Answer This Question Before Buying Your Next Stock

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The market will teach you what you need to learn.

An old trader I once knew used to say that. Here’s why I bring it up.

There was a gloat to the news yesterday. The Liberal win sent the market rocketing up — off surging bank stocks, mostly.

My eyes were elsewhere. Instead, I was looking at the rotting corpse of Blue Sky Alternative Investments [ASX:BLA].

The dead may tell no tales — but any autopsy will reveal the essential facts.

Here’s the story. Blue Sky was a market darling for several years. It rose from $1 in 2012 to as high as $14.49 in 2017.

Then in early 2018, a US research group called Glaucus came out with a report saying Blue Sky’s numbers were dodgy.

Turns out they were right.

Yesterday, Blue Sky announced to the market it was calling in the receivers.

There’s a lesson here…

Buying the dip? Be careful

Let me say upfront that I’m not overly familiar with Blue Sky.

I never recommended the stock or even paid that much attention to it. I never understood quite what it did. Just as well, perhaps.

Here’s something I do know. After Glaucus’s attack became public, the stock dived.

Blue Sky rebutted the allegations originally.

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But once the market had the scent of blood, sharks began circling everywhere.

The CEO of Blue Sky was gone within a month.

Now we come to the point of today’s missive…

I do remember a reader of mine wrote in after Blue Sky tanked and asked if he should ‘buy the dip’.

Warning bells rattled and lights flashed for me. Danger!

At the time, I cautioned my reader that I hadn’t studied the stock enough to say whether that was a good idea or not.

But, I warned, I generally don’t like catching falling knives like that.

One look at Blue Sky’s chart shows you why…

Source: Optuma

There have been investors buying Blue Sky all the way down since 2018. All of them have been crushed.

Here’s where our instincts can lead us astray.

In most areas of life, it’s natural to try and snatch a ‘bargain’ when one appears. They usually don’t hang around for long if they’re really big.

You do need to be wary of this approach in the stock market. 

There are too many situations where investors are simply looking to dump their stock on anyone who’s naïve or unaware enough to take it off them.

That’s not to say you can’t consider an idea like this. But you would need a very compelling reason to act.

There’s usually no rush whatsoever in a case like this, either. Markets do not like uncertainty. Any stock with a cloud over it will usually tread water at best or keep falling at worst.

That can tie your money up at an inopportune time.

Jumping on Blue Sky a week or two after it began falling was a fool’s game — the odds were against it turning around quickly.

This is not to say I’m immune to doing dumb things in the stock market. But I do try to pull the risk versus reward ratio in my favour as much as possible. 

But the case of Blue Sky begs a question: When can you ‘buy the dip’?

Market or stock selloff?

One distinction I make is the market selling off, as opposed to an individual stock.

For example, it the whole market tanks for whatever reason, that can give you an opportunity to buy a stock you’d like to own.

Occasionally, you can also see a stock selloff despite the underlying business going along just fine.

This happened to several of my small caps over 2018. The wider macro sentiment meant small caps were dumped…and there was no heavy buying interest to stop the fall, for a while. 

I think that the closure of some small-cap funds may have meant some involuntary liquidation of positions, too.

You do need to have the courage of your convictions in these cases. That’s not always easy because it’s natural to question whether you’re missing something.

So there are two ways to take advantage of a dip.

The biggest worry is if the underlying business is under pressure for some reason and the market is selling stock as well.

That’s when you need to be cautious.

In the case of Blue Sky, Glaucus clearly had powerful motivation to act in the way it did. That should have been a warning to any buyer.

That’s why I recommend you do read a bit about Blue Sky.

Everybody wants to hear about the winners in the stock market. I like studying the losers too…in the hope I can avoid the next one.

Because there will be more landmines like Blue Sky the longer you trade the market.

In any situation, it always helps to ask, ‘If this stock is so good, why would someone sell it to me?’

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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