All stock market traders – and plenty of investors – are trying to find stocks that are poised to go on a run.

But how to find this appetising situation – preferably, before everyone else? That is the conundrum.

Many investors swear by the broiling pot of technical analysis, in which the chart of a stock’s price and volume can, to the experienced eye, give up its likely future direction.

Trader Andrew Doig says most charting software available on the market comes with “a million esoteric indicators”, but he relies on a “bunch of fairly standard, simple indicators” to pinpoint potential breakouts.

Doig’s main tools are moving averages, relative strength indicator (RSI) and stochastic oscillators (momentum indicators that use support and resistance levels) to indicate price breakouts, which he then follows in short-term trades. His average trade length would rarely be longer than four to five days.

Some of the stocks he has traded into this year include African coal miner Riversdale Mining (RIV), gold and copper explorer Avoca Resources (AVO), coal producer Whitehaven Coal (WHC), underground coal gasification (UCG) and gas-to-liquids (GTL) technology player Linc Energy (LNC).

He first noticed Riversdale at levels around $7 in early February: the stock rose to $11.30 by late June. It’s currently around $9, and he thinks it still holds potential. Avoca was another that he liked around February, at levels around $1.60: it got close to $3 by late June, and is currently around $2.70. He still likes the stock.

Doig took a liking to Whitehaven Coal at around $4.80 at the end of June, and with the corporate action the stock has risen to around $6.30. “Coal is a hot sector, but we may see a pullback in Whitehaven before another attempt on the upside – but the stock has some work to do around $5.50 levels first,” says Doig.

Still in coal, Linc Energy (LNC) gave what Doig describes as “super strong buy signals” at $1.00 on July 1. He recently took profits at what he says were “overbought” levels at $1.95: Doig says the stock may come back to levels around $1.60, before “trying again.”

Another approach altogether – at the other extreme from momentum and technical-analysis based traders – is the fundamental stock selection process.

Fundamental analysts assess the financial health and level of financial risk of companies with the help of financial statements such as the most recent half-year and full-year reported results.

Stocks are analysed against a series of key indicators, including financial health, management, share price value, liquidity, share price trend and market capitalisation.

Elio D’Amato at Lincoln Indicators says a hot stock for a fundamental analyst is one that has either “sound fundamentals getting even better, or poor fundamentals improving markedly…improvement in either or all of the balance sheet, the profit and loss statement and the cash flow statement is a pretty key indicator that you can identify early, and it will always get picked up by the market eventually,” he says.

As an example, D’Amato points to engineering company Forge Group (FGE) and TPG Telecom (TPM). TPM was always a healthy business, but the real catalyst for TPM was its acquisition of PIPE Networks, says D’Amato. TPM has risen by around 80 per cent since August 2009.

Another stock D’Amato likes is Thorn Group (TGA), the old Radio Rentals business. “Thorn has been able to really get a niche in an emerging market of high-technology turnover in a lot of middle-income families, who are seeing the worth of turning product over. Strategic acquisitions have also helped Thorn too.”

D’Amato says you often see stocks putting in good results year after year, growing their earnings, but it takes a while for the market to pick up on it. “That’s where you can find the opportunity to look for the consistent performers, and eventually the market will repay the faith. When is the big question – but if the company keeps performing it will do well.”

At the moment, a couple of stocks that D’Amato thinks are in this position are PanAust (PNA), a copper producer in Laos, and Cellestis (CST), which makes a tuberculosis diagnostic and treatment. “PanAust is a good business, and Cellestis is a stock that has been producing good results year after year, but the share price is 25 per cent lower than a year ago…the market will repay faith in those sorts of businesses.” 

He says Cellestis has earnings per share treble what it was in December 2007, yet the share price is only up by about 50 per cent in comparison. “There’s a lot to like about stocks like that, where the earnings growth is quite attractive, but the price, although it’s rising, is not keeping pace with the earnings. When the market finally cottons on to the growth story of what some of these companies are about, they can be rewarded with a sharp run in the share price,” says D’Amato.

Gary Stone of Share Wealth Systems looks for situations where the volume is increasing, the price is breaking out – making new highs – and which have relatively high volatility, which gives the stock the potential to rise quickly.

Good examples of situations this year have been African gold and zinc producer Ampella Mining (AMX), African iron ore project stgeloper Sphere Minerals (SPH), US petroleum producer Samson Oil & Gas (SSN) and gold explorer Beadell Resources (BDR).

“Between March and September 2009, AMX rose from 10 cents to 60 cents, but on thin volume which would have been too illiquid to generate any worthwhile absolute profits. It then consolidated for four months between 50-70 cents.” He noticed a breakout entry signal to enter on 18 January, at 63 cents. “Daily turnover had risen to over $175,000 by then. AMX started rising steadily as did its volatility – from 3.9 per cent to more than 10 per cent,” he says. A volatility exit signal to exit on 24 May at $1.46 generated a gain of 131 per cent. “AMX has since tracked sideways, potentially setting up for another move,” he adds.

Sphere Minerals was a similar scenario, he says. “Pre-GFC, SPH had traded as high as $4.20, but its share price took a pounding, reaching as low as 20 cents late in 2008. Early in 2010, relative strength analysis showed that SPH had started to outperform the market.” He observed a breakout signal to buy SPH on 15 February, at $1.095. “A volatility exit occurred to exit on 29 April at $1.935, after a move of 76 per cent, and SPH is now trading around the mid $1.40s.”

More interesting are the trades that are still ‘open’. Stone spotted an entry to Samson Oil & Gas on 28 June at 3.8 cents, following a momentum signal. “Despite its low share price SSN was turning over more than $1 million a day then, and has since increased daily turnover as the share price has risen to 6.7c, a move of 76 per cent.”

Another open trade, Beadell Resources, was signalled as a breakout entry on 19 July at 20 cents. “Volatility has steadily increased from 5.9 per cent to 8 per cent as traders have moved into this rising trend, and BDR, is trading at 27.5 cents, up 37.5 per cent so far,” says Stone.

Analyst Delia Langdon uses a very different process, which focuses on “market activity”: the actual supply/demand situation for the stock, the buying and selling by the stock’s directors and associated parties, and the number of buy, sell and hold recommendations for the stock by brokers. In particular, Langdon looks for increasing buyer demand and the presence of ‘smart money’, or small amounts of people buying large parcels of shares.

Langdon says recent good performers using this criteria are oil and gas producer Roc Oil (ROC), resources engineering group Ausenco (AAX), gold and copper explorer Straits Resources (SRL) and mining services group Monadelphous (MND).

An example is ROC, first noticed on 1 July at 31 cents, the reasons being the directors had bought more than $500,000 worth of stock; the average recommendation (while still only a hold) was increasing, so it was becoming more popular; and there was large support in the market depth queue at 30.5 cents. Smart money was actually not evident at the time, and buyer demand was low – there were three times as many buyers as sellers. Support in the depth queue was a further plus.

Today, ROC is at 37.5 cents (up 20 per cent). “ROC had evidence of smart money at the end of August and a huge increase in buyer demand, but this has since come off the boil last week and the price consequently has fallen, in line with recent market falls,” says Langdon.

Ausenco was spotted on 7 July at $1.805, because the stock was trading at a 52-week low; buyer demand was increasing, after massive price re-rating on profit downgrades; nine brokers gave it on average a ‘buy’ recommendation; and there had been recent buying by a director (albeit a small parcel). The price today is $2.24 (up 24 per cent).

Langdon says Straits Resources (SRL) looked a buy on 8 June at $1.195, mainly because smart money was increasing at prices around that level; brokers were increasing their recommendations; and there had been director buying. The price today is $1.385 (up 16 per cent).

Monadelphous Group (MND) was noted as a good buy on 25 June, the reasons being:

– buyer demand and smart money had risen sharply following price declines; directors were buying; 13 brokers gave the stock on average a buy recommendation; and there was divergence between price and buyer demand. “As the price was falling in May, buyer demand was on the rise, which is a very good sign,” says Langdon. Today MND is trading at $14.07 (up 14 per cent).

 

Other articles in this week’s newsletter

The Fastest Moving Stocks

18 Share Tips – 16 Aug 2010

How to buy and sell shares with conditional orders

Is This Stock Swimming In Debt?

Boost Bond Returns With Laddering

Should You Be Range-Trading and Trend-Trading?

Mid August Is The Best Time To Buy Gold Stocks

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