SuperModels Community Join the discussion in the MSN Money SuperModels Community. SuperModels Recent articles: • This bear still has some bite, 8/28/2002 • Readers weigh in on General Mills, 8/21/2002 • Behind the curtain at Standard & Poor's, 8/14/2002 More... | SuperModels How to profit from a stock that's plunging You've probably had it with 'one-day' dips that last all year. Here's a better way to find opportunities amid the market carnage. Plus, tips for the do-it-yourself number-cruncher. By Jon D. Markman On Wednesday of last week, the shares of four small and medium-sized companies plunged more than 20% in a single day on volume at least seven times greater than average.
In the bull market, traders became accustomed to looking at such moves as buying opportunities, playing for a reversal as the cavalry of growth-fund managers rode in to defend their honor. But this is not a bull market, and for the most part, moves of that magnitude have been a red flag of much worse to come. They have become red meat, to be more specific, for the growing legions of quick-trigger short sellers ready to blast anything that wavers to smithereens.
The four stocks listed in the above table have little in common on the surface. One offers Web-based communications services, another runs hospitals, the third makes semiconductors and the fourth makes fabric for furniture. But the undercurrent linking them is an extreme imbalance of information among market players about their prospects for the future. One side, either the bulls or bears, suddenly has become radically wrong about the prospects for the stock. My research shows that in the past two years, this sort of one-day imbalance very often leads to further declines of a similar magnitude. In other words, once a stock plummets, its likely to plummet again. From March 2000 through the end of last month, 564 stocks sank by more than 30% in a single day on at least 300,000 shares traded and ended at a price greater than $7, according to research performed for me by Tony Kolton of Logical Information Machines. A day later, the prices on average were unchanged from their final price on the plunge day, but a month later the median stock was down 4%, six months later the median stock was down 23% and 12 months later the median stock was down 51%. Of the 437 stocks that have completed 12 months of trading since their plunge date and are still trading, 76% are down in price. (The results would probably be worse if all the -30% plungers that went out of business and were delisted were included.) See the table below for details. If youd like a spreadsheet with all the data, write me at jmarkman@microsoft.com and put "Plungers" in the subject line.
Dates: March 2000 through August 2002 Playing the plunge The follow-up drop typically comes after a few days or weeks of sorting out, as it becomes increasingly clear that bears had a clearer view of the prospects for the stock than bulls, who were guided by a set of false beliefs. When a stock dives 30% in a single day, after all, bulls on the stock often suffer from denial at first. But pretty quickly, they figure out that theyve been misled. Then they become disgusted and get ready to walk away. Fear becomes overwhelming as they question all their assumptions. As stocks enter a period of parabolic decline on increasing volume, institutional investors seem to jump out of the stock at greater and greater volume. I like to see the stock to sink below its 50-day moving average on this move, said George Fontanills, a Florida trader who likes this sort of set-up for short sales. You are looking for signs of fear, of desperation, of giving up, he says. If you watch a stock during one of these moves with five-minute tick bars during the day, you can just feel how support levels crumble faster and faster as the stock sinks. You can keep following the stock lower until you feel the volume dry up, or decrease to the point that sellers are no longer the dominant force in the move, that they have become less aggressive and reached an equilibrium or accommodation with buyers. Essentially, the 30% down-move tells the bulls that someone has information that they dont have, and that they should now fear more skeletons in the companys closet. Heres how Fontanills plays such situations. First, he determines whether the news that caused the plunge has a lasting quality that will cause the company to face a bombardment of bad vibes in the media. A revelation of accounting irregularities, for example, will potentially last longer than just a quarterly earnings disappointment. If the plunge looks to have staying power, Fontanills typically waits a few days or more for a mild rebound, then buys out-of-the-money put options that expire three months to 12 months out. Next, he says, we wait patiently for the stock to do what its destined to do, which is fall apart. He likes shares of companies about which there is a lot of uncertainty, pulling the stock in both directions. Wild oscillations reflexively create even more uncertainty, often persuading more shareholders holding long positions to panic. Case study: Tyco A good example: Tyco International In mid-January 2002, however, the first crack in Tycos story appeared when it announced that it would split up into four companies to make its accounting easier for analysts and shareholders to understand. That news was greeted with angst by investors, and a mildly negative one-day response. But two weeks later, on Jan. 29, 2002, the company slid $8.35, or 20%, to $33.65 in a single day of massive volume: 170 million shares. The catalyst was an announcement that it had richly compensated one of its directors for arranging the acquisition of CIT Group The news clearly shocked the companys partisans, many of whom were still smarting over the conflicts of interest that emerged in the wake of Enrons A week later Tyco went on to post -16% and -23% sessions back-to-back, falling to $23.10. For the next couple of months, the stock slowly worked its way back to the low $30s. But many traders came to believe that the -20%, high-volume day signaled a change not just in price trend, but also in 'opinion trend' about the stock. And they didnt need to wait long to be rewarded for that interpretation. In late April, further revelations resulted in three days of -19%, -4% and -14% as the stock sank further, to $17. The cycle of reconciliation between bulls and bears then began anew, as the stock worked its way back to the mid-$20s before another disclosure sent shares reeling down 27% on June 3 to $16.05, followed by two more back-to-back days of -16% and -31% on June 6 and June 7, to $10.10. Once again, the cycle of reconciliation between bull and bear points of view recommenced, and shares drifted languidly back to $17 by late August 2002. A technical how-to on crunching numbers To study the effect of -20% and -30% moves in any stock that captures your interest, you must learn to export price data to a spreadsheet program like Microsoft Excel. Its easily done from charts on MSN Money. Start with a 1-year chart by clicking Period on the charts top menu bar and choosing "1 Year" from the fly-out menu that appears. Then click "File" on the top menu bar and choose "Export Data." If you have Excel on your computer, the application will open and the daily high, low, close and volume data will automatically appear on a new sheet. Next, you need to prepare the sheet for your calculation of daily percent change. First, eliminate all blank rows where market holidays appear. You can either delete these rows manually, or use Excels AutoFilter tool on one of the columns -- Column E, for instance. Once you have Column E selected, click "Data" on the Excel toolbar, select "Filter" and then "AutoFilter", and choose Blanks from the list at the top of Column E (click on the arrow in the column header to see the list). When all blanks are showing, delete those rows. Next, click on the arrow again and choose All, to reveal all the data rows again. Now go to the bottom of the first open column and insert a formula that calculates the percent change. Then copy that formula up to the top. To spot the -20% rows more easily, choose Format/Conditional Formatting on the spreadsheet's top menu row and ask the software to turn all rows with less than -20% red. Thats it. Now eyeball the list or do further calculations to see what has happened in that stock after its 20% and 30% declines. The top plunge pick As for the current group of four stocks, the one with the best potential for further downside, in my opinion, is j2 Global Communications, which does not appear to deserve to be one of the few holdouts of the great dot-com bust. The company, which provides Web-based fax and teleconference services, has repeatedly reported higher and higher revenues during a time when all their rivals and vendors are reporting poor results. It strains credibility that one telecom-complex company, based on Hollywood Boulevard in Hollywood, Calif., could be successful and all others flops. Insiders bought shares heavily at $4 in early January, but since spring all insider activity has been sales around $19 to $21. The trailing price-to-sales multiple is a lofty 5.5. Technically, the stock had hugged its 50-day moving average en route to a parabolic advance that ended on Aug. 26, but it fell through that level on Thursday last week, and the next stop, if you believe in following such things, would be its 200-day moving average -- another 50% decline away at $9.85. J2 Communications and Culp do not have options, but I will track far-month, out-of-the-money puts on the other two companies that fell at least 20% on Aug. 27. They are: HealthSouth 2003 $5.00 puts (.HRCOA), $1.35 asked on Aug. 29; and Semtech March 2003 $12.50 puts (.QTUOP), $3.20 asked on Aug. 29. One more way to consider playing this idea: In the past two years, 222 stocks fell by at least another 50% after they had fallen by 30% in one day on high volume. The median stocks in that subset was down by 15% after a month. In the following table, I have listed stocks that have not yet completed 12 months since their plunge but were down by around 15% after a month. Ill track them and let you know what happens.
Fine Print To find stocks on any day that are down at least 20% on at least 300,000 volume, click here for my Plungewatch Screen . . . George Fontanills is the man behind the excellent options Web site, Optionetics.com . . . The back-to-school period increasingly looks like a bust for retailers. As the economists at ISI Group said, trying to put the whole economy into perspective, children en route to school this year are leaving their new homes in new cars but are wearing old clothes. . . . Thats not just bad news now, but down the road. One of the most knowledgeable buy-side analysts I know says that the all-important Christmas retail season tends to accurately forecast back-to-school. That would be really bad news for Toys R Us
While Jon Markman cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to jmarkman@microsoft.com. At the time of publication, Jon Markman did not own or control any of the stocks mentioned in this column. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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