How To Spot The Best Breakout/Breakdown Candidates
By Gary Kaltbaum
TradingMarkets.com
The following is an edited
transcription of this week's TraderTalk, a live, interactive workshop conducted by Gary
Kaltbaum for TradingMarkets members on Jan. 30, 2002.
My main focus today is to try to
isolate my favorite types of setups. First off, volume, to me, is the key.
Every big move, up or down, starts with a big influx of volume. So, always watch for
extreme volume days.
Next, 75% or more of picking a stock is picking a sector that is going your way. It is not
very often where one stock in a group is going up while all others are going down. Great
examples are the Homebuilders and Restaurants
of recent times.
Then you start looking for setups. What stocks are hanging
in a trading range? I start to make up a list. If a bunch of names in a group show up, it
emboldens me. If you recall, my reports on Homebuilders
and Restaurants
and recently Truckers
were right on, because the more names that are working in a group, the better.
Then you look and wait for a high-volume move above the
trading range. The more volume, the better. The more names, the better. I love cups and handles, flat base breakouts and gaps. Those are my
three favorites. When there are no breakouts, it tells you something about the market.
When the breakouts are low quality, that's another thing.
I am also a big believer in Relative Strength. I have made
several great calls on AOL Time Warner (AOL) over
the past six months for one reason: The markets kept rallying and the stock didn't go
along for the ride. So, the next question is if it can't rally in a good market, odds
favor it will sink when the market tops -- and that's exactly what happens. The same is
going on in General Electric (GE) right now.
I also compare stocks in the group as far as strength goes.
When you have a chance, look at two airlines -- RyanAir Holdings
(RYAAY) and US Airways (U). Which one do you
want to own? RYAAY, because of its strength.
Let's look at some charts. First, Genesis
Microchip (GNSS).
The main point on GNSS is that it was one of the first
stocks to break out after the follow-through day on Oct. 3. Look at the gap. Look at the
volume and understand one of my mottoes: "The first stocks to break out are usually
the strongest." GNSS fits the bill.
I included Darden's Restaurants
(DRI) and Bob Evans (BOBE) in the Restaurant group.
I could have also put up P.F.
Chang's (PFCB), Panera Bread
(PNRA), Brinker International (EAT), Tricon Global Restaurants
(YUM), Outback Steakhouse (OSI), Champs (CMPP), Ryan's Family
Steakhouse (RYAN) or Sonic
(SONC). Applebee's (APPB) broke out today
(1/30/02).
The point: Buy the groups when you see this type of action. It is meaningful and should
not be ignored.
McAfee (MCAF) was
another beauty, one of the first to break out and most importantly, a new name, which
means institutions have to start positioning. That's why it is always important to find
names you have never heard of
The next chart to look at is the Nasdaq
Composite ($COMPQ).
.
Please review the follow-through day of Oct. 3. Monstrous
volume and lots of doubt. Please read my
TM report.
The next chart is the reversal on Jan. 9.
High volume to the downside. Today's (Jan. 30) action was a
positive reversal indicating we may start bouncing around in a trading range. I suggest
buying "How
to Make Money in Stocks" by William O'Neil, to learn more about the follow
through day.
I actually put out a short on a bounce for Spx Corp. (SPW) last night (Jan. 29). It dropped $22
before bouncing today (Jan. 30). Notice the high-volume drop off the highs...no volume on
the rally. A high-volume drop like this stuck out like a sore thumb. Volume is very
important.
The same goes for Affiliated
Computer Services (ACS). Look how it topped on monstrous volume. That first
day is a clue to get out. Simple as that -- especially after a big run. The same thing
happened to many other names recently.
Let's look at Tyco
(TYC) next.
If you do like I do -- like Marder, like Haggerty, like
Kuhn, like Landry -- you must know that this stock gave multiple sell signals. Study them
all. These bozos that keep saying, "Don't worry," are now fools who lost a ton.
Don't let it happen to you. If I can teach you one thing, it is this:
The market is going to do whatever it
wants to do, regardless of what everyone thinks. And the market is going to screw
everyone, so when everyone is going one way, you will find me on the other side of the
ship.
Q&A
Q: Do you have a checklist (similar to Tim
Truebenbach) that you use for all stock purchases? If not, how do you keep from making
emotional decisions? Also, I assume that you watch the markets closely intraday. Do you
make trading decisions in the middle of the day, or do you execute a plan from the night
before?
A: Just
what I detailed above, but add in strong earnings growth. This takes all of the emotion
out. Every time I deviate, I lose money. A ton of work should be done at night with the
markets off. However, I also do a ton of intraday work.
Q: Would you take a trade on
the day of a gap? If so, what would be your limit?
Or do you wait for a follow-through day?
A: It
depends on market conditions and the stock recently. I did not hesitate to put a short on
(CHKP) when it gapped at $40.50 because it was a surprise gap. Fortunately, it
worked.
Q:
My question is about being stopped out,
just to see the stock reverse back into the base. Take American Woodmark (AMWD) today
(Jan. 30). What do you do in such a situation? Should we bite the bullet and buy it back?
If so, when?
A: First
off, it's the ones you don't stop out on that go down 50% that should worry you. I know it
sticks you right in the stomach on a day like today when the market reverses up, but you
have to remember, there is always another train coming along.
Q:
What would be a good volume
to search for when using the stock scanner? Would you search on volume of 150%? 200%?
A: 50%
in large caps and above 100% in others. The more the better.
Q: What do you do precisely for preparation for the next day?
A: Well,
according to my wife, I am nuts about how much time I spend, but the only way to get good
at anything is to work hard at it.
I follow almost every stock and all sectors. I am basically
looking for changes in direction in both movement and volume. I have proprietary software
that enables me to look at new highs, new lows, up on volume, down on volume, gaps,
five-year highs, and everything else under the sun. I then go through an arduous process
of weeding things out.
Q: What are the lowest-priced stocks, the smallest capitalization
and lowest average daily trading volume that will work with your techniques?
A: I
hardly ever buy under $12 or under 250,000 shares/day. I don't have any criteria on market
cap.
Q: When you're looking at cup-and-handle breakouts, do you also look
at indicators such as MACD, ROC or RSI? I ask because on some of the breakouts I have
examined in the past, some of the stocks will be forming a negative divergence on their
MACD, ROC and RSI indicators, indicating to me that the stock breakout might not follow
through very far after breakout. Do you take the patterns of these indicators into
consideration when choosing your breakouts?
A: I
don't pay attention to them, even though I probably should. I know a lot of people who are
very successful with them.
Q: I have been watching stocks gap up or gap down. I sometimes enter
a trade on the day the stock gapped, but it did not work. I got stopped out. Or it might
work a few days later without me. For those I passed, most are huge winners. How can I
optimize when to enter/exit?
A: Two
words: Scale in. I have found that it pays to do a little knowing that odds favor things
going my way, but as the questioner stated, many times you get stopped out only to see the
stock then go the way you wanted it to.
If the market is going up, gaps to the downside take a
little time. But when the markets are headed south...they crater quickly. That leads me to
Elan Corp. (ELN).
It gapped down 10 days ago, and look what happened since.
My favorite gaps are when a stock has been doing well...everyone loves it...everyone owns
it, and BOOM. It's like the Three Stooges heading for the door at once.
Imclone Systems
(IMCL) is another good example.
Q: I have noticed that most gaps try to fill. Do you enter
immediately on the gap or wait for a pullback?
A: I
disagree with that statement. I know this because I went back through 10 years of gaps --
over 80% didn't fill. That's good odds.
Q: This may be a little off the topic, but with the indices down
over 3% so far, it doesn't look good. With January often being a predictor for the year,
does this look to be another choppy but down year for the major indices?
A: I
don't know. I don't believe in seasonality. And more than ever, there are so many outside
variables that will twist and turn things. No one knows. Terrorism, accounting
scandals...who knows what's next? My biggest problem with this year is that most are
bullish about it.
Q: Do you ever pay attention to a stock's recent news when you
consider opening a position, or avoid stocks which will make earnings announcements in the
next few days? In other words: Do you trust your eyeballing unrestrainedly?
A: Yes,
because earnings, or the lack thereof, is the most important factor in stock performance
over a period of time.
Q: For your short plays, are you looking strictly at the charts, or
do you use some fundamentals? Do you set profit targets, trail a stop, or micro-manage it?
A: Purely
technical because the bad news usually comes out after the fact. I don't usually put in
trailing stops. I just watch it!
Q: Which (one) signal will cause you
to reverse a pick?
A: Price
and volume. Nothing else.
Q: Looking
at the TYC example from above, can you go over the clues you see here, so we can get the
next one?
A: High-volume
reversal today, which means buyers have the upper hand for this second. But it's a fluid
situation, so be careful. Odds do favor upside testing because of the market reversal, as
well as its own. I will not play it myself.
I hope this workshop has helped you. You are all
very lucky. I had to learn to trade all by myself. TradingMarkets is a great place to
learn. If there is ever anything I can do to further your education, it would be my
pleasure.
Click
Here For A Free 1-Week Trial To Gary Kaltbaum's Intra-Day Alerts Service
Related Articles
