Perceptions Matter
Stockscores.com Perspectives for the week ending February 4, 2005
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In this week's issue:
Investors determine what they are willing to pay for a stock by evaluating the company's business and its ability to make money. Stock price is based on the present value of future earnings expectations, which means that information about the ability of the company to make money is important to determining price. In the theoretical world, investors rationally analyze the fundamentals and arrive at a price they are willing to buy or sell the stock at.
The real world is a lot different than the theoretical world. The reality is that investor's perception of fundamental value is based on their emotional state. One investor can perceive value very differently based on a wide variety of factors.
For example, I have just finished traveling across Canada doing presentations to investors. During these presentations, I invite the audience to ask me about the stocks they are interested in so that I can give them my opinion on where those stocks are likely to go.
What is interesting is how the stocks that I am asked about vary from one region to another. When I am in Toronto, I get questions about large Canadian companies like Nortel, BCE or the Bank of Montreal. Questions about trading options on these stocks are also popular.
In Montreal, I won't get through a presentation without being asked about Bombardier, the Quebec based conglomerate. In Vancouver, the majority of stocks that I am asked about are penny mining stocks, which makes sense considering Vancouver's history as the penny stock capital of the world. At home in Calgary, we mostly discuss oil and gas stocks.
The investor in Calgary is less likely to want to buy Bombardier, but is eager to buy Oilexco. The Montreal trader moves in and out of Bombardier but has never bought a Uranium stock. Walk in to a Starbucks on Howe Street in Vancouver, and you may here talk of the future of nuclear energy.
The point is that how we perceive fundamentals has a lot to do with where we live. An investor in one region will be willing to pay more for a stock than someone in another part of the country because of their emotional attachment to the stock. A proud resident of Quebec wants to own Bombardier because it is a French Canadian success story. The trader in Kelowna BC thinks it is a good short because he does not see anyone buying Ski Doos.
Therefore, it is important to look past the fundamentals. Instead, a good trader evaluates how the fundamentals are being perceived. Perceptions are influence by far more than where you hang your hat making it hard to rationally deduce what the market will think about a company.
It is possible to see how investors perceive a story by looking at a stock chart. Rising bottoms on a chart indicate optimism, falling tops indicate pessimism. Whether your perceptions of the fundamentals justify it or not, optimistic stocks tend to go up and pessimistic stocks tend to go down. To be successful, you have to figure out what the market will believe, not what is.
Following the first rule of the Stockscores Approach will help a lot of investors get past their emotional attachment to stocks. Don't consider stocks that you like if the Sentiment Stockscore is below 60. Not because the fundamentals are bad, but because the market does not perceive the fundamentals to be good. If the Sentiment Stockscore is above 60, then the stock deserves more consideration.
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A common theme among Head and Shoulder Bottom, Ascending Triangles, Pennants and Rectangle Consolidation patterns is a break through resistance from low price volatility, usually with volume supporting the breakout. Rising price bottom formations in to the breakout point are common, but what market dynamic do these patterns really represent?
Rising bottoms are a sign of growing optimism among investors. As time passes, they demonstrate a weakening of selling force and increase power among buyers. As a stock moves up toward a resistance price point, the market is faced with the upper limit on what investors believe the company to be worth. We often see that stocks will go in to narrow trading ranges under resistance as investors come to a consensus on the value of the company. When stocks break out from this condition, they may be signaling significant new fundamental information at work in the market since resistance has been broken from strong consensus out of a period of optimism.
The Sentiment Stockscore is useful for finding optimism in the market, and the Signal Stockscore is heavily weighted on the abnormal market activity that comes with breakouts. By looking for stocks that have a Sentiment Stockscore of 60 or higher, and a Signal Stockscore of 80 or higher, we can consider charts that may have a good chart pattern set up. The Stockscores Simple Market Scan adds in some other technical filters to shorten the list of potential candidates further.
This strategy is not solely about finding stocks with good Stockscores. The most important step is visually inspecting the charts to ensure that the chart patterns are what we are looking for. A good chart pattern will have the following characteristics:
A break through resistance
Abnormal activity, in terms of price and volume activity
The break through resistance should be from a period of low price volatility. Low price volatility is characterized by the price range of trading on each day (how tall the trading range is on the chart) and by the range of trading over a number of days (are the trading days side by side on the chart, or is there a price trend?)
A show of optimism leading in to the break through resistance from low price volatility.
It is necessary to have all of these criteria, many traders forget to check whether the stock was trading with low price volatility before the breakout, or to make sure that the stock is truly breaking through resistance and will not encounter more selling pressure soon.
I ran this Market Scan on the NYSE and found a couple of stocks that have good longer term charts shaping up.
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1. BFR
BFR is breaking through resistance at $7.25 out of a period of optimistic rising bottoms. It looks like the stock has good potential to go up to resistance at $9, provided the stock does not pull back through support at $6.75
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2. KO
KO has been basing with an ascending triangle pattern over the past four months, and is now breaking through resistance. It has been a long time since the stock was able to show a break from optimism as the stock has been in a downtrend since last April. Good potential if support at $40.50 can hold up.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
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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