This column was originally published on RealMoney on May 14 at 12 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
It's been a great market if you're holding big-caps, industrial metals or the handful of story stocks trading at new highs, such as
But it's been a frustrating market if you're overexposed to small-caps, tech stocks or other speculative groups that require a strongly bullish tape to underpin their rallies.
Daytrading has also been a fantastic way to make money this spring, as abrupt reversals yield all sorts of quick profit opportunities. Add in the dozens of great trades in the energy sector, and no one can deny the resiliency of the 2007 uptrend.
But I suspect the easy money in the current bull wave is just about gone.
In its place, look for more downdrafts like Thursday's stomach-wrenching somersault and more selling pressure on attempts to lift the indices to new multiyear highs. In other words, I believe we're headed into a more typical sell-in-May environment, with the increased threat of an intermediate topping pattern.
If so, now's a good time to dust off a classic strategy that's been out of vogue in this hot spring market. It's called bottom-fishing. While most folks are still throwing money at stocks near new highs, beaten-down issues could serve up the most enticing reward-to-risk trades between now and Labor Day.
Unfortunately, most traders are lousy bottom-pickers because they fail to utilize a filtering methodology that limits their risk to real turnaround candidates. Instead, they treat these stocks like lottery tickets, not comprehending that downtrends can last for years and drop prices well below obvious turning points.
I apply four logical filters to uncover the best bottom-fishing candidates. Taken together, they do an excellent job of finding stocks that are washed out on the downside but still attract their fair share of value players.
Here they are, in no particular order:
- Price is sitting at or above weekly support levels.
- Price is trading above the 50-day moving average.
- Price is trading above the 200-day moving average or sitting so far below the average that it isn't an obstacle to a high-percentage, countertrend rally.
- On-balance volume (OBV) shows a clearly bullish divergence, with obvious buying interest.
You'd think it would be tough to find good bottoming plays with the major indices now trading at multiyear highs. But a surprising number of liquid stocks are stuck at or near their yearly lows this May, so the candidate list is much longer than expected. Let's take a look at the top picks.
fell sharply after a three-year rally topped out at $39.28 in February 2006. That decline sliced almost 50% off the stock's value before it bottomed out in August. The ensuing bounce ran out of steam two months later, just below $30. Price has been meandering in a 5-point trading range since that time.
Buying pressure has picked up considerably in the last few weeks, and the stock is now trading above all key moving averages. It looks like the long bottoming pattern is almost completed and price is ready to embark on a renewed uptrend. A breakout above resistance at $30 should issue a actionable buying signal.
began an ugly downtrend in early 2006. That selloff didn't stop until January, when price tested the September low at $12.95 and bounced sharply. This double bottom yielded a countertrend rally that failed at the August swing high. Price retraced half its short-term gains and then perked up again, jumping above key averages in April.
Notice the rounding action in the 50-day and 200-day moving averages. This is a classic recovery pattern that should eventually yield an uptrend that carries the stock into the mid-$20s. But price needs to hold support right here, so I'd guard a bottom-feeding entry with a stop-loss between $15 and $15.50.
The oil services sector is trading near new highs, but that hasn't stopped
from dropping like a rock in the last nine months. Although the decline ended in February, the stock has underperformed its peers by a wide margin so far this year. But that could change soon, because it looks like a new rally run is setting up.
On-balance volume shows active accumulation since the February low. Notice how this leading indicator spiked sharply last week and is now sitting at the same level as the 2006 high. This is a strongly bullish signal indicating that price could play sector catch-up and run quickly into the mid-$30s.
I've got another five stocks sitting on my bottom-fishing candidate list, but I've run out of space in today's column. So I'll follow up on Tuesday with a second collection of beaten-down issues that could get a major lift in the months ahead.
At the time of publication, Farley had no positions in any of the stocks mentioned in this column, although holdings can change at any time.
Alan Farley is a professional trader and author of
The Master Swing Trader
. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;
to send him an email.
click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.
TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.