Enjoy Being Right; Prepare to Be Wrong

This column was originally published on RealMoney on Nov. 28 at 12:00 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

While many smart guys make a living being contrarian (which I define as picking bottoms of downtrends and tops of uptrends), I gave up on that discipline a long time ago. Instead, I try to buy strong stocks on pullbacks and short weak stocks on rallies. I believe that as long as I'm leaning in the same direction as the prevailing trend, the odds of making money are increased -- so long as rigid discipline is a significant part of the trade.

If you're one of the much-maligned "momentum gang," you must understand why you are so despised by contrarians. As long as you are right, they are wrong, and it ticks them off. Why? As long as the trend persists, trading seems almost too easy.

But remember, these smart contrarians are professionals; they'll eventually be right. So during this uptrend, don't be fodder for the bears. This trend will certainly end, but it won't occur on your timetable. It'll surprise you. If you are locking in profits by consistently raising your stops into this maturing uptrend, you'll position yourself to make as much money as possible in this tenuous bull phase without the risk of giving it all back when the contrarians are finally vindicated.

Let's look at some stocks.

Monthly charts are too long-term to be used for trading signals. However, they really provide a great framework from which to begin your analysis. That's the case with Paychex(PAYX Quote). The first thing I see in its monthly chart, other than the dramatic uptrend between 1994 and 2001, is the low volatility in price movement over the past couple of years. Notice how tight the Bollinger Bands have been until the past couple of months. I often discuss squeezes in the context of daily charts, but they are just as powerful -- if not more so -- when they occur in a monthly time frame.

If a stock churns for an inordinate amount of time, doesn't it make sense that the majority of stockholders will have about the same basis in the stock? So as the stock moves higher, there is less inclination to take profits or to sell at "break-even." I believe this is what's going on with Paychex now.

Use shorter-term charts for timing, but the monthly view shows a stock with significant upside. After this morning's downgrade by UBS, Paychex just might come in enough for a better entry. But if $40 does not hold as support, I'd stay away from the stock; it might be a couple of years before it gets back there.

Baidu(BIDU Quote) has been strong over the last three days, and Friday's close was the highest the stock has seen since early September. That's a plus. Mind you, I'm making no assessment of the merits of the underlying company. With a forward-looking price-to-earnings ratio of 182, the current price is rich. However, Baidu's got China, which has about 1.3 billion potential Net surfers and a rapidly expanding Internet portal industry, and the inevitable comparisons with Google(GOOG Quote).

So, while the stock seems pricey, there are enough reasons to attract even more buying. If the stock breaks above the resistance drawn above, I believe the stage will be set for an assault on the September high. Irrational exuberance, Chinese-style? Maybe, but isn't irrationality a fundamental component of the stock market? Don't fight it; embrace it and profit from it. Of course, if the bears prevent Baidu from pushing through resistance, I'd just stand aside and find something else.

NutriSystem(NTRI Quote) has a great story. The company specializes in weight management and fitness products. It's also all over QVC, which opens up the impulse-buying "It's time I got in shape" market. With the Atkins diet apparently a thing of the past, NutriSystem has been the prime benefactee of an overweight society. And as long as New Year's resolutions exist, I suspect there will be a market for NutriSystem products. This is a tough stock to enter; the best trends always present that problem. But I'd sure use any pullback to the 20-day moving average as a buying opportunity. And because all trends end, don't forget to use stops.

Quality Systems(QSII Quote) was added to the S&P 600 small-cap index last week. The announcement was made after the stock had broken out, but the accumulation has continued. Still, Friday's session ended weakly, and it wouldn't surprise me to see this stock pull in a bit because of an absence of buying pressure. After all, the S&P 600 tracking funds are done buying.

This weekly chart of Goodyear Tire and Rubber(GT Quote) shows a stock with pronounced peaks and troughs within an uptrending channel. The uptrend downshifted about a year ago, continuing the uptrend on a shallower slope. But the trend is still up. If you're a buyer now, it pays to realize that you're buying at neither support nor resistance. You're buying right in the middle of the move, assuming the uptrend continues. I've indicated where I'd keep my stop. And if Goodyear made a lower high, I'd change my tires.

Be careful out there.

---

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Baidu to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to TheStreet.com RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.