Monster Stock Trader's  Instablog

While today was impressive on a percentage-gained basis, unfortunately volume was not quite so impressive.  It seemed at one point during the day that we may very well have a “follow-through day” on our hands, even though volume was probably going to end up below average.  That wasn’t going to concern us, to tell you the truth, as history shows that what really matters is the volume being higher than the previous session.  Yet it wasn’t meant to be.  At least for now, that is.  Volume died off and, despite a surge into the close, it came in lower than Wednesday’s totals.  So we wait and keep our watch list up-to-date.  There are certainly stocks we would be buying on a FTD.  Our subscribers will know exactly what we’re looking at.   

 

Yet as we wait, we also observe; to be honest, though, what we’re seeing is also a tad bit disconcerting.       

 

The Nasdaq, for one, looks like it could possibly be forming a classic head and shoulders topping pattern.  Not exactly what you want to see.  This head and shoulders differs from the “July head and shoulders” in that the neckline is trending down (a harbinger of lower prices) and that distribution is much more pronounced as the pattern forms (see chart below).  We await further confirmation and, of course, remain ready for anything.  

 

Another potential head and shoulders pattern looks to be forming in one of the best performing industry groups since the March low.  When you see an industry group that has been in the top 20 for over 6 months suddenly begin to fall apart, and the hardest hit stocks in the group are the top stocks (ARO, GYMB, BKE, ROST), it is cause for concern.  As you can see in the chart below, it’s been a tough couple of weeks for the Retail-Clothing/Shoe group:    


 

 

As for individual stocks forming potential head and shoulder patterns, we will save those for our subscribers.

 

We remain cautious here and, if one were to put a gun to our head, we’d guess that we’re probably going to correct even farther from here.  This is not necessarily a bad thing, though, as a 10-20% correction could be rather healthy so long as you have leading stocks hanging in there and forming proper bases.  We have quite a few of these stocks to hang our hat on so far and this keeps us from becoming too negative, yet if they get blown out of the water at some point (cf, ARO) we would have no problem taking a different view.  There’s also the possibility of a sharp shakeout to consider.          

In 1965, William O’Neil bought a stock called Fairchild Camera.  What happened next would teach him a painful yet valuable lesson.  After the stock gained over 50% in a little more than a month, it corrected all the way back to its 50 day moving average.  This made O’Neil, then in his early 30’s, nervous.  After all, he didn’t want to lose the rest of his gains.  So he sold his entire stake and locked in what profit he had left.  Well, Fairchild ended up forming an ascending base pattern and went on to climb 200% without him.  All O’Neil could do was watch.  It so upset him that he never forgot it.  And a good thing he didn’t….          

 

Fast forward to 1998: like Charles Schwab, AOL was another imperfect cup with handle (makes sense, since they formed during the same market).  Though AOL’s chart pattern was somewhat flawed, there was certainly nothing wrong with the fundamentals.  In the previous three quarters, earnings had increased 130%, 900% and 283%; sales had accelerated 45%, 54% and 67%.  Return on equity stood at 36%, more than double what it had been two years before; after-tax margins had also doubled.  All of this had, of course, caught the attention of institutional investors.  Mutual fund ownership in AOL jumped from 154 to 189 to 235 to 293 in the previous four quarters.  And, to prove yet again that you get what you pay for in the market, the stock was trading over 150 times earnings at the time it broke out.    

 

Like SCHW, AOL’s deep handle was the result of market conditions.  The Nasdaq actually undercut its September low in October, yet both the handles of SCHW and AOL held well above the lows of their cups, a tell-tale sign of strength.  Whereas SCHW broke out on 10/15/98, AOL broke out just eight sessions later: 10/27 (O’Neil was a busy beaver).  In fact, according to Justin Neilsen (WON’s personal assistant), there were times O’Neil was 200% invested in only two stocks (AOL, SCHW, SUNW and QCOM were his big winners from that time).  This incredible concentration helped him to enjoy his second best performance period ever: 1998, 401%; 1999, 322%.  

 

O’Neil would add to his position in AOL twice, on 12/16/98 and then again on 3/11/99, as it emerged from an ascending base pattern; however, it was when AOL was forming this add-on base that his experience with Fairchild Camera came into play.  Instead of panicking as AOL approached the 50 day moving average, O’Neil took a look at Fairchild’s 33-year-old chart and saw that it had indeed formed this precise pattern before continuing higher.  AOL was behaving just as Fairchild had three decades before.  This gave him the conviction to not only hold on to his AOL shares but to prepare to add to them. 

 

Adding to this conviction was another precedent stock: Redman Industries.  It had broken out of a thirteen week cup with handle pattern in March, 1968 on its way to a 767% gain in 12 months.  O’Neil bought it correctly, but ended up getting shaken out when the market got choppy.  He figured that was that.  Redman went on to form an ascending base, however; unlike Fairchild Camera, he bought back in.  From there it ran over 500% in 37 weeks. 

 

Shortly after the 3/11 purchase, AOL went on a classic climax run, basically doing a double in about a month.  O’Neil, seeing the end was near based on his studies of how stocks top, sold into this euphoria.  When it was all said and done, AOL landed O’Neil a nice 456% gain.  Nice work, if you can get it.

In this study we look at William J. O’Neil’s work in Charles Schwab (SCHW).

Schwab broke out of a 12 week cup with handle pattern and went on to advance over 400%.  William O’Neil bought it right at the breakout on 10/15.  It then promptly did nothing for about 2 weeks, even at times showing him a loss; still, it never triggered the 8% sell rule so he held on.  His patience paid off.  When the stock shot up and gave him an over 20% gain inside of 3 weeks, he knew he might actually have a big winner on his hands.  In fact, he would add to his position four times (10/30/98, 11/23/98, 12/14/98 and 2/23/99) on his way to a 313% gain. 

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In this, the first in a series of studies of history’s Monster Stocks, we take a look at AMGN

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Heavy volume moves higher, liquid growth stocks leading the way and support at key levels: that’s the tale the tape has told for the last week and a half.  Case in point, the Russell 2000:

The Russell has closed at the high of day (HOD) exactly 5 out of the last 8 sessions, and it’s come within a tick or two of a HOD close 7 out of the last 8 sessions.  Our point?  Demand has been such that investors have consistently bid the Russell into the close.  That’s encouraging, to say the least.  That sort of unremitting buying, should it continue, is what can really boost one’s returns.  In fact, all the indexes paint the same picture: long tails that demonstrate quite impressive intraday support.  The Russell has also risen above that 590 level that we were watching, and, more importantly, it’s stayed there.  The last index to do this (climb over its August high) was the Dow and it did it today.  So onwards and upwards.

A few stocks for discussion:

Rackspace Hosting (RAX), which we last highlighted in our Free Newsletter on August 28, put in an honest day’s work on Tuesday.  If it’s going to form an ascending base, however, it will have to step on it.  Time is short.  In all likelihood it’s forming a cup-shaped base.  One could certainly have initiated an “anticipatory” position on Tuesday, with the idea of perhaps doubling up on a “cup” or “cup with handle” breakout.

Sourcefire (FIRE), which we highlighted in The Monster Stock Report last week, had a good day as well.  Here’s what we wrote last week:

“Sourcefire (FIRE), along with its group-mate Arcsight (ARST – chart not shown), has been experiencing some very tight trading lately.  We consider this all the more impressive given the market’s recent weakness and the fact that FIRE is a thinner stock.  We hope that the recent breakout of ARST bodes well for FIRE as both these companies have outstanding earnings growth and are involved in a space (cyber-security) that is surely to play an important role on the world’s stage in the not-too-distant future.”


Salesforce.com (CRM) is a liquid growth stock that presents an interesting situation:


While CRM has 5 quarters of decelerating sales, look for this to change as estimates going forward call for much better results.

We saved what we consider the best for last: Baidu (BIDU) is a stock that, frankly, we’ve been trumpeting from the rooftops for about 100 points.  This is what they call a “big stock.”  And when it comes to a big stock you either go big or go home.  William O'Neil, founder of Investor’s Business Daily, once told me that you have to be prepared to "move heaven and earth" to get into a leader and that, once in, you "better hang on for dear life."  The worst feeling in the world is to be shaken out of a leader that goes on to be a monster stock.  This very thing had happened to him with Fairchild Camera.  Folks, if you aren’t in BIDU formulate an intelligent plan and do whatever it takes to get your share.  Be mindful of risk, of course, but also be aware of the risk posed by being left behind.  If BIDU pulls back to the 368-385 area, pulls back to the 50dma/10wma, pulls back period, snag some shares and start building your position.

Stocks like FIRE, HMIN PEGA and SXCI are becoming institutional quality right before our very eyes.  These and others are a part of the rotation we’re seeing out of junk-off-the-bottom (JOTB) stocks and into young, fast-growing companies that are operating in cutting-edge areas of the economy.  If this doesn’t make you stand up and take notice, then, sorry, you’re not alive.  Pullbacks are inevitable, so be sure to plan your trades wisely.  Give yourself “wiggle room,” the cushion that will enable you to operate coolly under pressure.  Don’t ever shoot yourself in the foot by chasing stocks.

Best of luck!

Holdings:  BIDU SWI PWRD FUQI GMCR

 

 

 

While it may not always be pretty, the market continues merrily on its way.  Both the Nasdaq and the S&P 500 closed at their highest levels so far this year.  While the Nasdaq did so on strong volume, the S&P 500’s volume was not quite as impressive, though it was above average.  So we continue to chant the same mantra: “Price and volume.”  Is the whole rally a function of “quantitative easing,” of the Fed’s seemingly endless printing of dollars?  Perhaps.  Is it just one big bear market rally?  Could be.  To this we would only say: “So what?”  Do we really want to leave money on the table over semantics?  We prefer to let the market dictate how we proceed and leave the arguments about economic conditions and fed policies to others.

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