Why bottom picking a stock is never a good strategy

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It is currently the reporting season with many companies releasing their financial year results, as well as their outlook for the coming year.

This tends to cause some volatility in the stock market, as companies report results that may be better or worse than expected causing share prices to rise or fall for a short period of time.

Over the past 18 months, there has been a surge in the number of new people investing in the Australian stockmarket, and given there have been some surprises this reporting season, I suspect it may be driven by the increased trading from these new entrants.

asx australian sharemarket

With many in lockdown, it is possible that they are sitting at home attempting to profit from the current volatility as companies report their results.

For example, prior to releasing its result this week, Appen rose nearly 16% from its close on Friday 20 August but after its announcement on Thursday that its net profit after tax was down 55.1%, it fell heavily closing more than 21% lower compared to the previous day's close.

Infant formula company, a2 Milk was up nearly 10% last week and rose another 5% this week before falling immediately after releasing disappointing results together with a weak forecast for the coming year. By market close on Thursday, it was trading at levels where it was nine days earlier.

Both of these stocks were previous market darlings pursued by retail investors chasing big gains with Appen rising more than 350% between 2018 and 2020 while a2 Milk rose nearly 150% more than the same timeframe. However, more recently, both stocks have been falling heavily, as they were down around 75% until a few weeks ago.

This indicates that many individuals are speculating on these stocks, however, attempting to bottom pick a stock hoping it will rise is never a good strategy, and attempting to do so based on an announcement is very hit and miss, as the above examples demonstrate.

The best and worst performing sectors this week

The best performing sectors include Information Technology and Energy, as both are up more than 2% followed by Materials up more than 1%.

The worst performing sectors include Consumer Staples and Utilities, which are both down more than 2% followed by Communication Services down more than 1%.

The best performers in the ASX/S&P top 100 stocks include Wisetech Global up more than 30% after releasing a great report and raising its dividend by a massive 141%. Qantas is up more than 18% while The Star Entertainment Group is up more than 10%.

The worst-performing stocks include Reece down more than 16% followed by Link Administration down more than 12% and Ansell down more than 9%.

What's next for the Australian share market

This week the stock market traded up over the first three days closing higher each day before turning down on Thursday in a sign that the bears from the prior week may have returned.

While the market is still technically bullish, it is searching for a two-year high and, as such, we need to consider that this may be occurring right now although it is a little too early to tell.

If the All-Ordinaries Index closes lower on Friday and trades down next week, it may be starting its move down into the low that is expected in September or October. If this is correct, we should get ready for a fall of at least 8 to 12% or slightly more.

That said, as I keep saying we need confirmation that a down move is unfolding before we react as the current bearishness may just be a pause in the current uptrend.

Given we do not have confirmation of a move in either direction, now is not the time to make emotional decisions rather you need to prepare yourself for what may occur.

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Dale Gillham is chief analyst for Wealth Within (AFSL 226347). He has an Advanced Diploma and Diploma of Share Trading and Investment and more than 25 years' experience in the financial services industry.