No Rear-View Mirror

If you’re new to intermediate-term
momentum trading, now is the time to watch out for temptation. A number of the
great names of the last bull are coming off their lows, some on positive
fundamental news.

But don’t let irrelevant regrets of
missing past leaders cause you to come lately to these issues. Look at the
market with a fresh pair of eyes. With the new class of leaders, they will
declare themselves by the resumption of prior uptrends from correction-recovery
bases, high relative strength scores, upward sloping lines and powerful
fundamentals or group associations.

EMC Corp.
(
EMC |
Quote |
Chart |
News |
PowerRating)
provides a good
example of what not to fall for. Shares in the No. 1 data storage company jumped
3 1/16 to 79 9/16 on volume of 21.4 million shares, 35% above average daily
trading volume as calculated over the past 50-sessions, a nice accumulation day.
The company reported Q4 earnings of 25 cents a share vs. Wall Street estimates
of 23 cents and year-ago earnings of 17.

The stock has cleared its 50-day and
200-day moving averages as well as its mid point, the halfway mark between its
pre-correction high and correction trough. All things being equal, this is a
good sign. It shows that the stock is making progress toward clearing overhead
resistance posed by the weak hands selling their shares and cutting their losses.

However, EMC is rather deep as a base
— a 50% decline from peak to trough on an intraday basis. I won’t automatically
rule out a stock because of a deep base but I usually look for other issues
that have held up better against a correction. The ordinary tests for overhead
resistance clearance may not suffice here.

Another problem with very deep bases
is the long road back to new high ground. A stock like EMC which has lost half its
value must double in price to notch a new high. Look how EMC has already moved up
52% and looks extended even though it’s still well off its old high.

EMC is a great company. But as famed
short-seller and Market
Wizard
Dana Galante points out, good companies can still make for bad stocks and vice versa. If the stock pulls within 5% of its old high, I’ll be
watching it. But this is not the kind of stock that I’d “cheat” on by
looking for early entries.

The top field of all
charts in this commentary uses a logarithmic price scale and displays a 50-day
price average in red and a 200-day moving average in black.
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 in black with a 50-day moving average in
blue for volume.

Remember that all stocks are
speculative and risky. On any trade, reduce your risk by limiting your position size to a percentage of your total
account and setting inviolable price stops. For an intro to combining stops with
position sizing, check out my lesson, Risky Business.