FAF Breaks Out, EMLX Craters
Historically, the Fed chairman’s
Humphrey-Hawkins testimony has ranked among the most influential events in the
financial markets. It looks like the market decided this time to anticipate Alan
Greenspan’s testimony rather than react to it.
Rate-sensitive financials and
retailers shot higher Monday, a day ahead of Greenie’s scheduled testimony
before the Senate Banking Committee.
In this column, I’ve pointed out a
number of tightening base formations and breakouts from tight formations in
financials and retailers over the past weeks. American Financial, which had been
forming a nice, tight consolidation
zone, broke out Monday, rising 8.3% on volume of 736,000 shares,
nearly twice average daily trade.
The top field of this chart uses a logarithmic price scale and displays a 50-day price average in
red. In the second field, a
blue relative strength line represents the displayed security’s price
performance relative to the S&P 500. The third field displays vertical daily
volume bars with a 50-day moving average in blue for volume.
There are several factors that go into
a sound base. In the above chart, note the extreme volume contraction the day
before the breakout, a sign that shareholders are holding tight, priming the
stock to explode in the event fresh demand comes to market. Note the progressive
tightening in the overall range. The stock’s relative
strength line confirmed the breakout.
The stock also had established a fine
intermediate-term uptrend prior to basing, an uptrend which also was confirmed
by the RS line. That stands out clearly in a longer-term chart I’ve added
a 200-day moving price average in black to the chart.
It’s a reasonable bet to expect dovish, though always carefully couched, remarks from Greenspan on Tuesday.
We’ve had a steady stream of reports showing a more rapid economic deceleration
than foreseen. Last month, the Fed twice slashed the federal funds rate by 50
basis point, and Greenspan told lawmakers that he favored tax cuts.
In the past, though, Greenspan has
tended to use H-H day as an opportunity to deliver new information, a fact that
has generated noteworthy volatility. In late 1999, Salomon Smith Barney
technician Alex Saitta issued a study on the
behavior of the S&P futures and cash index on event days. Saitta computed a
five-year arithmetic average of volatility. For a volatility measure, Saitta
used a percentage calculation yielded by dividing the day’s range by the day’s
close. Humphrey-Hawkins testimony topped the list with an average volatility of
1.6% on the S&P futures and 1.7% on the cash. Then, the
average daily volatility ran around 1.2% on the futures and 1.1% on the
cash.
Shares in Emulex
(
EMLX |
Quote |
Chart |
News |
PowerRating) cratered
Monday, losing nearly half their value. After Friday’s close, the maker of
data-storage network equipment Emulex
(
EMLX |
Quote |
Chart |
News |
PowerRating) said some customers were
deferring orders and, if deferrals increased, the company would not meet Wall
Street’s revenue and earnings forecasts for its fiscal third quarter.
Back in January, Bryan
Brown, principal of Spectrum Equity Services, issued two
bearish calls to his institutional clients on the stock. On Jan. 15 before the
open, Bryan issued a memo stating: “I believe this stock is in the process of topping. Rallies should be used to reduce exposure; rallies above $100 should be used for short entry depending upon prevailing circumstances at the time.”
He beat the drum again on Jan. 19, before the open. he wrote: “Recent earnings-driven rally notwithstanding, this stock
needs to be reduced on strength here. High conviction.”
I asked Bryan to share the ingredients
that helped him cook up this timely market call.
“The industry group action was exceedingly poor, and this was the last of the
Mohicans,” Bryan said. “The short
interest had shown a fairly aggressive increase from one tenth of a day to
five tenths of day. The absolute amount of short interest might not sound like
much, but a large percentage increase in short interest from either nonexistent or
extremely low levels argues that aggressive managers may be hedging long positions
or initiating preliminary shorts. The third point was on-balance volume poor was poor and eroding at the time the call was
made. Also, estimates momentum was falling apart.”
All stocks, of course, are risky. In
any new trade, reduce your risk by limiting your position size and setting a
protective price stop where you will sell your new buy or cover your short in
case the market turns against you. For an introduction to combining price stops
with position sizing, see my lesson,
Risky Business. For further treatment of these and related topics,
you’ll find extensive lessons in the Money
Management area of TradingMarkets’ Stocks Education section.