Two Approaches to Setting Price Targets

DOC and Go-Dog-Go use simple calculations.
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This column will be brief, plus informative. And I say that, because, well, that approach may come as a surprise to many of you longtime readers. To those of you new today -- and who now think of me as more of a TV star -- please, I beg of you, do NOT get used to this informative, to-the-point approach. It just can't last!

Anyway, a question I often get asked is, "How did you come up with the figure of $XX as the target for 'insert your favorite stock here'"?

And the answer is, I use two basic methods:

    The depth of congestion, or DOC approach. (Pretty neat acronym, huh? I just made that up!) The Go-Dog-Go approach. (Darn it, previously claimed by Dr. Seuss.)

Baffled? You needn't be, because it's pretty simple. Therefore, a few brief explanations and then a few easy-to-understand charts.

DOC

With the DOC approach, you need to follow three steps. The first is to figure out if your stock has emerged from congestion. For more on that topic, see last year's column from

Feb. 2 and this year's one from

April 5.

The second step is to then measure, in points, the depth of the congestion from the top of resistance down to the bottom of support. Now I already know your next question: "Do we use the highs, the lows, the closes, or a combination thereof in our calculations?" And my answer: I always ballpark the point distance anyway, so it really doesn't matter. Truthfully, this entire concept is estimation, so a quarter-point difference here and there isn't a big deal. You just have to use what looks correct.

After you've come up with the depth in terms of points, all you have to do is add this number to the breakout point. Viola! You now have a target that the stock should hit.

Let me illustrate with a chart of

Verity

(VRTY)

.

Here there was a clear breakout, and I gauged the target at 50 1/2. And it hit this target within a few days and actually kept going for a bit. Now does that mean set your sell limit at 50 1/2 and walk away? Well, you certainly can, but what I do is consider that target the

best

I can possibly do, and instead start to watch the stock a bit as it gets about halfway there. Generally, I might even sell a bit early -- say 49 7/8 -- rather than wait around and make the stock take out another whole number. But this discussion falls more in the arena of money management, so we'll revisit this in the future.

Let's take a look at how you can use this method on a longer-term play, this time a weekly chart of

Exodus Communications

(EXDS)

.

With this chart, you'll notice the congestion is closer in form to a big bowl. I always like my congestion to be bit flatter, but the volume surge on the breakout offset my hesitancy with this chart. EXDS not only hit 40, by the way, but kept going, recently hitting 146.

This brings up a good point with targets, and one I again want to stress: They fall into the "helpful tool" category. Nothing more, nothing less. Frankly, stocks often fall a bit short of the target, and sometimes they go past it by 400 points.

What I use them for, though, is to figure out if my reward/risk equation is correct. VRTY, for example, had a 10-point upside. And when I took the trade, I figured I was wrong if it dropped any more than 2 points. Therefore, my reward/risk was five. So, the target of 50 1/2 helped clarify things and gave me the quantitative support to make a solid trade.

OK, that's the DOC approach. Unfortunately, though, stocks don't always go into congestion, particularly the fast movers. No, they might only pull back for a few days and then scoot on upward. But those are often the stocks you want to be in, so how do you figure out targets for those?

Go-Dog-Go

The answer is the Go-Dog-Go method, and this is just as simple as the DOC.

The first step is to measure the distance, in points again, of the first upward "leg." Once a stock pulls back a bit and then indicates it wants to go higher, you just add the distance of the first leg to the bottom of the pullback.

A few charts should clear things up.

Remember, with these kinds of trades, you will not spot the Go-Dog part until the final leg (the final "Go") is ready to start. And you must wait for that -- otherwise you risk entering a trade that's not a Go-Dog-Go, but rather just a D-O-G!

Let's look at one more chart, this time one going down, so you can see this method works with shorts in the same way.

The important point to note here is I came up with a target of 0. (In fact, the target was negative.) Naturally, this is a bit silly, so you want to be reasonable in taking your profits. Nevertheless,

Manugistics

(MANU) - Get Report

made a strong run at the ultimate bottom!

OK, two ways -- DOC and Go-Dog-Go -- to get a handle around some price targets. Infallible? Of course not. Helpful? Absolutely! Always keep in mind that tools like this, and all of TA for that matter, should be used for one purpose: to give you an edge with your trading. But over the course of thousands of trades you might make, a little edge is often all you need to put yourself consistently in the black.

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide investment advice or recommendations, he welcomes your feedback at

gbsmith@ibm.net.