercised. I made $1.50 plus $0.26 ($1.76 or 4.3 per cent) in a month.
I also bought 300 shares of Molycorp (MCP), a start up rare elements mine in Nevada, and 1,000 shares of Arch Coal (ACI) at $6.60. I sold a call for MCP with a strike price of $13 and kept the money and the shares. I also sold a call for ACI for April for a strike price $7 and collected $1.75 in premiums. That’s 26 per cent return on my cost of $6.60 per share.
Selling SSO might look like a mistake as the price of silver rockets up. But I made good money and bought other stocks that should do well too. †