Who Will Lead a Market Bounce?
By Quint Tatro Jan 23, 2008 1:15 pm
Keeping a watch list of opportunities handy should pay off quite well in the event of a bounce.
Regardless of how you feel about yesterday's Fed action and the subsequent reversal in the stock market off morning lows, the constructive course of action at this juncture is to be on the look out for bottoming formations and prudent entries rather than get too caught up in the daily economic debate.
Even the most hard-core bear knows that strong counter trend rallies occur and should be respected. So if this is the start of a strong bounce higher, just what should investors be watching for, to signal that it's time to re-enter?
Since we have come down so far and so fast, I believe there to be a high probability that when we eventually do see a bounce it may be sharp, violent and very steep, which may not give most traders ample time to step in in a methodical fashion. This does not mean that you should throw caution to the wind, but it does mean that when you identify a set up that favors good risk reward, you should not hesitate. Another thing to keep in mind is that real bottoms are formed over time, through re-tests, so I feel there is no rush to be putting my protected capital on the line for maximum gain at this juncture. In fact, it would more than likely be hazardous to my portfolio health and I should still proceed slowly with small amounts that can be roped in quickly if need be.
It makes sense at first glance that it's the most beaten up sectors that have taken us lower and will more than likely garner the most attention. Financials and retailers are clearly the most probable bounce candidates due to the previous criteria, but they will also be the biggest beneficiaries of the rapid rate reduction by the FOMC and economic stimulus package by the U.S. government.
Many of the financial stocks have already gone through key reversals where a dramatic price drop correlates with a volume surge leading to an eventual reversal into positive territory that signals the potential start of a bottom. JP Morgan (JPM), for example, saw a dramatic sell off on January 8, which included a tremendous amount of volume. The following day the selling continued and the stock pressed through new lows but by day's end had reversed, closing 1.41% higher.
This would go down as a key reversal day and the possible start to the bottoming process. The next several days, while the general market continued to sell off, the stock actually was holding recent lows despite two attempts by sellers to push it through this critical level. Yesterday, the stock reacted very positively to the rate cut, tacking on 3.21% but failed to push through the bottoming highs of January 16. This is a key level as a bottom can only be confirmed in hindsight after a stock has made a series of higher highs and higher lows.
Once we see a higher high from this stock, it will be the first step. Another financial stock that saw a climactic reversal prior to yesterday's broad sell off is Legg Mason (LM). The asset management firm fell to new lows on January 9 similar to JPM but ended the day up over 1%. Yesterday served as a successful retest to this low as the stock was quickly accumulated to end the day higher by close to 4%. Both JPM and LM have been marking time around the most recent lows and each need to put in a shorter term high before we should really be encouraged, but investors who desire to start redeploying protected capital may desire to move in with a small anticipatory add with stops at new lows.
I am really challenged by retail but, as is my mantra, I must stick to the charts and put aside any bias I may have. The stocks have been behind the woodshed for some time and with such heavy short interest could continue to pick up steam as the Fed continues to lower rates and the economic stimulus plan kicks in. From a fundamental, technical and economical standpoint I believe traders should take a second look at Wal-Mart (WMT). While it sure isn't a momo flyer, the stock may be in a position to capitalize on the economic changes coming down the pike. Technically the stock has done nothing but churn for the last three years and has been inching towards some critical breakout levels for the last several months. While other retail stocks have continued to be pummeled, WMT has actually moved higher and stands positive on the year. The company is set to capitalize the most on any broad economic stimulus plan, in addition to scooping up new shoppers who are forced to leave the comforts of their local grocer for the big box discount store, saving a few extra dollars during an economic downturn.
Within the next few days we'll have a much better idea of where we are headed, but as always it helps to at least start contemplating a game plan. Every bounce starts somewhere and the strongest start is when not a soul believes a bounce is possible. We're getting pretty darn close and keeping a watch list of opportunities handy should pay off quite well.
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Position in JPM, LM and WMT.
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