When a Stock Is Trading at an Extreme, Look to the SGG for Clues

Glance at almost any internet stock price quote and you’ll see the high and low price of the stock for the past year. Some investors look for stocks trading near their lows, thinking they are more likely to get a bargain. Others look for stocks trading at or near their highs in the hope of catching a shooting star.

Market strategists might check how many shares are at the top or bottom of their ranges to measure the breadth of the market. If only a few stocks are driving an index higher or lower, the strategist might conclude the trend is weak. If most stocks are participating, that strategist will trust that trend a bit more.

Like many stock indicators, where a stock is within its range tells us something, but rarely will that be enough. That’s why the Stock Selection Guide includes several different metrics and requires you to think about the intangibles. Numbers are only a starting point. What ultimately matters is the company’s ability to deliver something customers want profitably and whether the stock is on sale or is too expensive.

Indicators rely on historical information. That makes them reliable because those numbers can be verified, but history can be their weakest link to a stock’s underlying value. Stock prices depend on what the market expects to happen in the future. If one year is always like the next, then buying at the bottom of the range and selling when it hits the top makes perfect sense. But as 2020 has reminded us — repeatedly — we can’t count on history repeating itself.

But an indicator might give us a starting point for a more thorough analysis. Once you’ve found a stock that’s trading at an extreme, the next step is to learn why that might be the case. And, after you’ve answered that to your satisfaction, you should ask yourself how likely that will change enough to move the stock.

I am one of those people who look for stocks trading at 52-week lows or highs. Once I identify a worthwhile stock, I go through a mental checklist that helps me decide how relevant the stock’s position in its range will be to my buy-sell-hold decision.

Are There Many Stocks Trading at Their Highs or Lows?

If the stock I’m watching is just one of hundreds of stocks trading at their all-time highs or all-time lows, then it’s the market that’s driving the bus, not company news. If I simply think the market is going up, I’d be better off buying an index fund because then I wouldn’t have to worry as much about one executive at a com­pany making a lousy decision.

I’ll then move to stocks in the same industry. Is the entire industry up or down? If so, why? And what makes this stock more attractive than buying all the stocks in that industry? Again, by purchasing an industry fund, I’m still minimizing the risk of one stock falling out of bed. I can either look at the firm’s competitors or compare the stock’s performance to an industry fund.

What’s the News Surrounding the Stock?

If it’s not the market and the industry driving the price, my attention turns to what makes that company unique. That’s part of the process of completing the Stock Selection Guide. Have profits plateaued or disappointed? Did earnings beat expectations? Are there new products or have they just lost a key executive?

I always assume that everyone else has the same access to news as I do, so just noting
some key events won’t make me a better investor. I have to decide whether the market is overreacting. If the market bids up a growth company because it’s making steadily increasing profits and is drowning in good ideas and the cash to implement them, then the stock price should reflect that. The real issue is whether I see anything different from the crowd.

How Confident Am I?

Measuring confidence is challenging because we tend to believe too much in our own opinions. Keeping that in mind, whatever my investment opinion might be, I won’t act on it unless first, the upside more than justifies the risk of being wrong and, second, I’ve done enough homework to think I’m more likely right than wrong. That’s baked into the Stock Selection Guide through their risk versus reward section and multi-pronged approach.

The Magic Bullet Is There Is No Magic Bullet

We all hope to find that one indicator that allows us to pick winning stocks. Markets are too complicated for anyone to get anything other than a temporary advantage. But measures like range or a financial ratio offer a great place to begin.

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This article was originally published in the October 2020 issue of BetterInvesting Magazine.

Sam Levine is a frequent contributor to BetterInvesting Magazine. He teaches securities analysis and portfolio management at Wayne State University.

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