How to Avoid a Catastrophe Before it Strikes

I looked at the stock and it was trading under a dollar.

Just like that, the bottom fell out, and the stock went from $11.05 to 80 cents.

The company had announced that they lost their contract with their main source of revenue – Apple – and were going belly up.

The company was GTAT. Here’s the chart:

 

 

Bankruptcies leave clues just as surely as a polar bear leaves footprints.

Before there were any grumblings or roar in the public domain, the stock was absolutely getting clawed down.

Almost any stop loss type would get you out before the actual news:

–          A fixed percent or trailing stop.

–          ATR-based stop (average true range).

–          A simple moving average stop.

–          Lowest close over the past several days

What wouldn’t work well as a stop would be anything in a financial statement.

Things like earnings, revenue, etc.

Those are useless because they tell you about the past.

You’ve gotta act quick in the stock market.

Earnings revisions are nice, but even they can be detected from price movements.

In other words, price is king.

But not just any stop or indicator will do.

If you had waited for a dual moving average crossover, you’d still be toast.

That’s like having a 30 minute delay on a getaway car.

Check out the chart above again. The orange line is a simple 200-day moving average. The yellow is a 50-day MA.

The crossover didn’t happen until after the fact.

You can chuck out those sort of delayed indicators when it comes to stops.

They can help identify trends, but not when it’s time to sell.

Now I don’t mean to discourage you from trading. It’s a very lucrative way to make your money compound.

But you’ve got to treat the cute little puppies like they’ll one day become a rabid dog that won’t hesitate to bite you on the keister.

GTAT’s story was absolutely amazing.

It was positioned in an exponentially growing industry, and we had traded it several times, making no small amount.

And that can be a problem for many traders and long-term investors.

They fall in love with the story of what the company might do instead of what price is telling you.

Price isn’t perfect, or you wouldn’t see so many violent swings that bite you in the butt like a rabid dog.

But I’d rather contend with a rabid dog than listen to the lies that vomit from the mouths of corporate officers.

At least I know what the rabid dog is all about, and I can develop trading rules to contend with their nature.

When push comes to shove, the CEO is going to become pure politician and dodge questions. Meanwhile, he’s selling his offshore account with both arms ahead of the plunge.

These landmines happen more often that you'd think

Check out this quick 1-minute video explaining the collapse of Enron >>

Trade smart,

Dan “Prince of Proof” Murphy