How to Spot Profitable Opportunities
Note: This article was originally published in February 2018. This article will follow up on the original set up, and show how the trade played out over 9 months.
One of the worst things that traders still do to this day is ignore stocks at 52-week lows, even when it comes to the biggest stocks in the world.
That’s because they believe three ideas:
- It’s never safe to buy a stock hitting a 52-week low.
- Stocks in downtrends tend to stay in downtrends.
- Nothing is more destructive than thinking a 52-week low is a good buy
But to be honest with you – that’s exactly when you want to buy. When everyone else is selling and becoming fearful of big named stocks, buy.
The question then becomes – how can we tell where the bottom is?
We simply abide by what herd mentality and momentum is telling us, which we can decipher using several technical indicators and fundamental analysis.
Look at iRobot (IRBT) in February 2018 for example.
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Here’s a well-known company that builds and sells robots to the global consumer market.
You’ll also notice there was a massive hole in the chart, which we can blame primarily on a ridiculous amount of undue fear. At the time of the sell-off, the company had just posted strong quarterly growth and profits. Sales in its fourth quarter were up 54% to $327 million, beating expectations. Then, even though the company predicted it would see $1.05 billion to $1.08 billion in 2018 sales, and earn EPS of between $2.10 and $2.35, which will work out to 19% growth, the Street wanted to see $2.70 instead.
That’s what sent the stock down 30% -- projections for 19% growth.
You can now begin to see just how ridiculous a 30% drop in the stock was. Fear was palpable for no real reason at all.
After identifying the fundamentally issue and concluding their was a severe overreaction, which lead to severe amounts of fear, which lead to a severe gap down, we can then begin to identify opportunity using technical markers, such as relative strength (RSI), Bollinger Bands (2,20), MACD and even Williams’ %R.
Let’s look at a two-year chart for clear historical picture.
- Take a look at what happens when IRBT hits the lower Bollinger Band set at two standard deviations above and below the 20-day moving average (2,20). It bounces.
- Now look at what happens when RSI hits the 30-line or drops below it.
- Now look at what happens when MACD slides too far south.
- Now confirm it all with Williams’ %R at or below its 70-line.
By first identifying why a stock sold off, we can then begin to look for opportunities using technical setups, which tell us what the herd is telling us. In this example of IRBT, we can see the herd overreacted in a big way to the downside.
The next time some one tells you that stock in downtrends tend to stay in downtrends, or that trading a 52-week low is never safe, pay the argument no attention.
Update: November 15 2018
IRBT bounced off the lower Bollinger Band as expected, and re-tested lows back in May. After that, it enjoyed a steep upward climb, from $64.53 to near a high of near $120 in August. When fundamentals and technicals point to oversold conditions, it can often present a buying opportunity.
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