My First Crisis

In this chapter of the book, the author tried to find out the following through fundamental analysis –

• The strongest industry
• The strongest company within that industry.

Whenever a stock started to act better than the market he immediately looked at the behaviour of the other stocks of the same industry. If those too behaved well, he looked for the leader- the stock that was acting best. He reasoned if he could not make money with the leader, he would certainly not make money with the others.

He started compiling earnings of whole industry groups like oil, steel, motor and aircraft. He compared their earnings and carefully evaluated their profit margins, the price-earnings ratios and their capitalizations.

Finally, after an enormous amount of concentration, he determined that the steel industry was the vehicle, which would make him rich.

Based on this judgement, he selected JONES & LAUGHLIN at 52.25 on margin, which was 70% at that time. On the 23rd of September 1955, he bought 1,000 shares for $52,652.30 and he had to deposit $36,856.61 in cash. To raise this amount he kept all his assets as a guarantee. According to his most scientific and detailed research, he was sure nothing could go wrong.

On October 10th, the stock dropped to $44, and he sold his stocks with a net loss of $9069.18. He was discontented because it was not a gamble but a scientifically selected stock. He continued because he had to save his property.

Based on further analyzing the stock tables he noticed Texas Gulf Producing was rising, a stock he never heard of. He knew nothing about the company’s fundamentals but still went for it only to recover more than half of the loss he made from Jones and Laughlin. This gave birth to his new theory known as “The Box Theory”. In the next chapter the author speaks about his Box Theory.

Takeaway- Trade the leader not the followers of the group. When you see a green stock in a red sea, then look for its industry and other stocks in the same industry. If the group is performing well then locate the strongest stock in that group, the best up-trending chart with the highest percentage of earnings and sales growth over the past 3 years. 

Confidence is required in a trading method. However, complete confidence in any one trade can prove to be deadly. Anything can happen in the market. Some of the best traders in the world are right only 50% of the time.

Before you buy a stock, always determine the amount of money you are willing to lose and have a set stop loss point if you get wrong. You can also have a time stop to sell if it does not move by a particular time or a volatility stop if the stock starts moving much more than its average range which will inflate the anticipated risk.

The biggest reason to manage risk and position sizing is also for the sake of emotional and mental well being.

One of the most beneficial things that a trader can do is to look back at the stock’s chart over the last year with the 5-day exponential average, and also the 10, 50 and 200-day simple moving averages. Charts are maps that show where the buyers and sellers of the stock have been in the past and where they may still be waiting.