Introduction

To be a consistent winning trader or investor, the skill to identify warning signs of declining stock and act upon these signs is crucial to ensure our earnings is protected and maintaining a growing portfolio.

A declining stock can be divided into two categories, which are declining in long term or declining in short term. Reason for a share to decline in long term is usually related to its financial fundamentals, therefore a fundamental analysis approach is used to detect its long term movements.

On the other hand, reason for a share to decline in short term is usually due to smart money manipulations, therefore a technical analysis approach is used to detect these short term movements. We shall discuss five basic points for each of these categories.

Warning Signs of Declining Stock – LONG TERM

1.    Decreasing Revenue

If a company’s revenue had been decreasing for 3 or more consecutive quarters, it means that the company is losing market share due to competition or the company’s industry is facing a down trend. Even if the company’s profit is still maintaining or even in an uptrend, a decreasing revenue is still an alarming sign as it is a matter of time the company could not maintain its earnings due to declining sales and successful business transactions which affects the company’s income.

2.    Decreasing Revenue Growth

Although decreasing revenue growth is relatively less alarming than decreasing revenue, but due to public perception, decreasing revenue growth means not meeting the public investors expectation. When the revenue does not meet the forecasted results consecutively, it will cause a stock to decline in long term.

3.    Decreasing Dividend Amount

Dividends are paid from company’s net earnings to shareholders. When the dividend pay-out amount is decreasing from year to year, it indicates that the company is having less and less net earnings. Although it may be due to decreasing dividend pay-out ratio by the company, but this rarely happens as companies are also aware that by doing so will cause its share price to drop, hence companies usually try to maintain its dividend pay-out ratio year to year.

It is important to note that we should compare the absolute dividend amount instead of dividend yield as dividend yield fluctuates together with the company’s share price.

4.    Increasing Dividend Pay-out Ratio

On first look, it may seem to be a good news, especially to dividend seekers as they get a bigger cut from the company’s earnings. However, companies who increase dividend pay-out usually means that they allocate less of their earnings to capital expansion. This could be due to the company is unable to find new opportunities or new market to grow its market share therefore choose to pay more of its earnings to shareholders. Less capital expansion will mean less growth or no growth in the future therefore causing share price to decline over the long term.

5.    Cyclical and Sunset Industries

Some industries are known to be cyclical in nature whereby they are sensitive to business cycle, such that revenues are generally higher in periods of economic prosperity and expansion, and lower in periods of economic downturn and contraction. Example of these industries are Oil & Gas, Shipping, Airline etc.

Winning trader or investor should always identify them and be cautions when trading or investing stocks in cyclical industries.

Sunset Industries are industries going obsolete due to technology advancement or change in market demand. Example of these industries are chain book stores, DVD stores, certain semiconductor companies etc. Traders or Investors should not expect a turnaround in stock prices on these companies as their products are losing market demand over time.

Warning Signs of Declining Stock – SHORT TERM

1.    Stock Trading in Distribution Phase

As discuss in previous “iVSA Article 16 - Importance of Market Structure & How to Identify Them” http://klse.i3investor.com/blogs/ivsatradingtipsandplans/100977.jsp, when stocks are trading in Distribution phase, it is very likely that it will decline after smart money have successfully achieve its net selling and took profits. Winning trader or investor should follow the footsteps of smart money to take profit at this phase before the start of Mark Down phase.

2.    Stock Trading near Resistance

As discussed in previous “iVSA Article 14 - Importance of Chart Reading” http://klse.i3investor.com/blogs/ivsatradingtipsandplans/99754.jsp, with regards to identifying support and resistance, resistance is a price line which is difficult for a stock to breakthrough unless it is accompanied with substantial volume. When the stock is trading close to resistance level and volume is low when it hits the resistance, it is very likely that the stock will turn and move southwards as it does not have sufficient volume for the breakthrough. Refer to previous “iVSA Article 14 - Importance of Chart Reading” for example and details.

3.    Share Price Increase Drastically Due to Good News

A winning trader or investor must always be mindful of news as most of the time they are engineered to trap uninformed investors or traders into bad trading positions, namely Buy High, Sell Low. Good news is often used as tools by smart money to attract public attentions and entice uninform investors to get into the market as people generally have the psychology and greed of not missing out on good opportunities, especially fast money.

Being a winning trader or investor, when good news is announced and share price has increased drastically, it is time to anticipate for reversal of trends and be prepared to sell before the Mark Down phase. That is why it is important for winning trader and investor to learn proper knowledge and skills set as discussed in previous “iVSA Article 14 - Importance of Chart Reading”.

Example below shows an SGX stock with a price spike (highlighted by the arrow) due to good news with regards to rumour of privatisation. Share price decreased drastically right after the price spike due to the engineered and timing of releasing the good news.

4.    Narrow Spread Bar with High Volume at or Near its All-time High Price

When narrow spread bar is coupled with high volume and the stock is at or near its all-time high price, it indicates that there is potentially more selling than buying within the high volume. This is because if there were to be more buying than selling, the stock price will go up and closes further up from the opening price. In this case, chances are the stock will turn sideways or reverse its uptrend subsequently and in the near future.

Example below refers to a popular SGX stock. At Point 1, the stock is trading close to its all-time high price and closes with narrow price spread, accompanied by higher than usual volume (at Point 2). This is a sign of declining stock as selling by smart money already started, winning trader or investor should take profit around Point 3 given this weakness in the background of the chart.

5.    Decreasing Volume During Mark Up Phase

As discussed in previous “iVSA Article 16 - Importance of Market Structure & How to Identify Them”, a Mark Up phase is whereby smart money will ramp up the stock price, accompanied by release of good news engineered to promote the stock, in preparation for profit taking during Distribution phase. The significant characteristic of a Mark Up phase is the unusually high volume accompanied by wide spread bar. When the volume starts to decrease, it is a sign of changing market phase from Mark Up to Distribution and Mark Down phase.

Example below is an SGX stock. At Point 1, it shows climatic volume during Mark Up phase. At Point 2, it shows decreasing volume during Mark Up phase. When an experienced trader or investor spotted Point 1 and Point 2 even before Point 3 has happened, he or she must be prepared as these are potential signs of turning point is near. Around Point 3, the stock direction turns and a winning trader will start to take profit given these weaknesses in the background of the chart.

Conclusion

The above ten warning signs of declining stock are some selected example of the basic signs that a winning trader or investor should put efforts to acquire the knowledge to be able to look out for these signs. These signs may happen independently at different timings or may be a few in concurrent. The skills to spot these warning signs require proper knowledge, time and experience to master, as part of your journey to be a winning trader or investor. Remember this - regardless of the method use: long term movements are driven by financial performances and short term movements are driven by smart money.

Watch out for next article in this series of education articles brought to you by iVSAChart, “iVSA Article 18 – Ten Signals of Rising Stock” under Series D: Daily Guide for Traders & Investors.

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This article only serves as reference information and does not constitute a buy or sell call. Conduct your own research and assessment before deciding to buy or sell any stock. If you decide to buy or sell any stock, you are responsible for your own decision and associated risks.