In our discussion “What to short now and how DIY?” in 1/20, we mentioned VRX.
In that article we recommended the following for ordinary investors (not day traders, not professionals):
- Don’t short a stock just because you think it is going to die. Short is a lot more dangerous than long. For short, you need to know more about the stock than you would do for long. You need to know both the fundamentals and price movement of the stock.
- Shorting a skyfalling stock is more dangerous than longing a skyrocketing stock.
- Be careful in shorting a stock that has fallen more than 90% from its peak of the monthly channel. Similarly, when a stock has risen more than 10x, you need to be careful with the long position.
- Don’t short unless the price bounces back to the channel-short-point of the down-channel. Don’t buy unless the price bounces back to the channel-buy-point of the up-channel.
Don’t short penny stocks. Don’t buy penny stocks either.
VRX met condition 2, 3, and 4, so we did not recommend ordinary investors to short.
Valeant (VRX) is a drug conglomerate. It owns multiple brands and multiple products. It is very hard for an ordinary investor to know what’s going on with the company. There is no way an outsider could have known that Valeant would sell two of its product lines, and to estimate the impact of the asset sale accordingly.
The best an ordinary investor can find information is from companies’ reports or from places like Seeking Alpha, Finance.Yahoo, etc.
For instance, an article like “Valeant Is Very Likely To Widely Beat Earnings Estimates” may convince many into buying the stock.
However, the author pointed out that “Long story short: this is a momentum play, not a value play.” The author also stated that he was looking for a chance to long “option”.
We agree with the momentum play, as we think it is better to play safe. But, we don’t suggest ordinary investors to engage in option.
For ordinary investors, the best protection is to stick to fundamentals and pricing trend.
A stock to trade is when its fundamentals match its pricing trend. Better yet, the Earning growth matches the Channel formed in the price movement.
The timing to establish a short (long) position is when the price reaches the channel short (buy) point.
So, how to look at VRX for now as an ordinary investor?
- Short term. The sale of the two product lines will boost the short term financial statements. A good sign.
- Mid-term. The management seem to stop seeking for rapid growth. A good sign.
- Most drugs are simply too expensive. The government is trying to do something, but the effect is unknown.
Simply put, as an ordinary investor, we don’t know if everything is going to be rosy for VRX. So, use momentum play to protect yourself. In practice, use band-trading tactics to make calculated profits.
Let’s look at the daily chart, it forms a down-channel, and the price is near the lower wall of the channel.
For a down-channel, we do not recommend “buy”. If you buy near the bottom of the down channel, it is an act of “bottom fishing”. It’s a sign of greedy, since you don’t really know the fundamental. You don’ know if the company will be turned around.
If you want to take an action wait for signs.
- To long: The daily chart needs to form an up-channel, with at least two peaks and two dips. It would be much better that the second peak breaks the longer term channel, at least the weekly channel.
- To short: Wait till the price bounced back into the down-channel, and touches the channel short line.
Let’s use Earning Channel’s Action Plan to help us on finding optimal timing. We set the channel sell line that, a proper time to short is when the price reached the upper wall, and then back to $16.05. Notice that the channel lines will move along with the price, the actual alert is near $16.05 but not exactly. You can also move the line down to have a stronger confirmation.
We can also use the same chart to set a buying point for long. We use channel break-up as an indicator that the price movement breaks the longer term trend. Notice that we moved the channel break-up line above the place where prices used to tangle for a while. So that, when the price reaches this channel break-up line, it is more likely to form a new upward channel.
When channel break-up is reached, please double check if a daily up-channel has been formed. In this case you may want to build up your long position at $19.74. Please remember VRX is a big company. If it turns positive, its fortune may last for a long time. Just like Peter Lynch taught us, there is always a second chance to buy, if the target is good enough for buy-and-hold.
Normally, the break-up is used to protect short-squeeze. You should always protect your short position with stop loss and channel break-up. In this case, to protect short-squeeze, you may want to move the break-up line lower, so that you will buy back to cover at $18.07.
So, here’s the conclusion.
Don’t bottom fishing.
Don’t try to be the smartest, buying at the lowest point, and selling at the highest point.
Don’t establish a long position in a down-channel.
Wait for confirmation to short or long.
The minimum confirmation for long is when the daily down-channel has been broken and turned into an up-channel.
The minimum confirmation for short is when the price touches the channel short point on a down-channel.
Hope this exercise is useful to you.