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May 14 2011  / Strategy Article
Defensive Stock
Investing To Beat The Smart Money

Part 2 - Look To The Charts

Part 1 - Smart Money Versus Retail Investor Psyche
Part 2 - Look To The Charts
Part 3 - Applying The Strategy To Uptrending Stocks.



How To Invest In Defensive Stocks and Beat The Smart Money - Look To The Charts


What should a small investor do when it comes to defensive stock investing? What can the retail investor do to beat the smart money at their own game. As anyone who frequents my site knows, I believe in staying with large cap, blue chip dividend payers. My strategy is covered here.

To understand defensive stocks and put in place a strategy that protects you from buying at over valued levels, you must forget everything you have been told about the merits of defensive stock investing. You must think "differently" about defensive stocks than your average retail investor. Remember that smart money managers buy these stocks ONLY TO SELL THEM. So why are you always buying them and holding onto them? Think about the return you will earn every year by actually buying a quality defensive stock at under valued prices and selling them TO THE SMART MONEY MANAGER at over valued prices. This about doing exactly the opposite of what the smart money manager wants you to do.

To accomplish this you must understand that in any downturn ALL stocks will fall including the DEFENSIVE STOCKS. In bear markets every stock sinks. It is a rare bear, when certain sectors do not fall.

Let's take a look at Johnson and Johnson, one of the pre-imminent Defensive Stocks heralded by every analysts worldwide, and how it fared in the various bear collapses over the past 10 years:

In 2000 JNJ lost 38.1%: If an investor had 10,000 in JNJ during this period and had bought at the high, it would be worth $6190.00 without taking any dividends into account.

In 2001 JNJ lost 24%: If an investor had 10,000 in JNJ during this period and had bought at the high, it would be worth $7600.00 without taking any dividends into account.

In 2002 JNJ lost 36.9%: If an investor had 10,000 in JNJ during this period and had bought at the high, it would be worth $6310.00 without taking any dividends into account.

In 2003 JNJ lost 18.6%: If an investor had 10,000 in JNJ during this period and had bought at the high, it would be worth $8140.00 without taking any dividends into account.

 In the bear market of 2008 - 2009 JNJ lost 36.4%: If an investor had 10,000 in JNJ during this period and had bought at the high, it would be worth $6360.00 without taking any dividends into account.

In between these bear market collapses, Johnson and Johnson stock also saw a variety of declines with some being as high as 11%. But then that's the nature of investing in risky assets. So now you know that even though many defensive stocks do not fall as far as the overall market, THEY STILL FALL CONSIDERABLY. When a stock falls how do you feel? Do you feel like you want to buy more? No, because we are fed all the lines like "don't catch a falling knife", or "the second shoe" to drop, or "we have a lot lower to go", or "this is the end of equities". But think for a moment. If the retail investor cannot move defensive stocks because they do not have the buying power to purchase enough shares in stocks like Johnson and Johnson, who then is buying all those shares? Could it be the smart money managers? Absolutely.

When in 2009 Johnson and Johnson stock reach $46.25, the dividend of $1.96 gave a return of 4.2%. Yet where were all the retail investors? They were selling their shares instead of buying. Isn't JNJ a defensive stock? Does that not mean it will continue to pay its dividend? Does it not mean that JNJ is in an industry that is by and large recession proof? Have they not increased their dividend annually for more than 25 years? As a small investor it took me a long time to come to the realization that bear markets were fire sales of large cap terrific corporations that suddenly were cheap and paid great dividends. In May of 2009 I was still buying JNJ. In the end I owned 1500 shares with an average price of $48.35. I earn 4.0% on my dividends annually and have sold covered calls far out of the money and earned an additional 4% a year. Total return has been 8% and now in this most recent push by smart money managers I will unload my shares for better than $66.00. That means I will earn 36.5% capital gain on the shares and 16% in dividend payments and covered calls. My total return will be 52.5% in two years. I unload my shares because I know based on charts that this stock will again go "on sale" sometime in the future and I want my cash free to buy it again. Over the past 10 years I could have bought JNJ below $50.00 at least 4 times. That's the true power of defensive stock investing.


It also proves that it is myth that an investor has to be 100 percent invested all the time. If over ten years I had only earned 30% on those 4 trades in Johnson and Johnson, my annual average for 10 years would have been 12%. Cash is very often an investment strategy itself.


In order to understand better, I use a simple charting method to establish OVER VALUED, UNDER VALUED and RETURN POINTS in my defensive stocks. It's easy to do this in defensive stocks as most have stable patterns of stock ranges.


The chart (below) shows Johnson and Johnson over the last 12 years from 1999 to 2011. Looking back this far, gives a much clearer picture of Johnson and Johnson stock. By dividing the stock into three sections - OVER VALUED, RETURN POINT and UNDER VALUED I get an even better picture to help decide how and when to invest.

The RETURN POINT shows that in general, an investor could expect that over the course of several years, JNJ should be able to recover to around the $57.50 to $59.50 value. That then is my RETURN POINT. The OVER VALUED prices are easy to spot since the stock constantly falls back to the return point. It is the over valued prices where I use stop losses to eventually unload the stock I have bought. The UNDER VALUED prices are also easy to spot, again based on the return point. It is at the under valued prices where I sell puts to get stocks at better discounts or during panics such as in 2000 and 2009 I will buy stock and sell far out of the money covered calls.


Using Charts To Beat The Smart Money

An individual investor needs to understand that chasing stocks is in the end a losing strategy. The smart money can push stocks up and down in very short order. Getting in and out of stocks profitably that smart money is in, is difficult to do in a consistent fashion. The moves can be sudden and strong both up and down. As of writing this article, the smart money has been leaving commodities for a few weeks now, YET the analysts are just now suddenly talking up defensive stocks. I can tell from emails I am receiving that many retail investors are beginning to buy defensive stocks. But if you recall from Part 1, the smart money has already bought most of the defensive stock they wish to own and are now pushing defensive stocks higher, to entice the smaller investors to get in on the action.


Look at the chart below. Since late March the smart money managers have been moving out of commodities and at the same time moving into defensive stocks that just a couple of months ago analysts were not commenting much about. I have marked in a light red circle the periods of selling by smart money in commodities and the periods of buying in JNJ.

Indeed when JNJ in March fell below $58.00 I was flooded with emails from put sellers who had sold the $60.00 strike positions and were closing them with losses. Even analysts were warning about JNJ at $57.50. But the chart on JNJ showed no need for concern.

So who was buying JNJ below $58.00 then? Smart money managers.

Looking at the chart on JNJ it is obvious the sudden move higher. This is not just related to JNJ, but a host of defensive stocks. Yet analysts are discussing this "phenomena" like it is just happening, when in actual fact the bigger purchases by smart money managers have already been done.


But it is easy to beat smart money if an investor takes the time to understand the stock and studies all of the above charts. Consider these points as you review the above charts:

1) JNJ even though a "defensive stock" will collapse just like all stocks in any bear market. Therefore as an investor, I know that Johnson and Johnson stock will fall dramatically should selling commence. It will go "on sale".

2) Looking at the charts I can see the over valuation zone in JNJ. Right now the stock is being pushed higher. I have to ask myself if there is any point in buying the stock when the smart money is pushing it into over valued territory. The answer is simple - NO.

By answering NO, I have ended forever the retail investor's biggest problem - buying stocks too high.

3) During market contractions, I now know that I can pick a RETURN POINT. This can give me as an investor a great deal of confidence to step in and buy some shares when the stock goes into under-valued territory. In my strategy I sell puts to try to pick up the shares at an even better discounted price. NOW I AM BUYING STOCKS UNDERVALUED! I have beaten the second worst problem of retail investors - NOT BUYING LOW.

4) I also know from the above charts that JNJ may fall further than I imagine. Therefore the best way to handle this is to buy in small lots and NOT USE UP ALL MY CAPITAL IN A PURCHASE, but to TAKE MY TIME buying stock. Forget worrying about commission rates. With today's discount brokers I can buy 100 shares at a time and average my way into the stock all the way down, because I know when it recovers that I will make such a large profit that commissions will be unimportant.

5) I know from the above charts that every collapse in JNJ has been followed by a recovery. Therefore I can buy with the confidence of knowing that at some point the stock should move back to the RETURN POINT.

6) I now know that buy and hold forever for this stock is probably no longer feasible unless I am content to see the stock move up and down and perhaps never actually have a decent capital gain at the end. Therefore I know that after buying the stock in UNDER VALUED territory, I will hold the stock, collect the dividend and then once it recovers above the RETURN POINT, wait for it to move into OVER VALUED territory and sell the stock.

7) I know from the above charts that there is no need to ALWAYS BE INVESTED. That if I buy the stock in the UNDER VALUED territory and sell it when it is OVER VALUED that I can get a very good return which will more than compensate me for those times when I am in cash waiting for the stock to pull back so I can buy JNJ stock in UNDER VALUED territory again.


9) By buying this stock in UNDER VALUED territory I will be selling it to the smart money, when they push it into OVER VALUED territory which is exactly OPPOSITE to what the smart money wants me to do as a small investor.


In the final chart below, is the past 12 months in Johnson and Johnson stock. It shows 4 opportunities during the year when an investor following the chart above which showed over valuation, under valuation and return point could  have made trades based on those valuations. A conservative approach would have returned 11.8%. However those who use stop losses could have made considerably more. In all 4 cases an investor would have been in the stock at the low and sold at the high. This shows that it is not necessary to always be invested but instead keep capital aside because opportunities will always present themselves throughout the year.




This type of study is very simple to do and does not require a degree in rocket science, let alone a degree in economics.

For those not interested in buy and selling defensive stocks, the above charts are an easy way to pick option strike prices to buy and then sell or for those investors interested in selling put options, an investor could pick the appropriate strike price based on the above charts. As well, if assigned shares an investor can take great confidence that the stock will, even in a collapse, eventually move back up to the RETURN POINT, allowing the investor to consider covered calls as a strategy.

This is a straight forward approach to investing in defensive stocks and a winning strategy that allows the small retail investor to beat the smart money managers at their own game.


In Part 3 I will look at another Defensive Stock and show the adjustments that are necessary on a defensive stock in an uptrend as the years go by. That Defensive Stock is PepsiCo.



Part 1 - Smart Money Versus Retail Investor Psyche
Part 2 - Look To The Charts
Part 3 - Applying The Strategy To Uptrending Stocks.



Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed or presented are financial advice, trading advice or recommendations. is a private website. Everything presented and discussed are the author's ideas and opinions only.
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