3 First Principles for Mastering the Market

The modern trading world offers access to more technology than ever before. With the advent of the internet, today’s retail investor has a more even playing field than ever before. Retail investors can gain instant access to real-time quotes, headlines, AI-driven strategies, and much more for little or no cost. That said, top institutional firms like Citadel have an advantage over the average investor because they have research teams of hundreds and the luxury of investing millions in AI analytics and high-powered trading technology.

Understanding the Intelligence Trap

One of the biggest pitfalls among amateur investors is falling into the ‘intelligence trap.’ The intelligence trap is the belief that because markets are a complex, trillion-dollar system, the solution to mastering them must be equally intricate. However, over my trading career, I have discovered that the truth is exactly the opposite.

“Simplicity is the ultimate sophistication.” ~ Leonardo Davinci

Instead of trying to beat the top investors at their game, smaller investors should zig when institutions zag. While retail investors have less funding and capital, they still enjoy advantages. For example, unlike large institutional investors, small investors can enter and exit positions without worrying about liquidity. This is a major advantage because retail investors can place market orders and cut losses without fear of moving the market.

First Principles Investing

Elon Musk often talks about how he takes a “first principles” approach to all his business endeavors. This approach means you boil down a situation to its fundamental, undeniable truths. Personally, I have done this with growth investing, and I have derived three critical components that make up my magical elixir for investing:

· Identify Stocks in an Uptrend: “A body in motion tends to stay in motion.” Newton’s First Law of Motion holds true for investing. Investors can immediately increase their odds by latching onto stocks that are already moving higher. Instead of buying low and selling high, investors should aim to buy high and sell higher. Additionally, the stronger the uptrend, the better. In other words, the easiest way to find the next stock to double is to identify a list of stocks that already have.

· Buy High Growth Stocks Pulling Back to the 10-week MA: Stocks follow fundamentals. With that in mind, investors should seek to buy fast-growing stocks in hot industry groups. That said, investors do not want to chase stocks. Rather, they should wait for a constructive pullback within an uptrend, such as a pullback to the 10-week moving average. This allows an investor to follow the trend while not chasing it.

· Run Winners, Cut Losers: I have discovered that running winners and cutting losers is the key to profitability. For instance, if an investor risks $1 to make $5, they can be wrong 80% of the time and still break even. By buying off a moving average, investors have a level to trade against. Should the stock break through the moving average, the investor can quickly cut losses and move on to the next trade.

“If you diversify, control your risk, and go with the trend, it just has to work.” ~cLarry Hite

Below are some examples:

Lumentum (LITE)

Lumentum manufactured the high-performance lasers and optical equipment that is necessary for interconnecting AI data center clusters. LITE is growing EPS at a high double-digit clip while sales are growing at a triple-digit pace. LITE has provided two phenomenal buy points over the past few years. The stock retreated to the 10-week moving average in October, then again in January. While the stock may have seemed expensive still during these pullbacks, the stock doubled after each. Additionally, its worth noting that shares had already tripled before the October pullback!

Image Source: TradingView

Other group members, such as Ciena (CIEN), have also performed well. The more strong performing stocks in an industry, the better.

Sandisk (SNDK) & Micron (MU)

Sandisk and Micron provide the data storage and memory used in AI data centers. Each company is growing its top-and-bottom-line fundamentals at a triple-digit pace. Sandisk shares went 5x before retreating to the 10-week moving average. While conventional thinking would tell you the stock was up too much before to the pullback, shares have more than tripled since. Meanwhile, SNDK tagged the 10-week MA earlier this month at ~$500 and has already moved up 25% since.

Image Source: TradingView

Micron has a similar chart to SNDK:

Image Source: TradingView

Remember, group strength is important. Western Digital (WDC) is another industry performer

Bottom Line

By stripping away the noise and focusing on high-growth leaders like Lumentum and Sandisk as they test key moving averages, you turn the market’s complexity into your greatest opportunity. If you stick to the trend and protect your capital, you will be a profitable trader.

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Ciena Corporation (CIEN): Free Stock Analysis Report

Western Digital Corporation (WDC): Free Stock Analysis Report

Micron Technology, Inc. (MU): Free Stock Analysis Report

Sandisk Corporation (SNDK): Free Stock Analysis Report

Lumentum Holdings Inc. (LITE): Free Stock Analysis Report

This article originally published on Zacks Investment Research (zacks.com).

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