A Valuable Signal in the Short and Long term for Penn West

“Successful investing is anticipating the anticipations of others” – John Maynard Keynes

Every day, investors take positions in securities that they are convinced will go up, while at the same time there are investors taking positions in the same securities with every expectation that the price will go down.  Some investments are focused in the short term, and others in the long term, and some investors are trading their own money and others are trading the assets of others.  The drivers behind the investment decisions vary widely, but are usually rooted somewhere in the fundamentals of the business, recent events and news or market and environmental factors.  With so broad a range of criteria and motivations, how do you anticipate how investor behavior is likely to impact each investment decision?

The best place to start is by understanding how investors have reacted to similar environments and price trends in the past.  In many instances, there is no historical consistency to how they have reacted to even the most similar trends historically.  However, even with the broad range of motivations and timelines, EidoSearch has quantified the fact that investors commonly DO react in a consistent way to the same types of price trends, patterns and environments.

By anticipating investor behavior, using their reactions to similar trends historically, you can model the range of likely outcomes and the consistency of investors reactions, generating valuable signals for short term traders and long term investors alike.

For this week, we looked for a current price trend in a security that emphasized the benefits of anticipating investor behavior, both in the short term and longer term, and found Penn West Petroleum (PWE).  The stock reached a 5 year low of $7.12 on January 23^rd, but over the past month it has gradually risen back up to $8.22.  The Bulls cite a turnaround plan that’s working, including the shedding of non-core assets, a short term rise in Natural Gas prices and a high dividend payout.  Bears continue to be concerned about high debt, poor performance and long term Nat Gas prices.  How are investors likely to react from this point?

This pattern in Penn West has seen a strong and consistent reaction historically by investors in Energy stocks, but one that has varied greatly depending on the time horizon of the investor.  This is best exhibited by the charts below:

Here is the one year price chart for PWE (in blue), and the 1 month forward projection for the stock price (in red).  We found 54 similar instances of this one year pattern in PWE in Energy Stocks, and the average performance in the next one month historically is -3.4% with 63% of the matches down in the next month.  Consistently, the rebound faltered and the stock pulled back.

In the chart below, we see the same 1 year price trend for PWE, but extend the forecast out to 3 months looking at the same 54 historical instances of the pattern.  Although investors in the short term (1 month chart above) were skittish, for the 3 month forecast you can see that the reversal was typically a short term overreaction and the stock traded up 12% on average and in 72% of the instances.

Finally, pulling the forecast out to 6 months, you can see in the longer term how consistently bullish investors have been in similar environments historically, with the stock up in almost 90% of historical instances an average of 37.8%.

There are effective signals in the short term and long term in the charts above, whether you are trying to profit on shorter term price movements or whether you are building in and out of a position for the long term.

For the record, we’ll put our stake in the ground in the medium term for a continued recovery in the price in the next 3 months…..with the expectation of some choppiness in the short term.