The Spirit of 3 Stocks on Fire

[David Randolph]

Over the weekend I've been thinking about my migration from being a trader to be an investor. I thought about the advantages and disadvantages of such an important strategic shift.

Listening to many great ideas coming from our dear Honours Members about short/long term investing and the spirit of 3 Stocks on Fire, I came to the conclusion that this step shouldn't be a decision, it should be a process.

When me and Ramsburg first thought about this project, we didn't have any portfolio management in mind, we just thought of writing about 3 stocks that were «on fire» everyday, and then have some message boards around the subject. But, quickly, it came to our mind and our user's minds: «buy 3 everyday, but now I have 20 stocks, when to sell?». It wasn't a sound model, just writing about 3 stocks on fire ... so we created the 3 Stocks on Fire Portfolio, then the 3 Pennies on Fire Portfolio and later the 3 SOF Fast Portfolio.

Now I have two options: the 3 Stocks on Fire Portfolio migrates to be a long term portfolio, or create another portfolio to suit mine, and others, long term needs.

I'll go with the second option, because the spirit of 3 Stocks on Fire can't be lost.

I'll substitute the 3 SOF Fast Portfolio for the Long Term on Fire Portfolio.

So, here's how it goes, starting tomorrow:

1. 3 Stocks on Fire

Returning back to the origin of this website, I'll write about 3 stocks on fire everyday. But the method used to pick stocks to write will change slightly:

- I'll put a poll with a list of stocks on the website at 5:30pm (NY time) and our users will vote for the stocks to be on the 3 stocks on fire of that day. They can only vote on stocks on the list I provide. At 7pm the poll closes and the 3 stocks with more votes are the ones to be analyzed.

So we'll have three analysis on new stocks everyday. I'll pick stocks for the Stocks on Fire Portfolio and Pennies on Fire Portfolio from these analysis, that is, if a stock is extremely attractive it can be bought for one of those two portfolios.

2. Stocks on Fire Portfolio

I don't know if you noticed, but there's a slight name change. It doesn't make sense to call «3 Stocks on Fire Portfolio» when the portfolio is actually composed of 15 stocks, right?

I will also change the number of stocks to be held on this portfolio, from a maximum of 15 to a maximum of 10 different stocks, 10% of capital on each individual stock, following the less trades / better trades principle.

Another change is that, in order to have time for a more profound research, the updates on the stocks of the Stocks on Fire portfolio will change from daily to bi-daily, that is, every stock's analysis will be updated in less than 48 hours (5 updates a day makes 10 in two days).

The stocks held on the Stocks on Fire Portfolio will always feel the pressure to perform, since without a doubt I'll find good stocks to buy when I write the 3 Stocks on Fire. This is why this is a position trading portfolio, stocks that fail to perform will be replaced by new ones.

3. Pennies on Fire Portfolio

This portfolio will continue mostly as it is, except that I'll make updates on all stocks held every 5 trading days (if I make 2 updates per trading day, all 10 stocks held will be updated every 5 days - this means each day I'll choose 2 penny stocks to update).

I will also start considering not only OTCBB stocks, but also Pink Sheet stocks for this portfolio.

4. Long Term on Fire Portfolio

Stocks can't just enter this portfolio, coming out of nowhere. They will come from the Stocks on Fire and Pennies on Fire Portfolios. If after very deep study I come to the conclusion that the stock is truly an awesome pick with enormous long term potential, the stock comes out of the other portfolios to enter the bigger league of long term investing.

I'll update every holding of this portfolio (maximum of 10 stocks, 10% of capital on each individual stock, as in other portfolios) on a bi-weekly basis. This means I'll update 1 of these stocks per trading day.

So, I'll make 8 updates per trading day, 5 Stocks on fire, 2 Pennies on Fire and 1 Long Term on Fire. I'll also write about 3 new Stocks on Fire, that can be candidates to enter Stocks on Fire or Pennies on Fire Portfolios.

Now I want to justify the replacement of 3 SOF Fast for the Long Term on Fire Portfolio (the 3 SOF Fast January Edition will still run its course until the 31st of January) and give you some clues about what will be the Long Term on Fire Portfolio:

- The 3 SOF Fast isn't much different than the Stocks on Fire Portfolio. The method isn't different enough, just the trading capital and the money allocated to which trade. I think that it isn't wise to trade stocks for income purposes, just for wealth purposes. For income purposes I recommend, after a lot of study, the futures market.

- The Long Term on Fire Portfolio is an urgent need, for me and many others on our community. The big money is made on the big moves, and now we are in an unprecedented time for exponential growth in a few selected companies. What I mean is, the long term isn't so long anymore, never in the entire world economic history it was possible for a company to grow from a few millions to some billions in market cap (with backup from fundamentals) in just a few years.

Now, if you have an extraordinary product or service, you'll be selling it worldwide in a short period of time. Globalization makes it possible. 10 or 20 years ago it would take 10, 20 years or more to expand globally. Now, the right product or service can go worldwide in a much shorter time period. Look at Google, that website was created just in late 1999, and 6 years later the company is a major global player with $138B in market cap (and there are several other examples).

- Picking on some of Aussietrader's ideas, I'll be looking for stocks at or near 52 week highs. I'll trust the market to start showing the best companies around. Then I'll look into their business model and financial strength. Stocks will only go to the Long Term on Fire Portfolio if I believe in them to own for 3-5 years, and if they have the possibility to grow 100 fold or more (of course, my believe can change over time as I get new fundamental information). For example, would I buy Google now, given this perspective? Of course not, to grow 100 fold GOOG would be worth $13.8T, more than the entire US economy. Never in the entire world history a company reached $1T in market cap, so that pretty much puts aside anything with a larger that $10B market cap.

- Also, I won't be looking for turnarounds in old companies, I'll instead consider new companies with amazing business models and financials, so they can grow worldwide and return investors several bags of profits.

- Another example, would I buy KO now? No, but does it make sense for Warren Buffet to continue holding? It may, because, if I buy it now and the company grows just 5% a year I don't get a very attractive return on my investment, but for a man like Buffet that bought the stock many years ago, maybe 5% more represents another double on his initial investment, don't forget that 

- I want to thank most of the work Aussietrader did and I agree with him on most ideas (man, are we learning with each other here?  ), I just disagree when considering averaging up. I've been thinking about this, and I consider there are two major disadvantages when one averages up a position:

1) You lose your money management rule of diversification. This means you may allocate more that you should to one position, and if that fails, you'll lose more than you should.

2) Imagine you're looking for stocks that you think have the potential to go up 10 fold (many times you find cheap stocks, but you «know» they probably won't go up 10 fold - one should pass those). You buy it, the stock doubles. If you double your position at that point, if the stock goes down 50% you're at home (instead of making 50%) and now you're looking at just a 5 fold upside potential (but wasn't your initial purpose to look for stocks that will go up 10 fold?). Going back to Buffet and KO again, it probably makes sense for him to continue holding KO (I really don't know), but does it make any sense for one of us to buy it now with a long term perspective? Would Buffet buy KO now? (he may, but probably that's just because of his size, he must invest in already quite large companies). Why bet more on an already wonderful pick, when our job should be to find them at their start?

Anyway, this is an open debate ...

The conclusion of this article is that there will be some changes at www.3stocksonfire.org to address some of the new needs, but its original spirit will not only be kept, it will be reinforced.

Also, this website is two in one, it is a portfolio management service and a traders community. Coming from the futures market I thought I knew much more about stocks than I actually know. There's still a wide world of knowledge outthere that I need to explore.

I want to thank your valuable help on this journey for stock market knowledge !

[boatguy]

Good Luck Dave and Ramsburg,

As we all learn more and evolve it only makes sense that 3sof evolves too.

You guys have a great site and I like the idea of trying new things and not growing stale and tired.

Great idea, should be interesting.

[valueseeker]

I like the idea of long term portfolio. Let's look at the following chart of some of the largest gains last year (300%+) & with beautiful charts

http://finance.yahoo.com/q/ta?t=1y&s=PRLS&l=on&z=m&q=l&c=ntri%2Chans%2Cvphm%2Cbtui%2Ctie

I believe all of them had consistent earning growth which sustained its steady PPS increase.

Dave: what is your definition of "long term"?

[rickjust]

hi David,
i am so glad you have come to a decision about the the future of 3sof. it seems to have been in flux the last couple of months, which is understandable for a new venture only a few months old.  
     i think the long term section will bring in all sorts of rewards and learning opportunities with so many great traders on this site ie: Aussie trader , Michael, shawfund , melf elf, et al: willing to share their knowledge this can only enhance the trading experience.
i like the idea of voting on the 3 stocks, often you pick stocks and so many members have valuable input and views on these picks.
one question i have is, as you, or someone pointed out, good long term picks can get into bearish mode without hurting it's long term prospects. will there still be a stop loss rule with these picks?
anyway , this site is an exciting place to be,
thanks for all your work,
maxi

[David Randolph]

hi David,
i am so glad you have come to a decision about the the future of 3sof. it seems to have been in flux the last couple of months, which is understandable for a new venture only a few months old.   
      i think the long term section will bring in all sorts of rewards and learning opportunities with so many great traders on this site ie: Aussie trader , Michael, shawfund , melf elf, et al: willing to share their knowledge this can only enhance the trading experience.
i like the idea of voting on the 3 stocks, often you pick stocks and so many members have valuable input and views on these picks.
one question i have is with long term picks do you really need to update these bi daily. wouldn't these be picks, being long term, suffer from the same idea as watching the intra day on short term picks, that is, watching every daily move when , as you, or someone pointed out, good long term picks can get into bearish mode without hurting it's long term prospects. will there still be a stop loss rule with these picks?
anyway , this site is an exciting place to be,
thanks for all your work,
maxi

Thanks for your post rickjust, I said bi-weekly, not bi-daily on the LTOF Portfolio:

I'll update every holding of this portfolio (maximum of 10 stocks, 10% of capital on each individual stock, as in other portfolios) on a bi-weekly basis. This means I'll update 1 of these stocks per trading day.

I have to go to bed now, its 3 AM here 

[rickjust]

thanks i just reread my post and corrected it ,
maxi

[AussieTrader]

What a great set up we have here.

David and Rams T2T (Trader to Trader) concept is clearly in action, as the shape and direction of 3SOF is being guided by the collective ideas and thoughts of the diverse membership.

Thats a great thing to be involved with.

Good Luck to all.

I knew David would not like to average up I am not saying it must be done, but I do think it's a tool that should always be 'available' in the right circumstance.

[valueseeker]

Let's look back to 3SF's picks last year and see what could've considered as long term picks? I bought & held the following stocks - VPHM, AOB, SVA, BTUI. If I kept DESC, I would have made good money too. PETS probably would have made the list too.

I bought GIGM at $2 back in June (way before 3SF's vote), and sold on the earning day in July. It dropped as low as $1.6-1.7. This goes another question: what is the selling criteria of these long term picks? Looking at the chart of VPHM, it dropped from $13->$10 and then again $24->$16. AOB dropped from $7.6->$4.2 (I luckily bought $2.38, sold at $7.45, and re-bought at $5.3 & still holding). Would 3SF long term portfolio sell VPHM & AOB? Or would you sell if it breaks TA & looking at re-entering? I need to go back to HANS, NTRI, TIE, etc. to see what is the maximum drop they had in their spetacular rise.


-Valueseeker

[David Randolph]

Let's look back to 3SF's picks last year and see what could've considered as long term picks? I bought & held the following stocks - VPHM, AOB, SVA, BTUI. If I kept DESC, I would have made good money too. PETS probably would have made the list too.

I bought GIGM at $2 back in June (way before 3SF's vote), and sold on the earning day in July. It dropped as low as $1.6-1.7. This goes another question: what is the selling criteria of these long term picks? Looking at the chart of VPHM, it dropped from $13->$10 and then again $24->$16. AOB dropped from $7.6->$4.2 (I luckily bought $2.38, sold at $7.45, and re-bought at $5.3 & still holding). Would 3SF long term portfolio sell VPHM & AOB? Or would you sell if it breaks TA & looking at re-entering? I need to go back to HANS, NTRI, TIE, etc. to see what is the maximum drop they had in their spectacular rise.

-Valueseeker

The selling criteria must be fundamental, not technical, so one can hold a stock for the long term. As said, it is nearly impossible to hold a stock for a big long term rise solely based on technical analysis, because of noise and intermediate term trends. A trendline can be broken, if fundamentals still stay on course, I'll continue holding.

I'll consider a stock as a long term holding on the LTOF Portfolio because of fundamental reasons and I'll hold the stock for as long as those fundamental reasons stay valid.

Long term means anything more than 2 years to me.

Thanks for the input ValueSeeker 

[echo]

I like your ideas, David. I very much like the fact that your open to changes as we move forward. I have much more confidence in 3sof knowing that your open to this type of change. If something is not working you do not hesitate to change it to better the portfolio. An example of that is that you started the year being a bear and you quickly changed your point of view to capitalize on this January bull run we're having. I have little doubt that you would change abruptly as the market changes. I feel much better with your trading. Thanks, David

ultra

[Dory99]

Hi David,

  I LOVE this site ( that's why I joined! ) and the tremendous enthusiasm and positive spirit that you bring to stock picking; however, I STRONGLY disagree with your views re "averaging up" or "pyramiding".

The bulk of the gains in my portfolio have been the result of employing the "averaging up" technique. I'll give you one example:

I purchased 410 shares of Intuitive Surgical (ISRG ) in August 2004 @ $24.51/shr ( around $10K invested ). Of course, as with all stocks, I hoped that it would go up ( seemed to be a great company with "disruptive" technology ), but, in the event the tide turned against me, I set a trailing 25% from the High Close as my exit point.

My technique is to purchase an additional $7500 worth of stock ( which is smaller than my initial investment of $10K ) each time the stock price increases @ 40% from the last purchase ( I use GTC buy-stop orders for these purchases.. unfortunately, can't watch the market all day.. have a "real" job.. darn!). Here's my history with ISRG:

Initial purchase: Aug 2004 410sh  @ $24,51/sh
subsequent purchases:                       Nov 2004 218sh  @ $34.38/sh
                                                       Feb 2005  155sh @ $48.18/sh
                                                       Aug 2005  107sh @ $70.37/sh
                                                       Nov 2005    76sh @ $98.58/sh         

So, all in all, I've invested @ $40K. ISRGs PPS today stands at $127.95/sh. My unrealized gains  = @ $83.5K. Had I JUST maintained my initial purchase, my gain would be @ $42K ( nothing to sneeze at, but not $83K!)   

By the way, like all of us, I've had MORE than my share of losers ( I'm just no good at predicting the way these things will run ), but, the losses are limited to $2500 ( 25% of initial $10K investment ) and have been X times offset by the big gains in the few winners.

Why the 25% trailing stop?:    

25% isn't a magic number, but, at least for me, seems to provide enough latitude for stock volatility without prematurely getting stopped out ( all good stocks have "dip" periods; e.g., during ISRG's run, it dipped several times @ 21% - 22% from its High Close ( defined as highest close since the day I purchased the stock ), but never hit 25% ), yet will preserve profits after a good run ( e.g., ISRGs High Close = $130.66, 25% trailing stop = $98.. if I sold at the trailing stop, I'd still realize a gain of @ $54K... not bad! ). 

UPL and APCS are other stocks that I've had similar results with.

At any extent, I've really enjoyed reading the commentary and following the thought processes that have evolved on this board, and thought that I'd share my story, for what it's worth.

Dory99

[Michael]

Hi David and Ramsburg

First of all an overdue Happy New Year. 2005 was a great year from an investing point of view. Even though I can't compete with the 3SOF portfolio I am quite happy with a 3 digit return. In fact 2005 was my second best year ever and I know this is mainly because of some of the great stock pickers on 3 SOF and especially the 2 of you!

It is hardly surprising that I love the idea about LTOF. In fact some of the best returns for me in 2005 has been momentum stocks where the momentum has been initiated by a fundamental change in the business. It seems to my that the time when the TA-guys exit the stocks is a great buying opportunity.

When that is said why all the rules? Keep it simple and stupid. Either a stock is fundamentally undervalued or not!

Why do you care if the stock is close 52 weeks high? Why are old companies excluded? Why only stock who can increase 100 times. Hell I am happy with 100%

Let me give you an example: I bought STX when it was close to 52 weeks low. I would consider it a rather old company and I certainly don't expect it to increase 10000%. But i do expect it to increase more than 100% within 12 month from the date I bought it.

Sure you can't find stocks that have a 10000% potential but they would also have a very different risk/reward ratio. STX had/has very little downside and huge upside so from a fundamental point of view it might be a better choice than a stock with 10000% potential.

You asked for debate so here you are. Lets make a portfolio for those of us that believes investing is simple. You buy something for $1 that is worth $2

Mike

[stocky]

Now thats what we 'atleast me ' wanted. I would recommend looking at VLO and HANS.

[eyalgo]

David thank u very much for your innovation.what about futures's researches.

[David Randolph]

Hi David,

  I LOVE this site ( that's why I joined! ) and the tremendous enthusiasm and positive spirit that you bring to stock picking; however, I STRONGLY disagree with your views re "averaging up" or "pyramiding".

Hello Dory99 

Most people disagree with me when I say «no average down» and «no average up». Perhaps you're right, but never forget that money management is the most important issue regarding long term success in trading. My extremely simple money management rule of a fixed percentage of capital in each position makes my life as a trader/investor more safe and simple.

I don't have to think how much money I'll buy on each stock, that decision is always the same, say, 10%. If I were to buy more of one stock, you're right, perhaps the portfolio would have more potential, but also more risk. And objectivity on position size would be lost.

Also, I think that on most occasions a stock will go down more than 25% from top to bottom on a long term rising trend. You would have lost Microsoft, Cisco and other big long term winners with that trailing stop strategy. Actually, if I may, I defy you to find a stock (just NYSE or Nasdaq) that went up 10 fold without any 25% pullback in between.

Thanks for your post, I appreciate it 

Hi David and Ramsburg

First of all an overdue Happy New Year. 2005 was a great year from an investing point of view. Even though I can't compete with the 3SOF portfolio I am quite happy with a 3 digit return. In fact 2005 was my second best year ever and I know this is mainly because of some of the great stock pickers on 3 SOF and especially the 2 of you!

Congratulations on a great year Michael and votes for an even better 2006 ! I learned a lot from you and I expect to continue learning. Now I know a bit more about stocks, and I understand some of your picks better, and why you pick them 

I read what I think is a great book (except when the author talks about technical analysis, he has no clue about the subject, he thinks that a technician is a trader that makes his buy or sell decisions based on the Dow Jones Industrials trend), it is «Mastering Fundamental Analysis», from Michael C. Thomsett.

Would you recommend any book on fundamental analysis?

When that is said why all the rules? Keep it simple and stupid. Either a stock is fundamentally undervalued or not!

Why do you care if the stock is close 52 weeks high? Why are old companies excluded? Why only stock who can increase 100 times. Hell I am happy with 100%

Well, my reasoning is, since I can only have 10 stocks held for the long term, why bother owning some that are «not so great»? They will give me a lot of work to find and update, and not so great returns ... I'm not thinking of buying «undervalued» stocks, given the traditional ratios like P/E, P/S, etc. I want companies where I can understand the business and I clearly see it growing over time, in good or bad economic conditions (if management isn't too bad).

You didn't comment on DIET, what do you think of it? With the new food delivery program (started January 5th), already growing revenues may explode on the upside over the coming quarters ... I just think it is your kind of play, am I wrong?

Thanks for your help Michael