Heyer Capital, LLC

If we hold together through the market close, today should qualify as the follow through day of the rally beginning from the March 6 lows. 

The “follow through day” is a day of heavy percentage gains in a major index accompanied by heavy volume and leadership from quality growth stocks.  To qualify, it must come on or after Day 4 from the market bottom. (IBD research shows the most common follow through days come on Days 4-7.)

This is not a raw “buy” signal. We’re in a bear market; all rallies must be treated with suspicion.

I sometimes get puzzled responses when I relate “Investor’s Business Daily” founder, Bill O’Neil’s, market aphorism that “All stocks are bad, until they’re ready to go up.”  A corollary saying is “Just because you like the company, doesn’t mean it’s a good stock to own.”  Case in point, Apple Inc.

In the past several years, Apple has been an enormous commercial success with its iPods, innovative computers, and iTunes. It was a tremendous cash-generating machine with outstanding earnings growth and a solid balance sheet.  In 2007, shareholders were handsomely rewarded, as the stock leapt from a ‘cup with handle’ technical pattern in April 2007 giving stock gains over 100% for the year. It culminated with a Christmas price peak over $200 that has not been overcome.

AAPL carved a deep base in the first few months of 2008, dropping over 40% from Point A to Point B.  It’s normal for high beta market leaders to correct more than the overall market, but 40% is about the maximum decline that’s acceptable in building a base digesting big prior gains.   AAPL charged up from B to C, and formed a typical consolidating handle.   The proper buy point at Point C, but only if the stock charges past C in heavier volume.  Waiting for such a movement, and not getting in too early,  puts the odds in your favor of fresh gains.

Why not try to get in earlier and try for bigger gains?  Look at any price point after C.  That, in a picture, is why.  It may indeed rally from Point D, but any price gains have to chew through all of the holders that bought in the prior two years at prices from $100 to $200 that will sell as the price advances.  Any stock gain is hindered by a flurry of orders of “Just get me out at what I paid.” That’s a textbook picture of upside resistance, particularly given the number of novice investors flocking to a brand name such as AAPL.  

Why bother buying stocks that have to fight battles through the next $100 in price?  Keep the bulk of your powder dry until the odds of success are in your favor.

The BKX (Big Bank) Index is staggering around multi-year lows and, from a technical perspective, more importantly, have given three lower highs and four tests of support.    Each time a stock or index falls to a given price, it absorbs a layer of demand at that price. Think of what such a chart is showing you, as a true snapshot of supply and demand.    

I don’t want to remind you what happens when there is no demand at a certain price, particularly since the money center banks are such a crucial part of the capital markets.  Their falling equity prices clouds their ability to raise capital.  Income statements show the past, and balance sheets show the future. 

This might also be an abject lesson in trying to bottom fish and “buy stocks for the dividends.”  Caveat emptor.   

One of the core ideas of the Investor’s Business Daily is that powerful earnings growth is the driver behind big stock moves.  As a corollary, big stock market winners are often found in new companies, companies that have IPO’d with less than eight years on the market.  What is the rationale behind this? Why did IBD’s research find this to be the case?  In a word, it’s innovation. Companies with successful new products or new management win market share and can make money hand over fist. With a turnaround showing up in the numbers, Wall Street sits up and takes notice, bidding up the stock price.

A good place to “shop” for stocks is among those that have recently IPO’d and just come to market.  Should you just buy it straight away from a syndicate broker?  Generally no.  Instead, wait for the stock to make its first base, or consolidation, and judge it’s action from there.

Blackstone (BX) is a good example of a failed IPO.  By failed, I mean failed for the Joe and Mary Lunchbuckets that bought the stock hoping to play along with the big boys in private equity.  It was obviously a winner for those that unloaded dear shares onto the market. (See the recent lesson in LVS for a primer.) 

This next one shows the rewards for waiting for a confluence of a market up-trend, hot sector, and idiot momentum money.  With a ticker named after our sun, SOL, you can figure out quickly this is a solar stock. In this market, facing $120+ oil, solar power is coming into comparative costs with other sources and the market is taking notice.  IBD puts SOL’s earnings growth in the top 1% of public companies.  That’s what I like to see. 

The stock put in a saucer base nearly three months long (Point A) emerging in a solid breakout at Point B. What if you missed that break out as a trade?  No fear.  Stocks that charge ahead like that will often make subsequent bases, providing reasonable entry points.  At Point C it started a new base that lasted nary a month.   A proper buy point is when it emerges from that base into new high ground Point D.  The logic is simple:  all stocks are bad unless they are ready to go up. A stock treading sideways may be suffering from distribution; waiting until it emerges from a base into new high ground puts the odds in your favor. 

Note how along this month’s advance, the daily lows glide above the 5 day moving average line. For quick traders (scalpers), consider a violation of that 5 DMA as a sell stop level. 

With the global Green Revolution buckling under pressure of bio-ethanol, drouth, and wheat and rice shortages, Potash is in the green lately.   Let’s look at the chart as a near-text book example of base-on-base growth:

At point A, the stock sagged along with the rest of the market in January, carving out a cup with handle base. It made a decent advance before creating a new base, what we’ll identify as a Double Bottom base, as it made a lower low at Point B.  The base buy point would be just above Point C.  

Note how as the stock advances it dances along the 5 day moving average (Point D).  That is as strong a ‘tell’ as I can find that momentum money is chasing a stock. (Sell stops below the 5 day moving average might be a good trade idea.)  Point E is an intermediate price rejection and reversal. Look for a new base to form and support at the 50 day moving average (way down under $170.)

Here are a couple of nuggets from last night’s Meetup:    

Shorting stock is definitely not for most folks, but I agree with William O’Neil (founder of the Investor’s Business Daily) that the best time to short stocks is when the charts is most amenable.  Just like buying a stock too early can lead to losses, shorting stocks too early is also a path to frustration. Let’s get beyond the basic rule: never short a stock that is still climbing, hoping to short at the peak.  Life is too short to lose money that quickly.   

 Instead, wait for a stock to peak, roll over, and wait… for… it…, make failed attempts to rally (particularly against the 50 day moving average.)  Wait for the big break in price and spike in volume, and then leg into the short.  I just happened to find a recent example that fits the bill.  Bill O’Neil suggests watching for a head and shoulders-type pattern, railroad tracks, climax top, or other typical “top” pattern.  More on those later.  The beauty of this example is how the stock reacted against the 50 EMA.   Let’s check the chart (click to enlarge).  

   The run-up starting at the Point A break out from the base is a textbook 5 month advance. The chart doesn’t show it, along the advance is held close to its 21 EMA, indicating strong institutional support. At Point B the stock starts making advances in price on low volume (Point F), and eventually rolls over in heavier volume.   If you were long the stock the prior few month, hopefully you took note of the violation of the 50 EMA  and booked some profits.   

 It’s important to note that the first stab down a Point C is not the typical, ideal short entry point. As Bill O’Neil points out, that’s just too obvious, and the market rarely lets ‘obvious’ win.  Besides, the stock had been a winner for months and surely the $10 pullback would bring in the bottom feeders hoping for a bargain. Why get in their way?  Maybe the stock is merely carving a nice base, and preparing for the next leg up.   

  The real “tell” is at Point D.  Three times, the stock makes a break above the 50 EMA, but can’t hold gains.  The stocks is faced with just too much overhead selling – folks that bought in the second half of the run up (April through July) that are trying to get out.    

Finally the stock gives up the ghost and at Point E (Oct 16), makes a definitive break downward on heavy volume after an earnings miss.  When shorting, that’s what you want to see: faltering earning momentum (or other catalyst); two, three, or four failures at the 50 EMA;  and a high volume price break.  

OSK recent carved a cup with handle that caught my eye, but it had the classic signs of caution.

First the chart. Click on it to make it bigger.

Note nice uptrend in the stock in the months prior to the stock forming the consolidation. (Lesson: look for relative strength) There’s a hiccup at the bottom of the base at Pt A. Usually I like to a nice smooth curve. I’ll live with a “v” shape now and then, but having a pattern interruption like this is a yellow flag.

Let’s zoom in on the handle, since that’s where the action is.

The handle started forming at point B, on Oct 1. The stock had advanced in the prior few week, but had hit some resistance and started moving sideways. The typical buy point from this pattern is when the stock resumes its advance and moves above that point B by at least 10 cents. We see on Oct 22 it tried to press higher at Point C, and came within 20 cents of the proper buy point, but just couldn’t muster the horsepower. It has since rolled over, and investors that jumped the gun anywhere in that handle are now down perhaps $3-$6 per share.

It’s important to note that while volume was muted in the handle (between B and C), which is proper, trading volume did not accelerate on the breakout day. If a stock is going to power higher, it’s better to have an increase in trading volume to validate the move higher.

Plump yields and booming global trade have shipping companies on Wall Streets sweet side this year. Let’s look at Diana Shipping. The stock has been climbing the 50 day average like a rope for the past year. At Point A, I started to point at the times the stock drifted lower and the price held along the 50 day moving average. (Gee, looks REALLY random to me.)

Now, I can’t say why for sure but there are several times where it bounces around the 21 day average, and at point B, that 21 day average provides some clean support. I’m entering the realm of “‘Looks to me’ guesswork,” but it looks like some heavy players use that 21 day line to add to a position without waiting for a growth stock to fall down to the 50 day. Just keep that observation in your quiver.

Similarly, if a growth stock doesn’t find firm bids at the 21 day line, the struggles to keep its head above water at the 50 day line…. well, just make sure you have good reasons to own it.

As the market made its recent retracement, the S&P 500 found important support at its 50 day moving average.

Why? My guess is foreign buyers that are tired of our low yielding Treasury bonds. Other market commentators note that there is an enormous amount of credit (what we used to call money) flowing in from overseas. Our dollar exchange rate may be very low in the eyes of those overseas, and therefore it makes our dollar-denominated assets look cheaper to them.

As the market dipped to the 50 day line, it reached a spot of traditional institutional buying or support. Maybe those traditions extend across the oceans.

Now that the 50 day line has acted as support, it will be very important for the SPX (S and P 500) to find support there again if it retraces lower. If support fails where it once held, I suspect that would be quite a negative tell on the market.

Oh, and congratulations to those who own index funds that are just now getting up to the price level of seven years ago. What about dividends? Let’s talk inflation while we’re at it.