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Relative strength and upward trend if bullish

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Recent bearish trades I've profiled haven't been working out. I don't necessarily think its because I'm a poor stock picker, but that the market internals are just getting too strong and like a rising tide, many boats are starting to rise with the tide.

For a bullish trader, one "key" to future success as the bullish percent charts turn higher as more and more stocks begin generating new "buy signals" and depict demand beginning to outstrip supply, is to look for greater and more prolonged bullishness from stocks that outperformed their respective sectors and the broader market.

Just as a rising tide lifts all boats (even those with some big holes in the bow), a falling tied will have similar impact.

In a declining market like we've generally been in since March, many stocks have been pulled lower as depicted by the broader S&P 500 Index (SPX.X). However, there are those that have outperformed on a relative basis. Often times, it the stocks that outperformed on a relative basis that often find the greater amount of bullishness early in a market recovery.

One stock I've been eyeballing in recent weeks that got a nice pop higher today is shares of drug maker Forest Labs (NYSE:FRX) $73.38 +5.56% on news that its new Lexapro selective serotonin reuptake inhibitor received FDA approval for the treatment of major depressive disorder. Many industry followers call the new Lexapro drug "baby Celexa." Celexa was perhaps Forest Labs' "blockbuster" drug that helped launch the company into the forefront of the antidepressant drug market along with its stock price.

Forest Labs Chart - $1 box

Today's trade at $74 triggered a "bullish triangle" pattern in FRX's point and figure chart. Under bull market conditions, Professor Davis' study found this pattern profitable in a bullish trade 71.4% of the time for an average gain of 30.9% in 5.4 months. With a bullish vertical count of $96, combined with a potential 30.9% gain from $74 to $96.86, this is the type of technicals I like to be looking long in the early stages of a bull market. Today's FDA announcement perhaps lights the fuse on the "powder keg" from which the "projectile" (price) will be launched. Remember, the bullish and bearish vertical counts are based off ballistics. Bullish FRX, stop $68 and longer-term target of $95.

Now lets look at relative strength of FRX versus the market as depicted by the S&P 500 Index (SPX.X). While FRX looks to have traded in similar trend the relative strength chart tells us that FRX held up well relative to the S&P 500 Index.

Relative Strength Chart of FRX versus SPX - 1 point box

The relative strength chart of FRX versus the SPX is longer-term bullish. While the chart isn't updated until the close of trading, we see that current price comparisons has the relative strength chart of FRX close to reversing back into a column of X after recently generating some buy signals. What's "neat" about the point and figure charts is that comparisons against "time" can be easily made. Note that the RS chart gave a "buy signal" at the "red 7" which was the first entry made in July. While the SPX continued a decline, FRX began basing and RS improved markedly. This type of action hints that the weak holders may be out of the stock and the stock is strengthening against the broader market.

Not to go into great detail, but Lexapro involves the removal of one of two enantiomers from Celexa to create a single-enantiomer drug. Celexa is a racemic mixture of two mirror-image halves called the S-enantiomer and R-enantiomer.

As explained to me by my brother, who is a specialty rep for Forest Labs, one of the "key" benefits that doctors found when prescribing Celexa versus other antidepressants, was that Celexa was found to have a lesser amount of side effects than other drugs in the category. For the patient suffering from depression, doctors feel it important to have a patient stay on a drug and not simply quit using it due to a side affects. This can be very important in the treatment of depression.

What many feel may be "important" with Lexapro, is the removal of on enantiomer. The basics here is that while Celexa did have some side affects (higher blood pressure, some male impotence/lessening of sex drive) the removal of one enantiomer helps lessen further potential side affects. Evidently, this type of science is not "easy" and has Lexapro potentially being another "block buster" type drug.

There are questions as to what extent the Lexapro will have on canibalization of the Celexa drug. However, as explained to me, Celexa will turn generic in the future anyway and Lexapro was next in the pipeline as a "better" drug to further build market share in the market.

Today I'm profiling 1/4 or 1/2 bullish positions in the FRX Jan03 $70 calls (FRXAN) at $9.80, no stop on the option, target $95. For stock traders, would look long similar weighting, stop $68, target $95 over next 6 months.

Jeff Bailey
Senior Market Technician
Option Investor

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