Beaten-Down Small Cap Looks Poised for a Powerful Breakout

StreetAuthority Network

Buying on weakness and selling on strength is the hallmark of the professional trader. While the average Joe investor attempts to buy stocks as they are climbing higher, the professional quietly waits for prices to drop in order to enter positions.

Obviously, not all declines should be bought. Sometimes a falling stock just keeps on falling until it's close to zero. Professional traders call the attempt to buy stocks that keep dropping trying to catch a falling knife. 

The question is how does one tell the difference between a falling knife and a simple pullback that should be bought? Here are three ways to help you tell:

1. Determine what caused the pullback.

If the pullback was caused by a one-time special situation, like an earnings warning, negative rumors, or even the selling of shares by an institution, this can create an opportunity to purchase shares at a discount. However, if the negative news comes in waves or something fundamental changes at the company, this could mean that prices will continue lower.

2. Watch the 200-day simple moving average.

The basic rule of thumb with the 200-day simple moving average is that shares that are in the process of dropping and are below that moving average should not be purchased. This can act as a line in the sand between buying and selling pressure. If shares are below the 200-day moving average and start to climb higher, this can be a buy signal depending on what caused the pullback.

3. Wait for the bounce.

Rather than trying to time the rebound, wait for it to start prior to buying. This is particularly critical with shares trading below their 200-day simple moving average. A bounce through a widely watched resistance level such as the 50-day or 200-day simple moving average can be a clear buy signal after a stock pulls back.

A recent example of a stock that has experienced a dramatic drop but has since bounced from the lows and appears to be setting up a powerful buying opportunity is small cap Aruba Networks (ARUN).

Aruba Networks is a California-based provider of computer network access solutions for mobile enterprises. In other words, the company provides Wi-Fi connection products and services. It boasts a $1.8 billion market cap, $586 million in trailing 12-month revenue, and almost $441 million in total cash. 

Most recently, revenue for fiscal Q3 2013 grew 12% to $147.1 million from $131.9 million in the year-ago period. GAAP net loss for the quarter was $20.2 million, or $0.18 per diluted share, compared with GAAP net income of $6 million, or $0.05 per diluted share, in Q3 2012. Non-GAAP net income for Q3 was $14 million, or $0.11 per diluted share, compared with $19.4 million, or $0.16 per diluted share, in the same quarter last year. 

Following the fiscal third-quarter results, released on May 16, the stock plunged almost 30% in one day.

In addition to the earnings miss, the small cap has been under pressure from legal troubles. Law firms have filed a class-action lawsuit alleging false and misleading financial information from the company. The alleged misinformation is due to the fact that Aruba Networks did not reveal its primary competitor Cisco's (CSCO) bundling advantage in the space. While I am not a lawyer and not qualified to comment on legal proceedings, this smells very speculative to me and difficult to sustain. 

It's important to note that despite the disappointing third-quarter results, gross margins remain strong and the company continues to operate effectively within its niche. So far, the stock price has agreed with my opinion. 

View photo

.
ARUN Stock Chart

The pullback has enabled savvy investors to buy on the bounce from the lows for almost 30% gains so far. Clearly no one knows what the future holds. Despite my bullishness on the company and skepticism about the lawsuit, anything can happen in the stock market. Always use stops and position size properly when investing. 

Recommended Trade Setup:

-- Buy ARUN on a break above its 50-day simple moving average at $16.45
-- Set stop-loss at $15
-- Set initial price target at $20.45 for a potential 24% gain in 12 months

Related Articles

Rates

View Comments (2)

Recommended for You

  • Tycoon buys 30 Rolls-Royces for Macau hotel

    A Hong Kong tycoon has placed the biggest ever order for Rolls-Royce cars, agreeing to buy 30 Phantoms to chauffeur guests at a luxury resort he's building in the global gambling capital of Macau. Stephen Hung's $20 million purchase surpasses the 14 Phantoms bought by Hong Kong's Peninsula Hotel in…

    Associated Press
  • 1 Tip To Lose Belly Fat

    It's Hollywood's Hottest Diet And Gets Rid Of Stubborn Fat Areas Like Nothing Else.

    AdChoicesagoodcooksSponsored
  • Tycoon's arrest sends shock wave through Russia

    Tycoon's arrest sends shock wave through Russia MOSCOW (AP) — The arrest of a Russian telecoms and oil tycoon has sent shock waves through the country's business community, with some fearing a return to the dark days of a decade ago, when the Kremlin asserted its power by imprisoning the country's…

    Associated Press
  • Before You Buy Alibaba, Check Out 4 Top China Stocks

    Before You Buy Alibaba, Check Out 4 Top China Stocks While investors gear up for Alibaba Group 's (BABA) hotly anticipated initial public offering, don't forget about other Chinese stocks that are worth keeping an eye on. Today's Young Guns Screen of

    Investor's Business Daily
  • Play

    Citi, Bank of America Offer Discounted Mortgages

    Citigroup and Bank of America will offer mortgages at discounted interest rates to help borrowers with low incomes or subprime credit. AnnaMaria Andriotis joins MoneyBeat. Photo: Getty.

    WSJ Live
  • Costco Stores in Canada to Stop Taking American Express

    “The credit card relationship between American Express and Costco Wholesale Canada will not be renewed when it expires” on Dec. 31, the company said today in an e-mail to Canadian customers. The message was attributed to Lorelle Gilpin, vice president of marketing and membership for Costco…

    Bloomberg
  • As Fed takes baby steps, Cramer's trick for profit

    In turn, Cramer says making money in the market, involves looking at the environment through the lens of the Fed. "The trick is to remember that they speak for the common person," Cramer said. "The Fed wants the common person to make money." With that backdrop always in mind, Cramer says it becomes…

    CNBC
  • "The Retiree Next Door": How successful retirees stretch their savings

    "The Retiree Next Door": How successful retirees stretch their savingsBy the time she hit her late 40s, Toni Eugenia wasn’t sure she would ever be able to retire. Eugenia, 56, a pharmacy technician who lived in Houston, was nearly $200,000 in debt and

    Yahoo Finance
  • Norwich Information Security MS

    Online, accredited, top ranked. NSA Center of Academic Excellence. Recognized by the Department of Homeland Security. Download your free brochure!

    AdChoicesNorwich UniversitySponsored
  • CNBC Anchor Calls Out Fed-Hater Bill Fleckenstein In Startling Shouting Match

    CNBC Bill Fleckenstein of Fleckenstein Capital appeared on CNBC's Futures Now program on Tuesday. Futures Now host Jackie DeAngelis came out swinging, asking Fleckenstein right at the top if he was willing to admit that he had misunderstood monetary policy. Sounding taken aback, Fleckenstein…

    Business Insider
  • Beanie Babies creator's sentence debated in court

    Beanie Babies creator's sentence debated in court CHICAGO (AP) — Federal prosecutors seeking to put the billionaire creator of Beanie Babies in prison for hiding millions in Swiss bank accounts told appellate court judges Wednesday that the toymaker's sentence of probation threatens to erode the…

    Associated Press
  • Apple to unveil new iPads, operating system on Oct. 21 : report

    The company plans to unveil the sixth generation of its iPad and the third edition of the iPad mini, as well as its operating system OS X Yosemite, which has undergone a complete visual overhaul, the Internet news website said. Trudy Muller, a spokeswoman for Apple, declined to comment. The iPad is…

    Reuters
  • Margaritaville casino owners seek bankruptcy

    The owner of Biloxi's Margaritaville casino has filed for Chapter 11 bankruptcy protection Tuesday, only hours before a hearing where the landlord aimed to seize the property. The filing by MVB Holding LLC in U.S. Don Dornan, a lawyer for landlord Clay Point LLC, said the company had planned to ask…

    Associated Press
  • Embraer to sell 50 E-175 jets to Republic in $2.1 billion deal

    Brazil's Embraer SA, the world's third largest commercial planemaker, said on Wednesday it booked a firm order from U.S. The deal, which will be included in Embraer's order book for the third quarter, is valued at $2.1 billion, the planemaker said in a securities filing. The planes will be operated…

    Reuters
  • Gilead Stock Is Falling On These Drug Setbacks

    Gilead Stock Is Falling On These Drug Setbacks Gilead Sciences (GILD) shares are backsliding Wednesday on news that the patient drop-out rate for hepatitis C drug Sovaldi is quadruple that of clinical trials. In addition, the biotech's Phase 2 study results

    Investor's Business Daily
  • Best Womens Wrinkle Creams 2014

    Mom reveals simple wrinkle solution that has researchers very excited. Try this free solution today to look and feel years younger.

    AdChoicesBellaLabs.comSponsored
  • Play

    What the Fed Meeting Means for Bonds

    Janet Yellen & Co. are expected to hint at their timetable for raising interest rates. Here's how investors should prepare ahead of the meeting.

    WSJ Live
  • Here's What Mark Cuban Wishes He Knew About Money In His 20s

    Cuban is the owner of the Dallas Mavericks basketball team. Billionaire investor and entrepreneur Mark Cuban is generous with his advice. When we asked him what he wishes he'd known about money in his 20s, he said:

    Business Insider
  • SHOE COMPANY: Our CEO Just Disappeared And Most Of The Money Is Gone

    "and like that: he's gone." This is an actual headline from a company press release: "CEO and COO disappeared, most of the company's cash missing." (Via FastFT) In a statement, German-based shoe company Ultrasonic said its CFO,  Chi Kwong Clifford Chan, has been unable to reach the company's CEO,…

    Business Insider
  • 10 rock-solid stocks for conservative investors

    10 rock-solid stocks for conservative investors Shares with low volatility can beat their indexes with less risk Bloomberg News/Landov U.S. Bancorp is the cheapest S&P 500 stock

    MarketWatch
  • Billionaire Investor Says Chinese People Work Harder And Western Companies Could Face Deep Trouble After Alibaba IPO

    Michael Moritz, the chairman of VC firm Sequoia Capital, is a huge fan of Chinese internet companies and reiterated his enthusiasm for the Chinese market in an interview with The Wall Street Journal Wednesday. The billionaire investor described the Alibaba IPO as a “major landmark event” that is as…

    Business Insider
  • Top Analyst Upgrades and Downgrades: AEP, BHP, GE, Incyte, 3M, Tyco, Under Armour and More

    Top Analyst Upgrades and Downgrades: AEP, BHP, GE, Incyte, 3M, Tyco, Under Armour and More Stocks were firm on Wednesday morning ahead of the FOMC meeting outcome. Tuesday’s rally may have sparked higher interest again, and investors are looking for bargains

    24/7 Wall St.
  • Tired of Living Paycheck to Paycheck?

    New website reveals how to save $1,000's when you're living paycheck to paycheck. See exactly how.

    AdChoices Media ForceSponsored
  • 6 Things Debt Collectors Wish You Knew

    The work debt collectors do is not popular, and has become increasingly derided by those who don’t like what we do or simply don’t know the facts about debt collection. Too often, debt collection is painted with a broad brush to create a portrait that isn’t accurate, and doesn’t properly educate…

    Credit.com