Stick to Stocks With Strong Stories in This Stalled Market

For the past several weeks, traders and investors must have felt like Rocky Balboa taking a punishing beating in the ring from Apollo Creed. Those who "held" are up against the ropes, waiting for the barrage of punishing head and body shots to finally end. They are hanging in there because they know if they wait long enough, Rocky always wins in the end! They have been the "champions"; they've had the taste of victory with last year's gains and they want it back again.

Well, this ain't Hollywood. There is no "magic" gun that fires an unlimited number of bullets without reloading, and unfortunately, the good guys don't always win every round. The sellers were in clear control of the market this week and are winning the short-term battle. I have said before and I will say it again: I believe when this market does turn around, it will be institutionally led, but followed by and fueled by the online traders.

A couple of weeks ago, it looked as if institutions were chomping at the bit, just waiting for something to force them back into the game -- not wanting to be the last out of the gate to catch the lows, but also not wanting to be the first to step forward for fear of another slaughter. The continued downturn and the potential for even more downside is scaring even the boldest of the institutions back to the sidelines. If the downturn continues and we approach Nasdaq 3000, this will scare them even more.

If the Nasdaq dips below 3000, it could create another wave of panic selling that we saw at 4000, which could drive the market considerably lower. We will not see a consistent move to the upside until one of two things occur: a news event that indicates the economy is slowing, or value is reached in which institutions are compelled by low prices to buy the leaders. Until I see institutions jumping back into the leaders, I am focusing on shorting. The longer this goes on, the larger the rock it will take to get the market to move, but that is the tricky part about the markets' "herd mentality." Sometimes it only takes one big player to break free from the pack to get the rest of the herd to believe the leader has seen the Promised Land and get them on their feet again.

Last Tuesday, the Fed raised interests rates an expected 50 basis points. We have all heard the comments in the past regarding the "overexuberance" of the market, and I believe the 50 basis-point increase had the expected effect on the market. Anything more could have caused another drastic selloff, anything less could have been enough to get it moving again. A slow and steady growth is what the Fed is happy with, but they may have overshot a bit.

The recent market action has forced me to change tactics. As a result, this past week I concentrated on some of the lower-priced stocks. Online traders are still trying to capture momentum out of the market, but they are trading scared, jumping in and out quickly. This scared trading has created multiple intraday bottoms on stocks. Just when you think you found a bottom, it heads lower again and again. In addition, the bottoms were very quick and tricky to identify. Taking this into consideration, I only played stocks with very strong news stories attached to them. Weaker stories simply did not follow through as traders took quick profits. Here are two examples of small stocks I played last week:

US Search.com (SRCH), a leading provider of Internet-based information-verification services, released blowout earnings on May 15 after the bell. The stock bottomed shortly after the bell where it made a quick but attainable entry after the open the next day, climbing from 2 to a bit under 3 1/2, where the momentum clearly turned around.

Autoweb.com I(AWEB), a leading consumer-automotive Internet service, announced a strategic alliance with America Online (AOL), causing the stock to climb from the open on May 17 from 4 1/2 to 5 1/2. Again, the bottoms and tops were very quick, but attainable shortly after the open.

On both of these plays I was quick to enter, but just as quick to exit due to the nervous trader action. Many inexperienced momentum traders are getting their heads handed to them due to the quick bottoms, lack of follow-through and nervous trading, because they are not waiting for the high-percentage trades and stronger stories.

As I said in last week's column, unless you are an experienced momentum trader, I recommend watching from the sidelines for now until the market decides what it is going to do. I wish I could tell you what will happen, but you know how I feel about people who predict what the market is going to do. However, more and more market analysts and newscasters on CNBC and CNN are jumping on the "market is going lower" and "many investors are looking for a safer place to put their money, such as bonds" bandwagon. This type of rhetoric may create a self-fulfilling scenario, forcing the market lower.

The increased frequency of small-stock momentum last week may be signaling that daytraders are returning, so I will continue to focus and play small stocks, both long and short, until the big momentum players return to the market. During this type of market conditions, I treat every trade as if I was shooting with a magic gun loaded with silver bullets, aiming at only the high-value targets and conserving them carefully for the big hunt later on. Capital preservation is the key.

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