Bargain Shopping
Stockscores.com Perspectives for the week ending May 12, 2007
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In this week's issue:
Most of us like a good deal. Big box retailers were built around this idea and the Chinese manufacturing industry thrives because North American consumers want stuff at low prices. But we all know that buying something because it is cheap does not necessarily mean it is a good purchase. We have to be able to discern between low priced and junk. Otherwise, we are just buying inventory for next year's garage sale.
The same can be said for the stock market. There are often times when stock's appear to be on sale but how do we know the difference between on sale and on the way out? Buying stocks because they are down is only good if they are likely to go higher soon after we take ownership of them.
Shopping for bargains in the stock market is relatively simple if you understand a few key principles:
1. Trade on the Side of the Market That Is In Control
The first criteria of bargain hunting is looking for strong stocks that are showing short term weakness. Take a longer term view of the stock chart and ask yourself a simple question, "Who is winning the war in the market?". The answer is simple; rising bottoms on the chart indicate the buyers are winning, falling tops mean the sellers are winning. We want to buy stocks that have long term rising bottoms but are making a short term move down from a recent high.
2. Stocks Regress to their Trend Lines
Up trends are comprised of upward moves and pull backs. Down trends are made up of downward moves and pull ups. The pull backs and pull ups are of a shorter duration and intensity than the moves. To identify the trend, draw a line across the bottoms of the pull backs and the tops of the pull ups. When the trend is up, the bottoms will be rising and the opposite is of course true for down trends.
Here is what is important. The best bargain hunts occur when stocks in up trends pull back to the trend line. We want to buy stocks that are under the control of the buyers but have suffered some selling pressure to take them back to their trend line. The trend line is a floor that strong stocks will tend to bounce from and act like the bargain table at Walmart. The trend line is where we should buy bargains.
3. You Won't Be Right All of the Time
Trading the market is not a science, you can not expect to always be right. You need to plan what to do if you are wrong about the trade and pick the point where you take the loss. Plan to exit the stock if it closes below support and have the discipline to follow the plan. The failure to do so turns the trader in to a long term investor, a depressed and frustrated one at that.
4. The Reward Must Justify the Risk
The buyers may be in control of the stock, the stock may have pulled back to the trend line and you may know where you plan to take your loss. However, you also need to have enough upside potential to compensate you for the risk of taking the trade. As a general rule, I want twice the upside potential as I have downside risk. If the stock has a price ceiling that will likely slow the stock from going higher, make sure it is twice as far to the upside from your entry point as the floor price where you are planning to take a loss if you are wrong. If not, forget the trade.
5. Stocks Correlate to the Overall Market
All stocks correlate to the overall market in some way. That means that on a down day in the market we expect most stocks to also be down. We try to remove the stock's correlation to the overall market by focusing on stocks that are abnormal but it is impossible to take away all of that correlation. Therefore, it is best to buy bargains when the overall market is also under buyer control. Judge this the same way for market indexes as you do for individual stocks. Rising bottoms equals buyer control, falling tops equal seller control.
Putting these all together, when looking for bargains we need to shop for stocks that are showing rising bottoms when the overall market is doing the same. Draw a line across those bottoms to establish the upward trend line and buy when the stocks show a sign of bouncing off of the trend line. Plan your stop loss point and make sure that the upside is at least twice the downside potential. Wrap all of that together with discipline and you are ready to start looking for the blue light specials!
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I went on a hunt for some bargains this week, using the Pullback Plays market scan to find stocks that were in strong upward trends but have suffered a pull back to their upward trend lines. There are lots of candidates, here are a couple worth considering:Back To Top
1. TER
TER may be better to leverage with a call option as it is a bit of a slow mover but the stock has been in a nice upward trend for a number of months and is now back to the trend line where it should bounce. Upside probably limited by long term resistance at $18 but that represents about a 4:1 risk reward ratio with support at $16.70.
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2. T.FNI
Hardly a cheap stock given the gains it has made in the last six months but all stock market bargain hunters care about is if the stock is likely to go higher after the buy it. T.FNI got away from the trend line but spent all of this past week pulling back until a nice bouncing candle off of the trend line on Friday. If this trade is to be valid it needs to remain above support at Thursday's low of $1.63.
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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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