5.5. BUYING "IN THE POCKET"
Whether buying pocket pivots in the base or within an uptrend, pocket pivots should ideally occur after consolidation of some sort. Naturally, the length of consolidation of buying within a base will be longer than the length of buying within an uptrend, also known as continuation pocket pivots. That said, some of the strongest price performers may only rest long enough to hit their 10-day moving average briefly before bouncing higher on volume, which, if conditions we have discussed in this chapter are met, would qualify as a proper pocket pivot buy point. This presents the investor with a multitude of possible buy points to get on board top-performing stocks and enables investors to initiate a position in a leader even if they missed the initial base breakout.
To better understand the entire concept of "buying in the pocket," we will review a short Pocket Pivot Model Book of pocket pivots that occur within a stock's base and which often give investors an early entry point in a fundamentally sound, leading stock building a proper base during a bullish market backdrop. We will then discuss buying pocket pivots in an uptrend, or continuation pocket pivot points, in a subsequent section of this chapter.
In March of 2007, Nvidia Corp. (NVDA) was rounding out and coming up off the second low of a potential base formed in the first quarter of 2007. This base was roughly 30 percent deep, and along the lows the stock was picking up some big volume support, as we see in Figure 5.7. The big volume spikes are positive signs off the lows of the potential base, and they provide a constructive backdrop and context to the pocket pivots that occur later on in the formation on May 11th and May 31st.
Figure 5.7. Nvidia Corp. (NVDA) daily chart, first quarter 2007. Two large upside volume spikes in the pattern constitute prior constructive action occurring in the pattern before the pocket pivots occur.: Chart courtesy of eSignal, Copyright 2010
Figure 5.8. Apple, Inc. (AAPL) daily chart, August 2004. The first buy point in AAPL's sharp 2004–2005 price run was the August 25 pocket pivot.: Chart courtesy of eSignal, Copyright 2010
Apple, Inc.'s (AAPL) pocket pivot on August 25, 2004 (Figure 5.8), was the earliest buy point for AAPL after the NASDAQ Composite Index had bottomed and turned to the upside on August 13th. Coinciding with this market bottom and follow-through on August 18th, which signaled a new general market rally phase, AAPL's August 25th pocket pivot was the first buy point in what became a very strong price advance that lasted into the first quarter of 2005 and during which the stock nearly tripled in price from the pocket pivot buy point.
Fundamentally sound stocks staging big upside price moves on heavy volume will always show up on our daily screens, as this is always a meaningful initial flag that a more sustained upside price move is brewing. But because of their extended condition after the run-up they are often not buyable without taking on greater risk. Following any strong price run-up over several days, however, a stock will inevitably begin to pull back and consolidate. If this pullback and consolidation occur in an orderly and constructive fashion, it is useful to watch carefully for potential pocket pivots to form as the stock finishes up its short consolidation following the sharp price run-up and sets up again. Verisign, Inc. (VRSN) in late 1998 provides a very good example in Figure 5.9.
Figure 5.9. Verisign, Inc. (VRSN) daily chart, 1998. A pocket pivot buy point occurs within the handle of a cup-with-handle base formation.: Chart courtesy of eSignal, Copyright 2010
In early November 1998 Verisign, Inc. (VRSN) had a sudden, sharp, three-day upside price burst as it pushed up the right side of a potential cup formation with a cascade of volume increases. As VRSN pulled back and formed a handle to fill out what was shaping up to be a cup-with-handle base formation, it drifted downward within the handle and then briefly dipped below the 20-day moving average on an intraday basis before closing above the 20-day moving average. The next day, on November 24, 1998, VRSN pushed up off of its 20-day moving average on volume that was higher than any down-volume days over the prior 10 days, a pocket pivot buy point. Two days later the stock cleared the high of the handle in the cup-with-handle formation for a standard new-high base breakout buy point. VRSN then pulled back sharply for two days, but held the 20-day moving average, right around the pocket pivot buy point of five days earlier. Buying the pocket pivot would have made it easier to sit through the sharp pullback after the new-high base breakout.
Another interesting example is Riverbed Technology, Inc. (RVBD) in May of 2007 (Figure 5.10). On April 25, 2007, RVBD had a big one-day gap-up move that sent the stock flying up off the lows of a 41/2-month base formation and through its 50-day moving average. Obviously, this move could be considered a pocket pivot buy point, but it became extended very quickly and so may not have been so easy to buy in real time. In any case, the huge-volume gap-up move through the 50-day moving average was an initial flag of strength in the stock, and the ensuing pullback and consolidation of that sharp, one-day price move were relatively orderly as the stock drifted lower, holding the 10-day moving average on a closing basis. Right off the 10-day moving average there were two upside days on May 2 and May 4, 2007, where the volume was higher than any downside-volume days over the prior 10 days in the pattern, hence each qualified as a pocket pivot buy point. Notice also that as the stock pulled down into the 10-day moving average, volume dried up on each of the days just before each of the two pocket pivot points, an additional sign of constructive action.
Figure 5.10. Riverbed Technology, Inc. (RVBD) daily chart.: Chart courtesy of eSignal, Copyright 2010
Sometimes pocket pivots occur in a base formation just before a stock is about to announce earnings, implying an information leak somewhere as volume picks up during the regular trading day and the stock stages a pocket pivot type move. As an example, we can look at Intuitive Surgical, Inc. (ISRG) on October 25, 2005, the day that the company announced earnings after-hours (Figure 5.11). Despite the intuitive uncertainty of the earnings announcement, the stock's price/volume action was telling another story as ISRG poked its head up above its 50-day moving average on strong, above-average volume. By monitoring the big stock leaders and checking their price/volume action going into an earnings announcement, it is possible to use pocket pivots as a sign that taking a position in the stock just before the earnings announcement is less risky than might otherwise be perceived. If the stock is showing pocket pivot action, including strong volume at the close of the day when the company announces earnings, then a position can be taken near the close of the normal trading session once it is clear that volume will exceed the highest down-volume in the pattern over the prior 10 days. Pocket pivot buy points going into earnings announcements are playable, in our view, and position sizing can be scaled to one's risk tolerance, and whether one is adding to an existing position or initiating one.
Figure 5.11. Intuitive Surgical (ISRG) daily chart, October 2005.: Chart courtesy of eSignal, Copyright 2010
Pocket pivots are often relatively quiet buy points within a stock's base formation. Amazon.com (AMZN) in the latter half of 1998 was working on a rather choppy base formation as it bounced along its 200-day moving average (Figure 5.12). By the time it was starting to work its way back higher up the right side of the base, selling volume was subsiding quite significantly, setting up a pocket pivot buy point on October 29th as the stock came up off the 10-day moving average on volume that was greater than any down-volume day in the pattern over the prior 10 days. Within three weeks the stock was breaking out of the 41/2-month base formation and into new high price ground.
Buying "quiet" pocket pivots can at times require some patience, but being able to sit with a partial position taken on a pocket pivot buy signal as long as the stock continues to track sideways tightly and constructively within its base formation can have its rewards. Once an initial position is taken on a pocket pivot buy point that is well "in the pocket," it can be doubled up on if a second pocket pivot a little higher in the pattern shows up, or if the stock stages a standard base breakout. We saw one example of this in the Jazz Pharmaceuticals (JAZZ) example in Figure 5.3 near the beginning of this chapter, and Infospace, Inc. (INSP) in Figure 5.13 is a similar type of situation.
Figure 5.12. Amazon.com (AMZN) daily chart, October 1998. A "quiet" pocket pivot buy point as the stock works its way up the right side of a base.: Chart courtesy of eSignal, Copyright 2010
INSP sets up a constructive "context" for its pocket pivot buy point by first staging a shakeout through the lows of the base it has formed from mid-July into the end of October 1998. Note how the stock undercuts a prior low within its base structure on September 24th as volume picks up sharply at 123 percent above average. This appears as a breach of support and hence is interpreted as a bearish development for the stock. However, this is too obvious, so the crowd is faked out here as the very next day INSP gaps to the upside and moves back up into the base structure on heavier volume than the previous day's gap-down decline and breach of "support" at the lows of the base. This is a very constructive "shakeout," which is simply part of the process of bringing in strong hands and cleaning out weak hands that every stock goes through as it forms what may later become a basing formation for an eventual successful upside price move. INSP then drifts down slightly over the next several days as volume dries up precipitously, setting up a very favorable context for the ensuing October 7th pocket pivot buy point. INSP holds above all of its moving averages following the pocket pivot as it moves tightly sideways and eventually resolves in a gap-up base breakout at the end of November 1998. Following that standard base breakout in late November, INSP did a little backing and filling, and several pocket pivots occurred in the pattern at that point, but we will leave those to the reader to identify.
Figure 5.13. Infospace (INSP) daily chart, 1998. A constructive "shakeout" in the base creates a meaningful, positive context for the ensuing pocket pivot buy point.: Chart courtesy of eSignal, Copyright 2010
Blue Coat Systems (BCSI) flashed a pocket pivot buy point in its base on May 15, 2007 (Figure 5.14). This was followed by a breakout to new highs that came right back in to test the pocket pivot point a couple of times before the stock began moving higher again. Buying the pocket pivot here gives the investors a slightly lower entry point that may make it easier to hold through any of the initial pullbacks to the 10-day moving average that ensued in the stock over the next seven days following the pocket pivot.
Before Charles Schwab Corp. (SCHW) cleared to new highs in late 1998, it produced a very clear, high-volume pocket pivot buy point as it began pushing out of a jagged handle within an overall cup-with-handle base formation in October of 1998. What makes this particular pocket pivot compelling is that it was also a handle breakout that occurred on the exact same day as the market follow-through on October 15, 1998, that ended the short, sharp three-month bear market of that year and signaled a new rally phase for the market. SCHW was a big leader in the market rally that began off the October 1998 lows, along with America Online (AOL). A lot of money was eventually made in these stocks when we were managing money for Bill O'Neil back then, but despite this SCHW did not go galloping right out of the gate following that October 15th pocket pivot buy point. It noodled about the 10-day moving average for another two weeks before staging a new-high breakout and starting its sharp ascent to the upside. See Figure 5.15.
Figure 5.14. Blue Coat Systems (BCSI) daily chart, May 2007. Buying the pocket pivot on May 15th made it easier to sit through the "uncertain" breakout action that ensued.: Chart courtesy of eSignal, Copyright 2010
Pocket pivot points can sometimes add clarity to the price/volume action in the chart patterns of stocks that are not quite perfect. For example, Sunpower Corp. (SPWRA) built one base in late February to March of 2007 from which it broke out as the general market was coming out of a correction and following-through back to the upside, initiating a new general market rally phase. SPWRA's chart formation was a little erratic (Figure 5.16), but the pocket pivot point of March 27th provided a clear, early buy signal that came only a few days after the March 21st market follow-through. SPWRA rallied approximately 38 percent higher before pausing to build another base, this time a cup formation from which it then proceeded to break out without ever pausing to build a handle, which may have thrown investors trying to buy the stock as they waited for the handle to form. However, all of this could have been avoided by using pocket pivot buy points instead. June 5th was the first pocket pivot buy point, but the stock immediately pulled back, which could have stopped out investors using a tight stop on the pocket pivot buy. However, one week later, on June 14th, SPWRA flashed another pocket pivot buy signal on which the stock could have easily been bought back in time to catch the ensuing price move.
Figure 5.15. Charles Schwab Corp. (SCHW) daily chart, October 1998.: Chart courtesy of eSignal, Copyright 2010
Figure 5.16. Sunpower Corp. (SPWRA) daily chart, 2007. Plenty of pocket pivot buy points providing excellent entry points on the stock.: Chart courtesy of eSignal, Copyright 2010
Figure 5.17. Sunpower Corp. (SPWRA) weekly chart, 2006–2007. Tight action along the lows in two separate bases seen on the daily chart is also confirmed by the weekly chart.: Chart courtesy of eSignal, Copyright 2010
The price/volume action along the lows in both of SPRWA's bases was fairly tight, and in the second cup-base was extremely tight. This was also confirmed by the weekly chart (Figure 5.17), which showed a series of four tight weekly closes right along the lows of the base coinciding with the tight sideways action shown in Figure 5.16 from late May to early June 2007, as well as three tight weekly closes at the end of March 2007.
Potash Corp. Saskatchewan (POT) is a classic "bursting" type of pocket pivot buy point that occurs as the stock bounces up off the 50-day moving average and through the 10-day and 20-day moving averages on a big spike in volume and one that is also greater than any down-volume in the pattern over the prior 10 days, per our volume rules for defining pocket pivot buy points. This pocket pivot on March 30, 2007 (see Figure 5.18) was a low-risk entry point for a roughly fourfold upside price move. Notice how POT was tracking tightly sideways throughout most of March 2007 as it quieted down and volume remained below average. This is exactly the type of action you want to see leading into a pocket pivot buy point as it sets the proper "context" for the pocket pivot to have a higher probability of success.
Stocks that start out their lives as sizzling hot initial public offerings often begin trading and within a short period of time are moving higher as they break out of chart patterns that on first glance do not appear to be buyable. For example, the big moves in solar-energy stocks back in 2007 also resulted in a huge number of IPOs in the group coming to market. These were often hot-IPOs right out of the gate, and among these hot IPOs was LDK Solar Co., Ltd. (LDK), shown on a weekly chart in Figure 5.19. Right after coming public LDK formed a short, four-week, V-shaped cup formation from which it then broke out of on no discernible volume increase, since the stock had very little history on which to base average daily trading volume. If investors were looking for a "sound" base off of which to buy LDK after it came public, it was not cooperating as it simply took off to the upside after briefly pulling back from its offering price of $27-a-share.
Figure 5.18. Potash Corp. Saskatchewan (POT) daily chart, 2007. The pocket pivot buy point occurs as the stock "bursts" up through three moving averages.: Chart courtesy of eSignal, Copyright 2010
Figure 5.19. LDK Solar Co., Ltd. (LDK) weekly chart, 2007. A short, V-shaped base does not look buyable on the weekly chart.: Chart courtesy of eSignal, Copyright 2010
Figure 5.20. LDK Solar Co. (LDK) daily chart, June 2007. A pocket pivot buy point presents itself in what otherwise looks like an unbuyable V-shaped base on the weekly chart (Figure 5.19).: Chart courtesy of eSignal, Copyright 2010
Setting the weekly chart aside, however, and focusing on the action in LDK's daily chart right after it came public revealed a slightly different picture (Figure 5.20). On June 22, 2007, LDK bounced up off of its 10-day moving average on volume that was higher than any down-volume day in the pattern over the prior 10 days. Interestingly, the volume on June 22nd was 1,204,400 shares traded, only 100 shares higher than June 8th, which at 1,204,300 shares traded was the highest down-volume day in the pattern within the prior 10 days. Strictly speaking, the definition of a pocket pivot buy point held on June 22nd, but if one hesitated to buy on that day, then the next trading day, June 25th, offered an immediate, second pocket pivot buy point. The main point in this example is that using pocket pivot buy points changes entirely how we think about buying compelling IPOs. Generally, the O'Neil methodology would dictate that we wait for a proper base of at least six to eight weeks to form, or at least a "high, tight flag" type of formation. In the case of LDK, the stock built a rather nondescript little V-shaped pattern that did not fit the definition of a "proper" base. Viewed from the perspective of using pocket pivots to determine proper buy points within patterns, LDK was entirely buyable as early as June 22, 2007.
Figure 5.21. Yingli Green Energy (YGE) daily chart, June 2007. A pocket pivot buy point on June 27, 2007, provides a ready entry point 13 days after the IPO date and before the stock has built any kind of "proper" chart base formation.: Chart courtesy of eSignal, Copyright 2010
It is not necessary to look at a weekly chart of Yingli Green Energy (YGE) to determine that the short flag formation it formed on the daily chart (Figure 5.21) was of insufficient length to be considered a "proper" high, tight flag formation since it only had one week down in the flag. However, in evaluating IPOs pocket pivots offer an entirely different approach to buying such hot IPO stocks—an approach that is not as dependent on the idea of the stock having to build a proper base formation first. On June 27, 2007, YGE moved up off its 10-day moving average on volume that was the highest in the pattern since the IPO date 13 trading days earlier, hence meeting the technical definition of a pocket pivot buy point.