How To Measure Risk

Posted onAuthorGSRTrades

Welcome to this week’s edition of The Growth Stock Report!

Traders,

We’ve seen some eye-opening moves of late, and have real conflict from market internals.

Our current position:

MARKET IN LIMBO

In this week’s edition you will find:

Where We Are:

Taking a look at the overall markets:

We’re still in limbo. We’ve had a massive rally off the year’s lows, but buyers are faced with technical obstacles and split internals.

Shorts have been burned. Most professionals will likely tell you they’ve been burned more times going short in their career than from buying. Just look at your charts. It is only in rare occasions that clear shorting opportunities expose themselves, and even then they don’t always succeed.

Looking at The Year 2000 Top it can bee seen that it took months for it to play out. Price action deceived market players into believing everything was fine, but it burned everyone as they bought into traps. Bull Traps.

We measure our risk carefully here, and only act when things are absolutely in our favor. We are not always right, but are smart enough to cut our losses short while letting the winners run.

More importantly, we know what we don’t know. We don’t see a whole lot of clarity in this market, though do see selective opportunities as discussed below.

Technically speaking:

After two weeks of solid gains, the major indexes cooled for the week. The Dow Industrial Average ($INDU), S&P 500 ($SPX) and Nasdaq ($COMPQ), despite having retraced much of the losses made for the year, are in technical limbo.

“Doji” candlestick signals in place on the weekly charts are signs of indecision which tends to go in hand with a turn in trend. We don’t take a whole lot of credence in these signs, though consider them in light of additional evidence discussed below which points to internal weakness in market.

We have no evidence to support the case for a bull market in place.

As leadership attempts to be established, we are seeing some decent names set up for potential buys, but without further evidence of a good overall market we don’t want to load the boat on them. Further discussion on leadership is in our “Growth Stock Landscape” section.

We suspect the buying for the past few weeks to be mostly short covering and also believe it can last longer while putting a floor on things.

If the market begins to fall apart in the weeks to come we will see short opportunities set up.

Volume indications for the past three weeks might suggest a bull that is running, or has ran out of steam, though is not strong enough for us to have a whole lot of conviction over it.

Watching volume going forward will be very important to see how many sellers step up on down days. If we begin to notch in distribution days it will give us reason to believe the institutions are sellers.

If we see buyers come in numbers on up days it will suggest institutions are supporting this market. We’d prefer to see accumulation after some consolidation has taken place as high volume at the end of rallies often signals the wrong way crowd coming late to the party.

Key chart action for the week:


Charts courtesy of Stockcharts.com.

Consumer Staples ($CMR) have lost ground over the past couple of weeks, but remain in stronger technical condition over Consumer Cyclicals ($CYC) which appear vulnerable to further selling.

The Semiconductor Index ($SOX) posted a gain on the week and have been very strong. We love to watch the semis as a leading indicator, and see this action as bullish for the overall market if it can be sustained.

Banks ($BKX) could be in the process of forming the right shoulder of a topping pattern. We see the high made in this sector three weeks ago as pivotal, and until taken out, we have to be bearish here.

Broker Dealers ($XBD) have been on a tear. We are seeing some leadership trying to be established here which is great for the prospects of a bull market. It’s too early to have faith here.


In rare form, the Dollar Index ($DXC) and Gold miners ($XAU) have been trending together for the past two weeks. This won’t last. Given the Dollar to be technically extended we feel it will give way to further gains for the miners.

Healthcare ($HCX) and Drugs ($DRG) have been consolidating over the past few weeks. This gives the sectors more of a durable technical base to launch from. We’ve liked this sector for a few months now and need to see it breakout successfully to maintain our favorable outlook. Be careful. If the sectors are unable to breakout it will turn into pattern failure which often triggers a cascade of selling. Buy above the current highs.


REIT’s ($DJR) and Homebuilders ($DJUSHB) hit a fresh high for the week and look technically strong. You can hardly read anything these days without real estate and bubble being mentioned, and to sum up our stance on the REITs as a trading vehicle we say trade what is. We have a few names from our “Setups” list here and believe they could breakout successfully.

Airlines ($XAL) have moved nicely higher over the past three weeks though have much work to do before truly breaking out of what has been a prolonged technically bearish condition. We saw a rare buying opportunity here three weeks ago as mentioned in a previous report.

Energy ($IXE) has been back in the saddle over the past three weeks as the price of crude oil has been flirting with the $50 mark. We see internal strength from the sector and believe it could very well hit new highs for the year – but we’re not going to take that bet until we see conditions set up properly. We’ll keep you posted. Crude closed above $53 for the week

The top 10 industry groups from the 6 month RS screen are:

  1. CONSUMER SERVICES
  2. GROCERY STORES
  3. RESIDENTIAL CONSTRUCTI
  4. DEPARTMENT STORES
  5. TECHNICAL SERVICES
  6. SEMICONDUCTOR-SPECIALI
  7. OIL GAS DRILLING EXPLO
  8. DATA STORAGE DEVICES
  9. APPAREL STORES
  10. FOREIGN UTILITIES

New Highs & Lows: The number of New Highs made for the week was up significantly as the number of New Lows has remained plateaued over the last three weeks.

The Growth Stock Landscape:

The scene in growth stock land has been encouraging. As we watch top fundamental stocks go from carving out bases, to setting up, to breaking out – we also see them increase in number. This is all an indication of a healthy market, we want to see it continue.

For the week:

New high highlights came from Google (GOOG), and Hansen’s (HANS). These have been model growth stocks to be trading in.

We had successful breakouts in Coach (COH), Legg Mason (LM), and United Health (UNH).

Retail has been hot. New highs from quality stocks Bebe Stores (BEBE), Chico’s FAS (CHS), and Urban Outfitters (URBN) have blazed the way for Coach (COH). Also hitting a new high was Gildan Activewear Inc. (GIL), which, while not new to hitting new highs, is new to our screen for stocks with top fundamentals.

Energy showed its resilience as new highs were made in Canadian Natural Resources (CNQ), Occidental Pete (OXY), Swift Energy (SFY), and Southwestern Energy (SWN).

Financial stocks Chicago Mercantile Exchange (CME), Legg Mason, and Nasdaq Stock Market (NDAQ) have also been spectacular.

And the Homebuilders put on an impressive display with new highs from DR Horton (DHI), Hovnanian (HOV), KB Home (KBH), Standard Pacific (SPF), and Toll Brothers (TOL). It should be warned that these are later stage bases which can mean they may be tired after extending themselves. We have some names from this sector poised to breakout but need to be cautious. Any sign of these breakout stocks faltering should be a warning.

What We Like – What We Have:

With the Yellow Flag out we are using caution for this market. This means we are extremely selective and go light.

Always respect the proper Buy Points as cited on our “Setups” page, and always respect a 5-8% stop loss.

Stocks setting up from well supported sectors include Coventry Healthcare (CVH), and Petro China (PTR). We also have Kendle International (KNDL) which is a micro-cap from the drug sector.

On the riskier side of things, Pulte Homes (PHM) looks good to go after several hombuilders have successfully launched. Keep in mind there is technical weakness evident in later stage bases.

And for an even higher risk play look at apartment operator Tarragon Corp. (TARR). Only those who can be nimble should consider this one.

Action from our open positions:

Our move into airline stocks has been working well, while good ol’ LCAV has been stellar.

RyanAir (RYAAY), First Target = 49.97.
Original Buy Point = 42.55. NOTE: We have lowered the first target here due to technical boundaries that will inhibit our first target of 20%. If we continue to see strength in the airlines we will likely setup again in the stock.


Southwest Airlines (LUV), First Target 18.06. = Original Buy Point = 15.05. The stock is currently in a topping formation that happens to be in a base. This means if buyers come in to override the formation (by sending price above the right shoulder) it will be extremely bullish. We see a close below 14.36 to be reason to exit.

LCA Vision (LCAV), has given us a 20%+ move. We’ve hit our first target and took half off. We’re going to let this one ride on the prospects that has the potential to mature into a 100% gain. No expectations, we just do what the stock tells us to.

What Was Important About Last Week:

STOCKS:

  • No. 1 U.S. auto maker, General Motors (GM), reported its U.S. sales fell 13% in May from a year ago.
  • Ford (F) said its sales were down 11% from a year ago.
  • Chrysler, a unit of DaimlerChrysler (DCX) , announced U.S. sales fell slightly in May from a year ago. But after adjusting for the two fewer selling days sales actually rose.
  • In the retail sector Wal-Mart (WMT) met forecasts with a 2.5% gain, with Target (TGT) and Costco (COST) also edging past expectations. Apparel chain Bebe Stores (BEBE) and luxury chain Nordstrom (JWN) also outperformed, while Federated Department Stores (FD) and the Gap (GPS) were short of their targets.

ECONOMY:

  • U.S. economy added only 78,000 jobs in May, which is far less than the 274,000 added in April. The unemployment rate edged down to 5.1 percent, which is the lowest level since September 2001.
  • Dallas Fed President Richard Fisher, told The Wall Street Journal and CNBC that the Fed was in the “eighth inning” of its rate-tightening campaign and that its policy meeting later this month would represent the ninth inning. This means the Fed is close to finishing its “tightening” of the monetary policy.
  • Jobless claims rose by 25,000 to a 2-month high in the week ended May 28.
  • The Conference Board said Consumer Confidence was up as their report broke a recent downtrend while claiming consumers appeared less worried about the job market and the economy.
  • The Purchasing Management Association of Chicago’s index of business activity fell lower than economists expected. The index did not indicate recession and has reverted to its average after big gains.
  • The Institute for Supply Management reported its index fell to its slowest pace in two years, though did not reach the mark of 50 which is the break-even point between expansion and contraction Factory activity has enjoyed a 24-month expansion, which is the longest in 16 years. High energy prices, a rebound in the dollar (which takes away from demand for U.S. exports), a big inventory buildup in the first quarter and a slowdown in automobile production contributed to the slowdown.
  • The Institute for Supply Management said its index of service-sector activity fell to its lowest level in two years.
  • The Office of Federal Housing Enterprise Oversight said the average U.S. home price was 12.5% higher in the first quarter than a year ago which is nearly the biggest gain 25 years.
  • In the retail sector same-store sales were up 2.9% from a year ago, which was lighter due to unseasonably cool weather.
  • The Labor Department issued a report showing that labor costs rose faster in the first quarter than initially thought.
  • Productivity, or output per hour worked, rose 2.9%, which is an increase from an initial reading of 2.6%.

What We Are Watching For This Week:

  • MONDAY: CMGI (CMGI), Quiksilver (ZQK).
  • TUESDAY: Albertson’s (ABS), Toys R Us (TOY).
  • WEDNESDAY: H&R Block, Inc. (HRB),
  • THURSDAY: National Semiconductor (NSM), Navistar International (NAV), Shuffle Master, Inc. (SHFL).
  • FRIDAY: Polo Ralph Lauren Corporation (RL).

  • On the economic front we have potential market movers with:

This Week’s Scans:

SETUPS

BREAKOUTS

BASE BUILDING

SHORTS

This Week’s Word On Discipline:

“He who lives without discipline dies without honor.” Icelandic Proverb

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