Dan Zanger says... Follow the Leader

By Matt Blackman

Daniel Zanger became the unofficial stock trading record holder in 2000 by transforming a $10,775 investment into $18 million in 18 months. Five months later, his stake had more than doubled again to $42 million. He first came to public attention when he was featured in a Fortune magazine article in December 2000 entitled, My Stocks are Up 10,000%!

I found his story truly awe-inspiring but after not seeing any articles about him for nearly two years, I contacted Dan in 2003 to find out what had happened to him. When I asked him how he was doing, he replied better than ever and was as puzzled as I was why no journalists had contacted him to follow up on his incredible story. Over the next while, I had the pleasure of getting to know Dan and learning some of the secrets that helped him create his incredible success. I did an interview with him in April 2003 for Stocks & Commodities magazine entitled Chart Patterns, Trading and Dan Zanger which triggered a bunch of new articles about him in the trading magazines. I was lucky enough to watch him trade for a day, which is an experience that I will never forget.

In a nutshell he has developed some very interesting techniques to find the most powerful leading stocks in leading sectors and uses them not only to find trades but to gauge the overall health of the market. Here is a summary of his shopping list for finding trading candidates and why he buys them.

1) Earnings, Earnings, Earnings.
To be a real winner a stock needs to be an earnings powerhouse. Companies with earning up over 70% in the most recent quarter and where earnings have accelerated or ramped up during the past 2 to 3 quarters earnings are ideal. Most of the big movers have earnings up 150 to 400% quarter over quarter. Stocks such as Taser Inc. (TASR) that made a more than 5000% percent move in 2003 and 2004 while earnings and revenue growth exceeded 200% or more each and every quarter for about 6 quarters. Another big mover that started in April 2003 and had similar earnings growth was Research in Motion (RIMM).

2) Dominate their markets.
These players were the dominant leaders of their respective field. Qualcomm (QCOM), went from $225 to $800 (pre-split) in just 6 weeks and Yahoo went from $80 to $400 (pre-split) in just 3 months in 1998 before GOOG was on the scene. Others include CMGI (a big mover during the internet bubble and made a move of over 6000% in 20 months) and DELL that went from $50 to $2000 (pre-splits) over a 3-year time frame. All of these companies dominated their industries. DELL another leader, changed the way computer products were marketed, carried a small “just-in-time” inventory, in home warranty service and the fastest computers of the day. This combination crushed competitors Compact and Gateway and in so doing made its shareholders rich. This market domination is the most overlooked aspect of selecting big winners in the market.

3) New company, idea, product or management.
That next piece of the puzzle is that all of these stocks were new or relatively new to the market and most of them had new products that were being widely accepted, not only in the US, but also in most of the developed and emerging markets. Companies like GOOG are known and its products used all around the globe as is YHOO and Research in Motion (RIMM).

4) Market direction. Don't swim upstream.
Most traders know that 60-70% of a stock move is determined by the overall direction of the market but what is the best way to gauge which way the market is heading? Is there a better way than examining advancers minus decliners, waiting for an index trend line break or moving average crossover? You better believe there is and that is following the leader of the market. But that being said, even a strong stock will be fighting an uphill battle in a bear market. Look for strong stocks in a bull market and laggards to short in a bear.

5) Under known and under owned.
It's all about supply and demand. A smaller supply of shares increases the chances for stock appreciation. The total number of shares that the public can buy is known as the float. Stocks that have a limited number of shares in the pubic float can experience explosive upside movement once they are discovered due to the small share supply. Taser (TASR) is good example of this as well. It started out with a float of just 3 million shares and now has a float of 57.2 million due to numerous stock splits. The stock price went ballistic in the process. There should be no more than 100-150 million shares in the float and the lower the better. Ideally, the goal is to find stocks that institutions are beginning to accumulate. This includes those with a higher degree of corporate executive insider ownership.

6) Powerful pattern power.
This is where the fundamentals and technicals compliment one another. Chart patterns will tell the trader that the stock is walking the fundamental walk and the market is recognizing this. You want to see the stock show good price action such as holding support and breaking resistance on increasing volume. Some of the best indicative patterns include bullish Flag and Pennant continuation patterns and Cup and Handle continuation patterns that show consolidation (see figure 2). An essential book in every trader’s library is Thomas Bulkowski’s Encyclopedia of Chart Patterns (2nd Ed) published by John Wiley & Sons. Remember bullish patterns are an indication of institutional accumulation.

7) Volume generators.
Volume is the true indication of what market players are doing for those who know how to read it. During extended periods of consolidation, patterns like Saucer and Cup and Handles are good indications that a move is imminent. But patterns by themselves are not much help unless there is volume support. Are traders buying dips or selling rallies? The first is bullish and is recognized by volume spikes following weakness or after a prolonged down move. The second is bearish especially if volume builds after an extended up move and means either shorts are capitulating and covering or ‘Johnny-come-latelys’ are jumping on board. If volume increases as the stock drops, it means that the smart money is using rallies to unload and the shorts borrowing to sell the stock short. When this happens the ride is usually over. Bullish continuation patterns should show volume dropping as the pattern forms with volume spikes on the breakout. If there is no spike, the breakout is suspect.

8) Follow the leaders.
Never marry a stock (or the market). There are times to buy and times to sell and market leaders provide advance warning that a reversal may be imminent. If the leaders begin to break down even in the face of good fundamentals, the market is probably not far behind. Once the market has turned, even a leader cannot fight the gravitational pull for long. No point in trying to trade or invest counter to the primary trend. When the market is going up, leaders will keep you in the trend and when the market reverses and heads down, they’ll tell you when to sell and when it’s time to look for laggards to short.

9) Price tells the story.
In a true bull rally, you should see bullish action. That's the powerful patterns discussed in number 6. Look for that tell tale stairstep pattern with gaps that aren’t generally filled for a while. When the breakouts happen on less volume than the prior breakout or gaps begin to get filled, the move is running out of gas. Sentiment can also be helpful. In a rally, stocks discount bad news. In a bear, they discount or ignore good news. Bad news, good action = bull. Good news, bad action = bear.

10) Use what works and don't be cheap.
Watching chart patterns and volume are two of the most powerful tools in picking market leaders. Other tools can be helpful too. Technical tools such as trend lines, moving averages, the McClellan Oscillator, seasonal cycles and time cycles are examples. Look at the daily chart over a nine to twelve month period. Do you see rhythmic dips and seasonal patterns? Resource and commodity stocks often exhibit distinct seasonal patterns based on growth and market cycles. Another important consideration is price. Cheap stocks rarely lead. Best to wait till they are over $50 and become interesting to institutions.