As I browse the typical investing discussion forums, I am continually amazed at how many people are interested in knowing whether now is a good time to buy some stocks that have absolutely been crushed by the ongoing bear market, while there have been some stocks that actually doubled in value or more in 2008 (JRCC, ANR, WLT, FDG are a few that come to mind).

Quite honestly, this is not a common occurrence in a bear market, as 3 out of 4 stocks will decline during such market conditions, and typically more than the Dow Jones Industrial Average or S&P 500 index themselves. However, it makes absolutely no sense to buy a stock that has declined day after day, when other stocks have held up reasonably well during the decline.

I actually read in one forum a question of whether it would be smart to consider investing in one particular stock that had declined from $35 to under $2 per share. Such an investment would be pure speculation! The stock declined 90% because its business was no longer viable! Stocks do not decline 90% if they are managed well and have a good business.

I recently posed this question to a friend in regard to investing… “when you are looking for a doctor while you are in need of surgery, do you go straight to the cheapest doctor, or the more expensive one with the good reputation?” Her answer was naturally the second choice. I then asked her “when looking for a stock to buy, are you more interested in the cheapest stock, or the more expensive stock that has been more profitable?”

You see, stocks are priced based on their ability to generate profits, and shareholder value. A stock that is in decline is declining for a reason. Now, it may just be that economic conditions do not allow that stock to perform very well, or it may just be that the stock is declining because the overall market is declining. However, if there has been a significant change in the company’s business, and the stock has declined significantly because of that, then it is not a good time to buy that stock. That is pure speculation. You have no idea when that company’s business will turnaround, and chances are, you are not Warren Buffett, with billions of dollars to invest, and the ability to influence the management of a company.

Therefore, it is essential that you focus your attention only on the strongest performing stocks. You can screen for stocks that have generated consistent profits and have outperformed the market averages. When the stock market turns around, it will be these leaders that will provide you with the best returns.

One other question that concerns me is that people want to trade or invest while the market is in decline and the economy is performing poorly. Well, this is actually a good time to invest in high quality stocks that you will hold for a long period of time, but most people are looking for substantial performance in a much shorter period of time. While the current bear market has yielded some strong performing issues in the energy sector (coal companies in particular this year, solar stocks in 2007), and agricultural sector, it is generally a wiser move to just sit tight while waiting for conditions to improve!

The most successful investors have had the patience to wait for the right opportunities when the market is ready to yield profits more easily. It makes no sense to try and buy a stock when it is in decline, as you simply have no idea how low it will go. Just look at MBIA, Countrywide Financial, Bear Stearns and Lehman Brothers! Some smart investors got burned by all of these stocks by buying them because they looked cheap after declining 30% to 50%, and then they fell much further!

Therefore, the smart thing to do in a bear market is sit tight, and monitor the market for the next great opportunities. Investors Business Daily is a great publication that allows you to monitor that best performing sectors and the emerging stock market leaders. I personally use the TC2000 software package by Worden Brothers to screen for the best performing stocks simply by identifying the stocks that have risen the most above their 52 week lows, and are closest to their 52 week highs. I then wait for these stocks to consolidate for a bit so that they offer a low risk entry price to enter a new position.

Now, when will you know whether it is safe to at least dip your toe in the water and consider buying a new stock? Well, last week we had a couple 200 plus point up day in the Dow Jones, and today we had a strong reversal to the upside after a weak open. This suggests that there is some new buying in the market, and this rally may have some legs. However, you must tread lightly until all of the major average surpass their May highs. If the markets are able to close well above these highs, and stay there for more than a few days, then it is very likely the bear market is over. Until then, sit tight and do your homework!

Once you have determined that it is safe to consider buying a new stock, figure out at what price you want to buy it, AND where you will sell it in case it starts to decline immediately and you have a loss! The easiest thing to do in trading and investing is figuring out what to buy, and maybe what price to buy. However, most people have no clue when to sell. A decent rule of thumb is to sell if the stock sells off over 7% below your purchase price. You must get out, and do not HOPE the stock will turn around. If it is a good stock, it will eventually, and you can re-enter. But, you must cut your losses when they occur.

If the stock then rises in price, learn how to lock in profits with trailing stops by monitoring the stock’s price action. Look for swing lows and support levels where the stock sold off to on a minor pullback, but then resumed its uptrend. These are excellent levels to exit positions if they are violated to the downside. Also, it is important to monitor unusual price and volume action in the stock. A sizable one day decline on large volume suggests distribution by large money managers, indicating they are no longer confident that the stock will continue to rise.

These are just a few tips for you to develop a trading/investing plan. The fact is, there are many ways to skin a cat, but you will always have the odds in your favor if you only focus on the top performing stocks.

Good Trading!

Scott Cole
http://www.kungfutrader.com
http://www.theultimatestocktradingsystem.com

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