Beaten-Down Stocks Provide Opportunity

This column was originally published on RealMoney on May 15 at 12:00 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Monday's downside reversal shows how tough it is to trade follow-through rallies these days. Even though the major indices closed near their highs on Friday, folks buying that recovery became the first bagholders of the new week. And it's obviously not the first time this infuriating game of gotcha has been played on market bulls.

Indeed, trading stocks near new highs has become a hazardous occupation these days.

Unfortunately, this is typical behavior in a topping market, where smart money is quietly taking profits whenever the erratic tape gives them the opportunity.

Traders are left with an obvious choice in this dangerous environment: Keep playing the same old game and get cut up by the big boys, or look elsewhere for their springtime profits.

On Monday, I examined growing opportunities in beaten-down stocks. This classic strategy has been essentially unexplored while we've spent our waking hours chasing the market higher this year.

With that tactic getting harder to execute successfully, a trip down to the market's underperformers might be a good place to make money.

Keep in mind that effective bottom fishing requires logically placed stop losses and tons of discipline.

If you've got your mojo working on both requirements, these five stocks could be your ticket to second-quarter profits.

Cree (CREE) got clobbered in 2006, dropping over 20 points between April and December. A year-end bounce failed, with the stock retesting the low in late January. Support held, and price has been on the recovery trail since that time. Note how it shot above the 200-day moving average on strong volume three weeks ago.

The stock is still testing the boundaries of the late-April surge and needs to hang on in order to continue the nascent uptrend. Accumulation looks constructive, so be on the lookout for buyers to emerge in the next week or two. After it trades above 20 for a few sessions, momentum should increase and carry price another 3 to 5 points.

Medicis Pharmaceutical (MRX) ran up to 40 in a strong 2006 uptrend. That rally died and gave way to a deep correction that finally ended when the broad indices ran higher in mid-March. The stock has now completed a double-bottom pattern and looks ready to start a run back to last year's high.

Price is congesting right at the center of the "W" forming the double bottom. This is classic price behavior before a sustained move to higher ground. The stock should be buyable on any uptick, but expect progress to slow when it hits resistance at the March gap between 35 and 36. It could take time to overcome that significant barrier.

Fording Canadian Coal Trust (FDG) has underperformed the coal sector by a wide margin since a group recovery began last year. That could change soon because the stock now shows signs of moving significantly higher after a downtrend sliced almost 60% off its value. But this play is still best suited to patient market players.

The stock rallied from 21 to 26 in the last six weeks and looks overextended on a short-term basis. So, look for price to pull back in order to consolidate its gains. Any decline should find support at the 50-day moving average, currently near 24. A trade entry at that level should be a good way to play the continuing recovery.

Advanced Medical Optics (EYE) ran up to 52.90 last July, in the final leg of a powerful uptrend that began in 2002. The subsequent downtrend accelerated in September when the stock gapped down over 7 points in one session. Price bottomed out three months later near 33 and started a slow recovery.

That uptrend mounted the 200-day moving average on high volume in late April. The stock has held its gains well since that time and looks ready to push above the recovery high at 44. Progress might slow in the lower 40s, where last year's gap will generate resistance, but I suspect the stock has enough horsepower to press above that barrier.

Brightpoint (CELL) was a hot-money favorite until it topped out at 28.28 in May 2006. It sold off for the next three months, losing almost 14 points before it bounced. The stock cut through that low early this year and printed a small triple-bottom pattern before a new uptrend emerged in March. That recovery has been very strong and persistent.

The stock jumped higher after earnings last week and is now sitting at new support near 13. Accumulation is building nicely, indicating that price will eventually surge to higher levels. In that regard, I'd look for a stair-stepping uptrend that reaches significant resistance below 20 in the second half of the year.