Every time the broad market, or a sector within the market, experiences a downturn, many well-meaning investors rush to buy. And they buy simply because their target stock has fallen a few percentage points.
Wow! They think. I missed Fred’s Fried Fish Stores last surge to new highs. Now, though, Fred’s shares have dropped five percent. I’ll grab a position fast, ‘cause it’s bound to go higher from here.
Okay . . . no one loves a good bargain in the stock market more than I do. And, as you know by now, the strategy we call “bottom fishing” is my favorite way of acquiring undervalued stocks with growth potential. But I’ve learned the hard way that buying a stock just because it’s lost a few points can actually end up in a loss.
A stock in the early (or late) stages of a downtrend (downtrend = price falling in lower highs and lower lows) is in a weakened state. As it sinks, it may periodically stick its head above water, but it is still a tasty target to nearby alligators (sellers) that lurk in market shadows.
Just so, if you want to be a profitable bottom fisher, you need to know the optimum signals for buying, so you don’t end up with a loss that depletes your bottom line. I’ll briefly discuss three of these signals below. (There are additional signals to consider, but we’ll talk about them at a later date.)
Recently, we’ve seen oil prices fall. Energy companies have suffered along with that fall, as you can see on the daily chart of Chevron Corp. (CVX), below.
Chevron Corp. (CVX) Daily Chart
Chart courtesy RealTick
- We can see that in late July and early August, Chevron fell from its all-time high of $135.10 down to ~$124.58, a 7% drop. Some investors decided August was a good time to grab shares. Hold it. Not so fast. When I buy, I look for a swell of new volume that tells me new buyers are joining the party. Chevron did not display an increase in volume during August.
- Chevron continued to fall during in September. Traders and investors who saw the energy icon’s continued weakness may have thought it was a good time to buy. But we’ve all heard of “falling knives,” and Chevron’s downtrend displayed a perfect example of that word picture. Most of us want to avoid that sinking feeling that comes with buying a position and then taking an immediate loss. In this example, Chevron’s 20-day moving average (red) (see arrow), acting as a downward sloping ceiling, told us momentum was still to the downside. So did the MACD (moving average convergence divergence indicator), which was also headed down (see arrow).
- Chevron tumbled to an intraday low of $106.65 on October 15th, and then rallied off those lows. Indeed, it shot above the 20-day moving average and that line reversed (from falling to rising) beginning on Oct. 22nd. The MACD also reversed to the upside. Was this our signal to enter? But we need to be mindful of our risk. At the end of October and into November, Chevron rose to $120, and was rejected by resistance at its 50-day moving average (green).
As of this date, price has settled down to $116.32. We need to see if Chevron’s potential new uptrend has a strong foundation of buyers. That means it needs to head higher, and climb above $120. Or, if the stock succumbs to more selling pressure, it needs to find buying support above $107. (Please know that oil prices will affect Chevron’s upcoming moves.)
When you buy stocks that sink from their highs in hopes of getting a good price for an undervalued company, you can reap good profits. Just make sure you can identify key signals that offer you the most opportune time to cast your line!
Keep green on your screen,