With each new bull market, new leaders emerge to lead the market. These companies are often found in technology, biotech, leisure and retail. When making your final purchase decision try and focus on stocks breaking out to all time highs. Former leaders will rarely be the biggest winner in the next round of a bull market. There are a few reasons for this. One is due to the impact of overhead resistance. What happens is that people who purchased at a previous high will usually sell once the stock reaches their buy point so they can break even and move on. Purchasing a stock with overhead resistance will constantly encounter resistance points as it moves higher. Another reason, is that too many people are aware of the former leaders. Remember that the largest price moves occur in companies that Wall St. is unaware of. As Wall St. begins to notice, more institutions initiate positions in the stock, driving up the stock price and providing support at major support levels. Soon after, you’ll probably hear the stock mentioned in financial publications and CNBC, driving the price higher. Of course, as a well informed investor, you are selling the stock at this point with nice gains in your pocket. Stay ahead of the herd!
All posts by Tate Dwinnell
Support & Resistance
A key ingredient to being a successful investor is knowing at all times where levels of support and resistance are.
Resistance is the area at which price progress has halted due to a decrease in buying and an increase in selling. It often occurs at levels where investors feel the stock is overpriced, but can also occur at previous highs as investors who bought at the previous high look to sell in order to break even.
Support is the area where buyers have begun to outnumber sellers, reversing the downward trend. Support areas indicate where investors have begun to feel the the stock is a good value.
It should be noted that resistance and support levels are not absolute as stocks will often break through resistance and plummet through support. I like to think of these areas as “tests” for the strength of a stock. Stocks that bounce off support and break through resistance are showing great strength and should be considered for purchase, while stocks that retreat at resistance and plummet through support are showing weakness and should probably be sold. Support and resistance become a self fulfilling prophecy as professional traders keep tabs on these important areas and make buy and sell decisions based on the action of the stock as it reaches support and resistance. You should be doing the same!
Common areas of support and resistance are presented below.
Moving Averages
Moving averages are important support and resistance areas to keep an eye on, specifically the 50 Day Moving Average. Many times, institutions and professional traders will add shares to their position at this point. However, a drop below this important line on heavy volume can signal further selling is ahead for the stock. Other important moving averages are the 20DMA, 35DMA and the 200DMA.
Trend Lines
Trend lines are also very important support and resistance areas and can be drawn in order to see where investors may buy or sell shares
To draw trend lines, connect support points to support points and resistance points to resistance points. A positive slope indicates and upward trend (higher highs and lows) while a negative slope would indicate a downward trend (lower highs and lows). Channel trends occur when there is no slope.
Whole Numbers (psychological support and resistance)
Support and resistance can occur at round numbers because traders tend to think in these terms when making buy and sell decisions. If a stock is purchased at 7 and makes its way past 8, then 9… they may say “if it gets to 10 I will sell”. With higher priced stocks multiples of 5 become more important. These become psychological resistance levels.
You see these psychological support and resistance levels mentioned in the news or magazines often. “Dow breaks 10,000!” or “NASDAQ needs to find support at 2000”
Gauging The Strength Of Support and Resistance
 Look at the history of the stock. Has it found support at a trend line or moving average in the past? How many times? If it has a history of showing support at a certain level, you can bet there is a good chance it will be supported there again. If it breaks the habit and is no longer supported there, look out! A deeper correction is most likely ahead.
Role Reversal
When a stock breaks support, that support line becomes resistance. Often times, a stock will break below major support and try and make its way back, only to be turned away by the new source of resistance. Why? Investors who purchased at support, only to have the stock plunge below quickly realize they made a mistake. If the stock makes its way back to the support area, they usually jump at the chance to get out without a loss. The opposite is also true. After a stock powers through resistance, that becomes a support area where traders are often willing to add shares. Investors who missed the initial move will often look to purchase if it makes its way back to the resistance area, creating support there.
Examples of Support & Resistance (click thumbnail for larger image)
The Triangle Revisited
A few days ago in a post titled “The Failure of a Triangle”, I looked at the failure of a well formed triangle pattern as the market continued to slump. It’s important to point at that while these particular patterns often work, they, like all patterns, are never gauranteed. Today I thought I’d take a look at another triangle pattern that did successfully breakout. The company is SFBC Intl, Inc. and it broke through the upper portion of the triangle with good buying volume. Notice the declining volume as the triangle forms and then the explosion in price and volume on the breakout. (click the image for a larger view)
What you see here is that the triangle formation is actually a handle formation for a much larger cup base. I think it’s important to note that the cup base is not a well formed base. You like to see a smoother base with less volatilility and more time spent forming the right side of the cup. While today’s move was a good one, it may have trouble getting above 40 in the near term due to market weakness and the magnitude of the advance in such a short time.
Please note this is not a recommendation to buy or sell.. always do your own research before making a decision. Have a comment about this or other posts? I’d love to hear it.. have a good weekend!
Has a Bottom Been Found?
The market continued its downward spiral heading into lunch today with no end to the selling in sight. That is until an impressive and surprising end of the day rally that saw the Dow reverse nearly 200 points with increasing buying volume. In fact, all of the major indices staged major reversals off their lows on greater volume than the day before. Why is this significant? Major reversal days like we saw today can often be seen at the bottom of corrections. However, we are by no means out of the woods. It’s a step in the right direction towards another rally in the market, but what needs to happen from here is a confirmation in the next few days by seeing another big up day with heavy buying volume. A confirmation day would be a signal that institutions are again in the buying mood and an indication to you to watch the action of leading stocks as they break out of sound bases (read more about sound bases in the tutorial at my website for self investors, SelfInvestors.com). A slew of successful breakouts following a confirmation of a new rally would provide further indication that the rally is for real and that the institutions are once again hungry for new purchases. It will be interesting to see how this will play out. Be patient, create those watch lists and stay tuned! (click the chart for a larger image)
If you’d like to receive my daily report which details the health of the overall market and pinpoints where the strength is, you can sign up here. You may also learn about gauging the health of the the market in the tutorial here.
Why It’s a Good Idea to Sell Before an Earnings Report
The greater the degree of uncertainty, the greater your risk in holding a position in a stock. All stocks are uncertainties, but there is no moment of greater uncertainty than that of an earnings report. It’s the time when the company reports on how well it is doing now and how well it expects to do in the future. Often times, other major announcements are made as well. It can be a time of extreme volatility, especially with small cap, high growth, CANSLIM style stocks. Sure, the upside potential can be great, but there are too many things that can go wrong, which could cause the stock to plummet. Remember, the name of the game is preservation of capital. You can always repurchase the stock once the coast is clear.
A company may report below analyst estimates, or the whisper number (earnings that the company is rumored to report, often leaked by an insider). There are times when a company will beat the analyst estimate, but not the whisper number and sell off.
They may release negative news about the company, the industry, or reveal a less than optimistic outlook for the future.
“Buy the rumor, sell the news”. Often times a stock will rise ahead of expected good earnings, only to sell off once the great earnings are released.
Here are a few recent examples:
AU Optronics (AUO) recently reported blowout earnings on April 27 and has been plummeting ever since. While the weakness in the market is to blame for some of the selling, it’s a classic case of buy on the rumor and sell on the news. Investors sent the stock soaring nearly 100% since the last earnings report, expecting the company to continue to report great earnings.
Tumbleweed Communications (TMWD) is a fast growing provider of spam, virus and fraud protection software that reported less than stellar results on April 27th and promptly sold off. It’s down more than 60%.
Looking Good & Feeling Good is BIG Business
You see it in awful new shows like ‘The Swan’ and ‘Extreme Makeover’. You see it in the booming popularity of Botox injections and its substitutes. You see it in the latest Atkins and South Beach low carb diet craze. People will go to great lengths and spend inordinate amounts to look good and feel good. This is certainly reflected in the rising share prices of the companies that cater to these needs.
Companies like Mannatech (MTEX), Reliv (RELV), Natural Alternatives (NAII), Nutraceutical (NUTR), NBTY Inc. (NTY), USANA Health Science (USNA), & Natures Sunshine (NATR) are experiencing record sales on booming demand for their nutritional supplements for everything from weight loss to athletic performance to women’s health. Companies that sell skin care and beauty aids are also doing very well. Helen of Troy (HELE), Inter Parfums (IPAR), Nu Skin (NUS) and Avon (AVP) are companies to watch in this area.
Cosmetic surgery and non invasive procedures are growing rapidly as well, helped by TV shows like the two mentioned above. Inamed Corporation (IMDC) is sure to benefit from this as a major provider of breast reconstruction, obesity solutions and non invasive surgery (they just got FDA approval for their answer to Botox – Hylaform). Laserscope (LSCP), a company that specializes in laser systems for removal of wrinkles, acne, sun damage, leg viens and hair is growing rapidly as well.
As always, any stocks listed in a post are not buy or sell recommendations, but suggestions for further research by you. Many of the stocks listed above are far extended from a reasonable buy point.
The Failure of a Triangle
This is the first in what will be a series of posts highlighting stocks that have failed from bullish patterns and will be categorized under “When Good Charts Go Bad”. It’s important to study the chart patterns that fail so that we can avoid purchasing the stock or get out before getting burned. Today’s look is at a bullish symmetrical triangle formation that formed after a successful breakout from a flat base several weeks earlier. Often cited as a continuation pattern, the triangle formation presents a brief pause after a significant run up, before breaking out to additional gains. (as always, click the image below for a larger view)
In this particular case, Team Inc. caught my attention as a well formed triangle formation and I watched it closely for a break above the upper portion of the triangle with heavy volume. It never happened. Eventually, the stock broke below the support level of the lower portion of the triangle with heavy selling volume. However, no loss occurred because no buy signal was presented. This is a great example of why it is important to look for a breakout above resistance with large buying volume. Without the wind at your back, your chances at success will diminish significantly.
A Big Test for the Nasdaq
The market has jerked investors around pretty good for the last couple weeks as interest rate, China slowdown and Iraq fears all weigh on investors minds. For months, many have said all we need for another leg to the bull market is a pick up in jobs and continued positive economic numbers. Well, positive reports continued pouring in on the jobs front, the corporate earnings front and the economy. However, they were a bit too good, fueling speculation that interest rates would rise sooner rather than later.
It all leads to an extremely erratic and as some would argue, irrational market. One in which it is difficult to make money in as sustained trends remain nonexistent. One of the most important aspects of the CANSLIM method of investing is to invest long only in a confirmed bull market. 75% percent of stocks move with the market. If you insist on investing long under the current market conditions, your chances of losing increase dramatically. How do you gauge the health of the market? By checking price/volume action of the three major indices and the action of leading stocks. The market is contstantly undergoing “tests” at major support and resistance levels. If you are unfamiliar with support and resistance levels it is critical that you at least have a basic understanding of these important areas on a stock chart because they are “test” areas that reveal to you clues about the health of the market. By looking at the chart of the Nasdaq it is clear that investing right now is not a wise decision. In the coming days, the Nasdaq faces a big test at a major support level (see the chart below).
Notice the first blue arrow points to the 200 day moving average, which is a major level of support. In fact, in March the Nasdaq was able to bounce off this line of support and rallied for several days. Well, here we are once again at this level of support. Will we get a bounce again? Today was a good start, but notice the lack of buying conviction evidenced by the lack of volume today on the nice move up. If a drop below the 200 day moving average should take place, the last line of support is around 1900 (blue line) where previous support and resistance has been found over the last sever months. A drop below signals major trouble ahead and probably an end to any sustained bull market from that point on.
I said above another way to gauge the strength of the market is to watch the action of leading stocks. Are they breaking out successfully from a sound base? Lately, that has not been the case. Many stocks have failed in their breakout attempts. Examples of failed breakouts can be seen in CRDN, LCAV and in my post below regarding ACH.
Preservation of Capital
The #1 rule of investment success? Keeping losses small (8-10%). When you are wrong about a trade, admit you are wrong and move on. It’s as simple as that. Get over your need to be right, or it will devastate your portfolio. In fact, by keeping losses small, you only need to be right about half of the time to be considered a successful investor. Remember this fact because it’s important.
Think about it.. three consecutive 8% losses can be overcome by one 30% move in a stock. Believe me when I say that buying a successful breakout of a leading stock can yield you a 30% gain in just a couple of weeks if not less. However, hold onto a loser for a 50% loss and the stock would have to bounce back 100% for you to recoup your losses. Many who held onto their losses throughout the bear market of 2000 may never recoup their losses.
In a recent recommendation to my members at SelfInvestors.com, I highlighted a breakout of Aluminum Corp. of China, which had just surged to new highs on heavy volume. Within days, the stock reversed, fell back into its base and ultimately plunged below major support. A sell decision was recommended just as the stock fell below major support of the upper trend in green and the 50 day moving average in red (see the chart below). As you can see, by holding onto the stock you would have suffered a crushing loss as the stock plunged another 25% over the next couple of weeks.