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May 8, 2012, 12:02 a.m. EDT
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Kevin Marder is a guest columnist and a co-founder of MarketWatch. He is principal of Marder Investment Advisors Corp. and a contributor to The Gilmo Report. Previously, he served as chief market strategist for Ladenburg Thalmann Co. and developed institutional fixed-income risk management software for Capital Management Sciences.
By Kevin Marder
Shares remain ensconced in a six-week reaction following a long-winded run that saw the Nasdaq Composite /quotes/zigman/123127 COMP +0.05% move up 24% in more than three months.
This decline, while it has sent some of the glamours to the powder room and others home for the duration, is nonetheless 1) normal, 2) necessary, and even 3) welcome, from the standpoint of the medium-term speculator.
Normal, because a typical bull market will have on average a few 8%-12% intermediate-term corrections. The below chart of the S&P 500 /quotes/zigman/3870025 SPX +0.04% puts this decline in perspective when compared with where the market has come since the Oct. 4 low.
Necessary, because a market is human nature on display. And at some point, the urge to take profits after a move up results in a surfeit of sellers, driving price down.
Welcomed, because most of the glamours had already moved well past their pivot points, the area which legendary speculator Jesse Livermore defined as the point at which price has the highest probability of moving higher.
This point, in most cases, coincides with the top of a sideways consolidation area of at least five weeks in duration, but preferably seven or more. These areas, known as bases, should be preceded by a strong prior uptrend. A base allows for price to return to an equilibrium state, where buyers and sellers are roughly equal.
The bases, for the most part, do not exist as they did in January. And this is why a market correction would be welcomed by the speculator. A correction allows leadership titles to reset themselves technically by forming new bases. The new bases, then, offer a speculator the best opportunity to enter a market leader as it is ready to launch a new move.
The speculator in aggressive growth names is either sitting on those leading titles that broke out of bases and hold up near their highs (Dollar Tree /quotes/zigman/109619/quotes/nls/dltr DLTR +0.96% would be one) or sitting in a generous cash position.
The latter is believed to be appropriate until more conviction on the part of large investors materializes. This will be evident by one or more accumulation days, of which there have been practically none for some time.
It is also probable that some glamours now forming bases will break out of those patterns while the averages are correcting, and before any series of one or more accumulation days present themselves.
Inexperienced operators will wait until the accumulation days present themselves before moving off their cash position to enter some of the leaders. Others will wait for an O'Neil follow-through day.
Simply buying a name that is extended above its most recent base by more than 5%, e.g. Dollar Tree, would get you into a leader, but not at a point that would afford much support should the averages and your stock pull back.
Among the names, the Street expects Petsmart /quotes/zigman/54520/quotes/nls/petm PETM -1.46% to grow earnings by 23%/12% in the January '13/'14 fiscal years. The vogue for retail names continues, especially those that can potentially deliver steady earnings growth in an uncertain economy. PETM's earnings stability has been high over the past several years, plus the shares are very liquid, which help explain the stock's popularity over the past three years.
Technically, the stock builds a tight base of eight weeks' duration. A potential pivot point for entry would coincide with the May 2 high of 59.36.
Similar to LinkedIn /quotes/zigman/5131883/quotes/nls/lnkd LNKD -4.96% , Zillow /quotes/zigman/5930210/quotes/nls/z Z +2.34% was not gifted with the best sense of timing. The online provider of real estate data came public in July at 20, then spent the last 10 months working off the excesses of its opening-day triple. When the bull market picked up steam in January, the stock was bogged down with a mountain of underwater holders, a.k.a. resistance. Even so, over the past six months, Z has quietly doubled.
Earnings estimates are for growth of 170%/104% in '12/'13. There are few billion-dollar market capitalization concerns with triple-digit estimates. This was one reason why this column earlier this year looked on Z as having as much potential as any of the current crop of glamours to become an outstanding performer in this cycle. Tripling on its IPO day didn't hurt, either.
Technically, the stock broke out to a high not seen since its IPO day, up 12% on volume 568% above average. The volume was particularly noteworthy, as it shows serious investor conviction at a time when the averages are correcting and other glamours are going by the wayside. For an aggressive speculator only, an aggressive entry would be on a takeout of Thursday's high of 42.50, using a junior-sized entry and an 8% protective stop in case proven incorrect.
In summation, the current decline is viewed as normal and welcome, from the standpoint of one who speculates over a time frame of weeks to months. Without a market correction like this, new opportunities in the form of bases would not present themselves. Opportunistic operators can test the waters, but only in those few issues offering attractive entry points technically.
And only within the confines of a generous cash position.
Charts created using TradeStation . ©TradeStation Technologies, 2001-2012. All rights reserved. All mutual fund ownership and earnings estimate data provided by Thomson Reuters.
At the time of this writing, of the stocks mentioned in this report, Kevin Marder or an affiliate thereof held no positions, though positions are subject to change at any time and without notice. The information contained herein may have been previously disseminated.
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