Book Review: Technical Analysis Using Multiple Timeframes

If you follow my trades and comments, you know I am more of a trader than investor. Given the recent per se deceit flowing from the mouths of government officials and CEOs, I have been spending increasingly more time honing my trading skills because investors (and the public at large) are apparently nothing but suckers.

I have learned this lesson perpetually since graduating during the dotcom bubble, experiencing the bubble’s implosion, watching Fortune 500 companies lie and steal (e.g., Tyco, Worldcom, Enron, etc.), realizing the Federal Reserve purposefully caused new bubbles in the housing and credit markets, and now witnessing the new wave of legal con artists at Bear Sterns, Merrill Lynch (MER), Lehman (LEH), Fannie Mae (FNM), Freddie Mac (FRE), et al. Rather than get angry and fill my days discussing moral hazards, I’ve decided to accept reality and enjoy myself while reading Brian Shannon’s Technical Analysis Using Multiple Timeframes.

First, let me preface my first book review by noting that I am extremely skeptical of marketing experts who sell trading systems and technical analysis products. However, I believe the Internet will allow a handful of successful investors and traders to build a loyal following if and only if said followers can make money. Brian is going to be one of those success stories.

When I first received Brian’s book, my wife joked, “How’s your textbook?” However, I think she was spot-on with her accidental compliment. Like a short textbook, Technical Analysis Using Multiple Timeframes is laid out in a very logical fashion and offers loads of practical knowledge. I would classify the book as intermediate level material, although it’s an excellent resource for technical analysis newbies.

For purposes of this review, the book has four sections. In the first section Brian introduces technical analysis, explains the four stages of a market cycle (accumulation, markup, distribution, and decline), and details the major variables in his methodology (price, support and resistance, trends, volume, moving averages, and time). In the second section he shares his secrets about how and when to buy long and sell short.

In the third section Brian addresses news and fundamentals concerning companies and their stocks, then he has a very nice intermediate/advanced analysis of short squeezes (and how to profit from them). In the fourth section he offers invaluable wisdom on risk management and exit strategies, his personal rules and insights, and an excellent conclusion entitled “Putting It All Together.”

It’s hard for me to go into too much detail because I don’t want to explain Brian’s system and defeat the purpose of reading the book. So, here are some core characteristics to consider:

• Brian is a pure trend trader. If there’s no trend, he ain’t trading.
• Brian possesses professional insights into market structure and the psychology of supply and demand.
• Brian is religious about risk management.

If you are serious about becoming a better trader or learning how to improve your buy and sell decisions, Brian’s book will pay for itself the next time you make a transaction. Unlike countless “classics” that spend 200 pages preying on our get-rich-quick tendencies, Brian skips the infomercial and delivers a practical framework we can use to make money or preserve capital.

If you are interested in purchasing his book or learning more, please visit:

Lehman Buyout Rumors Don’t Pass the Laugh Test

In the legal world, an incredibly illogical argument is said to “not pass the laugh test.” Last week an anonymous source told Reuters that the Korean Development Bank had Lehman (LEH) on their watchlist. LEH and shares of other financials rallied nicely on the news. However, no one stopped to question the absurdity of a savvy prospective buyer literally showing its cards to the entire world.

For those who did not take Econ 101 or Negotiations 101, here’s a quick primer:

If you are going to bid on an asset, do not tell anyone because then those people will buy in anticipation of the bid. As a result, the price will increase proportionally with increased demand, and you will be forced to pay a higher price for the same asset.

In this case, we are supposed to believe that a major financial institution would rather have everyone and their grandparents bidding up shares of LEH so Korean Development Bank could pay a higher price than they otherwise would have if they simply kept their mouth shut. For example, if the bank was planning to offer a 15% premium for LEH, they can either offer that premium on $12 or less, or they could offer that premium on $14 or more after alerting the entire world of their plans.

I honestly feel sorry for the average person who is investing their savings in the stock market on the bare trust that the financial media and SEC are actually doing their jobs. I’m glad longtime readers of SmartGuyStocks never buy on absurd rumors, but I can’t imagine how many hard working middle class folks bought LEH last week and are sad to see the results today. When Wall Street PR spin doesn’t pass the laugh test, those who are laughing hardest are those laughing their way to the bank as they pass the bag.

The Price is Light: Market Weighing a Skinnier Load

There is a famous American game show, The Price is Right, during which contestants attempt to guess the correct price of a certain item. The winning contestant guesses closest to the true price. A somewhat similar game is occurring with the stock market’s financial companies. However, rather than observing a familiar item and guessing the price based on a few simple known variables, many complicated and obscured variables affect the true value of financial companies.

Let’s attempt to play a simulated version of this game with the headlining stock Lehman Brothers Holdings Inc. (LEH). A little over a year ago, LEH was trading near $80 a share. The company was coming off a multiyear bull run and was profiting from investments related to the strong real estate market, the roaring global boom, and tons of private equity deals and IPOs. The market looked at LEH’s financials and imagined every investment providing superior returns, the global boom spiking without fail, and the deal flow continuing ad infinitum. Although none of those projections were connected to reality, they were included in the stock price nonetheless.

So, in our simulation we are now staring at a share of LEH trading at $80 in 2007. We are bright-eyed and having idealistic fantasies like parents do while staring at their newborn babe. LEH is our little darling. LEH can do no wrong. LEH is genius! We are guessing that the price of LEH is “right” at $80 - for sure.

While we are staring at our simulated computer screen enjoying the beautiful ascension of our darling, simulated LEH employees are making trades, signing contracts and checks for more projects, and marketing their services to prospective clients. As all the aforementioned booms started losing momentum, the quality of the then current deals began to erode. Long trades in real estate related securities started to sour. Deal flow came to a screeching halt. But all the while, LEH bulls kept demanding shares because they were living in a deluded intellectual world where LEH was invincible.

Last summer a handful of people snapped out of their daydream. So, LEH shares started to slide. Despite the mounting evidence that the boom had peaked, LEH management and their well-paid PR machine told the public, “Although you can’t see behind our veil, trust us that things are just fine.” And since most analysts, fund managers, and individual investors are too far removed from the company’s reality, they drank the Kool-Aid and guessed that the price for LEH was “cheap.”

This is the point when most people are simply investing based on the inertia of the market (e.g., “buy the dips”). Although any reasonably discerning person could find plenty of data to support that major problems were manifesting in the economy (if you are lazy read Barry Ritholtz’s brilliant blog The Big Picture), the inertia bots piled back into shares and kept them stable until February of this year. At that point, reality was harder to conceal and the protectors of the veil (e.g., CEO, PR team, Federal Reserve, National Association of Realtors, etc.) were forced to concede a host of problems. Thus, the next wave of sellers dumped their LEH shares.

Despite the concessions and selling, the protectors of the veil followed all their negative revelations with positive rhetoric and spin. They are, after all, trying to prevent us from accurately repricing the market all at once - because that’s what we call a “crash.” So, once again plenty of inertia bots started buying shares. As a result, we had a little rally from the middle of March until the middle of May. At that point, more of reality was revealed, and the next wave of selling began.

At this point, we are in the present moment: Monday, July 14, 2008. LEH has taken a hard beating down to $12.40. The mainstream media is finally reporting that LEH owns ghost towns and has an enormous amount of possibly valueless illiquid assets on their books. However, despite all the negative data about LEH’s reality, there are still people who continue to buy. And, despite those who continue to buy, the reality behind LEH’s veil has still not been fully disclosed - not to mention the economy is getting worse.

This same issue is true for the market as a whole. Although companies have revealed some things about the cancers growing on balance sheets, they haven’t revealed everything. And we definitely don’t know how much worse that cancer will be as the economy continues to slow. But, like contestants who know results of a reality show that was filmed but not yet aired, those who can see behind the veil are very well aware that share prices are not yet based on reality.

Legendary investor Benjamin Graham said, “In the short run the market is a voting machine, but in the long run it is a weighing machine.” So, we will continue this classic Bear Market game where insiders are forced to give us nuggets of reality and prices reduce another leg based on weight. Then protectors of the veil will find a statistic or two and claim things are bottoming, and we will have another bounce based on votes. Maybe LEH execs will even consider going public to end the slaughter? But until we know everything and get to stare at the naked skinny horror behind the veil, LEH and the market will continue to be inaccurately priced as a heftier load. Therefore, I recommend staying out of this volatile market unless you are an incredibly skilled trader. As the maxim goes, “When in doubt, stay out.”

Stay tuned for SmartGuyDH’s upcoming article about how to play this market …

Steal shares of Metalico, not church organs

• Buy MEA around 14.03

In the latest sign of the global commodity craze, churches in England are seeing increased thefts of metal from roofs, statues, and plaques. And last week, someone even stole the organ pipes from a 13th century church, presumably to cash it in for scrap.  Here in America, we have a little more respect for our religious institutions-so we limit our larceny to kegs and manhole covers.

The bottom line is that metal prices are soaring, especially in the scrap and secondary markets. And as iron ore prices increase (Rio Tinto recently announced it secured an 85% price increase for the current contract year), scrap metal becomes an even more appealing alternative. This is not likely a passing trend- Dan DiMicco, the CEO of Nucor, the largest metal recycler, stated last month of CNBC that he sees 15-30 years of a strong continued upward trend in metal demand and prices. He acknowledged that there may be some short-term blips, but the overall trend would be sharply positive.

Nucor is putting its money where its mouth is, gobbling up scrap metal operators. In February, it bought scrap broker and processor David J. Joseph (”DJJ”) for $1.4B. In April, its newly acquired DJJ platform acquired two smaller scrap processors for an undisclosed price. According to the company, it plans to use the DJJ platform as a “a platform for continued growth in the scrap processing industry.”  It also sees an opportunity for more consolidation in the industry as prices rise. And Nucor’s acquisition strategy appears to be on the fast track, as the company raised $2.05B through a recent stock offering and plans to raise an additional $1B by selling bonds for acquisitions, capital expenditures, and general corporate purposes.

So who might be a beneficiary of high scrap metal prices and a dominant industry player hungry for M&A? My bet is on Metalico (AMEX: MEA). The ~$500M New Jersey-based company operates a number of ferrous and non-ferrous scrap processing facilities as well as a lead-fabrication business. The company has been acquisitive in its own right, and its blowout 2008 first quarter was a result of successful acquisitions and high demand for scrap.

The street has begun to take notice: in the past few weeks, analysts have upped their price targets on the stock to $20 and $21, citing increased worldwide demand for scrap. And although the stock has risen over 40% this year, it is currently more than 20% off its high. Analysts currently expect revenue to increase by 135% this year and at least 13% the next. Given MEA’s recent track record, this latter number seems potentially very light.

Shares of steel-related companies, including MEA, tanked last week on worries over GM’s production cutbacks.  This despite an earnings announcement from Schnitzer Steel a few days earlier, whose CEO stated that “Global demand for recycled metals remains robust, driven by economic growth in developing countries.” Dan Dienst, CEO of Sims Group (another large metal recycler), appeared on Cramer’s show Tuesday night to dismiss any worries. He cited the “voracious” demand for metal, both ferrous and non-ferrous, that his company continues to see. He specifically addressed the GM issue, noting that “a couple million tons in diminished production” from automakers is not going to come close to offsetting the huge infrastructure demands from BRIC countries.

An analyst from UBS was out yesterday with a note to buy steel companies on last week’s overdone drop.  I agree, and believe that this is one of those aforementioned negative blips in a company with a clear positive trajectory. Between the strong demand for scrap metal and the possibility of a buyout, Metalico is a buy.

Disclosure: SmartGuyStocks is long MEA

SGS Five Investing Pitfalls: #3 The One-Dimensional Thesis

Savvy investing is tough. Success requires solid due diligence and constant observation of the economy. However, many investors like to oversimplify a thesis and then buy-and-hold with total confidence.

Since last fall I have received many emails from readers who challenged my assertion that the bull market was finished. On December 31, 2007, I wrote an article Banking Crisis: No End in Sight. Some Seeking Alpha readers passionately argued that banks were in as little trouble as their CEO’s alleged - despite the troubling mortgage and commercial loan data I provided.

The constant theme I noticed was that some people bought into stocks like Wachovia Bank (WB) on the general thesis that finance is the engine of capitalism and therefore will be fine in the “long term.” This is the same bullish rhetoric I quoted in my article as stated by Rich Pzena of Pzena Investment Management (PZN): “Citigroup is everywhere. It is a massive global franchise that will grow in line with global financial growth …” Try to explain that to the poor investors and employees who have seen WB and C shares erase all gains from the past 16 and 10 years, respectively. That, my friends, is as “long term” as long term gets.

The lesson here proves that developing a general thesis is not enough. In fact, a general thesis is merely a starting point for the savvy investor. The next action step is due diligence, and the following step is constant monitoring of the situation. When investors execute step one and ignore steps two and three, multiyear gains can evaporate quicker than Lake Lanier during a drought.

I can tell investors are ignoring steps two and three when they tell me broad-based statements like, “WB is a steal at 40 because it’s already down over 20% from its highs,” or, “With WB’s dividend, you can just load up the truck and get paid to wait.” Wait for what? The stock to go to 15 and the dividend to get slashed or suspended? If you find yourself ignoring important reports displaying a company’s exposure to a major problem (e.g., WB’s exposure to toxic debt), you are deluding yourself into the land of hope and dreams. And once you start using hope as support for your thesis, your investing days are limited.

Another perfect example of the one-dimensional thesis is Whole Foods Market (WFMI). A very oversimplified thesis states that organics are a growing trend. True. WFMI was the first-mover in the space and delivered an excellent retail experience. WFMI also had nearly zero competition. With those supporting data points plus the awesome financial metrics, WFMI was a screaming buy.

However, over the past several years many world-class companies have entered the still growing market for organic products. Traditional grocers such as Kroger (KR), Walmart (WMT), and Target (TGT) created isles dedicated to organic foods, while other organic retailers such as Wild Oats and Trader Joe’s simply attacked the niche - and companies such as Safeway (SWY) and Publix (PUSH) did both. Thus, WFMI lost its first-mover advantage as well as its pseudo-monopoly (i.e., pricing power). Once you add food inflation, rising shipping costs, merger costs (Wild Oats), and decreasing consumer spending, WFMI looks like a very ripe target for multiple contraction and decreasing earnings. But the one-dimensional thesis (i.e., increasing demand for organics) is still intact. If you relied on this sound thesis without due diligence and constant observation, you probably watched 6 years of gains disappear like organic double-chocolate brownie samples on the bakery counter.

So, next time you find yourself conceding to cognitive dissonance and ignoring new data points, take a step back and make sure you’re not succumbing to the pitfalls of the one-dimensional thesis. If you are the preventative type (which I highly recommend), then apply your trusty three-dimensional framework - sound thesis, due diligence, and constant observation - during all your prospective and current investments and trades. The added dimensions will blow your mind when you preserve and grow your hard-earned cash.

Water ETFs are Correlated to Market Tide

• Sell PHO and PIO around 22 and 24 respectively

Eleven months ago I recommended the water ETFs PowerShares Water Resources (PHO) and PowerShares Global Water Portfolio (PIO). I was specifically seeking an asset class uncorrelated to the broader stock market. However, I think too many traders and funds are buying and selling these assets based on the same signals as broader market indicators. Therefore, the investments have not met my thesis and need to be sold.

This is a good lesson for investing. We have many prospective investments, yet only enough cash to buy a tiny fraction of assets. As a result, we must consider our opportunity costs when holding investments that under-perform. Moreover, we want to cut our losses when a thesis has been proven incorrect. If for some reason these water ETFs start trading as if water is a scarce commodity, then I will happily jump back in the pool.

SmartGuyDH no longer owns shares of PHO or PIO

Putting PETS to sleep

• Sell PETS around $13.79

They say you can’t teach an old dog new tricks. Well, two-time SmartGuyStocks pick PetMedExpress (Nasdaq: PETS) seems to have one impressive trick down pat: beating earnings expectations, as it again bested analysts’ guesses this week for the fourth quarter in a row, growing sales 11% and profit 39%.

But there’s another trick that PETS can’t seem to learn- sustained stock price appreciation. Despite a long history of top and bottom line growth, a quick glance at PETS chart shows that it just can’t seem to remain in the market’s favor. Sure, it jumps after its predictably great earnings, but then it either seems to trade in a range or slowly trend back down.

So with the stock up over 20% in the last two weeks on the back of strong earnings and a shaky market rally, its time to cash out for now and take our gains. Advertising inventory will tighten up in the second half of the year with record dollars being spent on the upcoming election, and PETS could find margins slightly squeezed with increasing marketing costs.

We still stick to our original thesis that has proven true at each PETS quarterly report: pet medications are a growth market, and PETS will benefit. PETS has three secular trends working in its favor:

1. Pets are becoming a more integrated part of the modern family

2. Pharmaceutical companies are pouring more money into new drug breakthroughs

3. People are becoming increasingly comfortable ordering all sorts of products, including medications, over the internet

So while we reluctantly put PETS to sleep, its only because of the risk/reward benefit at this point. If the stock drifts back down to ~11, which it almost certainly will unless we see a true bull market, we will again be buyers.

SmartGuyAB no longer owns shares of PETS

Game Over for Nintendo’s Risk-Reward Ratio

• Sell NTDOY around 71.15

Avid readers of SmartGuyStocks know that Nintendo (NTDOY.PK) has been one of our favorite stocks over the past year. NTDOY is the only stock I have recommended twice. The company has delivered two of the most exciting products in the world: Wii and DS. However, I believe price appreciation is limited for the following reasons: skyrocketing shipping costs, the weak dollar, and the current point in the console cycle.

First, let me preface my comments by saying NTDOY is still one of the best companies in one of the hottest sectors in the world. If the global economy was steamrolling, I would hang on to NTDOY through the coming holiday season. Unfortunately, my wish is not the economy’s command. Rather than fight reality and stubbornly hold my shares, I am willing to take my extraordinary gains and accept that my risk-reward ratio has diminished.

Although many shareholders will focus on the positives at Nintendo, headwinds are gaining strength. As oil costs levitate, shipping costs perform the same miracle. These costs eat into NTDOY margins for both manufacturing and distribution. Moreover, the dollar continues its celebrity makeover as toilet paper. This will continue to diminish the value of building in yen and selling in dollars.

Thus, the great irony of globalization (i.e., foreign production is cheaper) begins to mature. The forces in the global oil and currency markets are stronger than those in the growing video game space. And until something changes, these costs will limit upside in NTDOY.

Lastly, the easy money has been made in the current console cycle. Those who remain in shares are playing chicken with the inflection point of the cycle. Some time in the next 12-18 months I expect Microsoft (MSFT) and Sony (SNE) to start introducing exciting concepts for their next generation consoles. These glossy press releases will create signs that the current cycle is in the latter stages. Once that happens, analysts and investors will start to look ahead. And once that happens, doubt will arise as to whether NTDOY will repeat their success in the future. If you are still holding shares at that point, you will be very disappointed to see Nintendo the company still minting money while NTDOY the stock discounts for the great unknown of the next console cycle.

I do not aim to find the absolute high and low of a cycle. Rather, I seek to capture the easier money when companies are in stride during their climb or descent. That’s why I have not made many picks since the market has traded in a choppier manner. I prefer shorts and puts when things are falling hard, and buys and calls when they are rising in a healthy environment. Occasionally I will offer a short-term trade that contradicts the macro environment, but those who follow my picks will make most of their money in the sweet spot of each cycle. My one-year track record on SmartGuyStocks validates this strategy.

On a technical note, NTDOY peaked in the high 70’s and has not been able to push back. This is more evidence that the macro environment has great control over NTDOY shares. I held my shares during the decline from the peak because I believed the stock had a chance to bounce back and charge ahead for another leg up. Despite excellent growth and earnings, the stock has not made new highs. Therefore, I believe we may be witnessing the best price for NTDOY we will get as the hype for Mario Kart and Wii Fit bring optimistic buyers back to the trading floor.

Of course, the economy could improve later this year, but I do not take my economic analysis from the White House. From where I sit, it’s game over for Nintendo’s risk-reward ratio.

A small company with HURC-ulean profits

• Buy HURC around $41.54

One of my favorite companies is Hurco (Nasdaq: HURC), a small manufacturer of machine tools and the software that powers them. Hurco’s machines help manufacturers decrease labor costs and achieve increased production efficiency. I first wrote about Hurco last August when the stock was trading close to 50. In that article, I mentioned that Hurco had experienced solid and consistent growth over the past few years, but has been an extremely volatile stock. I suggested that as long as growth remained strong, I would be a buyer on any undeserved stock price dips.

Well, I believe that time has come. Last week, Hurco announced first quarter earnings that left analysts looking silly. The company earned $1.21/share on $61M in revenue, vs. expectations of $0.90 and $50M. Last year, Hurco earned $0.84 on sales of $47M. Despite slightly down U.S. sales, growth was fueled by insatiable European and Asian demand, helped by the weak dollar. CEO Michael Doar specifically called out new successes in fast-growing India and Eastern Europe.

In response to this news, the market sent shares of Hurc up 30%. Since then, the stock has given back almost 20% on no news and is trading at a trailing P/E of less than 12. With net cash representing more than 10% of its market cap, record new order bookings, and limited exposure to the U.S. economy, Hurco has all the makings of a success story. Look for this little guy to fly during any market rally.

Disclosure: SmartGuyStocks is long HURC

Deja vu, Akamai style

As I wrote in October, SmartGuyStocks selection Akamai (AKAM) seems to be falling into a pattern.

1. Akamai reports strong (40%+) YoY revenue and profit growth, in line with or ahead of expectations

2. Analysts predict the end of the company’s growth at the hands of growing competition

3. Akamai reports strong (40%+) YoY revenue and profit growth, in line with or ahead of expectations

Given that this has been going on for a few quarters now, I think we can guess what the investment community’s reaction will be tomorrow.

But I’m still holding out hope that some analysts will finally re-consider their doom and gloom mantra, as Akamai’s results for the fourth quarter certainly appeared to snuff out any competition fears. Not only did revenue increase 14% and profit 22% over last quarter(!), but gross margin even increased by 20 basis points. CEO Paul Sagan certainly had every right to brag that “the value of Akamai’s differentiated services is stronger than ever.”

Sagan also reassured investors in this uneasy market climate, insisting that an economic slowdown may even help Akamai. Since companies save money by moving operations to the Internet, Akamai would benefit if the migration process picked up as businesses seek to cut costs in a tougher economic climate, he said.

A large driver of Akamai’s growth is the downloading of video content. The company provides technology that allows companies and government agencies to deliver digital internet content, such as commercials and videos. Between the announcement by Apple of a movie download service, the internet-only NBC soap opera “Coastal Dreams”, and the proliferation of forwarded video clips in my inbox, the growth of video is one trend you can count on. And given Akamai’s track record and position at the forefront of content delivery technology, this is one company I’m willing to bet on.

Disclosure: SmartGuyStocks is long AKAM