At Schaeffer’s Investment Research, we employ a three-tiered analysis approach known as Expectational Analysis® (EA) that was created more than two decades ago. EA utilizes traditional methods of fundamental and technical analysis and combines these with a third, crucial look at investor sentiment. It is this third layer of analysis that provides a critical edge in selecting stock and option plays. Both anecdotal and quantifiable measures of investor sentiment provide a window into how the investing crowd perceives reality. These perceptions serve as powerful contrarian indicators, as the crowd tends to move as a herd and is, to paraphrase the venerable contrarian Humphrey Neill, “right during the trend but wrong at both ends.” A look into the psyche of the collective investing masses, while also taking into account important technical and fundamental variables, can offer a reliable recipe for trading success.

The tenets of EA are behind our stock selection of Midway Games (NYSE: MWY), the Chicago-based producer of such entertainment software titles as Mortal Kombat and MLB Slugfest. The games are designed for personal computer use and specialized platforms, including Nintendo, GameCube, and Microsoft Xbox.

MWY shares have been on the rise since late May, appreciating more than 85 percent over the past five months. During the past several weeks, the stock has been shuffling sideways, making little headway but also failing to succumb to selling pressure. This consolidation has drawn the stock toward its 10-week moving average, an ascending trendline that has contained all but one weekly close since the week of June 10. The shares should use the 10-week as a springboard to launch higher and spike to a new multi-year peak.

Also intriguing from a technical perspective is the equity’s recent surge in relative strength as compared to the S&P 500 Index. This measure currently sits at a three-year high. Finally, the shares have relied on steady support from their 20-month moving average, a trendline that was tested successfully in May before the security embarked on its recent upward drive.

Moving on to the sentiment indicators (which provide our EA edge), it’s apparent that there are many segments of the Street that have not yet warmed to MWY as a viable opportunity. Options players, for example, have rarely been more pessimistic. Among options set to expire within three months, a haven for speculative players, there are 117 open put positions (bearishly configured options) for every 100 open calls (bullish bets). The resultant ratio, which we name the Schaeffer’s put/call open interest ratio (SOIR), stands at an annual high for MWY, suggesting a peak in bearish speculation.

Elsewhere on the sentiment front, lofty short interest on MWY indicates the presence of a large group of skeptics and provides a cushion of potential short-covering support. The number of shorted MWY shares represents 12.5 percent of the equity’s available float for trading and is 6.7 times the security’s average daily volume. If the shares continue to spike higher, some nervous bears may scramble to “cover” their positions, repurchasing what they originally sold and supplying some additional buying power for the shares.

All of these factors - strong technicals, moving-average support, encouraging relative strength, and continued skepticism - are lining up to earn MWY a score of 8.0 (out of 10.0) on our proprietary Schaeffer’s Equity Scorecard rating system. This reading suggests the stock’s path of least resistance is pointed north, and makes MWY a very intriguing choice, particularly from an expectational perspective.

This Article is from the Fall 2005 Top 10 Special Report. Get the latest stock recommendations from other top financial experts today!  Request your FREE copy of the newest report from NewsletterAdvisors.com.  Click here.