April 24th, 2009

Time To Put Some Money On Faster Horses?

I’ve used the metaphor of racehorses in their gates to describe stocks in the early stages of a bull market. (Or is it “analogy” or “simile”? Any teachers or professors out there help me out, please.)

I’ve offered lists of stocks poised to be the first out of the gate based of their charts when this market (or, more correctly, the buyers and sellers making up the market) finally decides between:

  • a) reconsider the Bear Market Rally as full fledged Bull Market or
  • b) springing the Bear Trap.

The jockeys and horses might wearing their favorite colors and ready to run but would you put any bets on them without first taking a look at a race form or handicap sheet? It seems to me you’d want to make sure the horse you put your money on wasn’t a nag; the same is true for stocks. Here are two whose charts look similar:

  • IBM
  • SFI (Istar Financial)

Both charts have excellent reversal patterns (a double bottom and an ascending triangle) with the price in both having broken above the upper resistance boundary. In addition, both have favorable moving average positioning: price above the 180-day MA, the 60- and 90-day both turning up and the 60- crossing above the 90-day.

IBM is a large-cap and pays a dividend of 2% but Istar is a small-cap and doesn’t. This is the beginning of the race and, if I want to win, I’m going to want to put my money on the fastest horse based on past performance (even though it has a greater chance of breaking a leg); I’d go with SFI.

While the reversal patterns look similar, note the difference in Price Scales of both charts. Most charting software and services spread the charts (when plotted in logarithmic scale) close to the edges so the price scales on each vary. Telechart tells you the scale by the indicating the spacing of each price line. In IBM’s case price lines are 5.46% apart, in SFI’s case they’re 36.78% – quite a difference.

The technical difference between the two stocks are Volatility and Beta (if you want more technical information, click on the links). Volatility statistically measures the amount of change (risk) and Beta measures the stock’s change vs. the market. IBM’s volatility is 38 and beta is .78, the same measures for SFI are 290 and 3.12. Volatility and beta work both ways, both up and down. SFI declined from 26 at the beginning of 2008 to less than $1; IBM declined by about 50% from its peak.

So if you are fairly confident that the market has turned and will now go up, then stocks with higher volatility and larger beta will provide a bigger, though more risky, bang for your investment buck. I’m now swapping some of my slower movers for faster ones.

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