I found a good article and would like to share with my readers on how technical analysis can come into a good play to analysis a stock and save you from facing a bankruptcy company in your portfolio holding.
Full credit to: Philip Teo
The Enron fraud shocked the world when it finally blew up in the year 2001.
Many investors suffered huge losses when they dangerously executed the dollar cost averaging strategy in a company that looks absolutely great on the outside but was actually rotting from within.
In fact, many of them could have gotten out way before the Enron fraud blew up if they have had knowledge about technical analysis.
I believe that as a trader and investor, you must learn how to protect your hard earned capital first before you even think about making money from trading.
In this post on the Enron case study, I shall share how investors could have gotten themselves out of trouble way before the ugly truth surfaced, just by using the technical analysis and risk management methodology that I will consistently advocate in this blog.
What happened behind the scene before the Enron Fraud imploded
I have also marked those events on Enron’s price chart below to illustrate the stock price trend when the events were unfolding in the public and behind the scenes.
A) 1996 to 2001
Fortune magazine named Enron “America’s Most Innovative Company” for six consecutive years.
B) 1999 to mid 2001
A group of 29 Enron executives and directors received $1.1 billion by selling 17.3 million shares from 1999 through mid-2001, according to court filings based on public records.
C) 17 Apr 2001
Enron announces $536 million in profits for the first quarter.
D) 14 Aug 2001
When Jeffrey K. Skilling suddenly resigns as chief executive, citing “personal reasons,” Mr. Lay retakes the job.
He says, “Absolutely no accounting issue, no trading issue, no reserve issue, no previously unknown problem issues” are behind the departure.
E) 20 Aug 2001
Kenneth Lay, the CEO sells 93,000 shares, earns $2m; urges employees to buy company shares.
Mr. Lay sends an e-mail to employees assuring them that the company is on solid footing.
He says in the e-mail that “one of my highest priorities is to restore investor confidence in Enron. This should result in a significantly higher stock price.”
F) 26 Sep 2001
In an online chat with employees, Mr. Lay says that Enron stock is a good buy and that the company’s accounting methods are “legal and totally appropriate.”
He also says that he and other senior executives are so confident about Enron’s prospects that they have bought stock within the previous two months.
He concludes by saying that the company’s third-quarter results will be very good.
G) 16 Oct 2001
Enron reports a third-quarter loss of $618 million.
H) 22 Oct 2001
The S.E.C opens an inquiry into Enron’s accounting.
I) 2 Dec 2001
Enron files for bankruptcy protection.
How investors could have protected themselves with simple technical analysis
As you would have read or will come to realize, I have and will always emphasized the importance of reducing or withdrawing your exposure to any particular stock when its key price support levels are violated on the downside.
The rationale is this; if a stock is really a truly worthy company, investors (especially insiders) would not have sold the stock below its key price support level.
When a key price support level is broken, general market sentiments have changed from bullish to bearish.As a result, the stock tends to encounter significant further selling pressure thereafter.
It is important from a risk management point of view that investors get out of this stock regardless whether there was any public news, rumors or information to justify the price plunge below its key support.
“Anyone can lie. Everyone can be wrong.
But only the price trend shows whether you are on the wrong side or not”
– Philip Teo
Essentially, anyone can say whatever they want to say about a company, including Fortune Magazine or the CEO of the company.
But at the end of the day, those people who really know’s what is happening and what is to come, will be the ones silently putting their money to work IN THE MARKET.
The ugly truth will always surface only on the hindsight way after the price has fallen much further.
And very often, the poor ignorant retail investors are the ones left holding on to empty promises just because they trust and listen blindly to what Wall Street tells them.
Let’s study how investors should have sensed that something was wrong and tried to get out of the stock before the Enron Fraud blew up.
1) Early 2000 to Mar 2001
Throughout the whole of year 2000, Enron’s price had rebounded on many occasions and was holding firmly above the $64 key support level.
But when the price plunged below this level in Mar 2001, it was clear that something was not right. This was the first signal that investors should have reduced their exposure or totally gotten out of Enron as a form of risk management or precaution.
This $64 level subsequently became a key resistance in which the stock rebounded and tested but failed to re-conquer in May 2001.
2) Mar to May 2001
After the $64 key support was violated, the stock price went on to form another key base around the $51 level, rebounding off this level on numerous occasions.
When this key level was subsequently violated in May 2001, it was the second signal that investors who did not get out earlier should do so.
This $51 level subsequently became a key resistance in which the stock again rebounded but failed to overcome in Jul 2001.
3) Sep 2001
After the $51 was breached, the stock plunged to a historically strong support level of around $38.
Following a brief rebound, the stock crashed below this key level.
Again, many investors opted not to cash out on Enron, partly because it was already too painful to do so and partly because Kenneth Lay continued to reassure the employees and the public that Enron is still very sound.
After breaking this $38 key support, this level subsequently became a key obstacle in which the stock rebounded and tested but again failed to retake in Oct 2001.
4) Oct 2001
The final leg of sharp plunge took place when the key support at around $25 was convincingly violated.
The price never ever came back to this level for a retest again as Enron went on to file for bankruptcy protection in Dec 2001.
And the below quote was an enlightenment that I had while working on this case study of the Enron Fraud:
Anyone could have lied. Everyone could be wrong. But the price always tell the truth.
So How Can You Apply This Enron Case Study In Your Future Investments?
Throughout the hundred years of stock market history, there were many cases similar to this Enron case study.
A few of those more recent and notable ones were the Worldcom fraud and the collapse of Lehman Brothers.
The stock price trends of these companies were very similar to the price trend of Enron’s before they finally collapsed.
Way before any signs or news about the scandal broke out, the respective stock prices had already started to violate key supports and trended lower persistently.
By the time the ugly truth surfaced, the stock price was already beyond redemption.
Cases like this will continue to surface in the future.
But I hope that after all that I have shared here, you will not be any of those unlucky ones to get caught in situations like the Enron fraud in your lifetime.
Please share this Enron case study so that more investors and traders can learn and avoid making these potentially devastating mistakes.