Remove Defensiveness; Accumulate Sound Breakouts

  • July 14, 2000
  • Mark Boucher

Since
March, we began to take a defensive posture toward the market
environment. First we recommended taking half profits in all positions and
moving trailing stops up tightly as our profits were soaring from January to
March, but the new economy/old economy theme fell apart. Next, we noted the
follow-through days of late May and warned investors that breadth was
sub-optimal and to stay extremely selective.


Last
week, Top RS and EPS New Highs
list numbered 20 or more each day, while Bottom RS/EPS New Lows
languished. The number of industries registering new highs is broadening
and the industry leadership is shifting. While my bias is still that this is a
bear-market rally — it is broadening (including small caps) enough that I think
we can at least temporarily remove the yellow caution flag and get slightly more
aggressive in terms of positioning on the long side. What that means is that
stocks breaking out and meeting all of our criteria but one, should be taken now
on the long side — but only in leading groups. Leading groups right now are
medical/health care, electronics, financials, and retail.


Last
week, we had breakouts in stocks almost meeting all of our rigid upfuel criteria
from Merrill Lynch
(
MER |
Quote |
Chart |
News |
PowerRating), and AG Edwards
(
AGE |
Quote |
Chart |
News |
PowerRating) in the financials, while
banking stock GBC Bancorp
(
GBCB |
Quote |
Chart |
News |
PowerRating) broke out and its group was among the most
frequent top five in our daily sub-group ranking. Also Varian
(
VARI |
Quote |
Chart |
News |
PowerRating) broke
out in the electronics top group. In retail, Chico’s FAS
(
CHCS |
Quote |
Chart |
News |
PowerRating) and Braun’s
Fashions
(
BFCI |
Quote |
Chart |
News |
PowerRating) came close to meeting our upfuel criteria and broke
out. 


This
week, we were defensive and took only GBCB and VARI (which just barely met our
institutional holdings constraint with 35% on the day of breakout). Next week,
we would take stocks meeting all but one of our upfuel criteria in top groups,
like medical, retail and other financial industries.



Last
week also took us out on half profits of part of Keithley Instruments
(
KEI |
Quote |
Chart |
News |
PowerRating),
and all of Key Production
(
KP |
Quote |
Chart |
News |
PowerRating). Thanks for some hefty profits from these two
— and KEI looks to be giving us more on the half position left.



Our
overall allocation remains low. We are now around 47% long (including open
profits) and 7% short for aggressive accounts using leverage (25% long and 3%
short for unleveraged, more conservative accounts). Last week our longs actually
lost an average of 2% due to stop-outs in KP and half of KEI (and with 50%
allocation starting the week this subtracted 1% from our overall portfolio on
the week), while our one short collapsed 16.4% (and with 7% allocation, this
added 1.14% to our overall portfolio), giving our overall portfolio a gain of
about 0.14% on the week, and leaving us with around a 73.5% gain on the year
(another new equity high) on a 12% maximum drawdown so far. Conservative
investors not using leverage show about half these gains and drawdowns.


For
those not familiar with our long/short strategies, we suggest you review my 10-week
trading course on TradingMarkets.com. 
Basically we have rigorous criteria for potential long stocks that we
call “up fuel,” as well as rigorous criteria for potential short
stocks that we call “down fuel.” Each day we review the list of new highs on our “Top RS and EPS New
High list” published on TradingMarkets.com for breakouts of four-week or
longer flags, or of valid cup-and-handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our
up-fuel criteria. Shorts are
similarly taken only in stocks meeting our down-fuel criteria that have valid
breakdowns of four+week flags or cup-and-handles on the downside. 


We continue to buy new signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors could stop at
50% long and 50% short). In early
March, we took half profits on nearly all positions and lightened up considerably
as a sea change in the new economy/old economy theme appeared to be upon us.Upside
breakouts meeting fuel criteria (and still open positions) so far this year are: Key
Production
(
KP |
Quote |
Chart |
News |
PowerRating) (@13.38 level) w/ 15.25 ops; PC Connection
(
PCCC |
Quote |
Chart |
News |
PowerRating)
(@26.46) w/ 49.25 ops;  Alliance Capital
(
AC |
Quote |
Chart |
News |
PowerRating)
(@44) w/ 44.5 ops;  Keithley Instruments
(
KEI |
Quote |
Chart |
News |
PowerRating) @37
— out on 70 ops on half position and now use 64 ops on half); and Elantec Semiconductor
(
ELNT |
Quote |
Chart |
News |
PowerRating) @50.25 w/
50.5 ops; and this last week we had no valid
pattern breakouts up in stocks meeting our up-fuel criteria (see 10 week trading
course): Varian
(
VARI |
Quote |
Chart |
News |
PowerRating) @ 52.81 — now use 40 ops on half and 45 ops on
half; and GBC Bancorp
(
GBCB |
Quote |
Chart |
News |
PowerRating) @30.38 w/28 ops. The average gain
in these stocks from breakout points of entry to Wednesday’s close is 68%,
substantially outperforming the Nasdaq, Dow, and S&P for the year to date. Continue to watch our
NH list and buy flags or cup-and-handle breakouts
in NHs meeting our up fuel criteria.


 




On
the downside, this year we’ve had breakdowns from flags (one can use a down
cup-and-handle here as well) in stocks meeting our down fuel criteria (and still
open positions) in:  Ciber
(
CBR |
Quote |
Chart |
News |
PowerRating)
@13.44 — now use 13 ops. These shorts are down
over 43% from breakdown levels on average so far this year (before
current prices or exits). Continue
to watch our NL list daily and to short any stock meeting our down fuel criteria
(see 10-week
trading course) breaking down out of a downward flag or down
cup-and-handle. 


 



The
trend of the market is becoming more clear at least on an intermediate-term
basis here. As long as Top RS/EPS New Highs number 20 or more and breakouts in
stocks almost meeting our criteria continue to expand, the market light is
getting greener for longs. Don’t rush out and load your portfolio full though —
instead wait for valid breakouts in leading groups that meet, or very nearly
meet all but one of our criteria. And don’t add more than two stocks in a week.
In this way, we’ll continue to let the market action determine our allocation
and posture.