The FTSE Aim All-Share index is a few points away from its 2010 low (excluding the quick Covid drop). Liquidity continues to be dire and private equity continues to take out companies where the public market has undervalued them. Sopheon (SPE) is the latest to receive an offer, this time of 1,000p (a 104 per cent premium to the closing price of 490p).
It’s a difficult market for traders. The long and grinding bear market leaves fewer opportunities. When the market is in a roaring bull run, stocks are running up, private investors are happy to deploy more capital, and hot money is sloshing around, allowing for tighter spreads and good liquidity. There’s also a tailwind of cash inflows.
When the market is in euphoria, opportunities to short trash become abundant – stocks reaching dizzying valuations provide downside protection on shorts. For example, if you’re shorting a stock on 50 times earnings, then for that stock to double it would need to trade at 100 times earnings (earnings being constant of course).
There is plenty of hype left to be shorted in the early bear market months. But once the fear kicks in, valuations shrink, stocks collapse, and despair prevails. The risk/reward fundamentally shifts. Going long against the trends is not the way to go. And going short on stocks that could be taken over is a risky business.
However, the longer the bear market lasts, and the fewer market participants left, the more battered stocks become, and the bigger the upside once the market turns and begins to trend upwards.
There’s always uncertainty in the world (although that may seem hard to believe thinking of the pre-Covid era). A pandemic, series of lockdowns, spiking interest rates, the war in Ukraine, and military actions in the Middle East mean that any idea of going back to what former US president Warren Harding called a ‘return to normalcy’ is extremely unlikely. Money is no longer cheap, and that is the biggest monetary shift in the past 40 years.
So how should traders play it? Although the environment has changed, the game remains the same. Find stocks with rising charts, tight consolidations, and preferably with strengthening fundamentals. It’s certainly a lot harder in this market – and there are lots of fake breakouts (or fakeouts) – but as traders we need to be more selective.
One company that is on my radar is a company that I thought might go under. But it didn’t, and McBride’s (MCB) stock price has risen significantly from the lows. Does this mean it’s out of the woods? Absolutely not. But it does mean that the trend has now changed, and with strengthening fundamentals, it is a candidate for a potential swing trade.
Chart 1 shows the significant share price decline from 2017 to 2022. It’s a long and extended stage four downtrend, which paused during 2020 but resumed normal service in 2021.
Using simple technical analysis will keep you from buying a lot of stocks that are likely to take money out of your trading account. Downtrending exponential moving averages, a downtrending stock price, higher volume on down days than up days, and of course the obvious one: bad news.
Whenever a stock has bad news, if it is institutionally held, then it’s likely there will be institutional selling. This can put a lid on the stock price for some time as it can take time to exit. Then there’s the market cap threshold – if a stock falls below a certain market cap, institutions will exit. Plus, there’s the gamble factor when it comes to buying downtrending stocks. Do you have a fundamental edge over everyone else when it comes to working out what the stock is actually worth? The chances are you do not. And so any purchase of a downtrending stock is a gamble that you’re printing the bottom. The odds of which are highly unlikely.
However, McBride’s stock price chart from the past two years looks very different. There is a clear bottom, and the stock price is now uptrending, which shows the bulls have the upper hand. The company's trading update told the market that for the first three months of the current financial year McBride had traded around £8mn ahead of internal forecasts at an earnings before interest, tax and amortisation (Ebita) level. Given that Ebitda is cash (but not profit) we know that the business is performing better than expected in terms of cash levels – depreciation is a non-cash expense and so Ebita is simply Ebitda minus the depreciation. This is good news given the company’s heavy debt level of £166.5mn.
Moving to Chart 2, we can see that the price has hit resistance of 44.5p twice. But the problem is where I’ve marked the arrow, the drawdown from that high was around 30 per cent. It’s no good having a stop below that as it’s too wide. Therefore, I want to see the chart tighten up and volatility decline in the area below the resistance zone.
Stocks that are volatile before they break out are stocks to be wary of. It signals there is still significant selling pressure on the stock that needs to leave before we can enter the stock for an attractive risk/reward.
The bigger our stop, the more reward we need to seek in order for the trade to be attractive. This is why tight stops (but not tight for the sake of it) are attractive and to do that we need shallow bases to trade from.
I’m watching McBride to see if this happens and I also note the next news will be released on 20 November. There is earnings risk here, and so I don’t want to be holding the stock overnight into this update.
