Category Archives: Technical Analysis

April 23rd, 2012

The Lower Boundary is Becoming Clearer

Less than two weeks ago I wrote ““Identifying the Boundaries of Stock Chart Congestion Areas” in which I talked about three potential bottom boundaries of the congestion area that was developing and might eventually turn into a recognizable chart pattern.  With time, the emerging chart pattern is becoming clearer and, I must add, a bit more worrisome.

 

The discussion of “boundaries” is actually at the core difference between fundamental and technical analysis.  In fundamental analysis, analysts look at the slowing Chinese manufacturing index, Spanish debt refunding, elections in France and the upcoming U.S. elections, this quarter’s corporate earnings reports and the guidance for the year, upcoming Fed meetings, jobs reports, etc., etc.  Those analysts would then attempt to distill and prioritize the voluminous and disparate data facts into a consistent picture.  Finally, they will translate that picture into not what it means today, where it all might be headed in the future and what the impact might be on the stock market and individual stocks.

Needless to say, there are about as many divergent opinions about each of these data points as there are analysts willing to speak about them.  Some of those opinions are meaningful and reliable while most are guess that are about as useful as yours or mine.

Technical analysts, on the other hand, focus more on the actual decisions continuously being made by millions of investors, whether rightly or wrongly, rather than the reasons for their having made them.  They look at the continually changing balance (or imbalance) between supply (sellers) and demand (buyers) as reflected in transaction prices and volumes.  The primary focus begins with whether that balance is shifting on a continuous basis in one direction or another because when that imbalance starts it tends to be self-perpetuating, reinforcing and continues for some time (i.e., momentum).

The market, after having risen nearly 30% since October, is currently almost perfectly balanced between buyers’ demand and sellers’ supply.  Based on investors’ various interpretations of those fundamental facts, nearly an equal number see the facts portending a bearish future as those who see the facts leaning in a more bullish direction.  In other words, about as many see the market glass as half-full as see it half-empty.

Our search for boundaries is an attempt to learn when that equilibrium balance starts tilting in one direction or another.  Sometimes the balance continues for a few weeks and sometimes it takes months.  In the last post, I inserted three possible bottom boundaries.  As a result of today’s severe open, one of those supporting trendlines was penetrated; if there isn’t a quick strong bounce before the close and into tomorrow, then more downside can be expected.  If the demand is insufficient to absorb the supply of those investors who see a pessimistic outlook then the market will break below both of the remaining support levels and will continue lower until a new equilibrium balance forms at lower levels.

April 12th, 2012

Identifying the Boundaries of Stock Chart Congestion Areas

I was traveling this week so, fortunately, I wasn’t able to react to the ups and downs of the market this week.  If I had, I would have been closing some really good positions on Monday and Tuesday and then kicking myself as I scrambled to put them back on Wednesday and Thursday.  The lesson to be learned that was reinforced yet again is to turn off the CNBC, tune out the noise of all those explanations (read “rationalizations”) for why the market had done what it had done and to focus intently on the longer term for true trend reversals.

For the past several weeks I’ve been writing to members in my Weekly Recap Report that

“This narrowing, trading range can’t continue indefinitely and, I believe, will in all probability be resolved with the market falling below the bottom trendline as contrasted with a highly unlikely blow-out cross above the upper boundary.  I’m guessing the cross (the “collision”) will take place as the market approaches the horizontal resistance trendline extrapolated to occur sometime towards the end of April.  Coincidentally, that also coincides with everyone launching into their seasonal ‘Sell in May and go away’ discussions.  Taking that course of action would have been the right move to take in 2010 and 2011 and could again be true this year.”

But even that wasn’t sufficient to call this week’s action as a reversal.  There are millions of investors around the world making a huge number of trading decisions every day.  It takes more than a few hours, days and even weeks of trading to have this ship, the market, list to the other side as the majority of them run from one side (the bull side) to the other (the bear side).

One of the most difficult challenges in charting is distilling from the daily action the true boundaries of emerging chart pattern that are emerging from the congestion of what will, with the clarity of perfect hindsight will be either an obvious reversal or consolidation pattern.  Boundaries require pivot points, the short-term reversals made be either the market or individual stocks.  I’ve inserted three possible bottom boundaries based on the market’s recent behavior:

The important take-aways from this exercise are:

  1. Don’t get wedded to one point of view or another too early as to the market’s future course (and that’s what we’re most interested in since it determines 50% of each stock’s performance).  Congestions, those times when sellers and buyers, bulls and bears, supply and demand are fairly much in balance struggling to take control of the future trend.
  2. Regardless of how astute or knowledgeable you may think you are, it’s nearly impossible to predict the outcome and nothing you do can change what the ultimate outcome will be.  The best course is to wait for the trend.
  3. Don’t get wedded to what you think will be the pattern likely to emerge.  Supply and demand is dynamic and constantly in flux.  It’s difficult making money during these congestion periods but profits are relatively easy to come by when either a bullish or bearish trend emerges.

It’s only after several pivot points are made over an extended period of time (weeks or months) that solidify the trendlines will you be able to determine whether the congestion will in all likelihood be a consolidation, a top reversal or a bottom reversal ….. and then the market will confound you further by either doing the opposite or continuing adding further clarity to the congestion area.

March 19th, 2012

Would I buy the stock today if I didn’t own it?

I can’t believe it’s been two weeks since my last post.  Please accept my apologies.  I’ve been doing exactly what I said I would do in that March 2nd post, I’ve been “shooting fish in a barrel”.  And for the time being, I believe my fishing respite is coming to a close.

The market crossed above April’s high and is slowly climbing to what might be the next resistance at approximately 1435-1440, or a mere 2.5% above Friday’s close.  Last week, the market ended 2.43% higher for the week so the next resistance may be reached by the end of this coming week.

Why could 1435-1440 be the next resistance area?  Not because so many others are talking about it (and they may because they look at the same charts) but because that’s approximately the level of the higher of two alternative necklines of the 2007-2008 reversal top of the 2007-2009 Financial Crisis Crash.  The lower is where last year’s correction began and the extension of the upper neckline is where the market is heading next.

It would be nice to think that once the market recovers a trend will continue unabated for an extended time.  Unfortunately and disappointingly, that’s not the way market’s work.  The market has risen 16.49% since December 16 and needs to digest this extended move.

I’m guessing that the market was recovering from the 2007-2009 Financial Crisis Crash until the European Debt crisis and the Congressional Federal budget stalemate last year stopped it in its tracks.  Even though we will soon enter a consolidation there should be plenty of further room on the upside before a major correction along the lines of last year’s.  Too many stocks haven’t yet fully participated in the unbelievably beautiful, stealth bull market that’s occurred since the beginning of the year.  For example, even though many of the banks and other financial stocks have led the market higher so far this year, most are still just now crossing the necklines in their chart patterns indicating that there should be another an equal amount of appreciate left in their move.

The challenge up to now has been to put money back to work without severely increasing risk.  The next several weeks will present a different sort of challenge: determining which stocks you own are 1) consolidating previous gains, 2) late bloomers and will begin their move after the market correction or 3) will be forever doomed and should be sold.  Here are examples of some that I’m evaluating:

  • BR: I recently added this stock on the expectation that a strong market will help it cross above its long-term resistance into all-time new high territory.  Was I premature by not waiting for that cross?  I didn’t follow a discipline of buying only after a breakout and now wonder whether I will soon pay the price of that violation.
  • EMN: Purchased the stock in the hope that the “buyers’ remorse” correction had ended and it was able to realize the potential of its ability to cross into all-time new high territory.  Should I patiently wait for that realization or should the stock be abandoned while I can exit with a small profit.
  • EXPE: Another stock I purchased on the expectation that a strong market will help it cross above a long-term resistance level.  But now a market consolidates will probably hinder the stock’s ability to cross above the upper boundary of the ascending channel and the long-term resistance level.  Wait it out or sell?  That is the question.

I’ve always found that the simplest way of deciding whether to hold on to a stock is thinking the mirror image of the question: “Would I buy the stock today if I didn’t own it?“

March 2nd, 2012

Stock Picking Now Feels Like Shooting Fish in a Barrel – Chapter 2

We hear a lot today about the individual investor being frightened away from the stock market.  We hear that the young, those who face the challenge of having to replace social security for their retirement have no interest in owning stocks.  Many today believe that owning stocks is risky, difficult and is nothing more than gambling.

However, the performance of the market and of individual stocks since the beginning of the year should have been an excellent testament to exactly the opposite.  Over the past several of months, I often feel as I did on July 23, 2009 when I wrote “Stock Picking Now Feels Like Shooting Fish in a Barrel“.  You should click on the link and read the piece but, for you who are too lazy, here are some choice quotations from it:

“This is a great time to be a stock picker! You don’t hear many say this these days but it’s exactly the way I feel. The market and economy felt like they were going you know where in a hand basket on March 9. But now that seems so long ago and with the vantage of the slow, 10-month market turnaround ….. picking stocks feels almost as easy as shooting fish in a barrel …… It’s not often that you can start with a clean slate (i.e., essentially a 100% cash position) …. we have little garbage to clean out and now have the pleasant task of finding new seeds to plant ….. Many stocks have charts that closely reflect the market’s bottom reversal pattern….”

The technique I described there was the “Stocks on the Move” scan; these days I run daily and it always delivers a long list of excellent candidates.  As I wrote in 2009, the scan parameters

“Sounds complex but the results filtered out with 135 amazing stocks.  I don’t mind saying I have a hard time deciding which of these 135 I’m going to add to my portfolio but I would feel comfortable and sleep well with nearly any of them (with the caveat that the market remains constructive by crossing above the neckline by Labor Day, as I expect it will). “

I present charts of the following stocks as examples in that July 22, 2009 post.  Note that by that year-end, the four stocks were up an average of 35% (the market had risen 16.88% of the period) and up over 100% by the following year-end (market up 31.82%):

As members to Instant Alerts know, I’ve bought I’ve bought 60 stocks for my portfolio since October 24, 2011 and today 75% of them show gains (four of over 20%) while I’m confident the remaining 25% will soon also show profits.

I don’t intend to boast; I mention this only to prove the point about how easy it is to find great stock to buy in at times like these.  If you buy stocks at the beginning of a bull run and are patient enough to ride them to the end of that wave then it should be relatively easy to generate some huge gains.  On the other hand,  it almost doesn’t matter what stock you buy or how good it’s chart appears to be, you’re facing significant risks and the probability of only small rewards when the trade is near the end of a market life cycle,.

In 2009, the Market Momentum Meter had turned Bull/Green on June 24, 2009, three weeks prior to the above post and the tool I use to time the market (the relative positions of four moving averages plus the Index itself as described in Market Momentum Meter) turned Bull/Green came on November 18, 2009.  We might again be at a similar inflection point, the beginning of a new market life cycle, because  Momentum Meter turned Bull/Green on January 31, 2012 and the moving averages are only 45-60 days away from a perfect bullish alignment.

Finding stocks to buy again feels like a bounty or riches, like shooting fish in a barrel.   The “Stocks on the Move” scan is again spitting out up to 200 stocks worthy of purchase (most of my 60 trades came from that scan).  As was true in 2009, many of those stocks presented classical bullish chart patterns or potential break out situations (click on image to enlarge) including:

  • ISRG on 11/3/11
  • SCSS on 1/27/12
  • EQIX on 2/2/12

At time like these, the challenge isn’t in separating the winners from losers, it’s in putting money to work quickly enough to take advantage of the market momentum move.

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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.

February 16th, 2012

Parallel trendlines for positioning targets

There are those who follow Bob Prechter, one of the strong proponents of the Elliott Wave principles have their ways of identifying price level targets.  And then there’s the crowd who hide out at Slope of Hope, the place where perma-bears can always find a reason for an impending correction or “much welcomed” bear market crash through targets derived by their overly precise application of arcane Fibonacci mathematics.  But I’ve always found a rather simple approach to projecting out potential targets by applying a resistance trendline parallel to the corresponding supporting trendline and thereby creating a channel.

Take for example XHB, the homebuilders ETF.First, you should note how reversal and consolidation patterns easily morph from one form to another without a general market tailwind.  Until last summer’s meltdown due to the domestic budget and European sovereign debt crises, it looked as if XHB would break out the upside of a symmetrical triangle.  Since last summer’s 30% decline, it now appears that pattern has morphed into an ascending triangle and, with cooperation of a more constructive general market backdrop and expectations for finally an improved housing market, that upside breakout might now be at hand.

If break out does materialize, the next question is what might be a reasonable target for the move higher?  Consider a parallel line as on benchmark:

Parallel lines are simplistic and anything but elegant but they usually work.  They definite position a target for one’s expectations.  They won’t let your dreams run wildly out of control and add a time dimension to a price expectations.

Reality never really works so perfectly but, if the market and XHB dramatically diverges from this trajectory then we can make mid-course adjustments when and to the degree necessary.

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February 9th, 2012

Will the Market Soon Cross into All-time New-High Territory?

There’s no question about it, I’m definitely in the minority.  First I wrote a piece entitled “KISS in Market Timing Too” in which I compared my approach to a complex algorithm developed by Ciovacco Capital Management called the Bull Market Sustainability Index (BMSI).

I followed that up with a piece yesterday entitled Market Momentum Turning, But Will It Accelerate? in which I see each of the four moving averages that I use in my Market Momentum Meter market timing tool having turned up and soon approaching a perfect bullish alignment (50-dma>100-dma>200-dma>300-dma).

Now I see something written by Ray Barros in Green Faucet entitled “S&P Nearing A Top?” in which he lists the following six indicators that have convinced him that the market is just one step like the failure of Greece debt negotiations away from collapsing into a bear market. Those six technical indicators are:

  • Price – Structure: The 12-Month Swing and 13-week swing show we are in a sell zone. Figure 3 shows that since the Dec 2, 2011 that the up move has been on declining volume and range. In this context this is bearish.
  • Time: Kress Cycles suggest we are in a window when a top is likely.
  • Momentum: Figure 4 shows that this up move has been on declining momentum.
  • Sentiment: The sentiment indicators I use suggest the S&P is skewed to the upside.
  • Normalised Volume: We saw a sell setup with ‘below normal range’ and ‘normal volume’.
  • PoMo: For me, this indicator generated a sell signal today.

He even includes charts depicting each of the above as supporting evidence like the one below:

However, I looked at those charts and what struck me was that: 1) they were so complicated and there was so much to digest that I couldn’t possibly make heads or tails of them and 2) I wondered what those signals might indicate if we hadn’t been in a secular bear market for the past 11 years.

The answer to his question of whether the market is approaching a top is definitely yes!  I have little doubt that the market will approach the previous all-time high of 1576 sometime this year or next.  The correct question to ask is will the market soon scale to new heights and cross into all-time new-high territory?”  Since my Market Momentum Meter is turning bullish at these loft levels, I hope the answer is yes and I think the answer will be yes.

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February 4th, 2012

FAST: Two Views from the Heart and the Mind

I’m always intrigued by those who go to lengthy extremes when comparing the Fundamental and Technical approaches to analyzing stocks.  For me it’s rather simple; I consider the Fundamental approach as the one using the heart while the Technical approach uses the head.  Fundamentalists point to their belief and their feelings about such factors as future earning results, growth rates and valuation multiples.  Technicians point to actual historical trading results and project those results into the future assuming all conditions remaining constant.

A  perfect example was a recent post by Chuck Carnevale entitled “Fastenal (FAST): A Vivid Case of Overvaluation. Carnevale’s case is that

“From 1994 to 2008 the Fastenal Company grew earnings from $.6 a share in 1994 to $.95 a share by 2008, resulting in a 23.7% compound annual growth rate. The normal PE line depicts a trimmed (the highest PE and the lowest PE trimmed) average PE ratio of 36.3, this simply indicates that the market has often priced this company at a peg ratio in excess of one. On the other hand, it is clear from the picture that the stock price often moved above and below the normal PE, and in many cases traded at its orange earnings justified valuation line…

 

…since calendar year 2010, Fastenal Company has grown earnings at the average rate of 33.9% per annum. This accelerated earnings growth should be considered as coming off of the low base which was created by the recession of 2008. Furthermore, we believe this accelerated earnings growth greatly attributes to the company’s current abnormally high PE ratio of 37.8. In other words, the market is valuing this company very optimistically..

 

…assuming that the estimates from the various analysts are within reason correct, then we would argue that this high-quality company, with no debt on its balance sheet, and a great record of earnings growth, is nevertheless very expensive today. We believe this is also apparent in the context of the fact that there are numerous other companies with similar operating histories, and dividend yields that are trading at PE ratios one-half to one-third of what is currently being awarded to Fastenal Company. “

Carnevale includes a number of tables and charts depicting the relationship between the earnings and sales growth with the stocks price history from 1994 to 2017 … yes 2017 to make his case.

As an individual investor, I like to keep things simple.  Why pay good money for expensive services to give me all sorts of information about individual companies and their stocks without talking about market conditions or the rotation of the big money into various industry groups?  It would be better to make my own decision using basic and readily available charts like this one on FAST:

An unequivocal ascending channel since 1994 with parallel trendlines and, yes, FAST is approaching the upper trendline.  If the stock continues to rise at its current rate then, after another 16% move higher, it will touch the upper boundary at around 56.  A slower ascent will allow a slightly higher touch point.  My conclusion is that one can get another 16% gain before the “overvaluation” becomes an issue.

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February 1st, 2012

KISS in Market Timing Too

KISS is an acronym for the design principle articulated by Kelly Johnson, Keep it simple, Stupid!  Variations include “keep it short and simple”, “keep it simple sir”, “keep it simple or be stupid”, “keep it simple and straightforward” or “keep it simple and sincere.”  The KISS principle states that most systems work best if they are kept simple rather than made complex, therefore simplicity should be a key goal in design and unnecessary complexity should be avoided.

Other forms of this maxim are “everything should be made as simple as possible, but no simpler” (Albert Einstein), and “”Simplicity is the ultimate sophistication” (Leonardo da Vinci).  The principle is true whether applied to the design of an airplane, conceiving the theory of relativity or developing a market timing tool.

The following statement was made in a post today entitled “Golden Crosses Can Lead To Golden Losses“:

“While both CCM [that's Ciovacco Capital Management] market models have jumped back into bull market territory, the Bull Market Sustainability Index (BMSI) is approaching levels that are typically associated with market corrections.”

Stick a statement like that in front of me and I had to find out more about the BMSI to see how it compares with my MMM (Market Momentum Meter) which members know that it is serves as the barometer of my market timing approach and is previewed here.

About the only similarity between my MMM and the BMSI is that both are depicted on a scale that runs from Red to Green.  While my is a simple 5 traffic light approach, the BMSI looks like this:

But the similarity ends there.  Where the MMM uses 4 moving averages and the underlying S&P 500 Index, the BMSI is constructed with 30 different indexes as follows:

Complexity doesn’t mean precision and precision doesn’t mean accuracy.  It sort of reminds me of Cramer inferring in his “are you diversified?” segment that investors are safe and can generate high returns over the long run by merely diversifying their portfolio.  Aggregating a large and diverse number of indicators doesn’t necessarily give a better market timing signal than do a combination of four moving averages.

I’ve back-tested the MMM back to 1963 and am convinced that it performs well.  It got me out of the market in 2007, signaled reentry back into the market in 2009 and kept me safe through the fears brought on by last summer and winter’s worst European sovereign debt and US debt downgrades and budget debates.  It’s just issued a new signal indicating ….. sorry, that’s for members only.

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January 27th, 2012

VTR and REITs: Awaiting Resolution of “Great Convergence”

As discussed in the previous post, the market is at a crucial juncture, something I have labelled “The Great Convergence”.  The confluence of risk and opportunity is seldom as obvious as it is today.  Many of the risks still hang over our heads (need I mention Europe sovereign debt, U.S. election season, renewed U.S. budget debates, housing market still on its back, another round of debate about healthcare, etc.) yet each, through the prospect of their ultimate resolution, presents impetus offers another reason to be bullish.

The Convergence is evident as the apex of the huge symmetrical triangle that has formed over the past 4-5 years in chart of the S&P 500 Index since 2007.

One sector that safe for waiting for more certainty are the REITs.  With the Fed announcing that they foresee low interest rates through 2014, the yields available in REITs still looks competitively attractive, even though the stocks continue to appreciate without any significant correction.  One stock that seems to fit that description is VTR (Ventas Inc).  With a dividend yield of 3.9%, VTR appears to be a stock in which one can sit and wait until the direction out of the Great Convergence is clear.

Rather than mimicking the chart of the S&P 500, VTR recently broke above a significant 5-quarter resistance trendline.  That may be considered a consolidation cup-and-handle after the long run from the reversal pattern at the bottom of the Financial Crisis Crash.  If it turns out to actually be a consolidation, then the next move could take the stock up to around 100 using the charting rule-of-thumb that a consolidation is at the mid-point of the move (the move after the consolidation should approximately equal the move before):

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