The Cyclical Price Pattern - An Opportunity to Make Money

There are many ways to make money with stocks. You can buy well-managed companies with growing earnings, hold them for years and watch the stock prices rise as the company succeeds. This conservative investing style sometimes rewards investors with huge long-term gains. For example, early investors in Microsoft saw their investments grow 7000% in 20 years. This is what patient long-term investors dream about. But more often buy-and-hold investors don't hit the jackpot; rather they realize more modest returns.

Another investing style is to trade stocks very frequently with the help of computer programs that buy and sell shares of selected companies. Here traders make small profits or losses on many trades minute after minute. If you like lots of action while you're glued to a computer screen, this investing style might be for you.

And then there is every imaginable money making scheme that falls between the above two styles. You can buy mutual funds, exchange-traded funds, index funds, buy and sell individual stocks, time the market, buy on margin, sell short, buy and sell options, reinvest dividends, or some other variation on the theme. Talk with fellow investors and everyone has their own tailor-made approach to investing.

This article is about one investing style - buying and selling cyclical stocks. It's a style that I use and I know it makes money. Buying and selling cyclical stocks for a profit is a challenge but with commitment, experience and the proper technical tools you can consistently make money over your investing career.

Cyclical price patterns can be found in many stock sectors such as: chemicals, retail, natural resources, technology, and semiconductors. The examples in this article concentrate on semiconductor equipment stocks. These companies make the equipment that make and test semiconductors. So the semiconductor equipment stocks are tied to the fortunes of the semiconductor industry, which is very cyclical. Therefore, the semiconductor equipment stocks exhibit cyclical price patterns.

The fundamental price pattern of a cyclical stock is very simple to understand. A single cycle has an upside during which prices rise to a peak and a downside when prices fall to a bottom.

For some stocks this upside and downside pattern repeats again and again for many years. In the Kulicke & Soffa (KLIC) price chart it's easy to see that each cycle has an upside, peak and downside. Notice that the heights of the peak and duration of the upsides and downside vary from cycle to cycle. But in general the cycles have the same overall form of the upside, peak and downside. Other semiconductor stocks have similar price patterns.

Buy on the Upside

Making money with a cyclical stock requires that you buy and sell the stock in a relatively brief period. It makes little sense to buy and hold cyclical stocks for many years because you'll simply experience alternate periods of unrealized (paper) gains and losses. With cyclical stocks you should take you profits when you get them.

It is intuitive that you will make lots of money as prices rise on the upside and you will lose money when prices fall on the downside. So the first rule to ensure a profitable trade is to buy on the upside. Then you can sell later on the upside or early on the downside just after the peak price. The second rule is never buy on the downside. Be patient. No matter how low prices go, do not buy until you have identified the next upside. The downside is for losers because the overwhelming number of possible buy and sell opportunities are unprofitable. Ignore any recommendations from brokers or analysts that tell you to buy when prices are falling. Just because a stock has dropped a hefty amount does not make it a bargain. A stock that has fallen 50 percent can still go down another 50 percent or more.

Why Buy and Sell Cyclical Stocks?

What makes buying and selling cyclical stocks such an enticing money-making opportunity for investors? Here are seven reasons:

• Large Gains are possible
• You have many chances to make money
• Cyclical stocks are safe investments
• Diversification among cyclical stocks is possible
• Cyclical stocks are investor friendly
• You can use rigorous analysis to make buy and sell decisions
• You can make your own buy and sell decisions
  

Large Gains are Possible

Potential gains on the upside are very large and you can make lots of money quickly. Buying and selling cyclical stocks lets you make hefty profits in relatively brief periods. Typically upsides of cyclical stocks increase two to eight times in price from the start of the upside to its peak in one to three years. The maximum upside gains from the start of the price upside to its peak for the five Kulicke & Soffa cycles were: 500%, 600% 650%, 700, and 850% respectively. Granted few, if any, investors had the savvy to buy at the absolute lowest price and sell at the peak, but buying and selling on the upside has potential for very handsome gains in a short period. And on the upside most of the buy and sell combinations produce profitable trades. The percent profitable trades on the five upsides were: 95%, 97, 92, 94, and 98 respectively. Thus on the upside almost all the trading opportunities make money.

Cyclical stock prices can be extremely volatile but volatility is the friend of the short-term investor. On one day the price can be up or down 25%. This volatility may be scary for some investors but it provides the astute short-term investor with great buying and selling opportunities. On the upside a significant brief price dip provides a great buying opportunity. Or a pop in price on the upside or downside may give you the chance to sell for an unexpected quick profit or to avoid or minimize a loss.

You Have Many Chances to Make Money

Because the price cycle of cyclical stocks repeats in an orderly predicable way over and over again, you have many chances to make money. When a new price cycle begins, you buy on the upside, hold the stock a relatively brief period and sell it at a profit. Then you simply wait out the downside of the current cycle and repeat the process when the next price cycle starts. If you miss out on a cycle, all you have to do is be patient and wait for the upside of the next cycle. When the new upside starts, you simply buy.

Cyclical Stocks are Safe Investments

Cyclical stocks of well-established companies are safe investments. Companies like Applied Materials (AMAT), KLA-Tencor (KLAC), Kulicke & Soffa (KLIC), Phelps Dodge (PD), INCO (N), Caterpillar (CAT) and John Deere (DE) are well-run companies with solid products and sound, proven business plans. These are not flash-in the-pan fad stocks that are here today and gone tomorrow.

Diversification among Cyclical Stocks is Possible

Prudent investors diversify their investments to avoid a calamity if one of more investments goes bad. Because there are many cyclical stocks, you can diversity your investments among several cyclical stocks. I usually own at least three or four at once. Three or four stocks are easy to monitor and I don't have to worry too much if one were to perform badly. I can make up losses in one stock with gains from the others.

Which cyclical stocks are good candidates? There are many. Cyclical stocks are categorized as consumer cyclicals, which are sensitive to changes in consumer spending, and the deep cyclicals, which respond to macro economic changes. Consumer cyclicals include retailers, restaurants and leisure stocks. Deep cyclicals include: gold, oil service, copper, nickel, agricultural products, aluminum, chemicals, paper, wood products and semiconductors.

I (Richard Howard) concentrate on the semiconductor equipment group that includes the likes of KLA-Tencor (KLAC), Kulicke & Soffa (KLIC), Applied Materials (AMAT), and Novellus Systems (NVLS). These stocks have a very distinct price cycle that follows the semiconductor cycle. I follow the Philadelphia Semiconductor Index, which includes 30 large semiconductor stocks, to get an overview the of the semiconductor group.

Recently, I have bought three semiconductor equipment stocks that have very large upside potentials: Amkor Technology (AMKR), Credence Systems (CMOS) and Kulicke & Soffa (KLIC).

Cyclical Stocks are Investor Friendly

If you buy cyclical stocks at the right price, you can sleep soundly. Once you understand the predictable nature of cyclical stocks, you can become an "expert" on their behavior. You don't have to simply guess at the direction of future prices because the price pattern is predicable. You make your buy and sell decisions on real data not just hunches or hopes. Therefore, you can be confident that your money-making system will actually work.

However, buying and selling cyclical stocks requires a commitment of time and energy from you. Unlike the passive buy-and-hold investing style where you buy and forget the stock, you must spend time learning about and watching the price movement of the cyclical stocks that you own. You are a short-term investor so you must be prepared to buy and sell when the price is right.

So when you own the stock, you must be vigilant because you have real money on the table. During this time you must be watchful for negative surprises, unexpected jumps in price, and any other news that could affect the stock price. This period can be stressful for some investors so it's a pleasant relief when you sell the stock - particularly when you made a nice profit. Now the money is not at risk and you can take a breather. I use the downside as a time for renewal of my energy as I get ready for the next buy upside opportunity.

You Can Use Rigorous Analysis to Make Buy and Sell Decisions

The predictable upside and downside pattern of price cycles lends itself to rigorous analysis using sophisticated technical tools. I developed the Complete Trading Model (CTM) and the Price Direction Indicator (PDI), two rigorous algorithms based on price data, that help you detect price changes from the downside to the upside and changes from the downside to the upside. CTM and PDI give you tabular and graphical output that helps you decide when to buy and sell.

You Make Your Own Buy and Sell Decisions

You can be make money without relying on professional brokers and analysts. If you're willing to educate yourself about cyclical stocks, you can be you own best advisor. You'll be free of the Wall Street buy machine that encourages you to buy at any price at anytime. The broker's job is to sell you stocks and take in their commission. Thus many of them would have you buy near peaks and on the downside. Most brokers and analysts are slow to see the coming changes in price In the long run you can probably do better making your own buy and sell decisions. Become your own guru specializing in a sector that interests you. If you are prepared to study the price behavior of a group of stocks, you can learn enough to manage your own investing activities.

You don't have to be a stock market guru to make money with cyclical stocks. And you don't have to listen to the talking heads and so called experts. In fact simply ignore them. Most of their talk is merely babble designed to fill magazine columns, sell expensive stock market newsletters and fill TV air time. Instead, spend your time doing your own stock research.

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