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No matter how bullish or bearish an investor might be on any given situation, things change. This seemingly obvious reality surprises investors again and again.

For example, the decline in the market over the past 2 weeks. I warned you that it would occur before it began. I even provided the reasons why. But investors require the complex to explain the simple. So they quest for ex post facto explanations from people who never even saw it coming! Rather than ask those who did. Oh well.

Perhaps my most mis-understood post was this post about Rackable Systems (RACK). My objective in writing it was to show the genesis of an opportunity as it unfolds real time-- from its first notice to its purchase; when, why, and how, etc. That initial post was to show that the key item that attracts me (and which does not necessarily mean that I consider it beyond that starting point), is resolute strength of the share price. RACK displayed that strength, rising to $56 from about $13 in about 5 months.

While I recognized that strength, I also recognize that things change. Specifically, that the displayed primary up trend will give way to a decline, which itself should set up a new intermediate term base that endures for a minimum 3-6 months. During that interregnum, I perform my due diligence by asking important questions: does this stock truly merit my attention? Is it an opportunity? For how long? etc. The fruits of this labor, from the first notice through due diligence to recognition of the stock as an investment opportunity that appeals to me, were the subject of my initial post. What remained to unfold was the decline that would would eventually attract my investment interest -- and dollars.

Which is precisely what has transpired since my post, as I had thought, and right on schedule. In fact, although RACK shares have tumbled to around $32 from $56, thereby scaring most investors, the shares have declined beautifully. Huh? Everything about this decline to date tells me that it is a correction in the stock price rather than a bear market for the company; the difference is that the share price will recover, and go on to new highs.

And here is the rub: while I expect my favored investment opportunities to be stronger than most during price advances, I demand that they also be less weak than most during declines. I also expect that they conform to area patterns as they build. For example, whereas I had expected RACK to decline to around $28 at the time I wrote the original post, I now revise that estimation to about $32, very near to this past Friday's (5.19) intra-day low trade ($32.61).

[click to enlarge]


Why is that? Look at the chart above. Trend line 1 captures the important low trades of this primary up trend, if it continues. (Otherwise, it is incorrectly identified. Recall Rule 1 of an up trend line: it captures each low prior to a subsequent higher high; thus line 1 anticipates a sharper high, higher than $56.) It shows Friday's low as tagging the line. Moreover, trend line 2 shows why the $32 again is a notable support.

And then there is item 3, the quickly-rising 200 day simple moving average, which itself is only weeks away from the same $32 support price. So there are three reasons why the share price for RACK should hold at this particular level. It is also why I will repeatedly purchase the shares in that zone: I prefer to purchase as close as possible to my sell stop.

I admit my methodology is not for everyone. Most investors require the market to ratify first their 'analysis' before taking action. Nothing wrong with that thesis, I suppose. The price of certainty, however, is the debasement of inherent value. Certainty itself is not a reward.

Consider that most investors reach for the news to explain the decline; in this instance, both of RACK as well as the market. And the 'news' for RACK right now is laden with all manner of reasons as to why the shares should plummet even lower from here. Not having expected either decline (that of RACK or the market), investors remain as confused and empty-handed as ever.

Learn patterns -- which do recur, and reliably so! -- and rarely again be surprised by market action. Or don't, and do. The decision, as always, is yours.

Source: Rackable Systems: Decline Not a Surprise (RACK)