July 14th, 2009

Following the Herd to New Heights

Here are two quotes, guiding lights, that if you copy them down and post them over the monitor of your computer or trading station will never fail you:

  1. “50% of a stock‚Äôs price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own”. The saying comes from a dissertation paper written in the 1960’s by a graduate student at the University of Chicago, Benjamin F. King. I came across it early last year, just as the Bear Market was starting and quoted it several times last year throughout the year. Adhering to it’s message enabled me (us) to avoid getting sucked into the market is it metamorphosed into the worst Crash in 70 years.
  2. Buy high, sell higher.” This principal applies to stocks making new highs and works better in some markets than others. As I’ve written frequently here before, I think the market’s on the verge of transition from Accumulation phase to the Mark-up phase of a typlical life cycle. It’s in early stages of the Accumulation phase, when the market is clearly in an upward trend, that this stock selection technique works best.

I make no attempt to hide the fact that I’m basically a momentum trader/investor. I like to buy stocks where the herd’s already begun moving the stock up rather than hope for a big score by buying a stock that’s at the bottom of its trading range and may, or may not, turn back up. If the market does come through with completing the formation of my long-term inverted head-and-shoulders pattern, then this is the perfect time to start running with the herd by buying stocks that are moving to new highs.

I haven’t updated these market report card statistics for a few weeks (click image to enlarge):

I’ve selected 5 prior periods when the S&P 500 was at approximately the same as today’s close. While the most sensitive crossover (the 90-day) has deteriorated (today 68.74% of stocks having crossed over down from 86% on June 5), the number of stocks with Golden Crosses and Bull Crosses has continued to grow.

I’ve added 5 new pieces of information at the top half of the table: the number of stocks hitting 1, 2, 3, 4, or 5 year new highs. New highs, especially those approaching all-time new high status, are a fertile ground for finding stocks with real momentum, especially when in sync with the market’s upward momentum. Note: Stocks that recently started trading (4 years or less) become especially strong momentum stocks [a prime source for stocks on IBD’s 100 or New America lists]. However, a 3 year-old stock making new highs will only be on the 1, 2 and 3 year list – not the 4 or 5 year new high lists.

Take, for example, the following:

  • SNX (Synnex):
    In all likelihood, the stock may suffer traders’ remorse and soon consolidate, retreating back to the 24-26 area but, after that, with a strong market tailwind could shoot up to new heights.
  • RDEA (Ardea Biosciences)Another relatively new IPO that’s forging new high ground territory. It, too, may soon consolidate in a traders’ remorse consolidation but soon afterward could be propelled to much higher levels.
  • LL (Lumber Liquidators)LL has made a new 12-month high and is within a hairs breadth of a new all-time (albeit 2-year) new high. LL also has an excellent volume accumulation pattern.
  • CTB (Cooper Tire):Not only has CTB made a new 12-month high, it has also completed a near perfect inverted head-and-shoulder pattern (mirroring what I hope will happen at the overall market level as reflected in the S&P 500).

I’ll post a Google spreadsheet listing them when the new high lists begin to generate some week-to-week consistency.

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