07/27/10 at 11:15 AM
Today I wanted to
write a bit about stock charts, but instead of getting into the
commonly referred to (but usually useless) patterns like "head
and shoulders," "triangles" and the like, I wanted to talk about
something chart-wise that has helped me to both pinpoint some
great buying opportunities... as well as avoid riskier
What is this mystery chart pattern? Well, it's not really a
pattern at all. It's just a manner of trading that is easy to
see when you examine a chart. I'm talking about "wide and loose"
versus "tight and right." I'm going to explain each below, what
they mean, and what they imply for your trading.
Wide and loose trading is just that - a stock that is up 7% one
week, down 4% the next, up 4% the week after and then down 5%.
In other words, the stock is whipping up and down day after day,
week after week, as the bulls and bears battle it out. This
situation, especially in a stock that's had a big run-up in
recent months, is a bad sign.
Why? Because the stock's wild ups and downs are telling you that
the public's eye hasn't come off the stock ... something that is
needed for the stock to build a sound consolidation. If everyone
is still following and involved in a stock, that means not
enough shares have been moved from weak hands to strong hands,
so the consolidation phase, at the very least, must go on
longer-or it may fail altogether.
Yes, it's true that some consolidations are going to be a bit
wild depending on the market's action. For instance, you saw
quite a few whippy charts at the major market bottom last March,
mainly because the market itself was so volatile. Even so, you
usually saw the best stocks show at least some tightness, as
most investors gave up, and professionals moved in.
Tightness is an indication that big-money investors are "in
control" of the stock. They are buying shares within a certain
price range, and thus, the stock tends to go straight sideways
for a few days or even weeks. It also tells you that all the
weak hands are out; if they weren't, the swings would be more
intense, as described above.
So why am I writing about this today? Simply because recently
we've seen many of these wider-and-looser patterns form. Yes,
some of that is because of the market itself, which has been
spiking up and falling down for the past few months. But after
monster advances during the past year-plus, many of the
best-known growth stocks in the market have been sloppily
chopping around... a sign most that investors are familiar with
their stories and are following the companies on a week-to-week
These patterns are failure prone-when a stock breaks out from
this pattern, it usually makes a little progress... but then
quickly gets smacked back. What's obvious in the market rarely
works! Of course, not every loose pattern will fail (a strong
gap up on earnings, for instance, can always change the playing
field), but the odds are against it leading to a major,
The good news is that these wide-and-loose patterns can
eventually tighten up. Usually, after a few failed breakouts,
most investors throw in the towel and move on. Then, assuming
business prospects are still compelling, the stock often
tightens up, breaks out and begins a new advance.
The moral of this part of the story: It's not just whether a
stock is generally trending up or down that's important. How the
stock is acting is also important - if it's a popular name and
is swinging around wildly, don't be in a hurry to buy. You'll
usually be better off waiting for a tighter pattern before
putting any hard-earned money to work.
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As always, during this difficult market period I am working hard
at building my Watch List and keeping it up to date. That last
part-keeping it up to date-is difficult right now because
earnings season is again upon us. And that means a daily dose of
big gaps up and down among growth stocks, depending on how
investors react to and interpret the news.
Thus, if you are going to be doing a little nibbling on stocks
here and there (and I don't think there's much wrong with that,
assuming you have plenty of cash on the sideline), you have two
choices. First, you wait for a company to report earnings, and
then look to buy afterwards if the chart and story are still
intact following the report.
Or you can look for strong, enticing growth stocks that aren't
set to report results for another few weeks, to give the new
position time to develop a profit cushion for you before the
quarterly report is out.
One stock that fills that bill is Finisar (Nasdaq: FNSR), which
has shown up in Cabot Top Ten Weekly a few times this
year, including a couple of times recently. It's a story right
out of 1999, as the company is the world's largest supplier of
optical gear for telecom equipment. And that means the company
is riding the boom in bandwidth demand, which stems from the
flood of data and video now traveling over telecom networks
thanks to myriad smartphones and other wireless devices.
Verizon is pouring billions of dollars into its 4G network, and
other providers like AT&T aren't far behind. The new iPhone 4
(despite its well-publicized issues), the iPad and the
popularity of Android phones should accelerate the need for
faster networks, and Finisar's equipment is a big part of that.
I could get into more details, but honestly, that's the ruling
reason-more bandwidth means more demand for Finisar's equipment.
As for business, it slipped a bit during the recession, but not
tremendously (sales growth was down 11%, up 12% and down 1%
during the final three quarters of 2009). And now it's really
ramping up-sales rose 33% and 76% the past two quarters, and
estimates call for 56% and 41% the next two quarters. Earnings,
by the way, have ramped up from three cents to 11 cents to 17
cents to 22 cents per share during the past four quarters.
The stock itself notched an impressive 10 weeks up in a row
during February, March and early April before settling into its
current choppy consolidation. The good news is that shares
haven't budged much despite the market's correction-FNSR has
actually hit a series of higher lows since early May, and is now
within range of breaking out above 16.6. A strong-volume move
above that level would be bullish.
And, as mentioned above, earnings aren't out until September
(its quarter doesn't end until July 31), so buying a little here
or on a decisive breakout has a good shot at working out. Just
remember to keep positions small until the market enters a new,
For more details on Finisar and other top stocks featured in
Cabot Top Ten Weekly,
All the best,-- Michael Cintolo
Editor, Cabot Top Ten Weekly
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