For the first time since the start of the blog, I must come clean on a correction, reason being that I didn't go long Platinum Underwriters Holdings (PTP) like I said I would, but instead went long Conceptus, Inc. (CTPS). The reason I did this was, as I told you, the market remains overbought, and I wanted to focus mainly on technicals. Conceptus looked better technically, although the valuation was questionable. It was also resting at the 200-day moving average, which in times like these is of true importance to me. Why? It's because:
- Everyone is looking at it, so it is a collective line in the sand where big things happen.
- Because big things happen, if you end up on the right side of the trade, you can really stand to profit with the big moves that tend to happen in these moments.
- I have something tangible that I can rest my limits against (the 200-day). When I go long a stock that's sitting at the 200-day, I simply put my stop loss (the price at which I'll get out of the stock) at 4% below. I've seen 4% to really be the breaking point where if the price can't hold there, the stock is going to continue to go against me and not recover.
Let me piece apart this trade and the aftermath. There are two things that happened here that are really key to watch:
- The use of the 200-day moving average, or what we call the smoothing mechanism
- The huge spike in volume that ensued after I bought the stock, which can often be quite a tool in trading
Because I don't want to turn these postings into tomes and also because there will surely be ample opportunity to talk about smoothing mechanisms in the future, I would like to focus here on the concept of volume spikes at key levels.
Oh, by the way, this trade is over. I got stopped out at a loss after 2 days, and PTP was up almost 10% in the meantime. Go figure. Each of them looked like good trades. There was just more gamble in one than in the other. Let's see why.
The Play-by-Play
Tuesday 20-April: I bought the stock at the open, at about $19.25. The company had just released earnings the night before, and it wasn't bad, I thought. The company generally met earnings estimates and beat by a penny on earnings. There's a theme that's been developing on the street over the past 2 weeks, though, and it's been getting progressively more pronounced. Stocks are priced to perfection, and you have to knock the cover off the ball when you report. This has been a rapidly developing concept, and it really came to light for me when the stock went against me that day, settling at about $18.30. My stop was at $18.06, so I had 1% or s
o to play with before I got stopped out of the stock. I was already down about 5%, though. On to the next day.
Wednesday 21-April: I went into this day with optimism, not for the open as much as for the close that day. I was just about sure as I could be that the stock was going to close up that day. I'll tell you why in a second. About 5 minutes before the open, when those who reign over price set the mood for the open, I saw that the target price for the stock (between the bid and ask), which was significantly above the closing price the day before, all of a sudden was put right below my stop at $18-ish. Under these circumstances, I would have been stopped out of my position immediately with my anticipated loss and then some.
I will hardly ever take my stop off a stock. A stop is what I committed to going into the trade and it is a committment. But like a lot of other commitments, in the words of John Keynes, "When the facts change, I change my mind." I pulled my stop off because some big guy with a lot more money than yours truly was trying to run the stock in and drive it lower. I was just about positive that he/she would not have succeeded by the end of the day. OK, why?
The reason is that when I was taking a hammering the day before, the number of shares that changed hands that day was the highest number anyone had seen in almost 2 years. Look at the volume spike at the bottom of the chart. Now if you've been reading this blog, you'll say, "Hey, wait a minute, el amateuro. You always say that the 200-day is the granddad of all resistance levels, and not only did this stock plunge through it, but more people participated that day than had in two years!" All true facts, but let me tell you something.
A stock plunging through its 200-day on explosive volume is a sign of people selling the stock out with conviction and is good ammunition to convince anyone (including me) to get out of the position and think of shorting it. That happens in the vast majority of these scenarios. However, when a stock busts through a key level on more volume than has been seen in over two years, that's not conviction. That's people panicking. We're talking people putting posting their resignations on Facebook and doing a full-on header right out the window. Sell conviction--buy panic.
Let's say a developer is hosting an auction of 100 houses that he got into financial trouble with and that are all in the same development with no distinguishing factors from house to house. He managed to sell one house at $200,000 last week, and most of the people in the room feel that therefore, the houses are about worth that and generally are looking for 5-10% discount on top because, after all, it's an auction. The seller is expecting to get about what he got last week for the house at $200,000. He starts the bidding at $210,000 and gets no bidders. Now he's at $200,000 and still confident. He gets to $195,000, and no bidders. He gets nervous and says that he is dropping the price to $190,000 on the next tick down, announcing it as the greatest deal anyone's going to get. Immediately, he unloads 25 houses. Tick-by-tick he gets down to $180,000 with only 10 houses left. Everyone in the room bought a house. Now, having sold so many houses and not wanting to go down anymore, he decides to hang onto the last 10 and wait to see what the open market does now. Now why would he do this? Two reasons:
- He's emboldened by how much inventory he was able to move and is now thinking that if there was that much demand in that price range, he might as well take his chances with the little inventory he has left.
- If he's smart, he'll realize that he has cleared out his buyer base for the near future, and if he wants to sell more houses, he'll just have to sell them way dirt-cheap.
In the stock market, we call this a capitulation day. This is when there is enormous volume in the direction of a trend after the trend has been going on for a long time. So what happens on these days is:
- Sellers unload a ton of inventory because they are afraid the stock will take a dive
- Because the sellers unload all their inventory, it has all changed hands. Now you have no more sellers, and only new proud owners of a stock at or around the current price.
Under these circumstances, usually there is nowhere to go but up. So in my case, what happened? Well, the stock went all the way down to $17.29 in pretty fast order. This big guy was really trying to run the stock down to the depths. With my stop off, I had no safety net on. Or did I? I was sure I did. Well, sure is a strong word. You can never be sure of anything in the market. Once you are, you're usually dead, but with all the sellers cleared out the day before, I was pretty confident standing in front of this train. I went on to continue my day job and came back to take a look about an hour later. The stock now was at its level of the close the day before. So it had leveled off and was above my stop again.
Now, as a noble trader true to his original commitments, but not to be taken as a fool, I put my stop back on. I almost handled this one brilliantly, and I really would have done nothing differently, even knowing what I know now (i.e., that the stock is up quite a bit over the last 3 trading days). But if I kept my stop off after the stock was above it, that would have just been dumb. You don't want to hang out there without a safety net for any considerable length of time. Then what happens? Well, I get stopped out for a 6% loss.
But look at how the stock found its legs and bounced to $18.63 as of the current day's close. Now would I buy it back again at this price? Not now. Reasons:
- The stock isn't appearing in the query I used originally to find it, so my original criteria for the fundamentals I am willing to invest in are no longer there.
- The 200-day is still above the price, and that is still a formidable barrier.
If I didn't have other options, however, I'd be fairly comfortable saying that this one will go higher. There's just too much support below it on that high volume day.
Trades for the Week
I'm not spending too much time on my trades for the week other than to list them:
- Sold Conceptus Inc. (CPTS) - 6% loss
- Sold Sun HealthCare Group Inc. (SUNH) - 7% loss
- Long Lender Processing Services (LPS) today
As usual, thanks so much for reading!
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Hey, Tibaldeo, having fun today? =)
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