Review of RVBD, Chart reading Tutorial

[Mike]

Riverbed Technology Inc was an early leader from the 2009 market bottom. It broke out of a split adjusted price of $12.28 during the week of 3/13/09 when the general market was signaling a new uptrend. That was the first-stage base. The PE was 20 and the 2011 forward EPS estimate was 0.85 at the time. This leads to a 130% expanded PE price target of $39.10. RVBD went on and formed a second, third and is in a 4th stage base stucture now. 3rd and 4th stage bases are called late stage bases. By the time they are formed they are on everybody's radar screen and investors that want to be in are in already. It is difficult then to find new money to come into the stock, often the late comers rush in at the end causing climactic price activity as new buyers become exhausted.

RVBD broke an upper trend line the week of 10/22/10 with a weekly spread being the largest price spread since the beginning of its run. Breaking upper trend lines and having largest spreads are potential climactic activity. RVBD had further to run however. Just prior to reaching its price target RVBD exhibited a weakness. On the chart it is labeled 2D, 2U. This means that RVBD weekly chart pattern exhibited two sharp down weeks followed by two up weeks closing at a new high. This is actually a weak pattern and stocks can be sold imediately on this pattern. RVBD shortly thereafter broke the computed price target and began an immediate correction which is where we are now. RVBD is now showing a possible head and shoulders topping pattern.

When too many leaders look like RVBD the leadership is out of gas which can cause the market to top. Too many topping late stage bases can be associated with an exhausted bull market.

[asomani]

Great stuff, Mike.

Do you have an opinion on linear vs. logarithmic charts for leading stocks? Do you know what is used by WON and those he's personally trained?

Thanks.

[Mike]

Great stuff, Mike.

Do you have an opinion on linear vs. logarithmic charts for leading stocks? Do you know what is used by WON and those he's personally trained?

Thanks.

Yes, I use log charts on longer views like Weekly interval charts. These are the only charts I draw trendlines on. I use Linear on daily charts. This is what Bill O'Neil uses and recommends. Bill primarily uses weekly charts in his analysis. He might use a daily chart when it comes to a buy or sell decision.

[Tom Ellis]

Thanks Mike for the excellent post. Having a P/E Expansion Target met, an upper channel line broken, 2 Up Weeks and 2 Down Weeks, an A/D rating of D-, along with the head and shoulders pattern certainly calls for caution with this stock. I appreciate you pointing this out as I will be more aware of these sell signals as I do my review tomorrow.

[ericoleman]

Mike,

RVBD's plunge highlights the subtle clues that you shared in your valuable lesson, which are likely only discernible to someone with vast experience and depth of knowledge. Thank you for the instruction, and I look forward to more posts of this nature.

Best,
Eric

[168barrel]

Thanks Mike for sharing the knowledge . Do you think APKT is in same predicament . Looking at the daily chart , to me it looks like a good short setting up .

[Mike]

Lets look at the APKT chart.

I computed a price target based on the well formed base just above $10 in 2009. The PE was 30 at the breakout and at the time forward estimated earnings in 2011 were $1.16 as they still are. Using 130% PE expansion this yields a price target of $80, this is not an exact science. It looks to me like APKT has topped out at $84.50 approximately where I would expect it to. I suspect the large weekly spread week of Feb 4 was a climax run. APKT made a new base after the climax run and broke out. It failed that breakout when it dropped below the 10-week line four weeks later.

I marked something on the chart "2D, 1U". This means 2-weeks down, 1-week up to a new high. This is a weakness pattern. A quick substantial drop and quik rise to a new high without putting in the time to form a base of sufficient length is pattern that usually portends weakness and you can sell immediately when seeing this pattern after a sizeable advance like APKT has put in.

Now I can see that a head and shoulders pattern has been established and the 10-week line is acting as resistance. APKT belongs on a short-position watch list for such time in the future it rallies back into the 10-week line. The last rally up to the 10-week showed an LEV divergence. The price rallied and Large EV stayed flat. I believe using EV in this way helps identify weak rallies into resistance that are likely to be turned back.

[168barrel]

Many Thanks for all that you done and showing us the way . That PE expansion formula you use is quite spot on ! I think I just found an arrow to add to my Quiver .

[Mike]

130% PE Expansion is taught by Bill O'Neil in some of his seminars.
The general procedures is as follows:

Pick the first institutional quality base coming out of a bear market. This usually means the price is above $10 and there are some earnings. Look for obvious volume clues as an indication of institutional activity. Find the initial breakout from this base and on that date you write down the PE. I keep the electronic version of Investor's Business Daily on my hardrive (back to January 2003). I can then look up historical PEs in the stock tables. Multiply this PE by 2.3 (same as adding 130%) and then multiply by future earnings estimates 18 months to 2 years in the future. This is your price target. For large cap stocks you can expand by 98% instead.

Now that you have done this you are not flying blind as to what kind of gains the market supports on a historical basis. When approaching a price target on a position you hold you can tighten up what ever mechanism you use for selling positions with some assurance that the upside potential is now limited.

[buzzman]

Hi Mike,
Thank you for the great analysis. I have added a couple to my short list.
What service do you use that provides all of the info on one chart?
Buzz