Believing in What You're Buying

To successfully navigate the challenges of trading during periods of low volume, specific approaches and strategies are required. Scott Hunter, of Vancouver’s Haywood Securities, shared a few thoughts on the subject with our friends over at Casey Research…

Each day we speak to dozens of resource business professionals in our quest for undervalued small cap companies exploring for, or developing, gold, silver and other metals resources.

These companies currently offer some of the greatest upside of any investment sector. But there is a downside: the stocks tend to be thinly traded, especially in the quiet summer months.

To successfully navigate the challenges of trading during periods of low volume, specific approaches and strategies are required. Scott Hunter, of Vancouver’s Haywood Securities, shared a few thoughts on the subject.

The first and foremost thing to realize about thinly-traded stocks is that buying them is a psychologically difficult exercise. Jumping into the market when everyone else is running for cover is tough enough, but to do so in the full knowledge that low volumes can make it difficult to exit a position requires ironclad belief in yourself and the companies you’ve chosen.

Low-Volume Trading: Writing out a Company’s Story

To make sure he believes in what he’s buying, Scott keeps a logbook in which he writes out the "story" behind each company that he follows, noting the pros, cons and reasons why he chose to put money into the firm. After buying a company, he goes back to the log each week to refresh his memory on why he believed his picks to be winners. This, he says, helps to filter out nagging doubts that inevitably crop up when the market gets ugly. Investors with such systems can stay focused on their course to profits.

One quality of thinly-traded stocks is that they are more prone to sudden and rapid drops in price, when nervous stockholders decide to liquidate positions. This makes picking a time to enter the market even more challenging than usual. A stock may fall considerably and then hold, looking ripe for buying, only to plummet even further, leaving early buyers out of the money.

Scott mentioned a few of the signals that he looks for, to tell when a floor may have been reached. In particular, he said to watch for a sudden increase in the size of bids. If numerous blocks of 10,000, 20,000 or even 100,000 shares are suddenly being tossed around, it’s a good indication that savvy investors consider the current price band a good buy. Scott also noted that such buyers don’t always take their entire position in one bid. Watch for buyers getting filled on a mid-sized bid and then immediately placing another at, or near, the same price, indicating that the purchaser is amassing a larger position at the current price level.

Of course, this is not a sure-fire indicator that a stock won’t fall further. And it’s also a strategy that works best for professional brokers who spend hours a day watching the fluctuations of the market. But for those investors with the time and means to keep a closer eye on a stock’s daily trading, this is one more piece of data that can be used to make a Buy decision.

Like any market, the quiet period will feature good and bad selling. "Good" selling comes when a stock’s price goes down for legitimate reasons – some fundamental problem with the company or its assets that the market recognizes. But there will also be a lot of "fear-selling" – quality companies whose share prices dive for no better reason than shareholders panicking at the overall state of the market and heading for the exits – a phenomenon exacerbated by thin markets. But that same phenomenon can increase the upside: such "excessively undervalued" firms are the ones likely to bounce back to higher prices, once the market recovers, yielding profits for those who got in during the dip. Hence our frequent refrain of "Buy on Weakness."

To spot opportunities created by such fear-selling, look for stocks that experience a drop in share price and then, several days later, undergo a larger-than-usual volume of selling. This is a sign of spooked investors bailing for no reason other than fear, and a prime time to acquire a good company for cheap.

Increased buying or selling volumes can swing a company’s stock price dramatically in thinly-traded markets. That is to say, if a holder of a large stock position panics and decides to get out at any cost, they may have to fill bids down to a very low price. Over the past month, we’ve seen several companies in a position where $5,000 or $10,000 worth of selling would have driven their share price down 30 to 50%.

Low-Volume Trading: Placing "Stink Bids"

In such a climate, you have a shot at getting filled at ridiculously low bid prices. What you do is place your "stink bids" at the low end of the bid spread (which can be viewed using the "market depth" function of stock-tracking services, or by asking your broker) and then leave it on the market for an extended period of time – you may just catch a drop in the share price during a bout of panic selling.

Another reason to bid low is that thinly-traded stocks also work in the opposite way: substantial buying can drive the price up quickly. Venture exchanges may be the birthplaces of "irrational exuberance." Therefore, savvy investors avoid buying at market prices and potentially having to pay a premium for their final blocks of shares. If you are in a rush to pick up some stock, it’s often advisable to make small buys and then wait for the share price to settle back to lower levels.

A way out for investors in thinly traded markets who want to sell significant blocks of shares when no one is buying is to call the company in question and ask about doing a "cross". Many companies will be more than happy to find a buyer who will pay a decent price for shares when the alternative is to have desperation selling drive the shares down, potentially triggering even further selling. This is particularly true if the company has just completed a financing and doesn’t want those involved to become disgruntled when their recent share purchases suddenly fall out of the money.

This approach is more likely to be effective for those wishing to sell larger blocks of stock – 50,000 or 100,000 shares. But for smaller companies, even 10,000 shares can have a significant effect on the price and thus be enough to make management pay attention. In any case, inquiring about a cross requires only a few moments, and it may well end up saving you thousands of dollars if you must sell when a stock you own is down.

The bottom line here is that you need to be more careful in a thinly-traded market. That usually means taking greater pains to inform yourself about the details of a stock’s trading history. When you want to sell shares in large company on the NYSE, you simply call your broker and ask him or her to sell, whereas, even for the best companies on the TSX-V, there are days when there are simply no bids. And the reverse can be true as well. You should know what you’re doing and understand the possible consequences of an attempt to trade – or work with a broker who does.

Regards,

Doug Casey and Louis James
for The Daily Reckoning

August 10, 2005

P.S. Thanks to Scott Hunter of Haywood Securities in Vancouver (604-697-7116) for sharing his thoughts with us for this article.

Doug Casey is the author of Crisis Investing, which spent 26 weeks as #1 on the New York Times Best-Seller list. He is also editor and publisher of the International Speculator, one of the nation’s most established and highly respected publications on gold, silver and other natural resource investments.

Your editors are hard at work in Vancouver (where the weather is absolutely perfect, by the way – a very nice change from humid Baltimore) so today’s installment will be short again…

That said, we’re going to turn to our team at The Rude Awakening…

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Dan Denning reporting from Colorado…

"America is creating jobs over 207,000, according to the Labor Department last week. But when you look closer, 50,000 of those jobs were in the retail business. Most commentators viewed this with anxiety, but for the wrong reason. The conventional wisdom is that the report indicates inflationary pressures and that the Fed will have to keep raising rates. In reality, the bigger concern is that American jobs are being created, on average, at lower average hourly wages.

"This is the vaunted shift to the "service" economy, driven by spending. Step back for a second and ask yourself this simple question: How does a nation get rich spending money? If you have a good answer to that question, let me know."

————–

*** Your editors were walking to a sushi restaurant last night when we overheard Addison "Beware the Housing Bubble" Wiggin say something shocking – "So Jenn and I were looking at houses"…

What?! The man who is so against being involved in the housing market, he actually wrote a play about the evils of buying a home – is going to be paying a mortgage? The thought of that stopped us dead in our tracks.

Seeing the look on our faces, he hurriedly continued, " No, no – it’s a good story."

"We’ve been watching this house in Mt. Washington since March that was on the market for $580,000…"

(So far, he has not redeemed himself with the story.)

"And we checked it out again last week, and the price had gone done to $499,000 – it dropped $80K in around six months!

"I think if we wait just a little longer, we could get this house at a reasonable price."

And that, dear readers, is how you play the market.

*** You know the end is near when banks start taking their creative financing techniques to new levels of ridiculousness…

Apparently, the banking industry has realized that there is one group of people that have failed to sell their souls to mortgage debt – illegal immigrants. Of course. Why didn’t they think of this sooner?

"This is a huge untapped market with people that live and work in this country and are capable of buying homes to realize the American dream," said Chan Peterson, executive vice president and head of community banking at Banco Popular, one of the earliest banks to enter this field.

So, basically the message we are sending here is: Sneak into our country, and if you can make it past border patrol – you win a house!

"Banks are counting on the fact that we do a lousy job with interior enforcement," said said Alenka Grealish, manager of the banking group at Celent, an independent research and consulting firm. "Once you’re in the country and you haven’t done anything wrong, the chances of being deported are very slim. Banks are banking on that."

Are we the only ones who see something just inherently wrong in this desperate attempt to lend people money?

In this era of housing mania, wonders never cease.