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Big Drops Are Big Opportunities

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Those big drops in the stock market can be murder to your portfolio. But, as the saying goes, "from the ashes a phoenix shall arise." The secret is to buy stocks that have been burned, but still have the potential to soar. This article will help you find more of those stocks.

There is a somewhat new phenomena called the "V"-shaped recovery. This is basically a swift move lower followed by an equally swift move back higher. People who watch every tick of nearly every stock will have an advantage over most investors; they know the best time to jump back in.

This leaves most investors out in the cold, unless they have the intestinal fortitude to withstand the big drops. But who among us didn't panic even just a little during those dips at the end of January and again this month?

Markets Come Back, Some Stocks Don't

It seems that just about every stock sees some pain in a market-wide sell off. Most will gain back the ground they lost and return to pre-correction levels. Glamour stocks, the ones with plenty of media coverage, are among the first to get those losses back.

The problem is that the speed at which glamour stocks gain back ground can be mind-bending. The stocks that don't get it all back at once should be the ones you focus on. The problem is, there are just too many of these stocks and some of them will never get the media spotlight cast on them.

Thankfully, there are stocks that get beaten up, give a pause at or near the bottom and then begin to head back higher. These stocks generally have something in common; it's a combination of upgrades and higher earnings estimate revisions.

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Gauging the Fear

Oftentimes, market-wide sell offs are predicated on macro events. Sometimes it comes when a country is not paying its bills (Greece), other times it could come from currency devaluation (China). These macro events tend to bring sudden and severe changes to prices across all markets.

There are signals, however, that tell us when traders are expecting a big change in the direction of the markets. It is not an infallible signal, but it has given traders a heads up many times in the past. The indicator I am referring to is the VIX, a measure of the volatility in the markets.

Without going into too much detail, suffice it to say that as the VIX rises, the amount of fear in the market is rising as well. Professional traders that have the dry powder often hold their nose and dive into the mess of the markets when the VIX is reaching highs. As the index begins to return to more palatable levels, regular investors tend to follow suit. 

Analysts Calling the Bottom

While traders and daily market watchers have the VIX to follow, those who focus on a day job most of the time are left with a different barometer. One of the biggest sources of market moving information (that doesn't come directly from the company itself) are the analyst reports that come from brokerages and specialty research firms.

Most analysts will just ride out the volatility in their respective foxholes and keep their heads down. There are some, however, that will go out on the limb when they think the time is right. I am not talking about the analyst that upgrades the glamour stock, it's the stock that few have heard of that has dipped to single digits.

Those big corrections give analysts the chance to really stick their necks out and start coverage or upgrade one of those unloved stocks that has seen its price drop dramatically. These events don't happen that often, but shortly after things start to look up, the upgrades will boost these stocks back to the double digits.

The Best Part of the Upgrade

When analysts upgrade a stock, they tend to say the story has changed and the outlook is getting better. Following a large macro-driven correction, some stocks break below the double-digit threshold and that can be just the thing that makes some analysts salivate.

It is not a surprise to most when I say that some upgrades are better than others. The total reversal from sell to buy is great, but the upgrade that carries the most weight is the one that comes along with a strong move higher in earnings estimates.

Not only is the analyst saying that the price of the stock is undervalued (thanks to the macro-driven correction) but the outlook has vastly improved and the earnings estimates are being revised up as a result. Other analysts see that upgrade and after some homework could come to the same conclusion. The best result is a string of upgrades with an equally strong string of higher earnings estimate revisions.

While there are many market sources reporting on the daily upgrades and downgrades, few are watching the estimate revisions as closely as the Zacks Rank. Use the rank in conjunction with macro selloffs to find the stocks that analysts like and foresee results improving.

Riding the Rebounds 

One of the most potentially profitable ways to cash in on rebounding stocks in a rebounding market is to focus on certain low-priced stocks.

Today you're invited to see the recommendations we're holding in our Stocks Under $10 portfolio.

We select a diverse group of companies on the verge of big upward moves and get in when the Zacks Rank and other proven indicators point to success ahead. Then we ride them long and high. For example, we've recently closed out positions with gains such as +63.2%, +49.1% and +40.9%

This is an especially good time to look into Stocks Under $10. This Monday, we're adding a new pick to the portfolio. This company stands to benefit directly from lower rates that will drive more home buying. With it well positioned to capture revenue on both ends from sellers and buyers, the stock looks to have a very profitable ride ahead of it.  

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Another reason to get started today is that you can download our just-released Special Report, 7 Best Stocks for the Next 30 Days. From our proven list of 220 Zacks Rank #1 Strong Buys, our team of experts handpicked these 7 for immediate breakout.

Don't miss the chance to download this report for free. It ends midnight Sunday, October 13.

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Best,

Brian

Brian Bolan is our aggressive growth expert and the editor of Zacks Stocks Under $10 portfolio.

¹ The results for the companies listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research’s newsletter editors.