MLR - A leading group got hit hard. What to do now? Is the stock market more likely to head higher or lower from here?

Published : January 21 2011 at 10:47 ET

The disappointment in leading cloud stock FFIV after Wednesday's close was due mostly to a shortfall in revenue projections going forward, a first in many quarters for FFIV. Other cloud stocks gapped down following FFIV's announcement. 

It is being debated whether the market will not correct further because QE2 (quantitative easing) has been fueling the market higher. The point is raised that when EQIX disappointed the market on October 6, 2010, other cloud stocks followed it lower. But after the short, sharp correction in cloud stocks, the group as a whole moved higher, outperforming the general market which, incidentally, also moved higher.

However, EQIX was not a leading stock in the cloud space before it disappointed the market. FFIV, however, was a leader. So it really comes down to whether QE2 can overcome the damage done to leading stocks over the last couple of days.

In the end, price/volume action of the major indices and leading stocks will point the way forward. After EQIX's debacle in October, a number of leading cloud stocks issued quality pocket pivot points which were buyable and profitable, so we sent out a number of reports in real-time whenever we saw such activity (APKT, PCLN, ROVI, etc in just October alone). Note, the profits from the winners far outweighed the small losses taken in the pocket pivots that did not work, assuming you adhered to your sell stop rules. Even the gap down of ALGN would have been an -8 to -9% loss from its pocket pivot buy point. And historically, such gap downs are very rare. Most importantly, we must remember that even legendary investor William O'Neil's success rate was 50% at best during good markets, which further stresses the point of always sticking to your sell rules.

In our model portfolio simulator detailed in our Follow The Stock service, we give guidance as to position sizing in relation to maximum potential losses, especially with the recent FFIV disappointment. Had any of you owned any FFIV, you could certainly recover quickly providing your position sizing was not over extended. On the other hand, if you had bought FFIV on the day of the October 26, 2010 pocket pivot, you would still be up about 10%. That said, when a stock gaps down, it is almost always best to sell and ask questions later.

On an administrative note, we very much enjoyed giving our first webinar here at Virtue of Selfish Investing, and are delighted that many others, including some who were not able to attend, have requested that we do a second webinar. We will be offering a second webinar possibly as soon as this Sunday, though we may instead decide to give another webinar again in real-time during trading hours in the coming week. Stay tuned.


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