Ed Note: Money Talks is honored to have Tyler Bollhorn illuminate his favorite technique at:

The Money Talks All Star Trading Super Summit
Saturday, October 24, 2009 -The Sheraton Vancouver Wall Centre

Click HERE for the Speaker Lineup and to REGISTER if you want to take advantage of this Event.

Chase or Choke?

Stockscores.com Perspectives for the week beginning Oct. 19th, 2009

I think that I might sometimes confuse people. Without knowing the context from which I speak (or write), it would be easy to be confused by a recommendation to buy a stock that has just moved up 20% but my advice to ignore a stock that is up only 10% because entry would be “chasing it higher” is confusing. Let me explain, and in doing so, outline a very important concept for traders.

There are two situations that I like to buy; stocks that are starting upward trends and those that are well in to upward trends. However, the circumstances for buying each are quite different.

Stocks that are starting upward trends are typically breaking with abnormal activity out of a lengthy period of sideways trading. I liken this sort of trade set up to a person yelling in a quiet room. It is easy to get the message.

If a stock has been trading around the same price for a lengthy time, you can assume that the market has a good comfort level with the price it has given to the stock. Investors have priced in all available fundamental information and come to a conclusion on price. There is usually a significant change in fundamental information when a stock breaks with abnormal volume from low price volatility.

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I find that this situation is how the majority of upward trends begin. Don’t take my word for it, check the charts of stocks that have been in strong, multi month upward trends and go back to when those trends began. You will usually see the break with abnormal volume that I look for.

As an example, check a two year chart of AMZN. Two months of sideways trading in December and January, abnormal activity with a break higher to start February. GOOG is another example, showing abnormal activity on a break through resistance in April.

Now, let’s talk about the second type of buying opportunity that I like to play. This trade set up is different from the first because it seeks stocks that are already well in to upward trends but which are showing short term weakness. This is the situation where we don’t want to chase stocks higher but, instead, buy them on weakness.

Go back to the chart of GOOG, print out a one year chart and grab a pencil and ruler. Draw a line across the bottoms, starting at the low of March and cutting past the July low.

What you should notice is that, right now, the stock is far above that line. To enter this stock on Monday would be to chase the stock higher, a real no-no for traders. Instead, when buying strong stocks, you want to buy them on pull backs to the trend line. The lows of August, early September and early October are good examples of this. At these times, GOOG prices had come back to the trend line. You were buying a strong stock on sale.

I heard an analyst say that he thought GOOG was going to $700 a share but that it was not a good time to buy it now, to instead wait for weakness. The interviewer asked a very obvious question, “If the stock is going to $700 and is only at $550 now, why would you not buy it now?”

The analyst did not have a very good answer to that question. As a trader, he knew that it was bad to chase stocks that were running away; he just did not know how to explain it.

The problem with buying GOOG now is that the reward potential is not worth the risk. All good traders know that they might be wrong on any trade, no matter how compelling the trade idea might be. Since we know being wrong is part of trading, we want to mitigate the risk as much as possible. When you buy a strong stock on weakness you are really limiting your downside risk and increasing your upside potential.

When you chase a stock higher, you are doing the opposite and that is a fast way to go broke.

Hopefully this helps to explain the difference between buying a stock that had a big up day and chasing a stock higher. It is ok to enter a stock on a breakout from low price volatility because that is how upward trends begin. However, buying a stock that is running away from its upward trend line usually leads the trader to having to endure a painful pull back.

There is a daily version of the Stockscores newsletter that I send out each evening after the market closes. Last week in that newsletter I featured six position trading opportunities using the same strategies and techniques that I use in the weekly edition. Here are two of those stock picks, two that have not yet run away and are still worth considering

1. EP

EP broke out on Thursday from an ascending triangle pattern that had been building over the past six months. It looks like the stock wants to get back to the $17.50 range that it occupied in early 2008 which it should be able to do so long as it does not break support at $10.35.

2. V.CNE

V.CNE broke from a pennant pattern on Wednesday on stronger than normal volume, signaling to us that something positive is happening at the company. Support at $0.28.

Tyler Bollhorn will be speaking at the:

The Money Talks All Star Trading Super Summit
Saturday, October 24, 2009 -The Sheraton Vancouver Wall Centre

Click HERE for the Speaker Lineup and to REGISTER if you want to take advantage of this Event.

Tyler Bollhorn started trading the stock market with $3,000 in capital, some borrowed from his credit card, when he was just 19 years old. As he worked through the Business program at the University of Calgary, he constantly followed the market and traded stocks. Upon graduation, he could not shake his addiction to the market, and so he continued to trade and study the market by day, while working as a DJ at night. From his 600 square foot basement suite that he shared with his brother, Mr. Bollhorn pursued his dream of making his living buying and selling stocks.

Much of Mr Bollhorn’s work was pioneering, so he had to create his own tools to identify opportunities. With a vision of making the research process simpler and more effective, he created the Stockscores Approach to trading, and partnered with Stockgroup in the creation of the Stockscores.com web site. He found that he enjoyed teaching others how the market works almost as much as trading it, and he has since taught hundreds of traders how to apply the Stockscores Approach to the market.

References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.

Disclaimer
This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.