June 22nd, 2015

The True Reserve Value of Gold

For thousands of years, in countless cultures around the world, gold has been recognized as an exceptional store of value and, as such, accepted in all forms of transactions.  Up until the twentieth century, most nations were still using the gold standard and the gold standard has historically provided long-term stability and inflationary controls.

However, as a result of central banks around the globe issue incredible amounts of debt in an effort to prop up or to stimulate their economies (and to not let their currency be left behind in a rush to the bottom in terms of exchange value), there just isn’t enough gold to support all the fiat currency that’s been created.

A recent article in Business Insider very graphically explains the problem in the following:

 

Gold

 

You read that correctly.  The price of all the 184,000 ounces of gold estimated to have ever been mined would have to increase 30x to around $34,000 per ounce if all the currency created would be converted into (spent to buy) that gold.  Clearly that’s never going to happen but it’s also true that the price of gold will have to increase from the current $1200/oz if it’s to continue backing up fiat money.

The only way this won’t be the case is if a global, recognized and accepted digital currency (like Bitcoin) replaces gold.

Check out the article here.

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January 14th, 2015

Homebuilders Building Foundation For Next Move

ImageSomething I learned long ago is that “industry group controls 30% of a stock’s price movement.”  So a logical place to begin the search for stocks with better than average relative strength but lower than average risk is by narrowing the available universe down to a select few Industry Groups.

One academic research study concluded that “a mutual fund manager’s success in identifying and emphasizing specific industry sectors in their portfolio was a far better forecaster of the fund’s performance than ability to pick individual stocks.”  Although the statistics were compelling on their own, they were even more impressive because the study found that managers with good industry-selection abilities were likely to continue to outperform their peers over many successive periods.

Through our Stocks on the Move scan, we’ve recently noticed that in addition to significant money flowing into REITs pushing their prices higher as discussed previously, the Scan also filtered out a significant percentage of stocks from a related industry group: homebuilders.  The Scan from a few days ago produced the following results:

Stocks on the Move Scan

A quarter of the stocks generated by that scan were REITs, or 13.3% of all REITs (REITs represent 6.3% of all listed stocks).  Homebuilders, on the other hand, represented only 4% of the stocks generated by the scan but those 7 stocks were a quarter of all the homebuilders (homebuilders represent only 0.4% of listed stocks).  Although homebuilders represented a small percentage of the stocks generated by the Scan, more homebuilders met the scan criteria.

One thing you should know about the Homebuilders Industry Group is that among all the groups, homebuilders tend to generate similar chart patterns and consistently move together.  In Chapter 15 of Run with the Herd entitled “Segmenting the Market”, I presented the following data on homebuilders in the periods leading up to and during the Financial Crisis Crash of 2007-09:

Homebuilders

The percentage price moves of all the homebuilders weren’t identical but they were in the same direction and on orders of magnitude similar relative to the average S&P 500 stock.  Over the six years to year-end 2005, the S&P 500 declined 15.0% while homebuilders appreciated anywhere from 404% to 1275%.  From the end of 2005 to the trough of the Financial Crisis, the average S&P 500 stock declined -49.3% while homebuilders lost anywhere from -62.3% of their value to over -90%.

It looks as if we’re facing a similar situation today.  After their huge 100+% recovery off the Financial Crash bottom, most homebuilders have been constructing a consolidation pattern throughout 2013-15.  But now members of the group are showing signs of being ready to exit across to the top of their respective consolidation patterns.  Using a typical “rule-of-thumb”, the percentage move following a consolidation should be approximately the same as the percentage move preceding it.  Using XHB, the ETF for the group, as a proxy that represents a move to approximately 65-70 (click on image to enlarge):

Homebuilders - 20150111

Five homebuilders whose similar charts clearly depict these consolidation patterns are (click on symbols for charts):

However, a word of caution.  If the market turns ugly and does enter what turns out to be a 25-30% correction then these patterns could turn from being consolidations into reversal tops and momentum reversing causing breakouts through the bottom boundaries.  These charts don’t predict … they only indicate that supply and demand has remained fairly balanced for nearly two years and, once it begins, momentum will generate an extended move in either direction.

Fundamentals like low interest rates, increased residential rental rates, increased consumer liquidity and savings from lower gas prices and improved job picture suggest that the breakout, when it does take hold, will be on the upside.

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January 6th, 2015

Forget Oil, Go Lithium

GigafactoryOil prices has tumbled more than 50% since the beginning of last summer so many investment advisers are recommending today that investments be made in the energy sector, arguing that the stocks have fallen so that many represent the best bargains in many years.

If you had been able to predict the oil price rout in July and sold short, you would have discovered that not all energy-related stocks and ETFs acted uniformly. Some actually went up (EEP up 12.49%, VLO up 1.68%) while others dropped anywhere from -5% to
-70%. For example, CVX decline -16.81%, COP declined -19.33, OIL -49.48, RIG -56.39 and CRK -73.99.

If you believe that oil prices can’t go much lower and will soon rebound then it would seem logical that buying an oil-related stock is a “sure thing”. But how does one select among the more than 300 energy stocks of all sizes, dividends, volatility, growth.

Oil Prices

Should you select those that performed the “best” over the past 4-5 months under the assumption that they will perform best in the future. Or, conversely, should you buy those that performed the worst because they could possibly bounce back the most. If you’re looking to put money to work, though a better strategy than catching one of 300 “falling knives” might be to look someplace totally different, someplace that will be “driving the future” rather than the energy that has “driven the past” (no pun intended).

Rather than betting on a recovery in oil prices, why not take out a stake instead in the industry making possible electric transportation – lithium, one of the most valuable natural resources of the new electronic world thanks to its unique and extremely valuable characteristics:

Lithium

As described in a recent Mauldin Economics report:

  • Lithium has such a low density that it floats on water and can be cut with a butter knife. When mixed with aluminum and magnesium, it forms lightweight alloys that produce some the highest strength-to-weight ratios of all metals.
  • Lithium tolerates heat better than any other solid element, melting at 357°F.
  • Lithium batteries offer the best weight-to-energy ratio, making lithium batteries ideal for any application where weight is an issue, such as portable electronics.
  • That same high energy density and low weight characteristic makes lithium batteries the best choice for electric/hybrid vehicles due to car gas mileage. A car’s biggest enemy is weight.
  • Lithium has a very high electrochemical potential, meaning that it has excellent energy storage capacity.

The lithium market is dominated by only three publicly-owned producers:

  1. Chemical & Mining Company of Chile (SQM);
  2. FMC Corp. (FMC);
  3. Rockwood Holdings (ROC)

Lithium Industry

In addition to its excellent dividend yield and relatively low (as compared to the pure-play ROC) price-earnings ratio, the SQM chart is most volatile and shows promise to bounce off the bottom of the horizontal channel it’s formed since late 2013 and attempt to cross above the upper boundary at 33, a 40% move.

SQM - 20150105

Tesla has just completed a gigafactory that exceeds all comparisons in the belief that the lithium-ion battery will be the power source for many more battery powered cars, drones, toys and power grid storage.  I’m hoping that SQM will benefit from that future.

January 2nd, 2015

BIIB’s Second Act

imageAre you one of those who missed the biotech burst, especially the 375% run-up from a leader like BIIB (Biogen-Idec) since its breakout on March 11, 2011?  You can’t make up the “opportunity costs” of not having bought but you have an opportunity in what may be left in the stock’s upside move by jumping on the stock as it looks to complete a easily identified year-long consolidation in the form of an ascending triangle, the first since beginning its run almost four years ago (to enlarge, click on image below).

Biogen Idec Inc. discovers, develops, manufactures and markets therapies for the treatment of neurodegenerative diseases, hemophilia and autoimmune disorders with such products as AVONEX, TYSABRI, FAMPYRA, FUMADERM and RITUXAN.  One of the reasons for the pause in BIIB’s upward trajectory was the uncertainties surrounding the company’s prospects as it faced expiration of its AVONEX patent at the end of 2013.  Articles like this one from May 2013 entitled “3 Bio Companies Facing The Patent Cliff” didn’t help.

But companies of BIIB’s caliber don’t just roll over when they face a challenge like major patent expirations.  It takes a while for them to regroup and for investors to regain their confidence,  Hence a consolidation in the form of an ascending triangle.  Apparently, the consensus among the majority of the stock’s investors is that BIIB has successfully weathered the storm with sufficient existing products and products in the pipeline that growth can be expected to resume.  Hence, a likely breakout from the consolidation pattern.

Some investors balk at buying and owning stocks with triple-digit price tags because of the fear of less volatility and more limited upside (BIIB is the 10th highest priced stock among the S&P 500 behind such leaders as NFLX (Netflix), ISRG (Intuitive Surgical), PLCN (Priceline) and CMG (Chipotle Mexican Grill).  But those concerns should be alleviated by knowing that BIIB ranks 71th among the S&P 500 stocks in 5-year average annual earnings growth of nearly 25%.

BIIB - 20150102

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April 5th, 2013

Gold (GLD) in an “Indecision Zone”

I was recently accepted as a “columnist” for the subscription portion of SeekingAlpha.com, a well-respected stock-oriented editorial site, and quickly got my first submitted article accepted.  Much to my disappointment, however, my second submission was wrongly rejected, I believe.  The rejection notice stated:

As a fundamental investing site, Seeking Alpha doesn’t publish articles based primarily on Technical Analysis.  Feel free to post this piece to your instablog.  Thanks!

Sincerely Yours,

SA Editors

As you might expect, this response raised my blood pressure on several counts.

  1. First, I thought that I had summarized most of the fundamental arguments, bullish and bearish, covering the subject of the future direction of gold prices.
  2. Second, I can’t imagine any site that doesn’t take technical factors into account when presenting content about stocks, markets, commodities and forex can do so without including a heavy dose of technical factors and opinion.
  3. Finally, why isn’t there a site that features articles contributed by vetted contributors focusing on technically-based market and stock opinions?  It might even be called www.stockchartists.com

In any event, the rejected article appears below. What say you? Should it have been rejected? Would you be interested in reading or even contributing to a technically-based content market opinion site?

========================================================================

imageI know both the bull and bear fundamental arguments surrounding gold, you’ve heard alll of them before.

  • The Bulls point to the fact that gold is both a commodity used by industry and consumers and, perhaps even more so, a safe haven alternative for fiat money and store of accumulated wealth.
    • Central banks around the world flooding the market with currency that eventually will lead to inflation and rising commodity and gold prices
    • A fixed world-wide supply of gold in a world of ever increasing demand
    • Increased demand resulting from the growth of ETFs
    • Increased demand due to increased wealth from emerging market consumers
    • Increased demand from governments beginning to accumulate
    • Continued political uncertainty
    • Finally, the price of gold is still only around 70% of its inflation adjusted peak price of $2300 reached during the 1970′s energy crisis.
  • The Bear’s argue that the price of gold has quadrupled with only minor corrections from less than 50 in 2005 when the GLD ETF was first made available.
    • Hedge funds are reportedly unloading their large cache of GLD
    • There will be better places to invest your money than gold as stocks and commodities continue to reflect an improved economic environment
    • The bull market for gold paralleled the secular bull market for bonds therefore a reversal in fixed income secular trend will also lead to reversal in gold prices.
    • QE and monetary easing will end soon and the excess money supply that the Fed pumped into the economy will begin to be drained
    • Governments are actually unloading their gold hoards

Rather than trying to second guess the experts and come up with my own prediction of gold’s future direction, I believe price action and trend best represents the consensus of how the world’s investors actually act on their beliefs. There’s no question that the price of GLD has stalled but what isn’t as clear is whether this the beginning of a reversal leading to sharply lower prices or whether this period could be actually represent the end of a consolidation pattern.

In the chart below, there’s not question concerning the top boundary of the pattern … it’s clearly defined.  There are two possibilities, however, for the zone’s lower boundary. The blue dashed line assumes the zone is a descending triangle reversal top pattern while the green dashed line assumes the zone is a flag consolidation pattern. We will be left in the dark as to which pattern interpretation is correct until GLD declines to approximately 137, or down another 7.4%, at which point GLD will likely find some support.

It’s said that “the longer the pattern the stronger the trend out of that pattern”. If the price stabilizes around 137 and then reverses, a major bull move could be launched that could finally carry GLD substantially above its previous high of 182. But if it again fails after that reversal at around 150, or today’s price, then a reversal top would be confirmed leading to further declines possibly to under 100. GLD is clearly in an “indecision zone” (click on image to enlarge) and I would wait to make any further commitments either way (bullish long or bearish short) until investors drive the price out of the zone one way or another.

Bull and Bear Gold Case

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March 20th, 2013

Rocket or Breakout? What say you?

imageThe second most difficult challenge (after auguring the market’s future near-term direction) is to select the best stocks into which to put some money to work so as to maximize potential returns while keeping risk of loss acceptable.  Most of the time, whenever you hear or read a comparison between two stocks, “talking heads” like Jim Cramer usually  throw out such slogans as “buy best of breed” as the guide in making your choice.  However, although “best of breed” is subjective and is boiled down fundamental factors like sales and earnings growth, great management or higher profit margins.  Seldom does Technical factors such as stock volatility, institutional support or relative strength seldom enter a “best of breed” discussion.

For example, on January 26, 2012, Cramer’s theStreet.com had a piece on XLB, the basic materials ETF in which they claimed that “DuPont Company (DD) is the undisputed king of basic materials. From the 2009 rally, DuPont was the top performing Dow component.”  However, PPG (PPG) wasn’t mentioned at all.  PPG represented only 4% of the ETF as compared with DD’s nearly 10%.  But which was actually the better stock to have bought more than a year ago.  A comparison of the two shows that PPG actually appreciated 58% while DD declined nearly -3% (click on images to enlarge).

PPG - 20130319DD - 20130319 I’m now sitting on some cash trying to figure out if I should redeploy it in yesterday’s momentum stock leaders (who are still advancing nicely) or taking a gamble on stocks that have great charts and look like they may soon breakout and become tomorrow’s leaders.

In technically-based comparison like these, IBD’s rule is to only buy stocks that are within a few percentage points above what IBD labels their “buy point”, those breakouts or crosses above resistance trendlines which are top boundaries of a variety of chart patterns such as inverted hear-and-shoulders, ascending triangles or IBD’s cups-and-handles.  This comparison might match up LKQ (automotive parts), a stock that’s advance 370% since 2009 in a near straight shot and, perhaps, may continue to advance higher against, for example, Williams-Sonoma (retail home furnishings).

LKQ - 20130320WSM - 20130320

Putting aside fundamentals and basing the investment choice strictly on a technical basis, the choice rests on how one evaluates two factors:

  • Trading off the risk one perceives in buying a stock continuing to advance after having nearly doubled in each of the past four years vs. the risk that a stock will continue to languish for continued economic sluggishness.
  • How important the psychic reward might be for you to have found a new “high flyer” before others vs. piggybacking on a winner that others continually discovered over the past four years.

I’ve always tended to chose the breakout but what say you?  Would you catch the tail of a comet like LKQ or get on what you hope might be a future rocket?  And why?

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February 15th, 2013

Bullish Technical Gold Outlook

imageHave you ever heard of the “fear industry”?  That’s what Philip Pilkington called those economists and writers who are the leading voices among what can be called “goldbugs”, those who believe that gold is the only safe haven among all asset classes.  In his recent blog post on Naked Capitalism entitled “The Fear Industry – Austrian School Propaganda and the Gold Market“, Pilkington writes

the sheer scale by which the fear industry has taken off is, to be frank, quite surprising. We have all seen the likes of Peter Schiff as a regular guest on the American business news spouting vague talking points about the impending dollar collapse and gold reaching $5000 an ounce…..What is so interesting is that the fear industry grows larger and larger at a time when the make-up of their key market – the gold market – has fundamentally altered its composition…..the fear industry’s most successful year was actually in 2011 and this in turn is reflected in the fact that the gold price reached its record high in the summer of that year……the fear industry has probably stretched itself too thin and it is likely that we saw its peak last year.  From here on in it will probably be diminishing returns and we’ll likely hear of more and more scams as people within the industry compete for ever scarcer resources…… the end game is just around the corner….”

On the flip side of the coin, there’s Trustable Gold who at the beginning of the year in “Gold 2013 – What is the trend for the gold price in 2013 and beyond?” summarized forecasts from various trusted sources:

  • “Bloomberg in November 2012 forecasted a level of US dollars 1,925.- per ounce of gold.
  • The bullion bank ScotiaMocatta forecasts a rising gold price in 2013 and would not be surprised to see a gold price above US$ 2,200.- per troy ounce of gold.
  • BNP Paribas estimated in November 2012 gold to reach US dollars 1,675 per ounce in 2012 and US dollars 1,865 per ounce in 2013.
  • Members of the London Bullion Market Association forecast a gold price of US dollars 1,843.- by September 2013.
  • The global bank HSBC predicts a very similar gold price of 1,850 US dollars per ounce of gold in 2013.
  • The CEO of Newmont Mining estimates that the price of gold in 2013 may increase to US dollars 2,550.
  • In November 2012, Deutsche Bank updated its forecast on the gold price to US$ 2,000.- by next year, i.e. 2013.
  • Credit Suisse expects a gold price of US$ 1,840.- in 2013.
  • In October 2012 private bank Coutts predicted gold prices to reach US$ 2,000.- in the coming months.

At the risk of being lumped with the “goldbug” crowd, I took another look at gold’s long-term trend to see whether I can add anything new to this debate from a technical perspective about gold’s future direction.  I believe I’ve discovered something interesting:

GLD - 20130215

Since it began trading in 2005, the gold ETF, GLD, has had three consolidations in its secular trend higher, each of which lasted around 2 1/2-3 years.  The secular trend channel ascends at the rate of approximately 20%/year and can be clearly seen through the upper trendline connecting the 2006, 2008 and 2011 peaks.  A parallel line connects the 2008 trough with a point slightly lower than the current price, 155.54.

I believe we may be at or very near the end of the most recent 2 1/2 year consolidation and, if the secular trend can be trusted, a new bullish leg will begin shortly.  Extrapolating the channel suggests that the target of this next push higher would be in the area of 240-270 (or gold prices of 2400-2700) towards the end of 2014.

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January 24th, 2013

AAPL Update

imageA friend asked last night whether it might be time to jump on AAPL, now that it’s dropped so precipitously.  I referred him back to a piece I’d written early last November when the stock was at 563 entitled “AAPL Gets a Cold, the Market Gets …..?” in which I said that AAPL was forming a perfect head-and-shoulders top reversal pattern and, if it held to completion then the stock could fall to 385.

At the time, a call that AAPL would fall to 385 looked bold.  However, head-and-shoulder patterns are one of the most reliable chart patterns as are the mirror image of inverted head-and-shoulders as bottom reversal patterns (click on image to enlarge).

AAPL - 20130124

AAPL gapped down 61 points, or 12%.  My friend asked three questions: Why didn’t you sell short when you had confidence in the chart?  Should I sell short now?  Or should I buy now since it’s dropped so much already?  Typical questions that we ask every day about every stock currently in our Model Portfolio or stocks that we are looking to buy.

The first two question can be answered as a matter of general policy: I don’t short stocks.  I’ve tried it over the years and have lost money nearly each time.  Stocks can double if you hold them long enough in good market conditions but the odds of them falling 50% is rare.  We believe that the market controls 50% of a stocks action, industry 30% and factors specific to the individual stock only 20%.  Furthermore, based on my study of the stock market over the past 50 years, I know that the market increases 70% of the time.  So the odds are against you 70% of the time when you bet a stock will decline by selling it short.  You have to have close to 100% certainty that a stock will decline before taking on such long odds and, because I trade stocks based on my assessment of supply and demand dynamics rather than fundamentals, I never have that level of certainty.

The answer as to whether AAPL is a buy today is also rather easy and summed up in the Wall Street saying: “Never try to catch a falling knife”.  Right now, AAPL is clearly a falling knife.  Someday, somewhere, it will hit the ground; it’s just that we don’t know where.  When it does, the tide of momentum will have to reverse.  AAPL fell because almost every large institutional investor had AAPL as one of their major holdings.  There just wasn’t anyone in the market to sustain the demand and keep the price rising.  The balance of power flipped from demand-driven momentum to momentum propelled by supply.

As the chart above indicates, it took eight or nine months for momentum to turn from demand to supply; it will take an extended period of time for it to flip back from supply to demand.  Individual investors don’t have to be the first ones to climb on that train since we have no way of knowing when it will change direction.  What we do know is that there will be plenty of time for the individual investor to climb onto a moving train that has as large capitalization as AAPL.

My earlier guess was that the “roundhouse” will be in the 350-400 range.  No need to panic and buy now.

December 11th, 2012

Our Discipline: A Case Study in MED

As I’ve written here often, I believe the best approach for the typical individual investor is to manage their portfolios employing the following three steps: 1) a well-founded, unemotional approach to market timing, 2) the notion of industry group rotation and 3) diversification that spreads risk among a fairly large number of individual stocks (i.e., investing approximately equal amounts among stocks in the portfolio).

Put another way, the portfolio management effort down to answering the following questions: How much money should be put at risk in the stock market at any particular moment and, if new money is to be put to work, which stocks should be added to the portfolio? 

I solved the first question for myself several years ago.  I collected data back to 1963 on the daily S&P 500 Index and, by asking a series of “what-if” questions determined when it would have been better to have invested money in the market making an average return than having it sit idle on the sidelines.  Or, stated in the reverse, when would having money sit on the sidelines been better for long-term returns than had it been invested earning an average market return?  The analysis resulted in my Market Momentum Meter, an unemotional barometer of market sentiment, that allows me to shut my ears to all the media noise and hype about what they claim is “Breaking News” and focus instead on the truth about conditions conducive to momentum-driven markets over the past 50 years.  Following the Meter’s signals over the long run, investors could have avoided market crashes while still taking advantage of the bull market runs.  I can attest to the fact it helped me avoid the worst of the 2007-09 Financial Crisis Crash.

Once the Meter signals that it’s relatively “safe” to put new money to work in the market,  I use a two-step approach for finding the stocks best for carrying that risk.  I scan all stocks to find those that meet one of four different sets of criteria and, once having narrowed down the population of publicly-traded stocks, I look at their charts to find those that might have a good chance of crossing above levels that stymied their past advances (in other words, those that look like they could soon breakout across significant, long-term resistance trendlines). The first stocks to breakout are first in line as investment candidates.  The discipline requires me to sometimes be fairly active and at other times to do nothing but unemotionally watch the Portfolio run with the market or sit idle safely protected in cash.

The debate/negotiations in Washington has brought us again to a crucial market pivot point.  The Meter indicates that when market conditions look as they do today it might have been best for us to have money invested.  I have begun running those scans to begin finding those stocks that look like they’re ready to trigger Buy Points in their charts by crossing above key resistance levels.

While 75% of the stocks currently in the Portfolio show gains and 69% have outperformed the S&P 500 since their purchase, few have delivered the sort of results as has MED since its purchase last March.  I had never heard of Medifast when it dropped through one of the Scans and presented a compelling chart.  When I purchased the stock, I wrote in the Instant Alert to Members that the stock is “a product of yesterday’s Stocks-on-the-Move scan.  It has formed an inverted head-and-shoulders reversal pattern at what I hope will be the bottom of a multi-year descending wedge pattern.”  Since then, the stock has advanced 95%:

As the usual disclaimer says, “Past performance is no guarantee of future performance”.  But, I believe in the discipline and am using it today to find the next batch of stocks some of which, with some patience and luck, will hopefully deliver what turns out to be the outstanding performers over the next nine months or a year.

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December 6th, 2012

More Reliable: Horizontal vs. Sloped Trendlines?

Over the past several years, charts have become more pervasive than ever in discussions, commentaries and prognostications about individual stocks and the market in general.  Even Cramer, who once considered technicians to be on the same level as astrologers or readers of tea leaves, no regularly refers to the analysis of one chartist or another.

One of my pet peeves, however, is that bloggers and media talking heads will insert trendlines in their discussions almost willy-nilly as they pontificate about the support or resistance they hope the line they drew will presumably offered them. Because the use of trendlines is so prevalent, it’s assumed that everyone understands their meaning and relevance; we rarely hear about the arbitrariness and subjectivity that goes into their selection.

Last week, I offered three examples of head-and-shoulders patterns (GLD, AAPL and FDX), each demarcated by a horizontal trendline, or the pattern’s “neckline”.  [As an interesting aside, I may have been one of the first to publish an alert about the possibility of AAPL forming a head-and-shoulder top which could result in a correction down to approximately 400 in my November 8 post, "AAPL Gets a Cold, the Market Gets …..?"  Now many are commenting about it and Cramer even had a segment tonight dismissing the stocks technical risks.] What makes the head-and-shoulder such a “reliable” (if you allow me to use that term in the context of something so subjective as the reading of stock charts) pattern is that the supporting trendline is horizontal.  I’ve seen sloping necklines but these never turn out to be as recognizable nor as accurate.

As I describe in my book, Run with the Herd,

What makes trendlines so confusing is that many trendlines that seemed so precise at first may lose their potency as new trading is tacked on.  As a matter of fact, as more transaction data over longer and longer periods of time with multiple trading days condensed into individual bars, you’ll usually find yourself drawing a plethora of trendlines.  Some trendlines are short and some long, some connect pivot points that once seemed compelling and inviolate become less significant and even irrelevant when viewed in a longer-term.  The support or resistance expectations implicit in short trendlines at one may become overwhelmed and irrelevant as more recent buying and selling emerges.

Trendlines are nothing more than an arbitrary, imaginary lines that visually connect two or more pivot points. Pivot points are those spaces in time and price where control is transfers between buyers and sellers, when one trend in one direction reverses and begins moving in the opposite direction. In reality, this transfer doesn’t occur in one transaction at one price but instead occur over a period of time, a large number of trades at a range of prices.  There’s no precise way of locating when that transfer is complete and the struggle continue even when a reversal appears to be complete.

Why is it important to locate these pivots? Because we believe that after having occurred several times at approximately the same point, the failure to occur at that same level sometime in the future means that the winner of the last battle has lost control of the trend and it now resides in the other side who will control the trend until the next struggle begins.  That transfer of control is the breakout.

Repetitive struggles at the same price make intuitive sense.  An institutional investor looking to sell its large holding in a stock will continue to do so as long as a stock’s price is above a certain level; when it drops to or below the level they hold their shares back from the market; they will continue to accumulate shares up to a certain price but not above that price.  But what can we say the same thing about pivot points at different levels?  Bottom line, they tell us little about what we can expect about where the next pivot might be and we can say little about whether that recent pivot is the beginning of a reversal or the continuation of a trend.

The above chart for LKQ presents a pretty channel but it offers little information about the risks of the trend failing, how much profit potential remains in the channel trend or when it might collapse.  It is easy to draw the channel trendlines after the fact but drawing those lines in 2010 would have produced the dotted trendlines.  Which more accurately defines the trend, the solid or dotted lines.  Is the stock currently within the trend boundary or is it outside the bounds and bound to correct.  The most common mistake when inserting trendlines is thinking that the recent pivot is critical in establishing a meaningful trendline.  In other words, trendlines are usually discovered within the time frames of the chart, rarely coming in from prior the chart’s beginning.  That’s why I always simultaneously look at a charts in three time horizons.

That error doesn’t occur when you look for breakouts across horizontal trendlines like this one for NEOG.  Is there any doubt that a cross above 48.00 indicates that the bears have lost control to the bulls who have launched a new push to higher stock prices?

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