Learning from the past: Potash Corp (POT) 2006-2008

Legendary investor Robert Rodriguez described a question he asked Warren Buffet and Buffet's response...

"I said what can I do to make myself a better investor, beyond just what I’m doing here and researching, et cetera? And he said, read history. Read history. Read history." (source)

In addition to reading books on history, it is instructive to look at historical stock charts to see how patterns and trends unfolded. These patterns can help us make informed choices about how to act in the present.

Potash Corp (POT) was a beautiful textbook example of how trendfollowing combined with an all-time high stock can work.

What were the ingredients to making money on POT?

1. Join the trend
   a. A stock that made an all-time high and therefore had no overhead resistance.
   b. The Canadian stock market was in an uptrend
2. Have an exit plan that limits losses but not profits
3. It became a 'story stock'. The storyline was roughly: population + china + food crisis + plants need potash to get higher yield + potash is only found in a few places + it takes years to develop a new mine + POT is the market leader = Potash is in short supply, the price is skyrocketing and POT is dirt cheap based on forward earnings! The story is perfectly logical and caught on like wildfire. I had distant relatives calling me in the summer of 2008 asking how to get in on this potash run (a contrary signal!).

Here is how the story played out:
1) The entry signal (new all-time highs) is shown in the second chart. And the Canadian index is shown in the third and fourth charts below.
2) The worst-case exit plan is a 7-ATR stop loss shown in the second chart. Other warning signals that the trend was changing from up to down are illustrated on the top Guppy chart and in the Canadian Index chart below. What I actually did with my shares of POT was sold part around the Guppy Inversion (red arrow #1) and sold the rest at a trailing stop.

Here is what the Canadian Index looked like at that time:

A few things to notice:

• The entire trade lasted almost two years and there were no shake-outs. Actually a tighter trailing stop would have worked well.
• A precise entry point was not critical. Rather, joining the trend was the most important thing.
• POT topped after the market index topped.
• The trend was much stronger and cleaner with POT than with EWC.
• Profits were much higher trading POT ($40 to, say, $180 is a 350% gain) than the index ($22 to $32 is a 45% gain).
• A downward sloping 200-day EMA was the last warning before the big sell-off for both POT and EWC

Stocks like POT don't show up very often but it pays to be ready when they do.