Calling a Top
Stockscores.com Perspectives for the week ending March 24, 2005
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In this week's issue:
How do you call a top in the market? We all like to ride strong up trends, but we also know that they don't last forever and we need to watch for the signs that the uptrend is running out of power, and likely to switch in to a downtrend. Here are some things to watch for:
Break of the Upward Trend Line: draw a line across the bottoms on a chart going back anywhere from six months to a year. If the current trading activity penetrates that upwards sloping line, then the uptrend has been broken. This is a sign that investors are worried about the lofty price levels of the stock.
Falling Tops: tops often come gradually, where the stock will make a new high, pull back, and the buyers will try to take the stock to another new high. If that second attempt fails, then the stock will make a falling top pattern, where there is a downward sloping line across the tops. This is an indication that pessimism is taking over from optimism, and a sign that the buyers are losing their enthusiasm.
Media Coverage: if the stock or sector's success is making headlines, it is probably time to sell. The media tends to react rather than predict, and so, when everyone is talking about strength, it usually means that the up trend is filled with emotion and likely to sell off soon.
Break Through Support: support is a floor price that represents a psychological barrier for sellers, it is the lowest price that they are willing to accept for the stock. If the stock breaks below that floor price, then it implies that there is something fundamental that warrants the acceptance of lower prices. As more people learn about this new information, more people will sell.
Let's apply these criteria to the energy market, by looking at the Canadian Energy Index ETF (Exchange Traded Fund), with the symbol T.XEG. Go to Stockscores and pull up that chart as you read this.
Notice that the upward trend line was broken on March 9. The sector then rallied back for about a week, but failed to make a new high, creating a falling top pattern. Last week, Newsweek had a cover page article about how high gas prices are, and that they are likely to go higher. In the past week, there have been numerous media pieces on the high price of oil and the expectations for the future. Right now, short term support for the T.XEG ETF is at $57.50, and break down below that would be the final step in a likely trend reversal.
Keep in mind that energy stocks typically top out around this time of year and find their bottom in August. Therefore, there is also a seasonal tendency working against energy stocks right now also.
Thus, we have the basis for a trading idea that we can then use to identify good opportunities. Remember, however, that no trading idea is 100% accurate, so we must keep an eye out for proof that we are wrong. If the energy sector is able to bounce back and hit a new high again, then any short positions we take in energy stocks should be covered at a loss, since the market has proven the idea incorrect. Always limit losses on any trade.
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Up trends do not last forever, and eventually stocks succumb to a shift in psychology and a retracement of recent gains. The Rolling Over Strategy seeks out stocks that are breaking down from pessimistic chart patterns after a good up trend. Stocks found with the Market Scan may represent good short selling opportunities for longer term traders.
Pessimism is best represented on a stock chart by falling tops. Falling tops indicate that, over time, sellers are gaining strength and buyers are losing their motivation. When stocks consolidate with falling tops, the pessimism is complemented by growing consensus on what the stock is worth. As a market comes to consensus above a support price, a potential trading opportunity takes shape.
We get a signal that the bears have taken hold of a stock when three phases have run their course.
The upward trend line has been broken
A price consolidation has evolved, preferably with a falling top signaling pessimism.
A penetration of support occurs.
A good short selling opportunity occurs when these three criteria appear, particularly on stocks that have made considerable price gains in the most recent three to six months. As traders take profits off of the table, and fear begins to build among owners of the stock, the downward momentum in the stock can increase, creating a profitable trade for the short seller that established a position on the breakdown.
I ran this Market Scan on the Canadian market, and found two stocks that meet the criteria nicely. They are both in the energy sector:
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1. T.WTO
T.WTO has made great gains in the past three months, but appears to be over extended to the upside. It is now testing support from a falling top pattern after breaking its up trend two to three weeks ago. Resistance at $60.50, so long as it can hold below that I think it has good potential to go lower.
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2. T.PD
Short term support on T.PD is at $90, and we are moving through that point today out of a falling top pattern that should set it up for a pull back in the near term. Resistance is at about $95, watch for a close above that as a clue that the short trade set up was not accurate.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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