February 29th, 2012

What Color is You Stock Chart?

When it comes to the stock market, you want certainty and equivocation just won’t do.  Is the market going higher or lower?  Will a stock appreciate 20% and when?  However, the first thing you need to establish, whether from the investment adviser or, if you’re a self-directed investor making your own stock selection and investment decisions, is the bias and prejudice about the market’s future direction, whether the opinion is based on an optimistic or pessimistic view of the market’s future.  This is true regardless whether you follow the fundamental or technical approach.

I’ve often said that while charts don’t predict the future they are an excellent tool for timing investment decisions.  They do help in deciding whether a stock is about to embark on a trend move in one direction or another, whether it’s in the middle of one or if a trend move had  begun so long ago as to now be on the verge of ending.

We long ago established that general market trends drive approximately 50% of the fluctuation of individual stocks’ prices (if not in terms of the percentage change then at least the direction).  Therefore, the adviser’s or investor’s biases and prejudices overall market view, whether they are bullish or bearish with regard to the market will color their interpretation of each stock chart.  My own bias was brought home clearly as I was preparing today’s Instant Alert for members.

Instant Alerts documents for members each trade I make in my own personal account and the chart I used to make the decision.  I made three trades today and, as I was writing them up, I realized the different conclusions that could have been arrived from three charts based on whether one was an optimist or pessimist, a bull or bear.

  • This stock’s long-term chart mirrors the general market in that it’s been trapped in a “secular bear market” for the past 12 years between 18 and approximately 60; it is now at the upper boundary of that range. If you’re bullish and believe that the market is destined to move higher from here then you should believe that the stock likely will cross above the upper boundary and enter all-time new high territory.  If you’re bearish, then the upper boundary represents an impenetrable barrier that won’t be crossed in the near future.
  • This stock has an extremely interesting pattern which, like many others now, could be interpreted as either a reversal top or a consolidation depending on your outlook (bull or bear) and the market’s future direction.  One can see in the chart either a partially-completed “double head-and-shoulders” reversal top or a horizontal consolidation channel with a possible near-term cross above the upper boundary. 
  • This stock has been trapped in a 12-mos. consolidation pattern.  Whether you see a horizontal channel, a future inverted head-and-shoulders or a partially formed cup-and-handle doesn’t really matter that much.  The point is that a breakthrough on the upside with a strong market as tailwind could lead to substantially higher prices.  But then again, if the market weakens, then the pattern could just as easily turn out to be a reversal top.

Bottom line?  You can see consolidations or reversals in your charts but, in most cases, what it actually turns out to be in the end all depends on the market’s future direction as to what the pattern will later be called.

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