DAVE'S DUE DILIGENCE
Bewitched, Bothered & Bewildered
By David Jennings
Thursday, August 03, 2000 10:06:00 AM
Last night's e-mail contained a question from Ken C.: "How can I tell if a sell-off is bullish or bearish?" The question was in reference to a July 31 column which discussed a selling climax for GSI Lumonics (Nasdaq: GSLI) and its bullish implications.
To provide some perspective, last Friday the stock gapped down over a point from the previous close to around 26, fell sharply lower, and actually reached an intraday low of just above 20 by 10:40 AM. Turnover in that period was well over a million shares. The stock rallied from that low to the 25-level through the remainder of the session.
Monday was a follow-through day. After opening slightly lower, GSI Lumonics rallied again, rising to a high of 29 in the afternoon. It faded toward the close to just under 27. In the past two days the price has declined on lower volume to where it went out yesterday at 24.
After the final bell, the Kanata, Ontario company reported sharply higher sales and profits for its latest quarter, and guided investors and analysts during its conference call toward improving sales due to a growing backlog of orders. Management also said it's expanding its telecom equipment business through the purchase of a private optical components company.
All in all, it was an optimistic report from a growing high-tech company that builds laser-based equipment used in automated manufacturing to the semiconductor, electronics and automotive markets. That's the company's bread and butter. The telecom equipment segment represents only a very small portion of the revenue stream.
Getting back to Ken's question, the previous column dealt with how GSI Lumonics' recent chart pattern provides a classic example of the four phases of a major operator's campaign. Legendary market technician Richard Wyckoff described these as accumulation, markup, distribution, and markdown.
GSI Lumonics stock has made what's known as a "round trip." After a period of several weeks of accumulation at the 21-level, the price was marked up steadily from early June to a peak of around 42 in mid-July. At this point, the shares were distributed to retail investors over the course of a few trading sessions on above-average volume. Once distribution was completed, major operators then sold short. Next came the markdown period when the share price was allowed to fall naturally.
The culmination of the final phase occurred on the morning of July 28. The price had fallen back to a point where major operators covered their short sales. It coincided with the price level where accumulation took place during late April until late May. Investors now have another phase ahead of them.
Just what it will be is up for debate, but that's part of how the stock market works.
The July 31 column also referred to an article about selling climaxes in the July issue of "Technical Analysis of Stocks and Commodities" by Martin Pring. Generally speaking, selling climaxes are thought to be bullish. Indeed, GSI Lumonics did rebound from a low of 21 to 29 before fading again.
Pring also notes that a rally following a selling climax is often accompanied by a test of the selling climax low. "The tipoff that the test will be successful can be seen from the fact that volume dwindles to almost nothing, indicating a lack of interest compared to the tremendous excitement at the previous low. The lack of interest at the second bottom typifies a very fine balance between buyers and sellers. Consequently, when the rally starts, it usually represents the early stages of a major move."
In my view, the stock has to retest its low which occurred during the July 28 selloff at 21 before it can rally again. If it doesn't, then investor perception will turn extremely bearish. They will begin selling their positions in order prevent a small loss from turning into a large one.
Wyckoff also advised subscribers to the market newsletter he published from 1908 to the late 1920s to implement stop loss orders with all their transactions. He felt preservation of capital was a primary factor in achieving investment success. If nothing else, stop orders provide a measure of protection against unexpected catastrophic events that could take place at any moment.
Richard Ney put it another way. "He who sells and runs away, lives to buy another day."
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