5.1. DR. K'S LABORATORY: THE POCKET PIVOT ADVANTAGE
In the O'Neil literature you will find many references to new-high "pivot point" buy points, as well as trend line and moving average breakouts, but you will not find any definition of "pocket pivot" buy points. This is because the concept of the "pocket pivot," essentially an early buy point relative to traditional O'Neil techniques, did not exist until it was discovered in Dr. K's Laboratory in 2005 as a result of research studies that were performed for the express purpose of finding a solution to the flattish, compressed, and somewhat sideways moving markets of the mid-2000s (see S&P 500 weekly chart from 2004–2005). Such markets contrast with the more strongly trending market environments seen in the 1980s and 1990s. In simple terms, a "pocket pivot," or "buying in the pocket," is an early base breakout indicator, which is designed to find buyable pivot points within a stock's base shortly before the stock actually breaks out of its chart base or consolidation and emerges into new high price ground.
Having met and talked with a broad range of institutional investors through our affiliation with William J. O'Neil + Company's institutional services department as well as at the workshops we presented at for the company, we gained a distinct and unique appreciation for the fact that institutional investors, such as hedge funds, mutual funds, and pension funds, do not like to buy breakouts to new highs. In fact, they generally prefer to buy stocks off of their lows, and sometimes the lower the better. Of course, if we think about this for just one second we realize that it is the institutions that create the bottoms of chart bases, including the volume/accumulation clues along the lows of a constructive base formation.
The premise of the pocket pivot is simple. If it is the buying of institutions that "carves" out the bottom of a constructive base from which a stock may break out to new highs later on, then we can postulate that the clues of their buying and accumulation in the lower parts of a stock's chart base should be evident, and could offer optimal, low-risk entry points to begin taking a position, particularly if the stock is a proven market leader. Such evidence will show up in the daily chart as well as the weekly chart, but to determine precise "pocket pivot" buy points we make prodigious use of daily charts.
The pocket pivot can give an investor a head start on accumulating a leading stock within a base formation. And in markets where standard breakouts are more often "fake outs" as the example of Dendreon Corp. (DNDN) in Figure 5.1 shows, the pocket pivot buy point technique can get an investor into a stock at a lower-risk price point and thereby make it more possible for the investor to sit through a pullback if the all-too-obvious new-high breakout buy point fails initially and the stock retrenches, corrects, or sells off.
Figure 5.1. Dendreon Corp. (DNDN)—a "big stock" bio-tech with a promising new prostate therapy flashes an early buy point.: Chart courtesy of eSignal, Copyright 2010
The pocket pivot was identified after much "lab" research going back through our individual trades since 1991, and then spot back testing through prior decades. Finally, the concept was tested again in real time under fire with actual money, and as an early entry point has proven to be a highly exploitable phenomenon. During the mid-2000s this was especially helpful as many standard new high base breakouts were not working in the shallow and sideways moving markets of 2004–2005. While there were small but sparse windows of opportunity such as one in late 2004 and two very brief windows that opened in mid-to-late 2005, many initial buys at standard, new-high buy points would quickly turn into −7 percent to −8 percent losers within a few days.
When operating with thinner, less-liquid and lower-priced stocks, the pocket pivot can provide a useful buy point that is less obvious to the crowd. When thin stocks break out through obvious resistance levels to new highs, the crowd tends to see them and hence is more able to run the stocks up, exacerbating the upside price movement. As well, when such thinner stocks begin to sell off, their lack of trading liquidity will exacerbate their downside velocity, which increases the risk inherent in such stocks. In general, stocks that trade less than $30 million in daily dollar volume or less than 750,000 shares a day fall into this category. There are exceptions to this, of course, but as a general guideline these parameters suffice for the purpose of judging a stock's liquidity and associated price volatility and risk.
Figure 5.2. RINO International (RINO) daily chart, 2009.: Chart courtesy of eSignal, Copyright 2010
RINO International (RINO) shown in Figure 5.2 was a relatively thinly traded stock at the time it broke out of a base in late September 2009. Note that the move up through the 15 price area in the latter half of September was fairly sharp, and the stock moved up rather quickly up through the 20 price level before pulling back sharply and finding support at the 10-day moving average. If investors had bought the breakout to new highs, the sharp pullback below the 10-day moving average might have caused them to be shaken out of their position. However, buying on the pocket pivot buy point before the stock rose above the 15 price level would have given investors buying the stock at that point a head start on the stock and put them in a better position to weather any pullback after the stock quickly rallied up through the 17.75 high in the base on the standard new-high pivot point.
Another example of using a less-obvious pocket pivot buy point in a smaller stock is seen in Jazz Pharmaceuticals (JAZZ), a thin, low-priced stock with a strong fundamental picture given its strong pipeline of new and existing products at the time. The move up through the 50-day moving average on December 9, 2009, occurred on a material increase in volume after the stock had been exhibiting very tight price action as it drifted into the 7.00 price area on extremely light volume. The fact that the pocket pivot occurs right after this extreme volume dry-up is highly constructive, and while the stock does not launch to the upside it does build a tight, sideways consolidation with virtually no selling volume in the formation.
Once a thin stock like JAZZ begins to move higher, its price moves, one way or the other, can be exacerbated by its small size and lack of trading liquidity; hence buying a solid, reliable pocket pivot point as the stock acts very "quietly" provides a strong entry point as one tries to build a position in the stock. Watching for pocket pivot action in smaller, thinner stocks with potentially strong fundamental outlooks can be rewarding, as the examples of RINO and JAZZ illustrate.