Make Careful Buys as Market Beckons

This column was originally published on RealMoney on Oct. 10 at 11:36 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

No doubt about it, this is a tough market environment. The major averages have been trending lower since early August.

Sure, we've seen a few rallies over the past couple of months, but they haven't led to anything other than frustrating selloffs.

Just when folks start to believe in the bull, it wimps out. Blame it on hurricanes Katrina and Rita, high oil prices, rising rates, seasonality or whatever else you can think of.

It really doesn't matter which scapegoat we choose; the market just remains ugly.

But last week's bearish trading action might be more significant than past declines.

Specifically, Thursday's high-volume selloff could turn out to mark a short-term bottom.

Let's look at a chart of the S&P 500.

Notice how Thursday's intraday decline was halted by strong buying, pushing the S&P back above 1190?

While Friday's close was just slightly higher than Thursday's, it was significant.

If this low holds for the next few days, expect buyers to start stepping up to the plate.

After all, the money that had been buried in oil stocks has to be put back to work.

A firm market environment should start pulling in more buyers.

Let's look at the flip side. A break of support implicates very aggressive selling.

In that case, I'd be very careful about opening any new positions.

Most stocks move with the ebb and flow of the market, so you'll want to have a very good reason for buying in a declining market.

Let's look at a few charts of stocks that might work here.

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AU Optronics(AUO) has fallen back to its March lows and it looks like deja vu all over again. Last time the stock fell to this level, it bounced up to around $13 and then retested the bottom. But ample buying interest halted the decline and forced the bulls to chase the stock higher. Now, the stock is back at prior support. After pushing as high as $13, AU has fallen back to support. The battle line is drawn around $12. If that level were to fall, I'd expect most of the current dip buyers to sell their stock and cut their losses. But if support holds again, the odds of another rally increase dramatically. At this level, I'd dip a toe in the water and buy some shares -- with a stop just beneath support.

This daily chart of ATI Technologies(ATYT) shows a failed breakout last Thursday. The daily volume was more than four times average volume. However, Friday's decline made every single Thursday bull a loser. If you bought on Thursday, you're underwater today.

As such, Thursday's trading range takes on added significance. With almost 25 million shares trading hands on Thursday, the high is important to track. ATI rose as high as $14.74 before meeting aggressive selling. Any advance back to Thursday's high will make all those bulls happy again. They'll be likely to hold on to the stock, and maybe even buy more. But if no buyers materialize to push ATI higher, I'd expect many of Thursday's bulls to close out their positions and wait to buy lower, probably around $13.

Last Monday, Charlotte Russe Holding(CHIC) was upgraded by Wachovia Securities. The stock jumped nearly 10% on very heavy volume.

That's not the story, though. The story is the persistent strength of Charlotte Russe in a very weak market environment. Those who wanted the stock were more aggressive than those who were selling; demand outstripped supply for the balance of the week.

Those who bought above $15 are now mostly happy because they are profitable. But if the stock fell back beneath $15, I'd look for many of those recent buyers to be come sellers. This market is just too skittish for patience. If I was long, I'd hold the stock, and protect it with a stop around $14 or so.

This weekly chart shows M-Systems Flash Disk Pioneers(FLSH) moving out of a multimonth trading range. M-Systems had been trading between $20 and $25 for all of 2005, until July, when the bulls began buying aggressively.

Now, the weekly trend of the stock is upward, but it's really having trouble pushing through $30. I see a potential trading range of $25-$30. If the stock pulled back to around $25, I'd be a buyer. But I'd also place a stop around $24. And if the stock closes the week above $30, then it's probably going to continue its uptrend without testing the breakout.

Be careful out there.

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider Charlotte Russe Holding to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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