Where Are You Coming From?
Stockscores.com Perspectives for the week ending January 7, 2007
In this week's issue:
A person who suddenly loses 80% of their vision will be devastated. A person who has lost 100% of their vision and then suddenly gains back 20% will feel elated. For most of us, our happiness is based on where we have come from. This is an important principle to keep in mind when looking at stocks.
Some one asked me recently why oil stocks are not doing well when oil prices remain historically high and every oil company is still enjoying great profits. Their logical analysis of the fundamentals suggested that these stocks should be doing well. The problem, of course, is that oil prices were much higher a year ago. Earnings are likely lower this year than last. The optimism that surrounded the Energy sector a year ago has gone away. As a result, oil stocks have not been a good place to be over the past six months.
That is one reason why it is important to look at stock charts, even if you consider yourself a fundamental investor. You need to understand where the stock has been and how that affects the psychology of the crowd buying it.
When looking at the chart, ask yourself what the average investor expects. Investors don't expect much from a stock that has been going sideways for some time. Even when they start to go up, expectations are for a pull back to the old trading range. When a stock starts to get in to an upward trend, investors begin to expect more and that is the time that stocks will tend to pull back. Expectations will fall with the pull back and the stock will usually start to rise again, going in to the second leg of its upward trend. As the stock rises higher and higher, expectations go up as well and that usually leads to the second pull back. The stock then will go in to its final and steepest push higher where investors have the greatest expectations for even higher prices. This leads to irrational exuberance where prices get too high, leading to a burst of the speculative bubble. The company can not live up to investor expectations and a sharp sell of ensues.
Now begins the downward cycle. First, the sharp sell of where investors who bought late in the up trend refuse to sell because of their high expectations but those who got in early take profits. Smart short sellers initiate positions and expectations begin to build for a downward trend. But, inevitably, there is a bounce back as "bargain hunters" buy the stock because it appears cheap. However, the trend reversal has begun and the psychology of the market has been shaken. Now the stock begins its longer but not usually as steep portion of its downward trend. Investors have much lower expectations for higher prices although the company is likely beginning to get cheap based on fundamentals. Soon, the stock will base out and go back in to a sideways trading pattern that may last years. Only the hard core followers of the company have expectations for higher prices, most investors have completely forgotten about the company.
Most investors have lost their vision while only a few have gained it back. A normal person, the person who makes up the crowd, is pessimistic and sees nothing. The experienced trader who makes up the small minority begins to look for signs that vision is returning, a reason to be optimistic.
It is very important to understand this psychological cycle to be a good trader. When looking at the chart, ask what the average investor is feeling and try not to feel that way. You don't want to be average.
The best time to buy stocks is in that sweet spot when pessimism begins to turn to optimism. It is the point where the market metaphorically begins to get its sight back and investors find reason to increase their expectations. Most stocks, most of the time are not in that state, so it is important to learn what the signs are and learn how to trade them.
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How do I find the "sweet spot", the point where stocks are likely starting an upward trend? First, we need low expectations among investors and the easiest way to see that is when a stock is going sideways and has done so for some time. I then look for a statistically significant price move to the upside with statistically significant volume support the move. This is a somewhat simplified but hopefully you get the idea.
I did a Google search for top performing stocks of 2006. One of the results of my search was a list of winners from the Russell 3000 index. The top five stocks that are still trading from that list are AXR, INAP, CRVL, SVVS and SVNT. I then looked at each of their charts and found the abnormal price and volume action occurred very early in their up trends, out of a period of sideways trading on all of these stocks. Not all of these stocks would have fit my criteria but these examples to make the argument that abnormal activity out of a period of sideways trading is a clue that the stock has good potential.
I did a Market Scan on Stockscores for stocks that had abnormal price and volume action and found 28 stocks that met those criteria. I then inspected the charts of each to identify those that were breaking from a period of sideways trading. Here are some stocks to watch:
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1. ICGN
Breaking out of a lengthy trading range this week, I would like to see it make a pull back and then give a confirming entry signal like a break from a flag pattern before entering. If the pull back does come, it will be important that the stock does not pull back through support at $1.
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2. LTRE
After trading between $9 and $9.50 for some time, LTRE breaks from a cup and handle pattern and looks like it wants to go to $12. Probably better to consider on a pull back and confirming entry signal so long as support at $8.90 is not violated.
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3. DLTR
The DLTR has not had much life over the past two years but showed a pulse this week when it broke higher on strong volume. It has resistance at $32 which may stall it in the short term but I think $38 - $40 is a reasonable target longer term with support at $30.
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References
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Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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