On May 21, 1973, U.S. News & World Report featured an enthusiastic cover story called “Brighter Days Ahead for Stock Market?”

“Conditions are shaping up for a sustained rise in stock-market prices,” the magazine suggested, citing analysis from a number of then well-known pundits, who almost universally expected better times ahead. “The market is ready to move up” predicted Ian Cramer of Kohnmeyer and Co. “We are buying stocks.” Pundits, it turns out, have been missing the boat for years.

The Dow, which at 900 had already been in a trading range for the better part of six years, went on to drop another 35%, hitting new bear-market lows and, for a period, trading at levels that hadn’t been seen since the late 1950s. The recently introduced Nasdaq went on to drop 50%.

The point of this history lesson? It shows the danger of investing in something because “it will come back.”

Yes, even among the lengthy list of fallen Nasdaq highfliers, many stocks will come back. The real question is whether you can afford to wait. While patience is a virtue when stocks are moving higher, it can too often become an excuse to sit on unprofitable investments that are going nowhere, slowly.

It’s a question we first broached a few months back, when we used historical rates of return to estimate how long the long haul might really be. And while the market has bounced significantly since then, many people are still underwater on positions they bought back in early 2000.

The buy-and-hold approach can be a very expensive proposition. The expense isn’t solely the time value of money, but the opportunity cost of not making other, potentially more profitable investments. Even in difficult economic times, there are always places to make money. As we’ve pointed out a few times over the past couple of months, despite sogginess in the major averages, there are certain sectors doing quite well.

This is the problem with “value” investing: You might see the value long before the rest of the market does. And while many individuals seem content to sit on dead money rather than take some losses and move on, the truth is that real wealth is created not through a steadfast devotion to particular stocks, but by consistent, absolute return. Personally, I don’t have the patience to sit through a two-minute commercial break, let alone a 20-year bear market in equities.

Weak stocks are weak for a reason. So although it’s always tempting to bottom fish, the majority of your trades should be in leading stocks, not the laggards you expect (read: hope) one day will turn around. Trading is like driving: The express lane will beat the bus lane virtually every time.

But we all like the idea of snapping up bargains. And — with the caveat that cheap stocks can often get much cheaper (or go nowhere for quite some time) — there are some basic bottom-fishing techniques that can make the shopping trip more profitable.

To start, we’ve often suggested that despite popular perception, trading is more about watching than actually trading. And although it’s tempting to buy recently battered stocks hitting 52-week lows, too often a low is just a temporary lull before the stock moves even lower. So whether it’s semiconductors or SBC Communications (SBC), at least wait for a recently battered name to stabilize for a few days before taking the plunge. This is why watch lists were created in the first place!

When a stock is falling, it isn’t your responsibility to stand in its way. A stock can’t be strong in the “long term” without first becoming strong in the short term.

Second, keep in mind that successful bottom-fishing, like most aspects of trading, comes down to appropriate position size. It’s perfectly acceptable to take positions in stocks trading at a fraction of their former highs, but putting too much of your portfolio into these can’t-lose losers is lunacy.

Weak stocks are, by definition, low probability and high risk. I wouldn’t suggest bottom-fishing in more than three or four names at a time — and then for no more than 3% of your overall portfolio in each initial position. It’s tempting to take a big swing on “oversold” names, but realize that it’s highly unlikely (read: impossible) that any of us will call every bottom. Declines of 10%, 20% or even 40% from initial entry points aren’t uncommon, reinforcing the notion that when it comes to overall allocation, less is more.

With any trade, risk management is key. And when it comes to small positions in beaten-down names, the biggest risk is often not losing money, but time. We live in a world of limitless opportunities but limited resources, and even with interest rates low and the broad market stagnant, you can’t afford to hold positions that continue to decline or go nowhere at all.

So instead of using a traditional stop-loss order based on price, when bottom-fishing I will often trade using what is known as a “time stop.”

In its most basic form, the market is made up of two key variables: price and time. When stocks are weak and probing new multimonth lows, traditional stop-loss orders are less effective because trends have a tendency to persist. Stocks that seem low often go even lower.

Rather than concentrating on price when bottom-fishing, focus on time. When you buy XYZ, do so with the understanding that while it might eventually come back, you aren’t willing to grow old in the process. Make a note that if the stock hasn’t moved higher in six months to a year, you’ll cut your losses and move on to the next trade.

This not only ensures you won’t be sitting on a portfolio of dead stocks, but forces you to bottom-fish only in stocks you expect to suffer a relatively short period of nonperformance. Stocks that you expect to eventually move higher, but not in the near term, should be relegated to your watch list, where you can monitor the price action until an appropriate technical buy signal suggests a good moment to pull the trigger. Time is indeed money, and you can’t afford to squander either.

– Originally on Feb 11, 2002 by Jonathan Hoenig

Markets are a combination of fear and greed — and bottom fishing is, by definition, the product of greed. After all, those who are intent on buying the absolute bottom aren’t satisfied to profit from a portion of a stock’s upward climb…they want to capture the whole shebang.

But like the watched pot that never boils, the bottom — a long-term, sustainable bottom — will come only when people stop looking for it. It’s kind of like the family car trip. As long as the children keep asking “Are we there yet?” the destination will never be reached.

Let’s assume, for a minute, that we’ve reached bottom and a new bull market has begun. Terrific! As we’ve discussed before, the big money is made on the big moves. You want to buy a stock because it’s going to go up 100%, not 10%. The reason to get back into the market, then, isn’t because the Nasdaq is going to 5000, but because it’s going to 15000…or higher.

But knowing that a real bull market will eventually challenge the old peaks, people shouldn’t feel a huge sense of urgency to buy back into the not-yet-forgotten favorites. From the crashes of 1929 and 1987 to the long bear market of the 1970s, there was never an instance when investors needed to jump in with both feet at the perfect time or risk missing out on the substantial upside that followed. Real bull markets take time to develop.

As we pointed out a few weeks back, it’s possible that any number of individual issues will make dramatic advances from here. But for anything more than a short-term counter-trend trade, I’ve found that the reward of picking a bottom isn’t worth the risk it entails. Stocks that are trading at their 52-week lows are, by definition, weak stocks. “Buy low, sell high” aside, my philosophy has always been that weak stocks are weak for a reason. Let them be.

What most pundits and investors don’t realize is that, in a bull market — a real bull market — there’s plenty of time to get onboard. In order to spot, and ultimately profit from, a real bull market, you don’t need split-second trades or complex arbitrage strategies. In the simplest terms, all successful bulls need is an awareness of the trend and the courage to stray from the herd. Let’s take another look at each.

The only reason to be bullish is because the market is bullish. Whether you’re trading orange juice or Oracle (ORCL), the best indication of the market is the market itself. So as tempting as it is to buy depressed issues making multiyear lows, there’s no reason to buy a security whose trend is clearly down.

When it comes to putting serious dollars to work, I’m generally interested only in securities that have performed well recently. While brokers and financial planners are quick to remind us that past performance is no guarantee of future results, the truth is that recent performance tends to be an excellent indictor of future performance. XYZ can’t be a winner over the long haul before first becoming a winner over the short haul.

Positive price action is one indication a bull market is beginning. Crowd psychology is another. In the early stages of a real bull market, there’s never a huge urgency to buy. The prevailing attitude isn’t greed or even fear…but doubt. Gains are viewed with suspicion; price advances are chalked up to short covering, program trading, seasonal factors…just about anything but the start of a legitimate bull-market advance.

At the start of a bull market, there’s very little interest among either individual or professional investors — even when prices go up. It’s only in the later stages that the public becomes interested. Remember, the S&P 500 gained 37% in 1995, 22% in 1996, 33% in 1997, 28% in 1997 and 21% in 1999…but it wasn’t until the first few months of 2000 that massive amounts of money started pouring into aggressive-growth mutual funds at record levels.

So when evaluating a stock or sector, I look for a combination of both positive price action and doubtful crowd psychology. Hopeful investors are those who’ve already put down their bets, but doubtful investors still have money on the sidelines. That’s where the opportunity lies.

One good indicator is the message boards. If the rise in a stock isn’t accompanied by a high quantity of equally bullish chatter, it’s a sign that there’s still plenty of upside to come. Two sectors worthy of consideration are real-estate investment trusts, or REITS, and gold. Their recent stellar performances have been given a ho-hum reception by investors still preoccupied with Priceline.com (PCLN).

Although REITS are up double digits over the past year and many are breaking out to new highs, most pros doubt the future will be as kind as the recent past. “Real-estate prices lag the economy” the naysayers quip. “It’s only a matter of time before REITS fall.” Of course, they’ve been saying that for 18 months.

Despite the landmark decision to add REITS to the S&P 500, the Yahoo message board for industry bellwether Equity Office Properties (EOP) has logged only 30 posts in the last two weeks, compared with Cisco Systems’ (CSCO) more than 15,000. And Manufactured Home Communities (MHC), which I recently recommended on Fox Television’s Cashin’ In, is up more than 20% year-to-date, yet has received just 98 posts on Yahoo since the board was created…in 1997.

Gold’s recent rise is being attributed to the World Trade Center attacks. But as we’ve pointed out before, the sector was on a tear long before Sept. 11. Homestake Mining (HM), which has a tantalizingly large short position, is up more than 100% year-to-date. Despite that performance, the stock has received a mere 12,000 Yahoo posts since Jan. 1. For comparison’s sake, Oracle (ORCL), a crowd favorite which is down more than 50% year-to-date, has received the same number of posts in the last eight weeks alone.

– Originally on Oct 16, 2001 by Jonathan Hoenig