To understand how we can profit in the future, the only things we have to learn with and from are our wits and the past. Provided our wits are in order, let’s then take a somewhat high-altitude look at how we can learn to analyze a chart better to profit from strong trends in leading stocks.
This time around, we’ll jump back in time to the ’80s, in order to see how one could have vicariously lived through Microsoft (MSFT) stock and profit from the early ascent of Bill Gates’ empire – for most of us though on a much smaller scale of personal gain than Bill of course.
Microsoft stock – then and today
We’ll look at a time window that occurred almost 40 years ago, however such historical distance does not make this a case less worthy of scrutiny. Humans and their (ir)rationality make up the stock market, molded together in what Richard Wyckoff called the ‘Composite Investor Mind’ – and human nature never changes. Thus, the stock market never changes. What was valid then is valid today, and will be valid for centuries until we find a way to reprogram our brains to dispense of our very nature, and with it what makes us human.
If you’d ask me nowadays whether MSFT might make for a good opportunity, I’d say that if you are in a market where you would consider buying MSFT at all, that would also be a market that would harbor 50+ tech stocks at the same time that would give you a multi-fold return at the same risk.
But there was a time when this was different, when MSFT was a young fledgling tech company establishing itself among the likes of IBM or Intel.
At it’s IPO on March 13, 1986, MSFT stock was priced $21 per share. On the charts below you will see much lower prices, due to the many splits that occurred in MSFT’s history. In fact, the company split their stock a total of 9 times so far, in a never-tiring attempt to make the stock more attractive for the everyday “investor” and dilute the floating share supply.
MSFT came to the market just before the onset of the cyclical 1986 bear market, which was mostly marked by declines in tech stocks (NASDAQ Composite declined by about 17%) while the Dow and SP500 traded in about 10% ranges and portrayed more choppy corrections than a marked decline. We’ll here compare MSFT to the NASDAQ as the most relevant index.
Early signs of strength
When comparing the charts of the exchange average to MSFT, one can clearly see that large holders of MSFT were not inclined to offload their shares during times of general market weakness that might scare out the casual holder. While the NASDAQ declined into consecutive lower Lows, MSFT trended sideways, and selling was reluctant. In fact, if you look in detail at the chart above, price moved up at multiple instances while the general market declined. With the the golden boys as underwriter, heavy buying support would be granted at any juncture so price would never substantially undercut the IPO valuation.
Massive growth in revenue and thus high forward expectations in earnings that would need to be discounted corroborated MSFT’s quality, and would have made the average growth fund manager foam at the mouth. An easy job for marking up the stock by its well-capitalized holders.
As almost always, a healthy and conducive market is a prime condition that should predicate any serious commitment in the stock market (Learn here how to determine whether you’re in one). The moment even a little weight came momentarily off the general market, MSFT continued to sprint up 80% under substantial volume spikes that suggested accumulation by large institutional accounts in concert.
Getting involved
A very healthy digestion pattern (green box in below chart) formed, suggesting sequential dissipation of selling, visible in decreasing overall volatility and volume trailing off. The absence of block sell orders and excess trading activity suggested clearly to the observer that holders were sitting tight.
The best buying opportunities come about when the general market itself corroborates a change in market environment. In January 1987, right when the indices turned around sustainably to the upside, MSFT gave an excellent chance to latch on to its trend as it would become a winning opportunity.
Right around the turn of the new year, massive buying demand overcame any residual supply within and after the digestion pattern, and follow-through buying blasted MSFT share price up 215% over the course of the next year.
The stock’s price trajectory offered multiple add-on points throughout it’s run, both at digestions, constructive pullbacks to support levels and short- and intermediate-term trend reversals. However on it’s last add-point, lack of volume demand would have led a seasoned market operator to suspect something was running afoul.
Exiting and profiting
A few days later, the notorious flash crash of 1987 happened (read about a young lady that became famous for her prediction of this crash). During this volatile time, indices declined more than 20% in a single session, causing global market losses in excess of $1.7 trillion.
Worse so, liquidity dried up almost completely for large stretches of the trading session of October 19, and many orders were filled sometimes hours later with wide slippage, causing large losses to market participants.
Fortunately, astute position- and risk management would have saved the day of a speculator trading in MSFT at the time. The more mature a stock run becomes, the less money one should commit at additional buy points.
Thus, even in the worst case for such an extreme market environment, a speculator adhering to a smart set of rules would have only experienced a minimal 5-10% loss on 0.5% to 2% of her capital (that she might have added to her late position in September). The brunt of the profit would have been carried from the much lower entry and add points, which widely offset such a small loss with a 130% gain (entry to exit) on 15% to 30% of her total capital.
Of the total 215% run, of course, some paper profits would have been given back due to the sharp pullback caused by the flash crash in October 18 & 19, 1987. Accounting for and expecting such extreme events is part of the job. However, a skilled stock speculator could have bagged >130% with proper entry and exit rules in a course of ten months – in itself massive in such a short window of time, but still a small number on what is achievable in great markets.
Using advanced techniques for concentrating the position with pyramiding and additional buy points, this percentage could have led to a very large realized profit in absolute terms. In good markets, one should not hesitate to pound the table as hard as possible and make the most profits out of a given opportunity. That means force-feeding money into the best stocks available at low-risk add-on points to maximize gains.
As the eminent Stan Druckenmiller stated in Jack Schwager’s classic series ‘Market Wizards’, “when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig”. That means losing small when you’re wrong and winning big when you’re right, using concentration and money management.
Of course, MSFT gave many more opportunities in the coming decades to make money, although increasingly less in later periods the more it achieved blue-chip status. There were many times that a speculator could have exploited with minimal risk, sitting out drawdowns of 30-75% that afflicted the “long-term investor”, and joining only on the upside. But of course, other stocks in the market at the same time would have given better opportunities, thus a great speculators really shouldn’t get married to a stock. He goes after the best opportunities in the market at a given time, and not after what his personal preferences might be.
This article once again shows how chart reading is a crucial tool for successful speculation in stocks. However, as clean as these charts look in retrospect, it is a whole different ballgame to assess stocks and markets in real time. If you really want to master every skill you require to become profitable consistently, check out my educational package. But for starters, why not grab your free chart-reading factsheet here to get started on your way?
