December 27th, 2005

Retracements and Testing Support Levels

It’s been difficult finding the time to write a post for the past week or so what with either my traveling or hosting visiting houseguests but the true time drain has been dedicated to reviewing trades and performance for 2005 and adding to my breakout watchlist for 2006. My price trigger watchlist grows daily and now includes over 300 stocks in various stages of setting up across all industries.

Recently, in addition to tech stocks (e.g., internet content, infrastructure, software) the industries closest to breaking out are those in the following industries: regional banks, insurance providers and brokers, truckers and food producers.

Breakthroughs come in bunches since, as we’ve mentioned before, 50% of a stock’s move is dependent on the overall market. So, being fully invested right now, my biggest problem is trying to make room for new breakthrough stocks so as to:

  1. capitalize on the large and quick percentage gains in breakout moves
  2. not splitting positions and thereby wind up with too many stocks for the size of the portfolio,
  3. not wind up churning my portfolio too much,

While many stocks follow through on a breakout and continue to make substantial percentage moves, others fail. Painful experience has taught me that it’s better to cut loses quickly on stocks that fail and redeploy those assets than hold onto to them.

The flys in the ointment are those stocks that retrace the breakout move and test the breakthrough trendline as a support level before resuming their upward movement. A good example is Eaton Vance (EV), the mutual fund manager:

After increasing 50% during 2004 and peaking at the end of last February, EV consolidated in a classic pennant formation. I drew a secondary trend line at 26 (the price trigger on my watchlist) through which it penetrated with a gap on November 18. It stalled at around 28 and, subsequently, has retraced 50% of the move. Whether EV is one of the stocks I sell to make room as new breakthroughs present themselves will depend on its relative strength as the market begins a new upward phase which, I expect, will begin after New Years Day.

Nuance Communications (NUAN)

A reader asked for the Stock Chartists’ opinion on NUAN, a firm in IBD’s Computer Desktop Software Industry Group.

NUAN “cratered” almost continuously after its IPO in 1996 in the low ‘teens, hitting a bottom at less than a dollar towards the end of 1998. A failed recovery saw the stock ride the wave of the tech boom to around $8 only to see it crash back to under a dollar by the beginning of 2001. After again recovering to $8.00, NUAN created a pennant consolidation from May, 2002 to August, 2005.

Had we been looking for trendline breakthroughs at the time, we would have spotted NUAN and added it to our watchlist with the hope and expectation that it would penetrate the upper boundary trendline of the pennant (which it did in early August, 2005 at $4.30).

Last week, it successfully completed its ascent back to the $7.50 resistance level (formed by inflections at that price 5-6 times since its IPO in 1996). Although we missed the move from $4.30 to the current level, we’ve now added NUAN to our watchlist with the expectation that penetration with conviction (a move above $8 with volume) of the resistance trendline, supported by a strong tech market, will lead to testing of the IPO high and significant new highs after that.

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