How to Make Money in Stocks Summary (C7): Leader or Laggard

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Do you have any stocks you are sentimental about?

Perhaps they have been good winners for you in the past, or you just feel safe and comfortable with them.

Well, unfortunately, there is a good chance that your comfortable favorites are the worst out of the good picks.

There are so many companies on the public market, why would you settle for the laggards?

Focus on buying those that are among the leaders in their industry and the best in their field.

That doesn’t necessarily mean they are the biggest or most popular.

It means that they exhibit the best growth in quarterly and annual earnings, the highest return on equity, the greatest profit margins, the strongest sales growth, and the most dynamic price movements.

The best companies will also have a unique and better offer than their competitors and be gaining market share from them.

A sympathy stock move is when the price change of a stock occurs in response to the price movement of another related stock or sector.

Avoid these. You want the leader, not the stocks catching the tail winds.

Even when a stock is making you a profit, it can actually be losing you money.

This is because it may be a poor performer in comparison to other stocks in your portfolio.

You must learn to sell your worst performing stocks so you can utilize the capital on the more profitable ones.

The fastest way to tell if a stock is a leader or a laggard is to check its Relative Price Strength (RS).

The RS measures the price performance of a stock against the rest of the market over the previous 52 weeks. The higher the rating, the better, with the highest rating being 99.

If the stock’s RS rating is below 70, avoid it.

Also, if you plot the RS on a graph and it has been declining for seven or more months, or has a sharp decline over four months, avoid it.

The RS is a proprietary rating only available in Investors Business Daily.

The best stocks normally correct 1.5 times or more than the market average.

For example, if the general market corrects 10%, the better growth stocks will correct 15% or more.

During a bull market, the stocks that decline the least are usually the best.

Once the market bounces back, the first stocks that make new highs are almost always the leaders.

The breakouts usually continue for several months. You want to buy within the first month.

No matter what the ‘pros’ say, never buy a stock on its way down. No matter how big the company, it could always go to zero.

If you already own a stock and it starts to drop, always cut your losses to a maximum of an 8% loss below the price you paid.

Read the next chapter here.

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