June 19th, 2009

Cramer and MON: What’s a Trendline?

Here he goes again, lecturing on what he knows not. Of course, I’m talking about Cramer’s half-hearted and back-handed endorsement of technical analysis and charting (see the Mad Money Recap). Here’s what he said:

“back at my hedge fund, whenever we had a stock that was twice hated by technicians… we would always absorb what they were saying… and then actually, literally try to find reasons to sell… so we could get in the heads of people who were trading the stock were thinking… we wanted to find some problems with the fundamentals because we did not want to ignore two enormous red flags that we got from technicians.

That is right, we would embrace technicians who were speaking in unison… albeit it in tongues, and try to find out what was wrong with the company… at the hedge fund I would use technical analysis to keep my bullishness in check… and to make sure that I was not being too optimistic.”

Where do I begin. Cramer only uses technical analysis to “to find some problems with the fundamentals”, “keep bullishness in check”, “get in the heads of people who were trading the stock were thinking”? Am I missing something? What’s wrong with using technical analysis to decide when to buy a stock? Why doesn’t he find stocks using charts and, if he feels so compelled, to then look for reasons people should buy it and then speak to them in his tongues … just like he does every week night in Mad Money. Absolutely the lamest discourse I’ve heard (or read).

So he heard from two chartists who told him he’d made a mistake “liking Monsanto” and, “if two chartists agree”, he has to listen to what they’re saying. What b-s? It’s not like they’re the only chartist who said it and therefore he had to consider what they said (but can tune out all other chartists about everything else). Millions of people are looking at the same charts and probably could have, would have, agreed with the analysis. Even more importantly, we’re looking at 6000 other charts and have relevant and important observations to make about them too.

One of the technicians convinced Cramer that a Monsanto:

“sell off on high volume told the truth… and this, I have to tell you, I really love this stuff, I have to admit … is the definition of what you need to be scared of…..this is the best example I have seen in all of the time that I have been doing off the charts… it is making a right shoulder on what is known as a head and shoulders top…this is one of those predictive patterns that technicians see over, and over, and over again… and while it may seem silly… that does not mean that it is not often right… if this stock falls below $78 or $77… then it crosses what is known as the neckline… it would also be breaking through the uptrend line… which is almost a universal signal to chart watchers that the uptrend is dead.”

Cramer gave basically a fundamental rather than a technical reason to sell MON from the second “technical analysts”, a writer for his website, theStreet.com.

But I have a different take on all this. While the pattern in the chart below looks like a head-and-shoulder top, these formations usually occur as reversal patterns after significant upside moves (the same in reverse for an inverted head-and-shoulders). The move up prior to their head-and-shoulder case was a relatively insignificant 10%:

Let’s zoom out and take a longer-term view of MON:

Now this is a chart pattern. There was a clear uptrend line since November and, like a host of other stocks (and the S&P Index itself), MON is waiting for a break above the resistance trendline (in the market’s case, the neckline of an inverse head-and-shoulder I’ve shown before in this chart). You can also see that MON is converging with the 60-, 90- and 180-day moving averages from above and looking to them as support. I don’t dismiss the possibility of a move to the ’70 and I surely wouldn’t recommend MON as a buy at this point …. but for profoundly different reasons.

At the core, I look to technical analysis mostly as an aid to timing my purchases and sales. I like to wait until a stock breaks above (below) resistance (support) before I commit to a purchase (sale). The ascending triangle depicted above represents a congestion of volume bounded by an upper resistance trendline and an ascending lower support trendline. These trendlines link pivot points, approximations of where the balance between buyers and sellers flipped, the area where sellers overwhelmed buyers (resistance) or buyers overwhelmed sellers (support).

On the plus side, an ascending triangle means that buyers were able to overwhelm (absorb readily available supply) at progressively higher prices. Given the state of the the market psychology, it’s unclear whether the supply of MON stock will continue to be absorbed. Instead supply may increase allowing buyers to find stock at continually lower prices, prices below the current upward sloping trendline.

The next pivot point down, and the last time that balance flipped, could be in the 70’s as Cramer’s technician indicated (the pattern then morphing into a horizontal channel). But then again, the stock could regain some stability (if the tone of the market turns positive) and turn back up.

The tug of war between buyers and sellers will continue so long as the stock is stuck in this range. A sustained move (either up or down) won’t happen until it breaks out of the boundaries of this struggle. Another way of seeing this is in the price/volume distribution chart described in an earlier post:

So what’s a trendline? It’s not some arbitrary line; it’s an estimation of where the struggle between buyers and sellers, supply and demand, has previously changed hands and could do so again in the future. Once MON is able to cross above 90-92, buyers and sellers can move the struggle onto the next battlefield, control over the 120 boundary.

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  • Ravi

    I am a regular reader of your blog and I am coming to this posting to ask you what tool do you use to get the price volume distribution for a stock symbol?

  • Guru

    Ravi,

    I obtain the PriceVolume chart from my broker, Fidelity.com, on their trading platform for active traders.

    I'm not sure what other sources might also have those charts.