Thursday we saw Penson Worldwide (PNSN:Nasdaq) drop over 20% after cutting their earnings forecast. This is what I call a “Dumper Play”, and we might be seeing a lot more of these as we head into earnings season. So let’s talk about Dumpers.
First of all, what is a Dumper? Dumper is the term I use to stocks that are down 20% or more overnight because of bad news. Take the previous day’s closing price and multiply it by .80. That gives you the "Dumper" price.
Why 20%? I think we are conditioned as consumers to act at -20% levels. A typical sales price starts at around -20%, so that is where we start to perceive a bargain. If you see 10% off, its more of a bonus, not really a “sale”. But 20% off, or even better 1/3 off, those are great sales. Once you get into 50% off sales though, you have to be a bit careful. Those are either super deals, or junk left over from last year that no one else wants.
This thinking is really similar to the way that Dumper plays work. Those typical sales percentages also correlate closely to Fibonacci percentages, which are 0%, 23.6%, 38.2%, 50%, 61.8%, 76.4%, and 100%.
Since we are planning on reselling our “sales item”, we need to be very careful that we are buying something that is desired by the market, and not just something that we personally perceive as a good deal. So I look at these percentages as "lookout points" for support. At around -20%, counter reactions start to become predictable. That is a point where people often react. But like any day trade, we first look for set-ups, then we need to see confirmation in the tape. Don’t fire until you see the whites of their eyes. So at 20% off, I start looking for support.
If a stock is only down 10% or 15%, it might have a nice rebound, or it might simply remain a weak stock. It’s not quite as predictable as a real “Dumper”. Dumpers have an important element, which I call the "Oh my god look at that!" factor. No one says, “Oh my god look at that”, when a stock is only down 5%. It needs to be a large enough drop to attract attention, like a train wreck. The counter reaction is only going to be predictable, if a lot of people are watching and being tempted. So you need a large drop and active volume.
When you are playing Dumpers, it is it very important to be aware of the fact that you are dealing with a lot of panic and pain. Fear is a powerful emotion and it will create dramatic moves in very short amounts of time. This is great if you are on the right side of the trade, but its going to be fatal if you are a stop blower.
So if you are at all in danger of blowing a stop for any reason, whether it’s a psychological reason or a shaky connection, stay away from Dumpers altogether. Do not trade Dumpers unless you are 100% focused and disciplined!
When we are playing dumpers, we are usually going after the first counter-reaction to the initial panic. The market always overreacts and the first reactions to news are often the most intense. Imagine your 16 year old daughter tells you she’s pregnant. Your first reaction is probably going to be "What????!!!!" Then, after the news sinks in, you can assess situation better and decide on a more appropriate response.
Maybe after calming down and really thinking about it, you decide ok, this isn’t an ideal situation, but we love her, we can help her raise the child, and she can still go to college. So there is some recovery. Or maybe you decide to go ahead with your plans to shoot the boyfriend and things slide downhill from there. But the first reaction is probably going to be the most intense. It’s the same with Dumpers.
So at the 20% mark we start to look for the situation to calm down, and look for confirmation of a counter reaction. Lets take PNSN as an example. It closed on July 3 at 25.36, and before the market opened on July 5 it hit a low of 19.64. The “Dumper price” was 20.29, so it hit well below that mark. Since news generally comes out before the market opens, and since the first reactions are usually the strongest, we want to carefully watch the pre-market action.
When I see a Dumper, I categorize them as either "Good Dumpers" or "Bad Dumpers". A Good Dumper has good volume and strong pre-market support off of the low. The counter reaction to the "dump" comes in strong and clear. The market identifies it as a bargain and snatches it right up. They will generally open well above the pre-market low. Dumpers usually drop a bit from open, because there are usually some remaining jitters, but if it is a "Good Dumper" it will hold support after open at a double bottom near the pre-market support, or at a higher low. And if it does, that is your long opportunity.
Bad Dumpers might have some pre-market support, but they will often come back down and open close to the pre-market low, so that when they drop from the open, they hit lower lows. The downtrend then, will still be intact.
You want to catch a Dumper long when it starts to up-trend, when it is hitting a higher low, or a double bottom, and starting to recover. If it opens at the low and sells from open, then its still weak and its going to be harder to find the bottom for a long. If it recovers off of the pre-market low and opens above that low, but then sells down from open to hit lower lows, then its still weak. The downtrend is still intact. So my rule is, “Go long Good Dumpers, and short Bad Dumpers”.
The ideal situation for a long is when the Dumper opens up above the pre-market low, and the market immediately identifies it as a bargain and snatches it up. It then drops back a bit from open, but never has a chance to revisit that low. You want to grab it off the first pullback for a long, and ride the first climb.
Can you play a bad dumper? You can try to catch the first bottom, wherever that might be, but you are dealing with much higher risk if you go long before it has started to establish an up trend. You have to be careful that you aren’t trying to catch a falling knife, and for God’s sake don’t let it hit a new low, because when it falls to new lows, it can fall fast. You are dealing with panic, so I prefer having the cushion of previous support.
The other option for playing a bad dumper is to short it. If it opens near the pre-market low, hits lower lows after open, gets a small climb and starts to falter, short it. From there, it should continue to downtrend, hitting lower lows, and can keep falling all day. If it is supported at a double bottom, exit. You can also wait and short the breakdown to a lower low, which confirms the downtrend if you can catch it. Don’t short it if it gets a big pop though, because that is a sign of recovery.
In the case of PNSN, it hit a pre-market low of 19.64, and popped to 20.94. I would normally categorize it as a “Good Dumper” because of the strong pre-market recovery. It opened at 20.73, well above the pre-market low. So normally the first bottom would be worth a long, if I could time it, and if it was supported above the pre-market low. The amount of selling that came in at open though, took it down below the pre-market low by 9:34 ET, and put it in the “Bad Dumper” category.
Looking for a long position at that point was higher risk. At around 9:48 ET, off of 19, we saw a better bottom set-up, but the bounce was small, only about 40 cents, before it started to falter. That was your short opportunity on this “Bad Dumper”, and from there it continued down to lower lows.
So this earnings season, the next time you run into a Dumper, remember its usually best to “Go long Good Dumpers, and short Bad Dumpers”, keep your stops tight, and don’t shoot the boyfriend.