Trolling For Bases
As the averages do what they will do,
don’t take your eye off the ball: the hunt for high relative strength, high
earnings growth stocks forming sound bases with rising relative strength lines.
When the market rallies in earnest, many of these stock will gain a surge of net
thrust.Â
One possibility is
Waters
(
WAT |
Quote |
Chart |
News |
PowerRating). The stock appears to be forming a cup-with-handle pattern
here. It tried to break out Tuesday, but the volume didn’t come in and the share
price ended back within the handle. Note the relative strength line nearing new
high ground and the rounded or U-shaped bottom with several intermediate peaks.
That serves to wring out the weak holders. Sharp V-shaped recoveries are failure
prone.
I
must emphasize the need to stay alert. I don’t predict bottoms, I react to
dynamic change. You don’t need to predict; you have time to react, provided you
are able to react quickly. The only way to react quickly is to constantly update your watch list of stocks. That way, when the base formations and breakouts occur, you see them in time to take advantage. And because you have vetted every stock on your watch list, you won’t be caught trying to analyze the quality of the breakouts on the fly. You’ll have pre-selected your targets. So don’t let the most recent rally failure discourage
you.
One of the most accurate market
watchers I know is Bryan Brown, principal of Spectrum Equity Services in Beverly
Hills, Calif. Bryan called the semiconductor top on March 13 when many professionals were loudly defending the sector. Throughout the current bear, he has stayed bearish and accurately used rallies as selling opportunities. Bryan took a decidedly bearish stance in Dan
Delaney’s Dec. 7 Overheard On The Street and remained
bearish despite the Dec. 8 follow-through day.
I asked Bryan to elaborate on what enabled him to stay with his accurate bearish call. Like any trader worth his salt, Bryan pointed out that all his opinions are provisional. He is prepared to change course with the market. That said, Bryan ticked off a
laundry list of points that enabled him to spot the December bull trap:
“First, all three of the key broad-market indices — the Dow, the S&P 500 and the Nasdaq Composite — were in uncontested downtrends. Second, the clearly defensive character of the market had not yet begun to change. There were simply too many yield surrogates such as electric utilities on the new-high lists. The, the Volatility Index, the Put/Call picture, and the bullish/bearish sentiment figures had not yet begun to exhibit the
extremes of pessimism generally consistent with market bottoms.
“Fourth, bear markets generally tend to
terminate in overreactions. Overreactions almost always consist of volume-driven undercuts of widely accepted support levels. That did not occur. Fifth, the consensus at the time was that the election was the key overriding weight keeping the market down. I found that too pat, too complacent. Finally, there was an unmistakable shortage of buyable merchandise.
Chart profiles were wide and loose, the earnings pre-announcement season was peaking, and Wall Street analysts were belatedly trying to bring expectations down before the end of the year.”
The top field of all charts in this
commentary 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 in black with a 50-day moving average in blue for volume.
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,
check out the Money
Management area of TradingMarkets’ Stocks Education section.