The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

23 May 2006

Rack 'em up! - The Sequel

No matter how bullish or bearish an investor might be on any given situation, things change. Sheesh, you should not have to pay this site's hefty subscription fee to learn such a self-evident truth. And yet it remains a reality that seemingly surprises investors again and again.

For example, the decline in the market the past ~2 weeks. I warned you that it would occur before it began -- and provided the reasons why. But investors require the complex to explain the simple. So they quest for ex post facto explanations from people who never even saw it coming! Rather than ask those who did. Oh well.

Perhaps my most mis-understood post was this post re Rackable Systems/RACK. (At least it is so far; I feel confident there will be others. :-) My objective in writing it was to show the genesis of an opportunity as it unfolds real time -- from its first notice to its purchase; when, why, and how, etc. That initial post was to show that the key item that attracts me (and which does not necessarily mean that I consider it beyond that starting point), is resolute strength of the share price. RACK displayed that strength, rising to $56 from ~$13 in ~5 months. While recognizing that strength -- and the stronger the better -- I also recognize that things change; that the displayed primary up trend will give way to a decline, which itself should setup a new intermediate term base that endures for a minimum 3-6 months. During that interregnum, I perform my due diligence: does this stock truly merit my attention? Is it an opportunity? For how long? Etc. The fruits of this labor -- from first notice through due diligence to recognition of it as an investment opportunity that appeals to me -- were the subject of the initial post. What remained to unfold was the decline that would set up the base that garners my investment interest -- and dollars.

Which all is precisely what has transpired since my post, as thought, and right on schedule. In fact, although RACK shares have tumbled to ~$32 from $56, thereby scaring the bejeezus out of most investors, the shares have declined beautifully. Huh? Everything about this decline to date tells me that it is a correction in the stock price rather than a bear market for the company; the difference is that the share price will recover, and go on to new highs.

[click image to enlarge]

And here is the rub: while I expect my favored investment opportunities to be stronger than most during price advances, I demand they also be less weak than most during declines. And to conform to area patterns as they build. For example, whereas I had expected RACK to decline as low as ~$28 at the time I wrote the original post, I now revise that estimation to ~$32, very near to this past Friday's (5.19) intra-day low trade ($32.61). Why is that? Look at the chart above. Trend line 1 captures the important low trades of this primary up trend, if it continues. (Otherwise, it is incorrectly identified. Recall Rule 1 of an up trend line: it captures each low prior to a subsequent higher high; thus line 1 anticipates a higher high, higher than $56.) It shows Friday's low as tagging the line. Moreover, trend line 2 shows why the $32 again is notable support. And then there is item 3, the quickly-rising 200 day simple moving average, which itself is only weeks away from the same $32 support price. So there are three reasons why the share price for RACK should hold at this particular level. It is also why I will repeatedly purchase the shares in that zone: I prefer to purchase as close as possible to my sell stop.

I admit my methodology is not for everyone. Most investors require the market to ratify first their 'analysis' before taking action. Nothing wrong with that thesis, I suppose. The price of certainty, however, is the debasement of inherent value. Certainty itself is not a reward.

Consider that most investors reach for the news to explain the decline; in this instance, both of RACK as well as the market. And the 'news' for Rackable Systems/RACK right now is laden with all manner of reasons (rationale) as to why the shares should plummet even lower from here. Yawn. Not having expected either decline (that of RACK or the market), investors remain as confused and empty-handed as ever.

Learn patterns -- which do recur, and reliably so! -- and rarely again be surprised by market action. Or don't, and do. The decision, as always, is yours.
-- David M Gordon / The Deipnosophist

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