Tuesday, May 15, 2007
When a stock behaves well in the face of bad news, then it's probably time to buy it.
I know it doesn't make any sense. I know it defies logic. After all, who in their right mind would buy stock in a company that's plagued with bad news?
But trading isn't about logic. It's about emotion. More specifically, it's about gauging the level of emotion in a stock and capitalizing on it when it hits extreme levels.
When sellers have pushed a stock down to levels so extreme that even a devastating headline can't push it down any farther, then it's a good bet that the sell side has gotten too emotional. This condition often leads to sharp bounces, and buyers can make outsized gains very quickly.
Last July, for example, Ford (F) released the worst earnings report in the history of mankind. Revenues and earnings were sharply lower than even the most bearish analyst's forecast. Management guided lower for the next quarter and the next year. And the long-awaited turnaround was pushed back even farther.
The stock responded to the news by dropping 10 cents.
One dime? One lousy dime?? In the face of the worst earnings report in the history of mankind, Ford shares only lost a dime. Sellers were clearly exhausted. And, even though there was no logical or sound fundamental reason to own the stock, I told S&A Short Report subscribers to buy Ford shares and call options.
As you can see from the following chart, Ford shares gained 50% over the next seven weeks…
It was a terrific example of a stock so beaten up emotionally that there's very little downside and plenty of upside.
A similar condition exists today in the homebuilding stocks.
Now, before you roll your eyes and tell me I should stop drinking so heavily so early in the morning, try to think of a sector where investors are more bearish. Try to think of a sector that's more beaten down. Try to think of a sector that's been more pummeled by a constant drumbeat of bad news.
There's no logical reason to buy housing stocks right now. But there's probably a pretty strong emotional reason to trade them.
The new housing starts for April get released before the opening bell tomorrow morning. It's going to be a bad number – perhaps even the worst number in the history of mankind.
Pay attention to how housing stocks respond. If they can rally in the face of bad news, then it'll likely signal the start of a new bull phase for the sector. And you'll do well to jump on board.
Best regards & good trading,
Soybean oil at five-month high on back of biodiesel demand. Palm oil at eight-year high.
More strength in semiconductors… new highs for Applied Materials and Texas Instruments.
Blue chips at new highs: Nokia, Verizon, Apple, Chevron, DaimlerChrysler, Bristol-Myers Squibb, and Valero.