CATALYSTS

 

Stock prices are moved by catalysts. There are four major types of catalysts.

1)      Liquidity: low cost of borrowing makes the investment in most asset classes quite alluring. An inflow of money makes price to go up. Rising prices bring joy and confidence to the soul of the masses. Higher confidence leads to higher risk appetite, which usually brings even more money into the stock market. This is a catalyst based on greed and vanity.

2)      Earnings’ related catalysts. If it is not about current earnings (beating estimates), then it is about future earnings (raising outlook above street’s expectations) or potential for future earnings (FDA approval, collaboration with another company, takeover rumors, announcement of new product, regulatory changes that could affect the whole industry). This is a catalyst based on momentum. The key here is market reaction. Reaction no news is more important than news itself.

3)      Valuation: I am simply not smart enough to define the intrinsic value of a stock; therefore I leave that job to the Warren Buffets of the world – people, which pocket is deep enough to survive prolonged periods of market irrationality. Who am I to say that certain stock should be traded at 18 times next year earnings or 28 times next year cash flows? Don’t get me wrong. There are plenty of smart people, who are constantly able to find stocks, trading below their intrinsic value and know how to profit from them. A big bow to them. For me their work is 50% science and 50%s art and gut feeling (experience). This is a catalyst based on common sense, but don’t forget that in trading the obvious rarely happens, the unexpected constantly occurs.

4)      Fear: of missing out on a big move or fear of getting short squeezed; fear of losing more than can afford to lose; fear of accepting that you were wrong.

I often look at the charts of stocks that make big moves in short time frame. How often? Every day, hoping that I will find out as many common patters in the beginning of those moves as I can. In hindsight, everything looks so easy. “I should’ve bought here and sold here and I would’ve made quick 10-15%”, but taking the proper decision in real time is always much harder than expected. Such fast moving stocks often experience violent corrections along their climb higher. Only the few with strong stomachs, enough experience and sound risk management behavior survive. How to overcome the fear of losing and act quickly when an opportunity presents itself? Risk smaller portion of your capital. A portion that wouldn’t hurt your confidence or sound judgment if you actually lose it. If you are risking 1% of your capital and it happens that you lose it, you only need to make 1.01% on the next trade to break-even. Can you do that? Absolutely. Then why you are afraid to take on new trading ideas, produced by your method? If you’re not able to sleep, then you are risking too much. If you are trading too often, then you are not risking enough. And one more thing. No one can buy at the bottom and sell at the top. If it happens, it is due to pure luck, not skill. Gradually build positions in equity that you like and gradually take profits when you exit.

How big moves happen

 

All markets cycle endlessly between contraction and expansion. But congestive phases use up many more price bars than trending moves. This suggests why making money in the markets can be so difficult. A trend may already be over by the time most participants see a sharp rally or sell off. At the least, risk escalates dramatically as advancing price can reverse or enter new congestion at any time.

Alan Farley

Case #1: ASTC

astc

On September 29th, ASTC gained 176% after 5 months of boring sideways action. The traded volume that day was an all-time high for ASTC. The company reported Q4/09 net income of $2.6 million or 0.15 per diluted share on revenue of 10.4 million compared with Q4/08 net loss of 1.5m or (0.11) per diluted share on revenue of 6.1m. Astrotech announced that it has engaged investment banking firm Lazard Ltd to advise the Company in exploring strategic alternatives.

A gigantic, earnings’ related one day move. What to do if you did not catch it intra day? Often such enormous one day moves tend to consolidate time-wise and price-wise before they continue.

A time-wise consolidation will look like a bullish flag. The big range day is followed by several small ranged days, located in the upper one third of the first day range. A break-out above the high of the big range day is then buyable.

In a price-wise consolidation, the stock often retraces big part (if not the whole) of the big range day move. It is not unusual to see the stock to come back to the bottom of the big range day candle. This is not the place to buy. You don’t buy blindly on weakness, because you don’t know how far the decline could actually continue. Instead you are looking at the bottom of the big range candle day only as a potential support. If it is, you are likely to see a sideways action, which gives time to the rising 10 DMA (this is the one I use) to catch up with the price. Several days of sideways, low volume action will form a tight range, which could be looked as a sign of accumulation as buyers are defending the opening range of the gap. Then you buy on the break-out from that range or on 5%+ move on at least 2 times the average volume. Actually here volume has secondary importance as in such moves, volume often tends to follow price.

Another recent example of Case #1 that I recently played was LEE:

lee

Case #2: TLB

tlbWent from 9 to 12 during the last 6 trading days as actually only 2 days accounted for the bulk of the move. What was interesting for me was that the stock was already up 156% in the 6 months preceding this 9 to 12 one week move. TLB had a quick run from 6 to 9 in September, followed by 3 weeks of sideways consolidation. The buy was on the day of the 5%+ move above rising 10 DMA. I am constantly looking intraday for 5%+ moves among the stocks that at least doubled during the last 6 months. Most of my trading ideas come from this screen.