Weekly Newsletter 06/24/11
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Market Summary Weekly Breakout Report Top Breakout Choices Top 2nd Chances New Features Tip of the Week
Prior editions of this newsletter with our valuable Tips of the Week are available here.
 Weekly Commentary  

As usual, we focus on the NASDAQ Composite index as it is from NASDAQ listed stocks that we see the most breakouts and breakdowns.

NASDAQ

The index is in a bearish descending triangle pattern bounded by lines A and B. The recent recovery, which was never very soundly based due to weak volume, is threatened following Friday's 1.3% decline on very heavy volume. The index did find support on Friday at the 200 dma level as it rose in the last few minutes of trading to close at that level. Should the index continue to gain ground early next week, it will meet some resistance in the vicinity of 2700 (line C).

The markets will continue to be erratic and prone to sudden bouts of panic until the debt ceiling is raised at home and the European debt situation is resolved. Political brinkmanship in Washington will make the markets ever more nervous as the August deadline approaches and the possibility of a US default becomes more possible, as improbable as that seems.

The European crisis will not be resolved until European banks are forced to accept a haircut on the sovereign debt obligations of at least Greece and possible Italy and Spain. With the Germans adamantly opposed to either lending Greece further money, so the banks can be made whole, or indemnifying their banks for their losses in the event of a Greek default, it seems probable that the impasse will continue.

For these reasons it seems likely that the present bearish trend in the US markets will continue.

The number of breakouts jumped to fourteen this week with an average gain of 3.5% - significantly beating the market averages.

 New Features this Week Additional Value that we added this week

We added an option to the Zack's Backtest page to allow comparison of gains to those of the major indexes.

This Week's Top Tip Tips for getting the most out of our site

This week we respond to two questions from subscribers.

Zacks Strategy Backtest

A subscriber noted that the performance given in the backtest when run from 2004 to the present was hardly a recommendation for the strategy. The results are shown in this chart from which you can see that performance was very good before the crash and then performed poorly after the March 2009 recovery until mid-2010. We were always puzzled about why it performed poorly even after the recovery had begun but never found a satisfactory explanation. 

Zacks Long Term

Over the last year, however, the strategy has performed exceptionally well as the next chart and table show. The strategy resulted in a 73% gain while the NASDAQ Composite gained only 18%.

Zacks 12 month return

Our Zacks selections are available on our Zacks Strong Buy watchlist. You will need to supply a Zack's login to access them, but a free, no obligation, 30 day trial is available by clicking the Zacks logo here:

 
Head and Shoulders Breakdown Success Rate

Another subscriber asked if our head and shoulders top (HST) pattern gave a 93% success rate as quoted by Bulkowski in his Encyclopedia of Chart Patterns (Wiley, 2000) and referred to in our strategy notes for this pattern.

We had never tested this so I performed an analysis of all the HST confirmed breakdowns (2606) since we introduced this pattern in July, 2006. I selected all the confirmed breakdowns and looked at whether or not they closed below their breakdown price in the next 20 trading sessions. I then tabulated how many remained below their breakdown price for each day and the average profit a short sale would have made for those days. You can see from the chart below that on the first day after breakout, 74% remained below their breakdown price, so to avoid a loss you would have needed to cover 26% of the breakdowns on the first day. At the end of the 20 sessions, just 43 % were still below their breakdown price, or 57% had pulled back to at least their BD price. Compare this with Bulkowski's finding that 45% pulled back.

Percent Sustained Breakdowns by Day


I also looked at the % average profit that was made each day based on the close that day for those that were below their breakdown price.

profit by day

To interpret the meaning of this chart, lets assume that you were lucky enough to cover the 26% of stocks that rose back to or above their breakdown price at the breakdown price giving you zero profit or loss. Then if you closed all 73% of positions below their BD price at the close on day one, you would make an average of 7%. If you closed all 67% of positions below their BD price on day 2 you would make 8%, and so on.

This tells us that the expected profit if we were able to cover each position at the best possible price for a maximum hold period of 20 sessions is 11.5%. This again is quite different from Bulkowski's finding of an average decline of 23%.

These findings are clearly significantly different from Bulkowski's but consider that our sample of 2606 is considerably bigger than his sample of 461 and our time period 7/2006 - 6/2011 is very different from his: mid 1991 to mid 1996. Also our algorithms, each conceived independently, for recognizing the HST pattern would also necessarily be very different.

My conclusion is that the HST pattern can be highly profitable as it is successful, giving at least a 7% profit, in 74% of trades.

 Market Summary Overview of market direction and industry rotation
Index Value Change Week Change YTD Trend
Dow 11934.6 -0.58% 3.08% Up
NASDAQ 2652.89 1.39% 0% Down
S&P 500 1268.45 -0.24% 0.86% Up
Russell 2000 797.79 2.05% 1.8% Down
Wilshire 5000 13424.9 0.21% 1.02% Up
 Best Performing Index
1 Week 13 Weeks 26 Weeks Year-to-Date
Russell 2000
2.05 %
Dow Jones
-2.34 %
Dow Jones
3.29 %
Dow Jones
3.08 %
 Best Performing Industry (by average technical score over each period)
1 Week 3 Weeks 13 Weeks 26 Weeks
Cigarettes Cigarettes Cigarettes Long-Term Care Facilities
 Most Improved Industry (by change in technical rank2)
Appliances
+ 54
Drug Stores
+ 64
Closed-End Fund - Debt
+ 137
Aerospace/Defense - Major Diversified
+ 166
Charts of each industry rank and performance over 12 months are available on the site

1The Market Signal is derived from our proprietary market model. The market model is described on the site.
2The site also shows industry rankings based on fundamentals, combined technical and fundamentals, and on price alone. The site also shows daily industry movements.
 Weekly Breakout Report How confirmed breakouts performed this week
# of Breakouts
Period Average1
Max. Gain During Period2
Gain at Period Close3
This Week 14 11.38 5.73% 3.46%
Last Week 3 11.31 6.43% 0.3%
13 Weeks 184 12.15 10.12%
-1.07%
1The average number of breakouts in each week over the previous 13 weeks.
2This represents the return if each stock were bought at its breakout price and sold at its intraday high.
3This represents the return if each stock were bought at its breakout price and sold at the most recent close.
 Top Breakout Choices Stocks on our Cup-and-Handle list with best expected gain if they breakout
Category
Symbol
Company Name
Expected Gain1
Best Overall GNMK GenMark Diagnostics, Inc 114
Top Technical NSTC Ness Technologies, Inc. 83
Top Fundamental VRTS Virtus Investment Partners, Inc. 32
Top Tech. & Fund. VRTS Virtus Investment Partners, Inc. 32
1This is the gain predicted by our Expected Gain model if the stock breaks out. Expected Gains for all cup-and-handle stocks are published on our site.
 Top Second Chances Stocks that broke out this week and are still in buyable range
Category
Symbol
Company Name
Expected Gain1
Best Overall VVTV ValueVision Media, Inc. 95
Top Technical BIIB Biogen Idec Inc. 33
Top Fundamental CPHD Cepheid 38
Top Tech. & Fund. CPHD Cepheid 38
1This is the gain predicted by our Expected Gain model after the stock has broken out which uses the volume on breakout as a predictive term. Because the model variance is +/- 38% the expectation can be negative.

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