The 'Crowded Raft' Theory in the Market

Editor's note: This Weekend Edition, we're taking a break from our usual fare. Today, we're sharing an essay from Enrique Abeyta of our corporate affiliate Empire Financial Research. In it, he shares the two biggest lessons he has learned over his 20-plus years on Wall Street... and explains how these concepts will lead to moneymaking opportunities in any market.

When it comes to investing, you're buying stocks, not companies...

This is one of the most important lessons I have learned over more than 20 years of managing money.

You see, when you buy a company, you control its cash flows and can use them for anything you want: to acquire other companies, reinvest in the business, or pay out a big dividend. Those cash flows are yours to decide how to spend.

Likewise, when you buy a company's bond, you're entering into a legal contract to be paid out in cash. Now, that contract may not hold (if the lender runs into financial problems). But it's a legal contract with real, identifiable cash flow to you.

When you buy a stock, however, you legally own a stake in the company... though you have virtually zero ownership over its cash flows.

It's management's job to decide what's in shareholders' best interest...

A company may take actions to distribute some of its cash flows via dividends or buybacks. But for the most part, its stock's value is determined by whatever buyers and sellers agree it's worth.

As simple as it seems, when there are more buyers than sellers, a stock goes up... And when there are more sellers than buyers, a stock goes down.

What's a stock worth? There's only one right answer: Whatever someone is willing to pay for it.

This concept is probably the single most important (and most difficult) one for investors to grasp. We're constantly told that a stock is worth the sum of the company's cash flows, the value of the assets, or any number of measures of "value."

But that's the biggest myth in investing.

During my first decade as an investor, I struggled with this concept...

Eventually, I learned to accept it... and it opened many moneymaking avenues for me.

How can we determine the balance between buyers and sellers? We don't have access to the millions of trades out there... But we do have access to the result of all those trades: the price of the stock.

This is the basis of technical analysis. It's the best way to see the balance between buyers and sellers.

We also have a way to tell when investors are overly excited (which alerts us to good selling opportunities) and when they're overly pessimistic (which alerts us to good buying opportunities).

One of our core strategies is to identify these technical moments via the relative strength index ("RSI")...

When a stock trades above an RSI of 70, that means it's overheated and due for a pullback. When a stock trades below an RSI of 30, that means it's overly hated and primed for a rally.

But we don't suggest going out there and buying every stock after its RSI dips below 30. The key is to combine an understanding of technical analysis with a solid fundamental analysis of the stock.

For instance, if a company is headed toward bankruptcy, it makes sense that its stock would become extremely oversold. Buying into one of these situations is like lighting your money on fire.

The key to executing these RSI trades is in the fundamental analysis of the underlying company to separate the winners from the losers. We won't always be right, but we'll be right a lot more often than we'll be wrong... And we'll make a lot more when we're right than we'll lose when we're wrong.

Here's something else I learned in my two-plus decades on Wall Street...

The vast majority of concepts widely discussed in the financial media are basically worthless when it comes to actually making money.

One of the most widely discussed – and least useful – is the idea of market rotations...

Most often, this is positioned as an argument between "growth" and "value," as if we were watching two football teams duking it out on the field.

Again, this is a huge fallacy. No matter whether a sector or the broad market is crashing or soaring, certain individual growth and value stocks will always move higher.

When a company is outperforming expectations, its stock tends to go up... which attracts more attention from investors.

Think of it like this... You're on a raft (i.e., a stock) heading down a river full of rapids. In the beginning, only a few people are on the raft, and you can easily navigate the rapids. As more folks climb onto the raft (i.e., more investors pile into the stock), it becomes less stable... Suddenly, even hitting a small series of rapids may send a bunch of folks flying off the raft (i.e., the stock falling).

Companies that are struggling tend to have fewer people on the raft. The result is that "lightly owned" (or even heavily shorted) stocks begin to get attention.

The result is what's called a "market rotation."

Think of instances when the market's big winners take a breather and the laggards start to catch up. In other words, the most crowded rafts have thrown investors into the water... and they've started swimming to the less crowded ones.

This can be extremely frustrating for investors, as what worked during a previous period is no longer working.

I've traded through huge market events – like the collapse of Long-Term Capital Management... the fall of Lehman Brothers... the tragedy of 9/11... and other major events that dramatically moved the markets.

In other words, I've seen all types of price action through all kinds of different economic environments.

And in my Empire Elite Trader service, I've booked an 87% success rate by using a no-nonsense approach to the market...

It's all thanks to a powerful new system that shows you how to make thousands of dollars in just days at a time... on more than 6,000 stocks.

Right now, you have the chance to get in before the price doubles... and even claim one free year of access to what I'm calling the "quick cash" system behind it all. Learn more here.


Enrique Abeyta

Editor's note: For the past three years, Enrique's powerful, new "quick cash" system has generated an 87% win rate in the stock market. It's a unique strategy that allows you to get in, get paid, and get out of a stock... without ever having to gamble on a company's long-term future. And in a market as volatile as today's, it pays to know exactly where to put your money to work. To get started, click here.