“Box” Your Gold Stocks … and find “an extremely rare opportunity”

By Travis Johnson, Stock Gumshoe, December 21, 2010

After several years of touting (and sometimes teasing) microcap mining stocks for subscribers of Stansberry’s super-expensive Phase 1 newsletter, Matt Badiali is launching a new letter that focuses on these small stocks, picks that he says are too small and volatile for his inexpensive S&A Resource Report letter.

This letter is called the S&A Junior Resource Trader and, as you might have guessed, it’s an “upgrade” subscription — in this case, the price is $1,450. And though it sounds from the letter like they’ll be picking junior mining stocks for the most part, they’ve got more of a “trick” than that — they’re also teasing a trading system that focuses on these picks and (this is the part that got me interested), one particular “extremely rare opportunity” to buy a particular stock.

So I’ll try to figure out what that stock is for you in a minute — but first, I should briefly share their tease about this trading “system.”

They say that over the last year or two, as Badiali and his colleague Brian Hunt sniffed out a few picks for a variety of other newsletters in the Stansberry stable using this system, they’ve developed a technical screening and trading tool that they think identifies winners. Here’s how they briefly describe it:

“Well, most resource analysts concentrate on one or two factors they think might indicate that a stock is about to go up.

“In the resource sector, that means most analysts choose to focus on either drill results… new ore grade samples… feasibility studies… permit approvals… new joint ventures… or the announcement of big new discoveries…

“But my colleagues, Matt and Brian look at a totally different set of data… one that blows the lid off conventional resource stock analysis.

“You see, this little known strategy has its origins in the 1950s Canadian penny stock mining boom, when a guy named Nicolas Darvas discovered that upcoming events about a resource stock (whether it be new drill results… permit approvals… mergers, etc.) actually show up in one place BEFORE it’s announced in the market.

“It’s called a ‘Box Chart.'”

And they go on to say how they’ve refined this system from Nicolas Darvas, setting their own data points and time period to help chart the best boxes to use to indicate buying points for junior resource stocks. And, of course, they have a fundamental aspect of this — they say that they only do this to the best stocks that they know have real potential anyway, thanks to their knowledge of the firm and their prospects and their industry connections — so this technical indicator only applies to stocks they already would have liked anyway, they don’t just “believe the chart” like many market technicians.

So what are they talking about? Well, I’m not a chartist or a technical trader, but the basic concept of the Darvas Box was developed, as you might imagine by that Nicolas Darvas mentioned. It is in its most basic form just a way of charting stocks that are breaking out of a trading range. If you set the time frame at eight weeks as Badiali and Hunt do, for example (that’s 40 days), then you look for stocks that trade in a fairly defined range for that time period and then break out of that range to the upside and make new highs (either 52-week highs or all-time highs, depending on how you read it). If they break out of the top of the “box” that you can draw on the chart of their short term trading range, then you buy (I hear a lot more about people using Darvas Boxes to find buys than to identify sells — from what little I know, Darvas used stop losses instead of a precise box to sell).

That’s an extremely simplistic explanation, and I think Darvas also looked for an increase in trading volume when he went searching for “boxes” (he did it using stale weekly Barron’s listings and searching for new highs in daily tickers, I think — this was more than 50 years ago, and he was a touring professional dancer, he wasn’t sitting at a tickertape machine in a Wall Street office. What he “discovered” and explained with his box theory of stock selection was basically the same kind of momentum trading that so many people use today — he wrote it up in a book titled “How I Made $2,000,000 in the Stock Market” that you can still buy (it was reprinted last year), though I haven’t read it.

So briefly put, the Stansberry guys have apparently developed some data-chewing version of a momentum screener that uses the Darvas Box to identify breakout resource stocks that are presumably indicating, through the speculative magic of the stock market and the considerably less magic mechanism of information leaking out of a company before it’s public, a future likelihood of big positive fundamental news (new drill results, reserves improvements, etc.)

I can’t share any particular wisdom about the Darvas Box or about the Stansberry version of it — if you like momentum trading as a sort of intermediate term thing (eight week indicators, holding periods usually under a year), then it may well appeal to you, but if you’re already doing that kind of momentum and breakout trading than you probably also understand it better than I do.

So let’s get to the part that I found more enticing: the “