Company Buyouts and the Stock Market.

A fairy tale story of the sorts.

My Story…. Over the years I have been lucky enough to be in the right place at the right time in the stock market, my magic kingdom. What do I mean by that? I have owned or been long shares of a company’s stock when they have announced that they were being bought out. Normally a very nice gap is created. I was not expecting the buyout, nor did I have a clue that it was going to happen. Two of my most recent trades that I was in when the companies were bought out were (RAD) Rite Aid and (PBY) Pep Boy’s. My hero’s… Mannie, Moe and Jack! LOL

The above trades were simple trend or support trades that I was in and they were so low priced that I don’t believe I was using stops. One that I was not in and I was really surprised by the gap created up when it was announced they were being bought out was (GMCR). What a huge price move they had.

Because of gaps like that one and because I only trade stocks, not options, I rarely will short a stock.

But here is where my story really begins and an observation that I have made. I have not researched this in detail, nor done the stats, and do not plan too. But it is worth considering.

A lot of times, I have seen companies that looked exactly like Cinderella before the fairy godmother came to visit. Tired, rundown, battered, dirty, and bruised. These are companies that you want to short! And if you look back at the long term story, back weeks and months, straight down. How could any company ever recover?

Add to that, when earnings are approaching, these are wonderful companies to short. Emotions are running high which gives them the extra juice to go down. Already damaged goods, we jump on them to ride the ship to the abyss.

But then the fairy godmother shows up all ready to use her magic to make the company beautiful again. A company buyout. Oh no! Suddenly our short setup rockets the wrong way. The pumpkin is now a beautiful Coach with a rocket engine, the mice, now valiant astronauts ready to take the company’s shares to the moon, and our Cinderella becomes the most beautiful company of all at the ball.

But do you remember what happened at midnight? The Coach turned into a pumpkin again, the astronauts to mice, and our Cinderella, back to mopping the floors.

Let’s go back and look at the long term story. Take a look back several months. Down! Broken, bruised and heading to the abyss. Is the company buyout really going to be able to sustain this move up over time?

Just think about it. Will a huge name that buys out another company save it? Over time a name will not rescue a company from the Abyss. Someone with a strong background in rebuilding and reorganizing the company might, but it will not happen overnight. Or maybe they can just swallow it up and bury it in their books. This will take time. So once all the excitement and celebrating settles down, so does the stock as the company is still worn out, filthy and broken.

Let’s take a look at (HOT). They announced a buyout at earnings and boom! The rocket engines turned on. Is there an indicator that can predict a buyout? I don’t think so. Go back on the charts and look at October 28. 2015. After 10 weeks or so, December 9, 2015 they had landed at the level they had taken off from, and in January 2016, in profit. What goes up ……..!

Here is another. Not a buyout, but a short that returned to the ground floor. Take a look at (KBIOQ). There was a person that shorted this stock. He now owns a Go Fund Me account in hopes that someone will come a long and give him some fairy dust. Look where price is now. It’s probably around where he shorted, but when you use fairy tale money, (margin) you’re taking a risk you really should not take, unless you can afford too. Like I said, stocks that are beat up and bruised that get a boost from the fairy godmother can be a bummer.

What can we do? Let’s have a plan before we enter the trade in case the fairy godmother shows up.

Here are five things you can consider doing if you short stocks.

1. Don’t treat every trade like it’s the one that is going to win the lotto and give you your kingdom. Be happy with small wins and accumulate.

2. Trade a size you can manage, if you are short. Your stop is not going to protect you from fairy dust and a huge gap up most of the time.

3. Plan on an extended trip to fairy tale land, in case your short decides to go BOOM to the Moon! Consider the long term story, what is it telling you.

4. Don’t play on margin you cannot afford to lose. After the tax collector comes and collects, most likely your trade will turn around and go into huge profit without you.

5. Go to the strip in Vegas if you still have to gamble with margin. It might be more fun and cheaper when you lose it all.

Remember… Trade happy and don’t be ruled by your emotions. You will be a success.