Catching Falling Knives

During the past week, the Dow, S&P 500, and Nasdaq Composite each broke down below the neckline of head and shoulders chart formations. Such a break is generally thought to be a fairly strong bearish signal, particularly when combined with weak fundamentals such as in the overall economy including things like high unemployment and low consumer sentiment. While no chart formation or, for that matter anything else, is ever a guarantee of market direction, it can be something that may be helpful if we are aware. I write that because when I make directional trades in a best stock for 2010, I try to make entries that are consistent with the market and sector direction. The idea, for me, is to try to give myself an edge since obviously when a market is rising most top stocks for 2010 can also be expected to be rising and, naturally, the same is true with respect to sectors. The opposite would also be true in that we could expect most top stocks to be down when the market is down. In that circumstance, of course, my bias for directional plays would be bearish.

One of the things I have seen with many traders is that they are so anxious to buy a best stock that they make their entry when the price is on the way down. That phenomenon is affectionately known as trying to catch a falling knife. The problem they face is that no one knows how far "down" actually is. For stocks like Bear Stearns or Enron or Lehman Brothers or a host of others "down" wound up being zero. Back in February or March a friend asked me what I thought about buying General Motors and I shook my head from side to side. But it's GM, he said, it won't go under; it has to come back. We have to remember that simply because it was a good company or simply because a company is good now doesn't mean that the stock price will go up. All too often we confuse a good company with a good stock and the two do not necessarily go together. General Electric (GE), for example, has long been a good, even great, company that traded in the $30 and $40 area. This past March it hit under $6 a share. Those who bought at $25, $20, or $15 on the way down were trying to catch that falling knife. I can hear them saying: "It'll come back." Maybe. Probably. But when?

Instead of catching that falling knife, if we like the fundamentals and like the company, why not exercise a little patience and wait until not only it signals a return to an upward move, but also wait until the market and sector head the right way as well? That movement may miss catching the absolute bottom, but it is just fine in my book to take a bite out of the middle once the market, sector and stock suggest that you have a little edge.

I certainly won't argue with those who try to catch those falling knives because at times their timing is near perfect and among the scars on their hands will fall the knife handle just before things turn. However, a very successful and very experienced trader once told me that we only get one perfect high exit and one perfect low entry in our lives and I know I've had mine so, for me, taking a bite out of the middle is just fine.

Top Stocks For This Week:

MCRI (Monarch Casino & Resort Inc.)
MCRI broke above a resistance Friday and has been moving up for the past three days. I considered an entry on Friday, but was a little concerned in that the upward movement was accompanied by falling volume and that often is a danger sign. Since we are in the midsummer doldrums, that may not be as significant as I would ordinarily suspect. While I like the price movement, I decided it would be worth waiting until next week to make my decision.

DJX (1/100 Dow Jones Industrial Aver)
The Dow Industrials 1/100 Index, along with the Dow, broke down through support and broke through the neck of a head and shoulders. I am looking at the possibility of entering a put debit spread, perhaps buying the Sept 85 puts and selling the Sept 80 puts for a debit around $2.60. The breakeven, excluding commissions, would be around $82.40 and the index stands below that now. The maximum potential return at expiration and assuming no adjustments, again excluding commissions, would be $2.40 or a potential return on risk of just over 92% if the index closed below 80. I should note that I do currently have a debit spread in my own accounts on DJX.

SWK (The Stanley Works) 
SWK gapped up at the open on Friday morning and moved above a resistance level on reasonably high volume. It looks like it may have a couple of bucks to the next upside target, but I am keeping in mind that a bullish move here may be contrary to general market direction so I will keep a fairly tight stop if I enter early in the week.

GE (General Electric Co.) 
Our Success Trading Group members entered a position in General Electric Co. (Ticker: GE) this week. We like GE at its current price for new positions.

Our Success Trading Group has closed 52 Wins in 52 Weeks and over 370 winning trades with a 95% winning track record on our Main Trade Table.

DRI - Darden Restaurants Inc. is currently trading at $32.36. The August $32.00 Calls (DRIHL) are trading at $2.05. That provides a return of about 6% if DRI is above $32.00 on expiration Friday in August.