What is a ‘story stock’? For those who don’t know – it’s used by many investors to refer to companies that sell a story and sell shares, rather than create value.
It’s similar to the ‘jam tomorrow’ phrase – whereby someone believes the company is the declarer of a never-fulfilled promise (this originates from Lewis Carroll’s 1871 book Through The Looking Glass and What Alice Found There).
These stocks always have an exciting technology, which is going to revolutionise the world or disrupt an entire industry. While these businesses offer a great story, the harsh reality is that they very often suffer from setback upon setback. This, in turn, creates a cash-call, and shareholders become diluted – often into oblivion.
It’s a proven fact that these stocks generate more bulletin board interest than those companies that are actually generating profit and cash. If you ask a person on the street which company they’d rather invest in – Company A, which makes no money, or Company B, which does make money, they’re always likely to pick Company B (why would you want to lose money?). Yet, the average person on the street says one thing and does another.
Story stocks are volatile
Because these stocks attract punters like a moth to the flame, they very often have periods of extended liquidity and volatility. When this happens, the market makers close their spreads, as they make a turn on every trade, and so their greed for a piece of the action gets the better of them. Tighter spreads attract more traders, and more traders means more volatility.
Very often, these stories will well overshoot their actual value and can increase several-fold, despite nothing much in reality actually changing. But as a trader, we don’t care about what the real value is. We just care about making money.
Spotting a story stock
The story stock is a rarely used part of my playbook, but it is nonetheless a nice little addition to the arsenal. The key to profiting from story stocks is to 1) accept that what you are looking at is likely worthless junk, and 2) buy it anyway if there is a good chance it’ll go up.
These stocks tend to be natural resources companies such as oil exploration, mining companies, or technology that people don’t really understand but know is exciting… These companies will all sound good, but a quick check of the balance sheet and income statement tells a very different story to the one the CEO is telling you (check director holdings – if it was that good, why do they hold no stock?!
‘…if it was so, it might be; and if it were so, it would be; but as it isn’t, it ain’t. That’s logic.’
Tweedledee – Through The Looking Glass
How to profit from a story stock
The way to profit from a story stock is to spot a story that sells well. The key is to buy at the bottom of the cycle (being late to the story can result in a significant capital loss). Spotting stocks that are starting to get traction on social media, and on bulletin boards, are stocks that offer opportunities to trade.
Charting is useful here as it allows us to view current market sentiment and price action through data – homogenising a stock’s opens and closes, support and resistance levels, and highs and lows into one data graph, or chart. We want to see historical spots that have good to buy and sell (also covered in my book) so that we can minimise our risk.
It can take a while for the story to take off, but what we want to see is increased volumes (as the stock gets noticed) and a gradual base and uptrend in price. From then on, it becomes a case of riding a wave of euphoria.
Most serious investors will tell you it’s gambling. In response, I’d say that investing is gambling. Any stock market-related activity is gambling – we do not have any control over the outcome of a trade or investment (unless you significant exert influence over the board but even then nothing is guaranteed). However, we are gambling with an edge. Over time, we trust our edge will keep us profitable in the market. And if you’re just realising right now that you don’t have an edge, well, you should probably try to find one.
You can learn more by downloading Michael’s fantastic free book How to Make Six Figures in Stocks. This can be downloaded from his website – https://www.shiftingshares.com/