How can an investor know when the stock looks as though it is recovering, whether it is just a head fake, or a real recovery? (May 29, 2003)

  Very good question. Try to think of stocks as going through phases of life. There is a larger phase over the years, and then there phases within the larger moves. When a stock is trending higher it tends to follow a routine: base, breakout, run higher until it exhausts the base, then bases again for the next breakout. This can occur on average 4 to 6 times before it needs a much longer correction or base. It can be longer than this, but on average stocks follow this pattern. The runs from base to base to base can last over years and can reap huge rewards (e.g., DELL, MSFT, CSCO in the late 1980's through the 1990's).

In between bases the stock runs up the short term MVA with an occasional test of the 50 day MVA. Just as with the larger bases, a stock makes 4 to 5, maybe even 6 runs up the short term MVA before it needs a deeper rest. That usually takes it down to the 50 day MVA. After a few such runs and tests of the 50 day MVA it needs to form a new longer base. Note how the cycle is about the same for all of the phases. That is key in understanding just where a stock is in its lifespan so you can make intelligent decisions about when to enter or exit based on what your goals are (really long term, short term options, medium range making good profit and moving on to the next stock that is ready to make the next move right now).

As a stock makes the runs up the short term MVA between the 50 day MVA tests, the action tends to get more volatile as the stock gets into the later stages (fourth to fifth bounce). In other words, the stock runs harder to the upside, but it also tanks harder to the downside. Your example of SSYS is a good one. It spent much of 2002 in a base. It broke out and ran to a peak in January 2003. It then formed the next base and broke out in March. From there is has run up the short term MVA without tapping the 50 day MVA. The first tow runs were nice and orderly, taking it up after nice lateral consolidations that moved laterally until the 10 day MVA rose to meet it and popped it higher. The last two short term MVA tests have been wilder, with tests down to the 18 day MVA and big bounces up off those levels. Then it gapped back down to test the 18 day MVA again before jumping back up. Now it looks as if it has made a lower high & needs a deeper rest. It has rallied from $10 to over $30 on this run; tripling in price, fourth bounce off the short term MVA, more volatile action. Those are all signs it needs a deeper test and maybe a new base.

Applying this to when to enter, if you are in the first or second and even third bounce up off the short term MVA, you enter when the stock starts to bounce from the test on rising volume. Not blowout volume, just solid, rising volume. Odds are it is in a stronger uptrend after that breakout and will rebound in a way that is typical for stocks in a strong uptrend. Thus we have better chances of success just waiting to see it start the bounce and then moving in. If it is late in the run, then the action will be wilder to the upside and the downside. The same tactics apply, but we have to understand it will be more volatile and be ready to act if we don't want to ride the stock longer term through a correction.


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