Anatomy of The Charts of Multi-bagger Stocks
A Study of How Mr. Market Creates Opportunities in Super Performing Stocks
There have been many super performer stocks almost every year that go on to run 10x or more in a couple years. I like studying the charts of these super performers and try to identify them early to get on the bandwagon at a relatively safe entry point. I have a set of elements that I look for in a stock’s chart setup that I think signal the stock has a high probability of entering a charged bull run. Having all of the elements do not mean that the stock will absolutely 100% rise; these elements are something I observe while studying some of the best looking charts and I have been fortunate to have picked out and played a couple of them using this setup:
The stock has dropped more than 90% in the past few years.
After the stock having dropped 90%, those prudent shorts who had built their short position at much higher prices have the incentive to realize their profits. Prudent long term investors might have started building their position for the ride back up because the stock might have dropped enough and entered a value area. It is important to note that this criterion by itself does not mean the stock is about to turn. As you are well aware, it’s mathematically possible for a stock to drop another 99% after having dropped 99%. Satisfying this criterion just means that conditions might be ripe for certain types of strong market participants to enter the market and create some buying power.
The stock has started building a base after the 90% decline, that is, visually on the chart, the stock has entered a period of wild chopping action, which likely means some buyers have started covering or building a long term position. As noted in my previous post, this period can last between a few months to about a year and can span 200+% top to bottom. The highly volatile choppy action is designed to shake out weak market participants such as those sitting on long term large losses from buying during the previous vicious decline, or short-term traders who just want a quick gain. Quick gains and losses of 50+%, creating the chopping action we see on the charts, after 90% decline is a tactic to lure those stubborn traders sitting with big losses to finally give up on their position with the last shred of dignity.
Surprising strength/reversal with strong relative volume accompanying the solidly advancing weekly candle bars.
This is a strong signal that the stage 1 base building is ending and the stock is about to commence its big run. Strong volume on big advancing weeks shows committed buying power and in my view the best indicator for future gains. Note that “surprising” here is a subjective word and that’s why trading is an art rather than a science. It’s an impression you get towards the end of the base building phase, that Mr. Market would create the anticipation that the stock would continue to go lower until suddenly the strong buying comes in to finish the base building phase. There are quite a few ways that Mr. Market creates this anticipation and I will add my impression in my study case to elicit this point.
During early stage 2 advances, the stock should rarely break below shorter term moving average and if it happens, it should last only a week or two.
We can anticipate the stocks that go into a strong advancing phase to “act well” and defend their moving averages religiously. With this anticipation, we know when we are wrong and we can create a trading plan to use some simple indicators such as weekly ema to cut our losses early and just ride the stock as long as we can.
Market Capitalization is 300-500M or lower.
This is really the only fundamental metric I look at when I am planning a trade. Lower market cap gives the stock runway for bigger gains. I don’t look at other valuation metrics like P/E or P/S because I strongly believe that stock’s prices/price action give you all the information you need to know.
Example 1 - NetEase(NTES)
The backdrop was that NetEase, a Chinese internet company, went public almost immediately after the 2000 internet bubble had burst and the result was a logical, vicious 97% top-to-bottom decline in just over a year. After it made the all time low in July 2021, it started a stage 1 base building phase with the typical volatility. Volume dried up in this base building phase. Notice that towards the end of the base building period, the stock had bumped against a previous low of split-adjusted 0.05 and started a “slow bleed” decline that’s kept under the 10 ema most of the time, creating the anticipation that the stock will continue its decline and one day break previous all time low. SURPRISE, it didn’t! And then in April 2002, buying interest suddenly showed up and the stock broke out of the base with two consecutive weeks of passionate buying. This surprise element is somewhat important because the price action itself creates buying demand as it flashes a big warning signal to those still holding a short position and draw in those on the sideline still waiting on the sideline to hope to get in at a lower price. The optimal entry point is buy as close to the 10 weekly ema as possible after this initial strong break out with a stop loss at the 10 weekly ema; The profit taking rule then, as the stock advances, is to stop out with a weekly close below the 30 weekly ema. If you had just been following this strategy with strict discipline, you would have been able to ride NTES until November 2003 for about 2,000% return in a year and 7 months.
Picking your own battle
As I reasoned in my previous post, one important advantage that retail investors have is that they can pick their own battle. As retail investors, you have the choice to wait for the optimal entry point. The optimal entry point is after the break out of the stage 1 base and not while the base is building. Just imagine if your were buying on the way down or while the base is building, you would likely be sitting on losses, big or small, wondering whether to cut loss as the stock drifts or plunges down from day-to-day. If you had entered after the optimal entry point presents itself though, you would have a relatively smooth ride to 2000% return. Yes, it had a couple of violent shakeouts along the way(there were two 40% declines with one of them breaking below 30 weekly ema but closing back above by the end of the week); These violent shakeouts are to be expected during phase 2 advances; If you bought near the breakout point, you would likely be sitting with a healthy profit to keep yourself calm and be at a much better position to take a wait and see approach to see the stock pick itself back up and continue on its march higher. I find this mental advantage super helpful as it keeps me cool during time of stress. It’s no fun seeing your stock dropping 40% in a couple days/weeks, but if you were still sitting with a healthy profit or only a small loss after the decline, it keeps you objective, clear-minded, and decisive to take action(if necessary).
