I mentioned earlier this week that I never buy stocks making 52 week weak lows:
Yahoo!, eBay, Amazon.com: Interesting to note: All three web giants hit their 52 week lows today; Of the three, I find eBay intriguing — especially if we slow down.
That said, there is never a reason to buy a stock making a 52 week low. Never.
That prompted an emailer (from TheStreet.com) to write:
"That kind of absolute statements such
as "never buy a stock making a 52 week
low" is what always makes me suspicious about your intellectual ability."
OK, so you can better understand both the point of my statement, as well as the philosophical underpinnings of this, here’s the thinking (and I’ll use small words so even the emailer can get it): Any stock making 52 weak lows will ALWAYS be technically weak, and therefore undergoing a (possibly massive) institutional distribution. EVERYONE.
When will the hedge funds, pension plans, mutual funds and foundations be done selling? How the hell can you tell? I sure can’t.
So let me ask you: Which 52 weak low will be the bottom?
That’s not a spelling error or a typo, when a stock is making 52 weak lows, its because they are,well, weak.
Let’s go to some charts:
DELL: Which 52 Week Bottom Did You Buy?
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So I once again ask: Why catch the falling knife?
Think about stocks making 52 weak lows as if you were short them: At what point would you cover?
Instead of merely guessing, consider using a down trend line or a 50 day moving average; I like to use a trailing buy stop . . .
Capiche?
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UPDATE March 22, 2006 5:45am
I discussed a "special situation" stock in the comments, and its worth going into more details on. My original statement is written with a bit of flourish to make a point: there is so rarely a reason to buy a stock making a 52 week low, that making it an exteme rule avoids lots of money losing mistakes.
Don’t buy a stock merely because its making 52 weak lows, or because its cheap — will save you from yourself 98% of the time.
If I was being perfectly honest, I would have written "almost never" — but then the exceptions start swallowing the rule. I want to emphasize that its only in the very rarest of circumstances that I would even think about making those buys. It is a slippery slope, and we would all soon be bottom fishing way too often and paying dearly for it.
I certainly would never buy a stock JUST BECAUSE I THINK ITS CHEAP, as those stocks tend to get even cheaper.
Micromuse is a great example: During the bubble, I sold Micromuse as high as $205. When the market cratered, I bought it back at $165, and quickly got stopped out. It
was one of those "value stocks" I wanted to own. So I waited and waited
and waited — finally it was down to book value — around ~$3 or so. I still waited.
One day, on no news, it just collapsed — totally fell apart. Traded down to $1.43 or so — profitable, with $2 in cash! The hardly efficient market was saying a buck was worth only 75 cents.
I called Cody Willard, who told me he heard of a Janus
telecom fund that was being folded into a larger fund — everything
in the telecom fund was being liquidated. That was the excuse that allowed me to buy MUSE as I could stand — and in less than a year, it went to $10.
That is a very special situation — rather than merely buying a stock making 52 week lows because of its "cheap" valuation . . .
distribution is key. the spread between the multiples of different ownership requirements can be quite large, driving increased volatility.. it also changes depending on the general trend of multiples.
BR,
this is a very general question but do you (or anyone one else here) have any volume targets to tell you whether say momentum players have capitulated and into value hands? like if stock trades x% of float or average daily volume would that indicate that new ownership is taking over?
and i’m obviously speaking of a bottoming process…
Barry,
Superb explanation of why a 52-week low stock is always, ALWAYS, technically weak.
Your wonderful explanations, plus everything else on your blog (I relished your advice on buying and making coffee, for example), are why Big Pix is in the “great site spotlight”. Take a bow!
Indeed Barry, it’s been proven time and time again that you are far better off buying a stock that just made a 52 week high as opposed to buying a stock that made a 52 week low.
If your emailer wants to try and catch falling knives, or if he thinks his account size is large enough to stop the downward momentum… why not let him go ahead and lose his money? ESPECIALLY, after a rude email like that?
I don’t know how many people here have taken physics, but there are alot of similarities to some of the momentum, velocity and acceleration principles in physics and technical analysis.
He might of bought a stock at its 52-week low and made money which is a possible reason he is bitter to your words. Yet I still won’t attempt to catch that falling life (i.e. URBN)
Depends on your timeframe, herr doktor. DELL has massive long-term support at 22.50-23.50. That was the bottom of the range it traded for most of 2001 to early 2003.
DELL tagged 23.60 last week. That was a very low-risk time to buy with risk to 22.50, looking for a rally back to 28-29, which was the top of the trading range from 2001-2003.
Maybe DELL ultimately goes lower back to the 2000-2001 double bottom around 16-17. Who knows. But i’ll take a 3% risk for an 18-20% reward any day, especially if the payoff can be had in just a few weeks or months.
I don’t generally recommend catching falling knives. But there are some 52-wk lows worth buying and some that aren’t. The ones that dip to major l/t support after a grinding selloff are buyable as long as you understand the risk/reward. The ones that are midway points in a decline with no discernible chart support nearby are not buyable.
This is particularly true with widely-held, large-cap stocks. I wouldn’t try this method with a smallcap or microcap.
DELL is at one of those buyable points right now, though I’d love to see another whoosh down to 22.50. But I may not get that chance. It’s already up 4% off that 23.60 bottom.
Finally something I feel at least minimally accomplished enough to speak to. (Can’t write worth a crap but that’s another story).
Anyway – the problem with the proposition is obvious – if everyone felt that way then the stock would never be bought and eventually would go to 0. Since very few stocks ever go to 0 there must be something else going on in the dynamic other than “52-weak” low.
Just the other day Doc Steenbarger wrote about if a trader bought the SP 500 after a rising day vs a trader who bought it after a falling day what would be the result 3 days later. Turns out the trader who bought after the falling day experienced .20% whereas the trader buying on the rise would only get .01%. So obviously there is merit to buying “on the dip.” And these are random, uninformed trades.
But the question is where do I buy Dell? The answer, grasshopper, is found in the inscutable East – among the rice merchants of old – you watch for the tell-tale candlesticks and they will tell you when to buy. I see from DELL’s chart an NR7 3 days ago at 23.63 and that resolved to 24.57 on Friday’s close (including an up day on Thursday’s overall down day). From a trader’s standpoint that wasn’t too bad.
Dell’s float is 81% owned by insiders and mutual funds. 19% is actively traded every day. We may be seeing distribution in this stock but with over 50 million shares traded daily it is difficult to tell. Somebody is taking those bids.
Seems to me that one really good reason to stay away from a stock which is making a 52 week low is that by definition it is already below its 200 day/40 week MA which is going to become a significant resistance line. You are also buying into something with open air under it unless you start to strain the definition of support by reaching back years into history- with DELL, you aren’t really talking about a 52 week low you are talking about more like a 3 1/2 year low and I’m not sure how relevant that is now as a support level.
You can certainly make a couple of bucks off of of a sick stock on swings, but I don’t consider achieving a new low a buy signal- if it was, drkoop.com would still be around. :P
I’ve had some of my best success buying stocks which have suffered big drops. I haven’t paid any attention to the “technicals”, but rather to what I see as the fundamental business prospects in comparison to the current price. I do appreciate the technical perspective provided here — that’s one reason I follow this blog religiously — to learn something new.
I’m not sold on the idea of technical analysis, and certainly don’t have the time to be a day trader. So I’ve got a longer time horizon. On the other hand, after the plunge of 2001-2003, I’m not a believer in buy and hold either. So now I’m trying to time the market as to what the next year or two will bring.
Getting back to buying at 52 week lows, I have had more success than failure in doing this. My biggest success was Corning, where I kept buying as it went down from over 100 to below 2. I bought some at 50, 22, 13, 8, and 3. Ended up selling everything in March at about 26.50. So most of my trades on the way down ended up being winners, including some that were big winners. The hardest purchase, and ultimately the most rewarding, was when I bought more Corning at < $3 per share. That was a new low at the time and I was dying as Corning's price continued to fall below $2 per share. These trades all looked to be stupid for some time after the purchase (from a couple of months to a couple of years). But given my investing time horizon, they worked out for me. I probably won't be making many more of these types of trades. It was just too painful on the way down. I think it was Byno who said that the most gut-wrenching trades have proven to be his most successful...
I agree it doesn’t make sense to be in a hurry to buy stocks with weak technicals. HOWEVER the fundamentals are your trump card. A few years ago EMC was trading at tangible book ($4.41) and generating a few hundred million per year in free cash flow. This was basically free money although many insitutions refused to invest then because of the chart and some feared further weakness around December product introductions. It was a perfect time to buy despite the really bad chart and 52 week low.
This is a good post and a helpful discussion for most I’m sure.
Never buy a stock making a 52-week low: the reason that you are right and the emailer is wrong, is, simply, that this is a good RULE to follow. Traders need rules, to keep themselves disciplined. Any rules that will increase the probability of a good trade should be followed. This is one of the most simple and effective rules. Once trading rules start being broken, emotion takes over, and you are doomed.
Thats a fair comment — BUT you never know when a cheap stock will get cheaper —
I sold Micromuse as high as $205, and when the market cratered, it was one of those “value stocks” I wanted to own. I waited and waited and waited — finally it was down to book value — ~$2.73 or so.
I still waited. One day, on no news, it just collapsed — totally fell apart. Traded down to $1.43 or so — with $2 in cash!
I actually called Cody Willard, who told me he heard of a Janus telecom fund that was being folded into a larger fund — and everything in it was being liquidated.
I bought as much MUSE as I could stand — and in less than a year, it went to $10.
I would say that was more a special situation than a question of valuation . . .
I completely agree with the idea of avoiding stocks making 52-week lows. It’s just good solid technical analysis.
The only exception I would make is when I see a clear 5-wave Elliott Wave pattern with clear Fib retracement levels and momentum or other divergences in the 5th wave.
Such would seem to be the case with Dell at 23.
I don’t think that there is anything magical about technical analysis, it just gives you a framework within which to analyze price (and volume!) action. Sometimes it works and sometimes it doesn’t, but I really don’t see how you can pick entry and exit points (let alone a reversal) without it.
I think Barry is right- before you buy into a stock at a 52 week low, ask yourself if you would cover if you were short in it at that point? Put another way, would you short a stock just because it hit a 52 week high? I doubt that. Once a bottoming pattern forms on a loser and it has at least a week or so of strong up days, maybe… otherwise you’re just trading on guts in my opinion.
Fundamentals are important, but in theory are already accounted for on the charts, albeit by a lot of people who seldom understand what they are putting a price on. DELL is a good example- it went up a bit largely because of the decision to begin using some AMD chips which many considered to be proof that mgmt has come out of its coma.
But the AMD stuff is only going into some 4-way servers which are a very small part of the x86 server market. DELL will continue to lose share to others in the 1 and 2 way corporate markets and is still not in a position to compete in the 8 way market for super-computing projects (which spec AMD) where there are some nice margins.
Another “fundamental” that has been neatly ignored is the impact of rising transportation costs on DELL’s business model. They are heavily reliant on a JIT supply chain and that becomes progressively less efficient as fuel costs increase against some very thin margins for consumer level products.
So I would say that where basic technical analysis comes up short is when the fundamentals are either ignored or misunderstood by the pack and price/volume is distorted. But eventually, Reality the Assassin pays a visit and straightens things out again for a while at least.
The 52 Weak Low
Barry over at The Big Picture offers some very simple, but very solid, trading advice:
there is never a reason to buy a stock making a 52 week low. Never.
OK, so you can better understand both the point of my statement, as well as the philosophi…