I decided to write a 5-part series (this is part 3 of 5) on the common misconceptions that really need to stop being promoted. Keep in mind, these are all my humble opinions, but after 16 years of trading and studying market history, one really begins to notice what works and what doesn’t.

Common Misconception #3 – Buying Low-Priced Stocks

In September of 2004, a friend of mine had $20,000 he wanted to invest in a stock. I told him to buy $GOOG. He asked: “How much is it trading for?” I told him around $105. He immediately jumped out of his chair and yelled: “105 dollars per share!!!” It was a similar reaction to the one Doc Brown had in the movie Back to The Future when he screamed: “1.21 Gigawatts!”

I asked my friend what was the big deal? He said that it wasn’t worth it for him because he couldn’t buy many shares. This is a common misconception that I hear all the time. Many investors only think about the number of shares they can buy, when they should really be thinking about percentages. For example, people would rather buy 10,000 shares of a $2 stock than 100 shares of a $200 stock.

This is all wrong and leads me to my main point: You get what you pay for! What I mean by this is most lower priced stocks are low for a reason. They are usually struggling, low-rate companies that are not backed by the institutions. Think about it in today’s market. The majority of the quality stocks out there all trade for $50 per share or higher. There’s a reason a steak at Morton’s cost more than a hamburger at McDonald’s. It’s because you are paying for quality. In addition, these “expensive” stocks tend to be highly supported by the institutions.

This point is especially important for beginning investors who are trying to turn a small amount into a larger one so they can “afford to buy $AAPL.” You can afford to buy a higher priced stock right now if you simply think in terms of percentages. As for my friend, well, he bought 10,000 shares of a $2 stock that he sold at 60 cents one year later. Meanwhile, $GOOG tripled during that same time. Oh well

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1) Democrats and Republicans will fight and continue to hate each other (gotta start with something attainable so I can at least get one of these right).

2) Google ($GOOG) will get back into China and, as a result, Baidu ($BIDU) will get hurt. Even if this doesn’t happen, $BIDU has topped and will see $80 or lower at some point this year (it closed 2011 at $116.47).

3) The Los Angeles Dodgers will be in the World Series (trust me, I have that Sports Almanac from Back to the Future Part II and Biff has no idea about it).

4) Apple’s ($AAPL) growth will slow and the stock will perform in-line with the general market (plus/minus 5%). Of course they will still grow (20-25%), but you can’t sustain 50%+ growth when your sales are $110 Billion. Remember, there’s a big difference between a company and the performance of its stock.

5) We will see a third leg down in this Bear Market correction with a possible bottom in March/April. It will be swift and catch many people off guard. The only way I don’t see this happening is if the Fed starts QE3 (or some form of easing) to prevent the decline.

6) I will make my CNBC debut at some point this year. It will be in a hexagon split screen with Howard Lindzon, ZorTrades, Carrot Top, Josh Brown, and one of the Kardashians. It will be hilarious and one of CNBC’s highest rated segments ever!

7) Brett Favre will throw an interception. It might be in one of those Wrangler Jeans commercials, but I wouldn’t be surprised to see a short-term comeback later this fall.

8) The Mayans will be wrong and the world will NOT end on December 21, 2012. I know this because I just bought some Advil that expires on 7/2013. C’mon! The drug companies wouldn’t lie to us, would they?

9) Ancestry.com ($ACOM) will drop below $10 (it closed 2011 at $22.96). Their business model makes no sense to me and I can easily see Google or Facebook coming out with a free competing product to connect people and crush their business. After all, isn’t that what Facebook is for? Connecting us with people that we have successfully been avoiding for the past 15 years.

10) There will be a HUGE rally at some point this year. It may only last for a few months, but it will be long enough for traders to produce a decent return for the year. My reasoning is that Obama wants to get re-elected and will use every resource available (Congress, the Fed, etc.) to make it happen. Don’t argue with it, just trade it and enjoy the ride!

All these predictions are for entertainment purposes only. If you take anything I say (or anyone else’s predictions) seriously, you deserve to be beaten with a wooden spoon . In all seriousness, I specifically did not give any long ideas because I’m not comfortable with the market right now. But don’t worry, follow my blog this year, and when the market’s healthy again, there will be PLENTY of trading ideas.

Happy New Year and best of luck in 2012!

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1) I am finding very few quality setups. Many of the stocks I got stopped out of recently have traded lower, and most of the stocks on my watch list have failed to breakout…all these observations make me cautious for now.

2) When I tweeted these thoughts earlier, many people responded: “You’re in the wrong stocks.” I realize that a few stocks such as $AAPL $GOOG $BIDU $PCLN $LULU $AMZN $GMCR are acting well, but the leadership seems to be narrowing.

3) The narrow leadership reminds me of Sept/Oct 2007 when the market was being driven higher by 3 stocks: $AAPL $GOOG and $RIMM. I’m not saying that we are topping here, but I would prefer to see more “broad-based” participation. In addition, most of the big cap stocks mentioned above are getting “later-stage” in their moves and are extended from proper buy points. Keep in mind that I look for the best “low-risk, quality setups” that I can find.

4) The debt ceiling issue is not a factor in my stock trading. Why? Because after it’s done, the media will find something else to scare us. Remember Egypt, Greece, Libya, the earthquake in Japan, all the nuclear waste that was headed our way, Italy, Greece again, etc. That’s why I pay attention to the price action of stocks and ignore the news.

5) I always keep an open mind and realize that my analysis can be wrong. Therefore, I constantly maintain a watch list of quality stocks. If they begin to act better, I will be ready to pounce on the long side. For now, I remain in 100% cash. If I’m wrong, I’m not worried because I can always get back in.

I suggest being a little defensive and trading lighter-than-normal positions until conditions improve. Keep in mind that I trade with an EXTREMELY defensive posture and I use tighter stops than most traders. I live by the Paul Tudor Jones quote: “Play great defense, not great offense.” Although the major averages are holding up well, my trading instincts are telling me to be defensive for now.

$AAPL $AMZN $BIDU $DIA $GMCR $GOOG $IWM $LULU $PCLN $QQQ $RIMM $SPY

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1) Don’t marry ANY stock because at the end of the day, they ALL disappoint. Trust me, if you don’t know this, study history or you will learn the hard way.

2) I have no problem riding trends and trading stocks all the way up. In fact, one of my favorite quotes is: “Just when you think a stock can’t go higher, it usually does.” What I do have a problem with is when people say: “I am NEVER, EVER selling the stock!” People said the same thing about the big cap tech stocks in the late 1990′s ($DELL $CSCO $INTC $WCOM $MSFT $EMC $YHOO), and rode them all the way up…only to ride them all the way down.

3) Apple is a PHENOMENAL company with earnings and sales that are off the charts. However, it’s not exactly an undiscovered story! The company will grow its $100 billion in revenue next year, but it CANNOT sustain +80% sales growth. Again, it will grow, but the growth rate will eventually slow.

4) Don’t ever say “This time it’s different.” Those are very dangerous words.

5) Sorry for the reality check, but the current big cap growth stocks ($GOOG $PCLN etc.) will eventually become dead money…just like the prior big caps.

6) For those of you who think Apple is immune to a market selloff, let me remind you that it corrected -60% (from $200 down to $80) during the Bear Market of 2008.

7) I spoke to a few people today who have owned Apple since it traded in the single digits. I asked them when are they going to sell, and they replied: “NEVER!” This worries me because the same mentality that causes you to ride a stock up, also leads you to ride it down.

Again, I have absolutely nothing personal against Apple. I am simply trying to remind people to eventually think of an exit strategy or at least lock in SOME profits along the way up. You are more than welcome to send more hate mail, but it doesn’t matter because people are going to do whatever they want anyways. I sincerely hope you make a fortune with all your trades, just keep in mind that ALL stocks eventually disappoint, which is why you should NEVER marry a stock.

$AAPL $CSCO $DELL $EMC $GOOG $INTC $MSFT $PCLN $WCOM $YHOO

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1) I believe that the market is healthy 2-3 times a year. Do your homework, identify those times, and invest accordingly. The rest of the time, I prefer to stay out mainly to take a mental break and focus on other things. For example, since the March 2009 low, I intensely traded the market for about 14 months and never took a break. When the market went into its recent corrective phase, it gave me time to work on my business, take a brief vacation, do post analysis of my trades, spend more time with family, and most importantly: take a mental break! Even if trading is not your main occupation, you’ll be surprised how much more productive you can be at work when you’re sitting in cash, waiting patiently for new bases to build, and not constantly watching the market.

2) Shorting is flat out too difficult and frustrating. In Jack Schwager’s Market Wizards, William O’Neil says that: “Selling short is quite tricky. I myself have only made significant profits on the short side of two of the last nine bear markets.” I’m not a big fan of re-inventing the wheel. In other words, if one of the top traders of all time is telling us that shorting is difficult, then who am I to think that I’m going to be any better at it?

3) Effective use of capital. In 2002, a hedge fund manager that I have tremendous respect for shorted some of the bond insurers ($MBI $ABK) saying they would eventually fail. He was mostly correct in his prediction, but there were a few problems. First, it took over SEVEN years for his call to play out. Second, the stocks increased over +50% from 2002-2007 BEFORE they eventually fell apart; this can be painful and excruciating when you are short a stock. Third, during that period, there were huge winning stocks (such as $TASR $HANS $AAPL $GOOG) that increased from +500% to over +2000%. In my humble opinion, I would rather invest my capital on the long side in stocks with infinite upside potential than frustrate myself on the short side for limited gains. In other words, I WOULD RATHER MAKE DOLLARS THAN PENNIES!

4) Limited gains. A $20 stock can theoretically go to $1,000 or higher on the long side. A $20 stock can only make you $20 on the short side and that’s only if the company completely goes out of business! Realistically, the company’s stock will stabilize in the single digits even if the common paper is worthless.

5) In 1999, after CMGI’s stock rose from $1 to $120, a very sharp money manager I know was adamant that the stock was going back to $1. Once again, he was dead right with his prediction except for one thing: the stock tripled to $360 before it collapsed back to $1!!! This proves the old stock market adage that: “Just when you think a stock can’t go any higher it usually does, and just when you think it can’t go any lower it usually does.”

6) Shorting seems to only work well in full blown Bear Markets and not in intermediate 8-12% corrections. For example, I know people who shorted stocks effectively back in August 2008, and they were frustrated that they covered WAY too early. In their defense, no one expected the severity of the ensuing correction at that time. Another example is the current market environment. Some people are shorting now with the expectations of a new Bear Market, but they could also end up frustrated if we abruptly turn and move to new highs later this year. My point is that either way: SHORTING IS VERY FRUSTRATING!!!

7) Whenever you are loaded up on the short side, you wish for the worst possible news to come out. You hope for a bomb to go off somewhere, Middle East tensions to escalate, swine flu to spread, a plane crash, anthrax in the mail, or a deadly virus to breakout that can only be cured by capturing the host monkey from the movie Outbreak. In other words, we turn into sick individuals just so we can make $1.37 on our $FAZ and $QID positions! I know this point may sound a little disturbing, but trust me, if you are in intense trader like myself, it’s very true.

As I said in the beginning, this article is not meant to offend short sellers. I simply think that shorting is too frustrating and I would rather take a mental break and focus on other things while the market is correcting. I will leave you with one final thought: The best traders I know do post analysis of their trades. Go back and isolate your short trades. Be honest and ask yourself if you’ve made a net profit on those trades. I’m guessing that over 95% of you will answer no. By the way, I’m also in that 95%…another reason why shorting is not for me.

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1) Stocks are acting very strong technically. Over the past 3-4 weeks, I have suggested to slowly scale into this market. The majority of stocks that I recommended have worked out well and they are now either barely correcting or they are pulling back orderly on light volume. Examples include $GMCR $ISRG $NETL $LULU $IPXL $NFLX $CLNE $ATHR $CAGC $BCSI.

2) The major indexes continue to climb on strong volume and consolidate on light volume, a positive sign in my view.

3) The big institutions continue to put money to work. If you are a large mutual fund or hedge fund, your universe of growth stocks is limited. In other words, you have to buy Big Cap stocks with liquidity. Even if you do not trade these names, it is worth observing them to see what the big boys are doing. The price action in $AAPL $ISRG $GOOG $BIDU $AMZN $PCLN $V $GS is very constructive. The majority of these stocks are breaking out or building new bases to possibly break out over the next 4-8 weeks.

4) The stocks that continue to show up on my fundamental and technical screens cover a wide range of sectors showing me that this recent rally is broad based. Examples include: Tech, Retail, Energy, Semis, Restaurants, etc.

5) Everyone seems to fall into one of two categories. They either hate this rally or they are a cautious bull. I would consider myself the latter. My point is that VERY FEW people are in the crazy bull camp and feel this market has any legs left in it. Keep in mind: “The markets tend to fool the majority.”

A word of caution: I realize the markets have had a nice run over the past few weeks. I am not saying to jump in right now if you are not invested because we could see a pullback. If you did get in recently, hopefully you have decent entry points on your stocks and you have “room” to let your winners ride. If you did not get in, don’t chase extended stocks but rather look to buy them on pullbacks to logical support areas. Overall, I remain positive on this market because of the strong signs listed above.

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1) I believe that the market is healthy 2-3 times a year. Do your homework, identify those times, and invest accordingly. The rest of the time, I prefer to stay out mainly to take a mental break and focus on other things. For example, since the March 2009 low, I intensely traded the market for about 8 months and never took a break. When the market went into its recent corrective phase, it gave me time to work on my business, take a brief vacation, do post analysis of my trades, spend more time with family, and most importantly: take a mental break! Even if trading is not your main occupation, you’ll be surprised how much more productive you can be at work when you’re sitting in cash, waiting patiently for new bases to build, and not constantly watching the market.

2) Shorting is flat out too difficult and frustrating. In Jack Schwager’s Market Wizards, William O’Neil says that: “Selling short is quite tricky. I myself have only made significant profits on the short side of two of the last nine bear markets.” I’m not a big fan of re-inventing the wheel. In other words, if one of the top traders of all time is telling us that shorting is difficult, then who am I to think that I’m going to be any better at it?

3) Effective use of capital. In 2002, a hedge fund manager that I have tremendous respect for shorted some of the bond insurers ($MBI $ABK) saying they would eventually fail. He was mostly correct in his prediction, but there were a few problems. First, it took over SEVEN years for his call to play out. Second, the stocks increased over +50% from 2002-2007 BEFORE they eventually fell apart; this can be painful and excruciating when you are short a stock. Third, during that period, there were huge winning stocks (such as $TASR $HANS $AAPL $GOOG) that increased from +500% to over +2000%. In my humble opinion, I would rather invest my capital on the long side in stocks with infinite upside potential than frustrate myself on the short side for limited gains. In other words, I WOULD RATHER MAKE DOLLARS THAN PENNIES!

4) Limited gains. A $20 stock can theoretically go to $1,000 or higher on the long side. A $20 stock can only make you $20 on the short side and that’s only if the company completely goes out of business! Realistically, the company’s stock will stabilize in the single digits even if the common paper is worthless.

5) In 1999, after CMGI’s stock rose from $1 to $120, a very sharp money manager adamantly convinced me that the stock was going back to $1. Once again, he was dead right with his prediction except for one thing: the stock tripled to $360 before it collapsed back to $1!!! This proves the old stock market adage that: “Just when you think a stock can’t go any higher it usually does, and just when you think it can’t go any lower it usually does.”

6) Shorting seems to only work well in full blown Bear Markets and not in intermediate 8-12% corrections. For example, I know people who shorted stocks effectively back in August 2008, and they were frustrated that they covered WAY too early. In their defense, no one expected the severity of the ensuing correction at that time. Another example is the current market environment. Some people are shorting now with the expectations of a new Bear Market, but they could also end up frustrated if this is only a 8-12% correction. My point is that either way: SHORTING IS VERY FRUSTRATING!!!

7) Whenever you are loaded up on the short side, you wish for the worst possible news to come out. You hope for a bomb to go off somewhere, Middle East tensions to escalate, swine flu to spread, a plane crash, anthrax in the mail, or a deadly virus to breakout that can only be cured by capturing the host monkey from the movie Outbreak. In other words, we turn into sick individuals just so we can make $1.37 on our $FAZ and $QID positions! I know this point may sound a little disturbing, but trust me, if you are in intense trader like myself, it’s very true.

As I said in the beginning, this article is not meant to offend short sellers. I simply think that shorting is too frustrating and I would rather take a mental break and focus on other things while the market is correcting. I will leave you with one final thought: The best traders I know do post analysis of their trades. Go back and isolate your short trades. Be honest and ask yourself if you’ve made a net profit on those trades. I’m guessing that over 95% of you will answer no. By the way, I’m also in that 95%…another reason why shorting is not for me.

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1) Big Caps: I have said all along “watch the action of the Big Caps.” Why? Because the large institutions traffic in this area and watching these stocks usually shows us what they are doing. Last week $GOOG rose on strong volume and $AAPL $ISRG $PCLN $AMZN $BIDU all pulled back on light volume, a sign that the large funds are not selling their shares yet.

2) $AAPL: After reviewing RIMM’s earnings Thursday night, I don’t see how Apple doesn’t obliterate their upcoming quarter’s earnings. In their last conference call, Apple said they “couldn’t keep up with demand.” In this economy, there are FEW companies who can say that. I think you can trade Apple as a “buy the rumor, sell the news” play. In other words, buy it here at $195 (it should have support in the 186-188 range) and sell it into a potential run to $220 by its earnings in late January.

3) The Dollar rally is over! There is INSANE speculation in the $UUP 23 calls for Dec, Jan and Mar. There’s a reason why the specialists closed it Friday RIGHT ON $23! If you don’t understand this, don’t worry about it. All you need to know is that the market tends to fool the majority. In other words, when the entire world speculates the same way, it almost never happens. I don’t expect the UUP to close above $23 anytime soon. Therefore: Dollar Decline = Stock Market Rally.

4) $CML: Compellent Technologies. Strong technical Daily and Weekly chart, hot sector, 16 quarters of revenue growth…sounds “compelling” to me! The entire Storage sector is strong ($STX $WDC $CAVM). You can buy CML here at 22.50, it should have support in the 20-21 range. I’m expecting the stock to be up 30-50% in the next 12 months.

5) Internet Security: This entire group acted very well this past week. Stocks to watch include: $RAX $ARST $BCSI $FIRE $FTNT (recent IPO).

6) India: Many Indian-related stocks showed great relative strength this week. Ideas include: $WIT $RDY $CTSH $INFY $TTM.

7) China Water/Infrastructure stocks: $RINO $TRIT $HEAT. China plans to more than double its spending on environmental protection in the five years from 2011-2015. They plan to invest $454 billion during this period, compared with the $205 billion allocated for the five years between 2006-2010. I expect this increase in spending to benefit these stocks and I look for continued announcements of government contracts to help their strong earnings and sales growth.

8) Miscellaneous ideas: $HGSI (continues to trade in a very tight range, a sign that institutions are not selling shares) $LULU (46% of its float is short) $SWM (strong chart, added to Goldman’s Conviction Buy List recently).

9) One final note, if I am dead wrong about my call for a market rally, it doesn’t bother me at all. Why? Because I trade with stops and I don’t have an ego when it comes to trading. Remember two VERY IMPORTANT trading rules: “Always cut your losses,” and “Separate your ego from your trading.” The market doesn’t care if you have to provide food for your family or if you have 10 kids to put through college. In other words: respect the market, take what it gives you, and ALWAYS protect your portfolio!

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Although the NASDAQ Composite’s volume was higher on Thursday, the S&P 500 and NYSE Composite volume was significantly below average. This is troublesome because it shows a lack of conviction from the big institutions. More importantly, I am finding very few quality stocks breaking out of sound technical bases. There are definitely some trading opportunties, but they seem few and far between right now.

One positive about Thursday’s market was the action of the Big Cap stocks. $PCLN $AMZN $ISRG and $GOOG all performed well, but unfortunately, they rose on weak volume. My gut feeling is the action in these stocks “masked” some overall weakness in the market on Thursday.

Again, my best advice is to remain cautious and wait patiently for better opportunities. I realize that the market has been resilient lately, however, I would rather see more stocks “setting up” and better upside volume. If you decide to trade, keep positions light and always maintain a loss-cutting policy in case your positions turn against you.

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Although I was a bit cautious last week, I’ve said all summer that the NASDAQ Composite is headed to 2400 with sharp, nasty corrections along the way. Don’t get me wrong, I reduce my equity exposure when we have these pullbacks in case the market doesn’t rally back. However, when the NASDAQ bounces nicely off its 50-day moving average and I see stocks like $BIDU $AAPL $FIRE $CDE and $CERN breaking out on strong volume, it’s hard not to feel positive about the market.

Another thing I observed last week was the strong action of Big Cap stocks such as $BIDU $GOOG $GS $AAPL $PCLN and $AMZN. My feeling is that many large institutions are significantly under-performing the major indexes. Since their universe of growth stocks is limited, they have no choice but to “plow into” these stocks when they are “chasing” performance. Combine that with the abundance of liquidity, a Fed that will NOT raise interest rates this year, and zero inflation and you have a recipe for higher prices into the end of the year.

Here are some trading ideas:

Big Caps: $AAPL $BIDU $PCLN $AMZN $GS $GOOG $ISRG. When I highlighted $BIDU last week at $382, I got a reply telling me how “crazy” I was to recommend such an expensive stock. $BIDU finished the week at $427 highlighted by a Citigroup analyst who raised his target to $480. I like being the crazy guy whose stocks go up $45 points in 4 days!!!

Gold stocks: $CDE $IAG $GOLD $AEM and $GLD (the gold ETF). These stocks continue to go up on strong volume and correct on lighter volume, a positive sign. According to Marketwatch.com: “The Hulbert Gold Newsletter Sentiment Index (HGNSI) which reflects the average recommended gold market exposure was unchanged recently at 25.2%. This is important because the HGNSI is nowhere close its record high of 90% and…the HGNSI saw peaks of 64.3% and 60.9% at gold’s highs earlier this year.” (click for article) As I mentioned two weeks ago, Gold could quickly surge to $1,100-$1,200 since many seem to be “doubting” or even ignoring the move. If we do see higher prices, the gold stocks mentioned above should benefit.

China stocks: $EJ $HMIN $CTRP $PWRD $KONG $UTA $DGW $WATG

Internet Security: $BCSI $FIRE $ARST $RAX $SWI. This entire group is strong and worth watching.

Biotech: $DNDN $HGSI

Miscellaneous ideas: $GMCR $GFA $QSII $NEU $PALM $HITK

All of the stocks mentioned above have decent support around their 20-day moving averages. Please keep in mind that the purpose of this blog is to help people with idea generation. If you trade some of these stocks, PLEASE, PLEASE, PLEASE use stops. In other words, if some of these stocks turn against you and the market doesn’t cooperate…protect your portfolio! Thank you. Good luck trading!

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