New Low Observer's  Instablog

After the news of Herbalife (HLF) getting slammed, we were curious about what the downside targets for the stock might be using Edson Gould's Speed Resistance Lines. Below is a chart representing the conservative downside target of $45.45 and the extreme downside target of $24.33.

So far, HLF appears to have support for the stock price at $45.45. However, if HLF falls below the $45.45 level, it would suggests that HLF will decline to, at minimum, $34.89 before finding stabilization in the stock price. A decline $24.33 would mean that HLF could revisit the 2009 lows.

We believe that it is worth examining whether or not these downside targets are accomplished. In our view, the downside targets are reasonable estimates of where the stocks could go before initiating new research on whether these companies have viable business models.

Disclaimer: This piece is a continuation of the examination of Edson Gould's speed resistance lines as explained in prior articles. This is not an endorsement to sell short at the current levels nor buy these stocks once falling below the extreme downside targets.

On October 25, 2011, we published a chart of Green Mountain Coffee Roasters (GMCR) that utilized Edson Gould's Speed Resistance Lines [SRL] to determine what the possible downside targets might be. At the time, Green Mountain Coffee Roasters was trading at $64.75. However, our use of the SRL indicated GMCR had a conservative downside target of $59.63 and an extreme downside target of $37.21.

After reach the level of $59.63, GMCR's stock price rose marginally before falling significantly to the downside resting at the $39.42 level. Soon afterwards, GMCR rose as high as $70, but did not go above the SRL rising trend established at $59.63.

After reaching the $70 level, GMCR promptly fell to the $37.21 level which established what we believed to be a "support" level (green arrows; definition here). Support levels, if broken, would result in the stock of GMCR going to the previous downside levels that helped to establish the upside trend at $22.53 and $8.30.

In after-hours trading on May 2, 2012, GMCR plummeted from the closing price of $49.52 to as low as $28.50, a loss of -42%. We believe that GMCR has a new support level of $22.53 and upside resistance (definition here) at $42. If the price of GMCR falls significantly below $22.53 (i.e. $21) then we would expect that the new downside target of GMCR is $8.30.

(click to enlarge)

As an investor, if you have a stop-loss order (definition here) at $45, then you'll only be able to get out of the stock at the next best price. This means that if GMCR opens at $30 tomorrow, you're only able to get out of GMCR at $30, not $45-$44 under normal market conditions. Right off the bat, you'll lose 33% more than you had planned.

Typically, when a stock crashes it would usually rebound to a higher level before continuing the declining trend (if it happens to be going lower). The stop-loss order will trigger automatic selling of GMCR even though we expect that it might rebound from the $28.50 low of today to, at least, $35.50 tomorrow. If nothing else, selling on the short-lived rebound would reduce the amount of loss while a stop-loss order typically ensures the maximum loss in the shortest period of time.

This explains why we are against the use to stop-loss orders as a means to avoid losses. The best way to avoid significant lose is to consider the downside targets before buying a stock. After considering the downside, we recommend putting an amount that you're comfortable with even if the stock were to decline -50%.

As we've described many times in the past, seeking specific companies at a new low inherently implies that value attributes are far greater than when a stock is trading at a new high. This has been the case with a majority of stocks that appear on our watch list.

We've demonstrated this in the watch list summary section of our April 27, 2012 Nasdaq 100 watch list. Furthermore, the recent acquisitions of Transatlantic Holdings (TRH) and Cephalon (CEPH) highlight our claim that quality companies invested in near the new low are the most likely candidates to be acquired by much larger companies. A perfect example is found with news from Warner Chilcott (WCRX).

Today it was announced that Warner Chilcott (WCRX) was going to put itself up for sale as a means to "…enhance shareholder value." On the news, Warner Chilcott's stock price rose as much as +20%. However, as a member of the Nasdaq 100 Index, Warner Chilcott appeared on our December 16, 2011 at $14.02, when the stock was within 8.68% of the 1-year low.

On Friday, April 27, 2012, WCRX closed at a price of $18.79, which was already a gain of +34% above the December 16, 2011 watch list price. Now, with WCRX trading around $22 per share, we believe that the value component of WCRX has been eliminated and recommend that those who own the stock should consider selling the principal, at the very minimum.