New High - New Low Ratio (NH-NL)

...The new high/new low ratio (NH-NL) ratio has been around for many years but different investors use this indicator in different ways. Some investors plot the ratio on a chart using the number zero as a neutral designation with positive numbers equaling more new highs than new lows and a negative number equaling more new lows than new highs based on a specified period of time. I have developed and used the NH-NL ratio in a completely different way from some of the more popular methods. I started to follow stocks making new highs while reading the paper Investor’s Business Daily many years ago. I didn’t use the news highs as an indicator but I only studied stocks to buy from the list. As I became a more experienced investor, I subconsciously started to gauge the market while noting if the new highs were increasing or decreasing. After the stock market bubble burst in 2000, I started to record the difference between the daily new highs and the daily new lows. I would enter them into an excel sheet along with the price and volume of the major market indices and study their relationship. Within two years, I was convinced that the major market tops and bottoms could be located easily by aggressively studying the price and volume of the major indices and studying the ups and downs of the NH-NL ratio. The general market indices often give investors false moves in all directions and many market services and investors have developed new indicators to help assess the market to try and pinpoint turning points without great success. Many of these secondary indicators are successful in showing the investor if the market is weak or strong but they fail to pinpoint the strength or weakness of a turning point with great accuracy. Many of these secondary indicators give false signals along with the general market indices.

With several years of serious study under my belt using my method of the NH-NL ratio, I have accurately protected my money during downturns and have accurately guided my buys when the market has reversed and started a new sustained up-trend (not a head fake).

How do I use my NH-NL ratio?

I start by recording the daily new highs and new lows from Investors Business Daily (my preference) but you could use any free or paid service on the web. Over the past five years, I have developed key levels that the market must reached or violate to trigger certain actions. I am not pulling any of these numbers from thin air as they are all based on actual experience and have not been derived from back testing. For a market to convince me that it is following through and is starting a new up-trend, it must present me with a minimum of 500 new highs per day on a consistent basis. When a week ends, I add the weekly NH-NL totals and divide by the number of active trading days to get the weekly average. The average must have a minimum of 500 stocks per day for me to consider risking over 50% of my cash in new positions (the new leaders). Once the weekly averages reach 800-1,000+ stocks per day, we know that the market is in a full fledged rally and you can start to commit your entire trading stake and use margin. In 2003, the market gave numerous instances when the new highs topped 1,000-1,200 stocks per day, a very impressive amount. When the market shows strength like this, the trend has become obvious and you must have your money working for you by following the trend. Keep in mind that 75% of all listed stocks will follow the general trend of the market.

Recently in September and October of 2005, the NH-NL ratio has been negative, meaning that we are seeing more new lows than new highs. When this type of action happens, you must lock in profits and move your cash to the sidelines. It is not safe to invest on the long side of the market when the ratio is negative. Often times, a bear market may be forming when the ratio weakens and turns negative. If the market confirms a bear market or down-trend, it can be an opportune time to make money shorting stocks or using advanced strategies with options (I only recommend this for advanced and experienced traders). You must determine f the market is in a down-trend or if it is trading sideways. If it is trading sideways, it will be better to pull your cash to the sidelines and wait for a direction to form (either up or down). This article is being written and published on October 25, 2005, the first day after the NH-NL ratio has turned back to the positive side after 13 consecutive days of a negative ratio. The past two weeks have averaged negative ratios with some days only reaching 15 quality new high stocks. This type of weak action could signal a bottom in the market as we get ready to form a new rally. The most crucial indicator to watch over the next few weeks will be the NH-NL ratio to see if it can continue to gain strength and increase the new highs to 500 or more stocks per day. If this happens, the current indication that a rally has formed on the major indices will be confirmed and you can start to commit more than 50% of your trading stake to new leaders breaking out of sound bases or stocks moving higher from establish support areas.

As I look back at my archived hard copies of IBD, I can see the strength and weakness that this ratio gave us throughout 2002 and 2003. I am reminded how the ratio went from negative territory in September of 2002 to a positive ratio in October of 2002. After reaching positive territory, the new high ratio soared into the 800-1,100 range in the first six months of 2003 as we were in a strong bull market, the strongest year since the bubble burst. I don’t know what next month or next year holds for investors, but you can get a good idea by tracking this indicator as it turns back to the positive side after a very poor October (2005). I once wrote about the Halloween indicator and I am now convinced that it has some validity, especially if this NH-NL ratio confirms another rally as October draws to a close.

Piranha

The "M" in CANSLIM

...What does the “M” in CANSLIM stand for?

According to William O’Neil, it represents the market and direction it is heading in. Over the past several months, you have listened to me write about the “M” in CANSLIM almost every single week. Some of you have wondered why I put so much emphasis on this one letter in the CANSLIM acronym. It is very important to understand and recognize what type of market you are in before you ever make a stock purchase or place a large position. If you don’t know if the current market is a bear, a bull or if it is trading sideways, how can you realistically make money and set goals based on a blind strategy. Markets trade in trends and 75% of all listed stocks will follow the general direction of the major indices which include the NASDAQ, the DOW and the S&P 500. If the market health is poor and a bear market has developed but you don’t know about it because you haven’t assessed the health of the “M”, you may lose money by placing a long position in a stock. The stock you buy may have a nice chart pattern and excellent fundamentals but it may come under pressure due to the general market weakness and sector weakness. The same can be said in a bull market: a stock that is sub-par may perform strongly and give the investor solid gains due to sector strength and overall market strength. Study the market and you will see that stocks move in groups and most of the stocks in a strong industry will move in tandem (up). The same holds true for weak markets; if you own a stock in an industry that is starting to churn or breakdown, it may be wise to pull in a potion of you position to lock in gains. More times than not, the strongest stock in an industry group must conform and move in the direction of the others. A perfect example can be the home builders, they have moved in tandem for the past five years. If you look at their weekly charts for the past several years, you will see that they all have the same patterns but with different numbers.

I trade based on two major criteria: a strong up-trending market (a bull market) or a market that has reversed to breakout and follow-through telling us that the “M” in CANSLIM is gaining strength.

Second, I use the daily new high and new low ratio (NH-NL) to compliment the overall strength that the market is presenting. The price and volume alone can fake out many investors and lead them down the path of faulty investing. In order for the market to be strong, the NH-NL ratio must compliment the general outlook and present us with at least 500 new highs per day on a consistent basis. When both the NH-NL ratio and the “M” in CANSLIM are strong, we can justify placing larger positions and labeling the market as healthy. William O’Neil, the founder of Investor’s Business Daily, states that many of the best stocks over the past 50 years have made their advances when the overall market was strong, not weak. The NH-NL ratio is always comprised of the strongest stocks in the current market and we know that these individual leaders are responsible for the bulls and the bears.

How can an investor monitor the market action to tell if it is weak or strong?

As mentioned above, the first thing to look for is a breakout of one or more of the major indices with volume greater than average. Next, I look for the daily new high/new low ratio (NH-NL) to be entering new high territory and reaching new highs of 500-1,000+ stocks per day. In 2005, we have not had one day exceed 1,000 new highs to date (October 22, 2005 – almost 10 complete months of trading). In 2003, we had several instances when this number was reached multiple times in one single week. In 2003 we were in an obvious bull market and in 2005 we are in an obvious sideways market. On a side note: Sideways markets are typically tougher to trade than a market that is trending in one direction, whether it is up or down. Sideways markets whipsaw investors up and down and typically cause frustration that leads them to make poor decisions. It may be wiser to sit in cash during an extended sideways market because you will never know if the market will be up or down the next day. In bull markets, stocks move higher and in bear markets they move lower and a trend can be targeted but sideways markets provide us with many head fakes!

During bear markets, the strongest stocks that propel the market back to the bull side will typical have the strongest relative strength ratings when everything is weak and investor confidence is low. These stocks will become the new leaders and will typically emerge from a few specific industry groups that are gaining strength. When the market reversal happens, the first 10-15 weeks will be crucial as the biggest winners will breakout during this time. It is not to say that additional winners can’t breakout after the first 15 weeks of a new up-trend but the odds decrease and your risk rises. When the follow-through occurs in the market, you must see an increase in market volume from the previous day and substantial price advances that equal or exceed 1%-2% for the NASDAQ, DOW or S&P 500. When we see two or more of the indices follow-through on the same day, it increases the validity of the new up-trend.

Markets typically top after a prolonged period of higher highs and the first sign of a possible climax run or topping of the NH-NL ratio. If the market starts to make new highs on large volume but it is not moving as high as it was during the entire length of the up-trend, it may be topping. If price progress is poor and the volume continues to increase, the market may be churning or topping. I will immediately turn to the NH-NL ratio to gage the strength of the individual leaders to give me a glace at the broad market strength. One of the biggest black eyes that an investor can receive is during the topping of a long bull market where they made extensive gains and have emotions that are telling them they are genius. If an investor ignores the “M” in CANSLIM and holds their winners while the market tops and then starts to decline, their gains will be erased quicker than they were accumulated and their egos will be shot. When red flags appear, such as moving average violations, support levels sliced and the decline of the NH-NL ratio, it is time to lock in profits and move to cash until things settle and you can figure out what is happening.

Never listen to personal opinions on the market offered by talking heads because they are usually wrong or don’t understand the key factors that decide if the market is going up or down. It is most important to understand the exact condition and health of the market today rather than trying to predict where it will be in 6-12 months. Is it currently up-trending, moving sideways or down-trending? When you understand this last question, your trading results will improve dramatically. You could be the best stock selector in the world but that doesn’t mean anything if you buy and sell during the wrong time because you don’t study or understand the “M” in CANSLIM. Always know the exact direction, health and conditions of the “M” in CANSLIM before you ever put on a trade.

Remember, you could be right in every aspect of your stock analysis but if you are wrong about the direction of the market, you will most likely lose money.

Piranha

The Breakdown of LaBarge

...I wrote an article this past summer (July 2005) for a major financial website that will remain nameless but have since been informed that the article will not run so I now have the authority to post it here. I was going to post the article on this site after it was released for publication. As you may notice, the style of writing in this article is slightly different from my “to the point” writing on typical case studies (it contains more fluff than I like). Sometimes the mainstream media and financial publications need a certain appeal for their audience. I typically write what I think and what I see and worry about political correctness and proper article layout later. As long time members of the community already know, LaBarge (LB) was a major part of the screens throughout the first half of the year before hitting sell points and red flags (it is an MSW All-Star with a 134% gain in eight months). Enjoy the breakdown of LaBarge from my July 2005 article analysis:

The Breakdown of LaBarge
by Chris Perruna
Founder and President
MarketStockWatch.com
MSW Financial, LLC Company

Whether you are launching into space, cruising through the dessert or swimming in the artic, harsh environmental conditions will try to stop you in your path. High performance electronics and interconnect systems will allow you to continue your journey but where do we find such awesome devices. Just ask your local government, phone the nearest military base or walk on over to NASA.

Incorporated in 1968 and based out of St. Louis Missouri, LaBarge (LB) provides the military, NASA and private companies such as Boeing (BA) and Raytheon with these types of complete electronic systems solutions, circuit card assemblies and high-level assemblies for specialized applications. The majority of Labarge’s customers belong to the defense, aerospace, natural resources and industrial industries. Its products are used in various technology applications, including military communication and radar systems, military and commercial aircraft, satellites, space launch vehicles, down-hole instrumentation in oil and gas wells, and mail sorting equipment. In fiscal year 2004, 48% of LaBarge’s revenues were generated from defense customers, 14% from natural resource customers, 13% from industrial customers and 10% from customers in the government systems market.

With a market cap of $313 million and 980 employees, CEO Craig LaBarge has guided the stock to new 52-week highs by increasing sales and earnings year over year. Revenues are up over 67% versus the same quarter last year while net income has advanced by 93% during the same time period. Mr. LaBarge gives his investors a good feeling by producing a return on equity of 19% while jump-starting earnings per share by almost 89% versus the same quarter one year ago. This year (2005), LaBarge is expected to report EPS of $0.67, $0.82 next year and just short of $1.00 at $0.98 in 2007. Building on the past (2003: $0.23, 2004: $0.45), it is evident that LaBarge is on track to sustain growth for many years to come especially with its new memberships to the Russell 3000 Index, the Russell 2000 index and the New Russell Microcap Index.

Looking at a simple daily or weekly chart, you can see that LaBarge has almost tripled in price during the past year with a 100% gain in the past six months. Where should an investor enter a stock that looks to be extended from safer buying territory? Further analysis will provide us with a clue that LaBarge has received support at the 50-day moving average since March 2005 and the 200-day moving average since 2003. The stock has been recording higher highs and higher lows since the New Year and it has done so in convincing fashion. A breakdown of any of these long term support lines should concern you and raise a red flag as I like to say.

When buying a small cap stock, I prefer to see strong cash flow and LaBarge provides us with cash flow that exceeds the industry average by almost 98%. Belonging to the electrical equipment industry, LaBarge shares company with other names such as Agilent Technologies, Inc (A), Fisher Scientific International (FSH)., and Garmin Ltd (GRMN). The industry as a whole hasn’t performed extremely well but LaBarge, an undiscovered gem on Wall Street, still has room to growth and give investors a reason to smile. As of April 2005, only 27 institutional investors have placed a position in LaBarge, fifteen of them being money managers and 10 of them being mutual funds. To put the numbers of institutions into perspective, Boeing, a client of LaBarge, has over 1,750 institutional investors from Wall Street.

Is LaBarge undervalued? The price-to-sales ratios suggest that the company has room to grow since it is lower than the S&P 500 average and well below the industry average. The P/E ratio also suggests that the stock is undervalued compared to the industry average and evenly valued when compared to the S&P 500. I do raise an eyebrow when studying the liquidity of the company; it seems to be weak and may lack the ability to cover short term cash needs. If the company runs into revenue decreases or other financial difficulties, the lack of liquidity can hurt the company and the underlying stock price. The balance sheet can offer us a better look into the quality of the company and how management handles business. Total cash has decreased from Q2 2004 to Q2 2005 from 8.68M to 0.30M as debt has increased from 6.87M to 37.95M. However, total assets have increase from 75.39M to 124.49 during the same time period.

LaBarge crossed above $20 for the first time ever but pulled back at the end of last week. The 50-day moving average sits at $16.64 and support is holding strong at this invisible line. A healthy pullback to the moving average in below average volume could signal investors a new entry position or present an opportunity to add additional shares to an existing position. Eventually LaBarge will have to correct but I wouldn’t speculate when other small caps such as Hansen Natural Corp. (HANS) have moved from $5 to $105 in less than two years without a major correction. As a current shareholder in LaBarge, I will be staying put until I see any major red flags or warning signs to sell the stock such as a break of the 50-day moving average on above average volume.

As they say in poker, “Know when to hold them and know when to fold them” and I won’t be folding this hand anytime soon unless conditions change drastically. For a further look into the company, please take the time to visit their website (http://www.labarge.com/) and learn for yourself how LaBarge may someday lead us into further oil and/or space exploration. We now know that temperature doesn’t matter when it comes to their products, so take a break from the extreme summer heat of 2005 and aim to make some cold hard cash with this growth stock.