Sunday morning musings on timing a perfect entry.....

Being something of a message board and social media junkie when it comes to stocks, there's a common refrain I hear from those I suspect to be retail investors just like me.  

Retailers will often hesitate, trying to decide on the optimum entry point.  "Is now a good time to buy"?  That's something I've frequently seen on stock sites, regardless of the equity being discussed.

When is the right time to buy?  You've researched a stock, and for whatever reason you've decided you want to buy in, but you don't want to make a purchase and see it drop almost immediately by 5 or 10%.  

Deciding on the perfect time is nearly an impossible task.  

Some swear by the technicals, and will draw lines out on a chart representing traditional support levels, then they'll put a limit order in based on that analysis.  Others will keep a close watch, and when they first see it start climbing they'll jump in with a market order, hopeful of catching some momentum which will launch them well clear of their entry point.

If you play the markets long enough, sometimes you will do well, and other times not.  And I would argue that even if you make the perfect decision on an entry point, the stock you just bought could still trade down 5 or 10% and maybe even more.  

How could that be you may ask?  How could someone time their entry perfect and still see the stock they purchased drop by a significant amount?  If someone times things perfectly that means it can't drop.  Right?  

In my opinion no, and of course I will explain.  

The first thing retail investors need to understand is that they are not buying shares directly from those selling, we're not dealing with auction style markets.  It doesn't matter whether its the NYSE, the Nasdaq or OTC, or any of the Canadian exchanges.  When buyers purchase a stock they're going through a Market Maker Broker Dealer, or MM for short.

We'll use my favorite hypothetical stock, ABC which we'll say is trading around $10.  I look at level II and see that the bid is $9.95 with an ask of $10 and that there are 100 lots showing on the ask.  So we'll say I decide to buy 10 lots, 1,000 shares and I put a market order in because I'm convinced ABC is going to be moving up any day now.  

My broker will then pass the order to the house showing that $10 ask, looking to get the order filled. We'll call the brokerage that gets my order Moonshot.  There's a problem though, while Moonshot is a MM for ABC that doesn't mean that they have clients with shares to sell, or any themselves for that matter.

Moonshot could pass on the order, telling my broker to go to another house, but invariably they'll simply fill the order by going short.  If they pass then they risk getting a reputation as a non-performer.  Brokers will by-pass non-performers because in the public markets speed of execution is everything.  

Of course mine is just a small little 10 lot order, 1,000 shares.  But what if I'm not alone and a number of other investors have been watching ABC and decided that $10 is a good price to get in at.

Market Maker Moonshot could find themselves short tens of thousands of shares.  MMs are in business to make money obviously, and they're not going to want to cover off a short position by paying more than what they sold at.

So what is a MM caught short to do?

Years ago the US Department of Justice (DOJ) documented a practise they discovered that they dubbed "Moves on Request".  Basically it involves MMs asking each other to change the bid and asks being quoted in order to give off an impression that a stock is either weak or strong.  You can read about it here:  

https://www.justice.gov/atr/case-document/competitive-impact-statement-9

Using my example of ABC which MM Moonshot has found themselves short on, the DOJ article documents how a broker who is short will contact other MMs and ask them to move their bid and asks down.  This has the effect of making the market for ABC look weak and it can reasonably be expected to drive the PPS down, allowing Moonshot to cover off their short position, buying back the shares sold for $10 at a lower price.  

The opposite would be done when Moonshot or another broker finds themselves with shares to move, asking other brokers to move their bids and asks higher to give off a bullish impression.

Why would MMs co-operate in this fashion?  Its a quid pro quo system, quid pro quo meaning "you scratch my back and I'll scratch yours".  Other brokers comply because they know they'll be in a situation where they too will need to make a "move on request" because they're long or short.

So even though a retail investor may have picked a perfect entry, he could still see the PPS fall after he buys in, that's life.  Sometimes its not a matter of timing the market, but rather of time in the market.  While some will get scared off and bail on a drop in the PPS, others will hold tight.  And if the stock they've bought is a good one that is able to catch the attention of buyers, then those that showed patience will have a chance at profits.

Sometimes you get lucky, it happened to me recently with LAC, the stock for Lithium Americas.  

Regular readers (both of you) will recall that back on April 27th I did a blog posting wherein I offered up the opinion that I could see LAC dropping as low as 65 cents on the handle portion of the chart pattern I saw playing out.  

I didn't pull the number out of my rear end, it was based on the chart. Between March and July of 2015 LAC had hovered over and under that 65 cent mark, before and as the left hand side of the cup started forming.  Ultimately it was a guess based on what I perceived to be a support level.

Before I give myself too much credit though I have to admit to some impatience.  On April 27th, the same day I expressed the opinion that I could see LAC dropping as low as 65 cents, on that day I picked up another 1,000 shares at 75 cents.  The reason?  Simple, I wanted to increase my holdings a little and I was afraid of news or something coming out that would send the PPS much higher before I got a chance to add.

But I also put a limit order in at 66 cents on that same Friday Apr 27th, that was set to expire on Friday May 6th.  During the trading week of May 2nd to 6th I was going to be busy and unable to watch the trading during market hours, and if my 65 cent prediction came true I wanted to be able to add at close to that price.  

It was an order for 2,000 shares at 66 because I don't ever expect to get the bottom of a bounce. And on Monday May 2, it filled.  When I saw that LAC had traded as low as 66 cents Monday evening I checked to see if I'd gotten my fill, and was somewhat surprised to see that I had.

Good, but far from perfect.  Obviously I should have gone for the whole 3,000 at .66....then again, maybe I wouldn't have gotten the full 3,000 filled at 66 cents, I shall never know.  As it stands my average cost was 69 cents plus brokerage fees,  With LAC now trading up around 88 cents that's a gain of over 25% so I'm not gonna complain.  

Given my opinion of LAC's chart, I very much like the chances of it climbing north of $1.00 CDN. 

Please note though, with respect to my comments on LAC, this is a highly speculative investment and its not suitable for everyone obviously.  Not everyone has the same tolerance for risk, and investment objectives can vary widely.  

Getting back to the central theme of this post, timing the perfect entry, good luck.  The way I see things the board is tilted, and the  direction of the tilt does not favor the retail player.  With that being said forewarned is forearmed.

Good luck.