As I have said, trading patterns repeat themselves over and over again. In my Feb. 28 column,
Dumpers, Making Money on a Bad Story, I explained that a dumper is a stock that is down more than 20% from the previous day's close on moderate to bad news. The Street almost always overreacts to bad news, so I like to find and play these stocks the next day as the Street digests the news and determines it wasn't really that bad after all.
I put a list of stocks on my screen that are gapping down (opening at a price that is lower than the previous day's close). Then I sift through the news to ensure it's not the sort that could cause a stock to halt or continue its downward spiral, such as missing earnings by 30%, bankruptcy, a
Securities and Exchange Commission
investigation or an allegation of fraud. I watch these stocks during the premarket and as they open. The normal action I expect from dumpers is for them to gap down and then either dip slightly and then bounce or simply climb from the open. This indicates the Street finally took a look at the news and decided the stock has suffered enough and is now undervalued. Value buyers jump in early at the first dip or at the open and drive the price up. I have been playing this bounce for years with great accuracy.
I have also mentioned the importance of tracking your patterns to determine when they are reacting predictably and when they are not. This dumper pattern has been dormant for a few weeks now. For some reason, value buyers have not been jumping in at the first bottoms, and it has caused me to sit on the sidelines with this particular pattern. In the past week, it returned with power and I went on a dumper search all week. The overall movements of the market were sporadic and hard to read, so I concentrated on individual patterns this week instead of general moves. Here are few plays I tried:
On Monday, July 17, I noticed the dumper pattern had returned. The first dips, or even the first upticks of stocks gapping down with moderate bad news, were good buys, creating good opportunities to exploit this pattern once again. After I noticed the pattern was back on Monday, I was on dumper alert on Tuesday.
On Tuesday, July 18, I was watching
, a maker of software for speeding Internet transmissions of audio and video. On Monday night, it had announced a warning of widening losses and costs associated with an acquisition of another software company. The news did not appear to be too devastating, so I watched the action. The premarket action was looking pretty strong, but it had a mix of selling so I decided to wait until it hit its first bottom dip to jump in.
As you can see from the chart above, it closed Monday night at 44 5/8, opened the next day at 36 and dipped to 35 5/8. It was a quick bottom but attainable for an entry point after it upticked from the low. If you were not looking for it or ready for it, it certainly would have been too fast to see, analyze and get in. This is the importance of premarket planning.
The chart above shows a closer look at what happened the morning of the 18th. You will notice from the chart it dipped slightly but started a steady climb until it hit 39 1/4, where it paused. The safe exit point was here at 39 1/4, or it could have been held a bit longer. I chose to exit because the overall market was weak, as the chart below shows.
This made me miss out on another 1 1/4 points of profit, but exiting with a 3 1/4-point profit was enough for me in this down-trending market. I would rather lose opportunity than capital from my portfolio.
Because this pattern was still active on Tuesday, I looked for additional dumpers on Wednesday. I keep doing this until the patter is no longer predictable. I was watching
, which was down because it missed earnings expectations. The bad news was a bit stronger than I normally like, but the premarket action looked good.
As you can see from the chart above, it closed at 41 13/16 on Tuesday, gapped down to open at 30 3/8 and then dipped to 29 5/16 before starting a slow stair step-up. The bottom was slow and easy to identify, but the pause between 9:45 a.m. and 10 a.m. EDT almost had me exit the trade. But other dumper stocks were still climbing so I decided to stay in the trade for a bit longer. Watching the macro aspect of the market paid off. Digital Microwave increased in momentum and finally topped out 35 1/4 around 11 a.m. I missed the very top but got out just under 35 for more than a five-point profit gain.
Patterns repeat, but you will not know that unless you meticulously track them on paper. When they are active, play them; when they are not, stay away. Last week it was my dumper pattern; this week it may be a completely different pattern. Track, identify, analyze and go in for the high-percentage kill. That is the key to high-percentage trading.
Ken Wolff is founder and chief executive of Paradise, Calif.-based MTrader.com, a daytrading and swingtrading Web site. This column provides general information about momentum trading. TheStreet.com has no affiliation with MTrader.com, and no endorsement of MTrader.com or momentum trading is intended. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at