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Analyzing the Market for a Winner

01/03/03 09:37:13 AM
by Koos van der Merwe

A strategy to find a winner in the market using price and volume.

Security:   MED
Position:   Sell

Finding a winner in the market is not easy. Day traders usually have two or three stocks that they trade, ten even twenty times in one day, becoming so familiar with their movement that trading is almost instinctive. Investors on the other hand, have their list of blue chip companies that 'they like fundamentally,' and look for opportunities to add to their positions, holding for the long term, and trusting that management will be honest in their financial reporting.

End of day traders however, look for stocks that promise a return that will give them above average returns over a year. They have no loyalty to any particular company, but look for patterns and setups in their charts that previously gave them good returns. Finding these stocks is not that easy, and once a stock that meets ones parameters is identified, taking the plunge and purchasing it is even more difficult.

Medifast Inc. (MED) is a case in point. On February 4, 2002 the price was at $.38. Their ticker then was MDFT, with very little to distinguish the company from any other penny stock. From December 2001 to March 2002, volume increased, as did the price, rising from $.38 to $.91 before settling down at the $.85 level, where it slowly drifted down on low volume to $.64.

Now, this should have tipped me off that there was more to the share than meets the eye. Volume rules are simple, but effective:

1. A RISING price on RISING volume signifies STRENGTH.

2. A RISING price on FALLING volume signifies WEAKNESS.

3. A FALLING price on RISING volume signifies WEAKNESS.

4. A FALLING price on FALLING volume signifies STRENGTH.

Medifast price and volume.
Graphic provided by: AdvancedGET.
Average volume had drifted down over the period from 36,400 to 12,400. Falling volume with falling price equals weakness. Then suddenly on July 22, 2002, volume jumped to 211,800 and price fell from a high of $.72 to a low of $.60, closing at $.65. This triggered a warning that something was happening to the share price, probably a bored holder was getting rid of a large parcel of stock. The buyer had purchased the stock at approximately a 16% discount. My daily summary analysis program (Technifilter Plus) had picked up this large volume with the large drop in price. Two days later the share was brought to my attention again because it had gapped up and although the volume was below average, I decided to watch the share for a few days.

I drew a JM band (15-day moving average offset by 2%). On July 25th, the company gave me a JM buy signal on strong volume. The price then fell on falling volume, telling me that sellers were drying up. I bought the share, and rode it up until August 12th. On August 13th, I was stopped out when the price dropped from $1.89 to $1.55 on reasonably good volume. I then watched the share as it drifted sideways on volume that fell below the average. Then on the 10th of September the share triggered by rising from $1.30 to $1.43 on high volume, closing at its high. At the same time it broke above the upper JM band line, giving me a buy once again.

I then rode the price upwards until October 23, when I received a stop-loss sell. However, the drop in price was on low volume which I knew was a sign of strength. I sold but followed the price closely, looking for a re-entry level. The share bottomed on the 25th of October on below average volume, rising the next day on volume still below average. This worried me because a rising price on low volume is a sign of weakness. I decided to wait. The price moved sideways on falling volume for the next two days, and on the third day, October 31st (not shown), rose strongly on high volume. I purchased the share once more at $3.07 and was stopped out at $3.50.

I then watched the share as it gave a JM sell signal, and considered going short, but the price was falling on below average volume, a sign of strength, so I decided not to take the risk.

On December 4th, the share gave a JM buy on above average volume, a sign of strength. But on the next day when I started placing my order, the price started falling on low volume, another sign of strength. I waited, and managed to buy on the bid at the low of the day. The following day, the price fell even further, giving a JM sell signal. I entered my stop-loss order, expecting to take a loss and was pleasantly surprised to see the price rise, but still on low volume. Then I realized that the price was forming a triangle, which is a consolidation phase. Because of this, I stayed with the share and was stopped out on December 30th at a price of $6.10 as the share fell on very high volume, a sign of weakness. It is possible that short sellers entered the market, believing that the price had risen too far too quickly. I shall now wait for a re-entry level, knowing that when I do find a buy level, any initial price rise could be from short covering.

The target for the triangle is $6.77 calculated as follows. The high of the triangle is $3.99. The low starting the movement into the triangle is from $1.21, peaking at $3.99. The difference as shown is $2.78. Add $2.78 to $3.99 and we get $6.77. The high reached was $6.68, close enough to the target price to be acceptable, a good reason for short sellers to step in at this level rather than earlier. I will now wait for a pullback to a Fibonacci level of $5.19 (38.2%). If this does not hold, then I'll wait for the 50% level at $4.75 or the 61.8% level of $4.32 before buying the stock again. With luck, I will have found another stock offering the same opportunities as Medifast gave me. The stock will be in my watch list, and I'll look at the chart daily.

One final point: when I enter the market I always buy on the bid, but I always sell at the market. I want to buy at a price I am prepared to pay, but when I wish to sell, I want to be out immediately.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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Comments or Questions? Article Usefulness
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Date: 01/04/03Rank: Comment: how do you buy on the bid? jai
Date: 01/06/03Rank: 5Comment: 
Date: 01/07/03Rank: 5Comment: 
Date: 02/11/03Rank: 4Comment: 
Date: 02/18/04Rank: 4Comment: To Jacob Singer Originally I had copied the R/G strategy from my Stocks Commodities Magazine. I was unable to use it effectively and wanted some help or hints on how it might work more effective for me? When I get a buy, sell, short, cover indication from the EXPLORER on Metastock. Buy for instance what other indicators would be best to apply to my end of day chart to find the best stocks to purchase at the open of trading the next day? THANKS Earl

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