WiseTech Global Ltd (ASX: WTC) shares are up 6% to $27.90 this morning after the software player defended itself from a short seller and returned to the ASX boards.
The stock opened 6% lower in showing how many market participants are guided by price action and headlines.
Generally letting stocks’ behaviour guide your own behaviour is a recipe to fail in the market.
What is the problem?
Any business trading on a huge valuation that uses an aggressive acquisition strategy is vulnerable to a short attack.
While the large buy / sell spreads for a relatively illiquid stock also offer the opportunity for exaggerated price swings on the upside or downside.
The tactic of dumping a lot of stock on market by short sellers to force the price down was first popularised by legendary U.S. trader Jesse Livermore.
In theory it can work on less liquid stocks when there are not enough buyers to meet the dumping onto the offer price and panic or automated stop losses amplify the downward pressure.
As a word of caution Jesse Livermore’s inter-war memoirs are an entertaining read, but partly fictional.
The other trading concept of ‘tape reading’ popularised by Livermore still exists today, despite stock prices no longer being printed off tapes. The concept today means any number of vague trading techniques related to price action, volume, and supply.
For investors rather than traders, the WiseTech saga also has many lessons.
The obvious one is that all stocks on sky-high valuations are vulnerable to large corrections. Blindly buying stocks constantly rising may seem easy while it works, but it’s not investing and often leads to big losses.
In the U.S. for example the wildly popular ‘cloud king’ tech stocks have recently been slaughtered on valuation grounds.
It is not unusual for a tech stock like WiseTech to lose 30% or more of its valuation from highs that are supported by over enthusiasm.
Secondly it’s worth noting aggressive roll-up strategies can look attractive over the short term. However, whether they succeed is generally not evident until over the medium term.
Roll-up strategies bring a lot of risks including over integration and paying too much for a capital-raising fed business like WiseTech.
Common sense dictates that the seller of a business always knows its true value better than the acquirer.
Should you buy WiseTech then?
This is the million dollar question. For disclosure I own some WiseTech shares, but it’s my second-smallest holding alongside MNF Group (ASX: MNF).
It’s a small holding as I’m also uncomfortable with the acquisition strategy and its implications. As such I won’t add to my small WiseTech holding today. However, I’m won’t sell given it’s a small position and I have a long term approach.
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Tom Richardson owns shares of WiseTech Global and Dicker Data.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of WiseTech Global. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.