One of the most common questions we get asked is how to trade stocks, especially ones in which the investor is uncertain of how much more room there is left to run.
It's good to start with a basic fundamental analysis, trying to find companies with significant upside potential. PepsiCo Inc. (NYSE/PEP) is a stock that has done extremely well lately.
PepsiCo over the last few years has embarked on a massive expansion eastward, paying $4.2 billion for a yogurt company in Russia called Wimm-Bill-Dann Foods. Prior to that, PepsiCo paid $2 billion for Lebedyansky, the largest juicing company in Russia.
At this point, between snacks and drinks, PepsiCo is now the largest food and drink company in Russia.1 The Russian market, as well as the surrounding nations, are continuing to see growth in the middle class. However, their level of consumption in the snack food area is extremely small when compared to Americans. This could provide a very long-term opportunity for the company.
However, the stock has had a tremendous performance so far, and a common question when asked how to trade stocks is about timing. Technical analysis can help give us some indications of how to trade stocks that have outperformed appropriately.
One of the simplest technical analysis tools is the trend line. Essentially a trend line gives us an indication of the general direction of the stock, as well as key levels that must be met. If a trend line is broken, this is an indication that the momentum is beginning to shift.
A more complex way in which how to trade stocks is to look for an over-extension and possible mean reversion. This simply means that a stock might have moved too far to either the upside or downside, and at some point the stock will revert back to its mean.
The RSI is clearly in overbought territory, but this doesn't mean that the stock will crash. Many times and RSI will remain overbought for quite an extended period of time. Notice how far higher the stock is than its 50 and 200 day moving averages. The stock over the past month has actually started accelerating to the upside, an angle that cannot be sustained for much longer.
Another way to look at how to trade stocks that have outperformed, yet are strong companies is through the use of options.
Let's you bought PepsiCo sometime last year and are sitting on substantial profits. You might not wish to sell at the current price, but are nervous since the technical analysis shows us that the stock has moved far ahead and is due for a pullback.
Since the beginning of 2013, the stock is up over 17% already. PepsiCo is a huge company, that rate of return cannot possibly keep going indefinitely. At this point, taking some profits could be a good idea, depending on one's overall portfolio goals. Or, one might consider selling calls at a higher strike price and buying puts at levels below the current price, to help protect against some of the potential downside, while still allowing an investor to receive the dividend. Note, that if a call is sold and the price moves above that level, the stock will be called away. (this type of trade is for more advanced traders)
Of course, how to trade stocks is extremely individual. Each person needs to look at their own risk profile and their time horizon. If one is more active, using technical analysis in addition to other indicators, then the advice on how to trade stocks will be significantly different as compared to a long-term holder.
Having said that, these days one must continue reallocating a portfolio to reach optimal returns. Buying and holding blindly forever is not a good method of generating strong and consistent returns.
There are different ways when considering how to trade stocks, but using a combination of fundamental and technical analysis as well as prudent judgment make sense. PepsiCo fundamentally is a strong company, however the technical analysis shows that it has gone much higher and faster than what is possible over long-term.
We would be inclined at selling a portion if we held any and waiting for a pullback to reenter. However, each individual must determine what's best for their own portfolio, this is only our opinion based on our own theoretical portfolio.
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By Joel Laceda - BehindWallStreet.com
1) Bloomberg BusinessWeek, “PepsiCo prepares for a snack war in Russia” March 4, 2013
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