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Tuesday, July 18, 2006

Be Right and Sit Tight

By William Trent, CFA of Stock Market Beat

We noted last week that the energy boom appears set to continue for some time. We have also written several times in the past about how we believe the stock market is currently in a long-term P/E compression cycle. We found this piece from Financial Sense that encapsulates part of our investment thought process and wanted to share it.
Financial Sense: “The Key to Stock Market Success!” by Elliott H. Gue 07/06/2006

Jesse Livermore was perhaps the most famous stock trader of the early 20th century; he made and lost millions of dollars in his day. And, for the record, that was a lot of money 100 years ago. Livermore was most famously immortalized in Edwin Lefevre’s thinly veiled biography Reminiscences of a Stock Operator, probably one of the best and most helpful books on trading and investing ever written.

One of Livermore’s trading rules was “Be right and Sit Tight.”
He also said this is one of the hardest lessons for any investor to learn. In other words, Livermore suggested jumping on board a major trend and then having the courage to hold on to make the really big gains.

Clearly, energy is just such a major trend. As I’ve outlined on numerous occasions in The Energy Strategist, demand for oil and gas is booming while the world’s ability to expand supplies and production is, at best, limited. The great commodity bull markets throughout history have lasted for at least 15 to 20 years–this current up-cycle has more than a few good years left in which to run.

But that doesn’t mean there won’t be corrections. Long-term readers are well aware that we’ve seen three significant energy corrections during the past 12 months. Each pullback lasted between one and three months and resulted in prices 15 percent to 25 percent off the highs for most stocks in the group. Each pullback also represented an excellent buying opportunity as the group subsequently rallied to new highs.

We agree that the energy market is one place where there is such a trend. The other places we think we are right are the upswing in commodities and the compression cycle in stocks. A big part of our discipline will be sitting tight on these major themes.

On the other hand, when things go too far in one direction or another there may be opportunities for short-term plays. (In our book, those are 3-month to one-year - we are not day traders for the most part.) We want to take advantage of the shorter-term movements, when possible, without violating the overall sit tight principle. That could mean lightening up on positions, writing covered calls or taking shorter-term long positions in certain stocks when we think the time is right.

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