understanding Chart Patterns
Stockscores.com Perspectives for the week ending May 22, 2005
In this week's issue:
While technical analysis offers hundreds of indicators all designed to offer some insight in to the future direction of a stock's price, one cliché rings true for successful stock traders.
A picture is worth a thousand words.
Reading chart patterns is a basic skill that all stock traders should master, for no single technical analysis indicator has made me money in the way that understanding chart patterns has. My approach to stock selection is simple; find stocks with good chart patterns and ignore most other aspects of stock analysis. Amazingly, the ability to read stock charts only requires the mastery of six simple concepts.
Support
This is a floor price that investors have established for a stock. Based on all fundamental information available to investors, this is the lower boundary for what investors are willing to accept for the stock. It is the bottom line, and is important because a break through the bottom line often signifies new and negative information, or a change in investor psychology.
Resistance
The exact opposite of support, resistance is the ceiling price that investors have established for a stock, and represents the maximum price investors are willing to pay for a stock, based on all the fundamental information that they have to judge. Breaks through resistance are often motivated by new, fundamental information in the hands of some investors who can then justify paying more for the stock.
Optimism
It has been said that investors should never fight the trend of the market. Ideally, we want to buy stocks that the market is optimistic about, since this optimism will help the stock to move higher. Optimism is characterized by rising bottoms on the price chart of the stock.
Pessimism
If the investment community is in a bad mood about a particular stock, that stock will not likely move higher since few investors will see the company's fundamentals in a favorable light. We can see pessimism on a stock chart if there are falling tops in the price behavior.
Volatility
Volatility equals uncertainty. Investors are not really sure about what the stock is worth if the stock's price volatility is high. Therefore, the market has come to some consensus on what the company is worth when there is relatively less volatility in price. Most good chart patterns show breaks from low price volatility, because breaks from low price volatility often occur when there is significant fundamental change in the company's business.
Abnormal Behavior
As new information becomes available to investors, price and volume behavior often become relatively abnormal. The reality of the stock market is that it is not fair, and some investors have access to information before others. When these investors act on new information, they often create abnormal activity.
Good chart patterns are comprised of some combination of these six factors. For example, breakouts from Ascending Triangles often telegraph an up trend. Ascending Triangle Breakouts are defined as follows:
1. Rising bottoms on the stock chart, showing optimism.
2. A horizontal line of resistance at the top of the chart, showing an upward limit on fundamental value.
3. A movement from high price volatility to low price volatility over time, signifying an increased consensus among investors on what the company is worth.
4. Abnormal price and volume activity on the day that the stock breaks through the resistance price.
Keep the six characteristics of chart patterns in mind when you are looking at any stock chart, because virtually all chart pattern are some combination of them. An understanding of these six factors gives you all that you need to predict where stock prices are likely to go in the future.Back To Top
It is much easier to make good stock picks if you focus on a market sector that is strong. This week, I started my research process differently by first using the Sector Watch tool to find a market sector that had a high Sentiment Stockscore. One of the strongest sectors right now is Biotechnology, so I then did a simple market scan on the Biotechnology sector, looking for stocks that have a Sentiment Stockscore of 60 or higher and traded at least 100 times on Friday. From that list, I found the following stocks that I think have good charts, and therefore, good potential to go higher in the weeks to come:Back To Top
1. XOMA
XOMA is forming a nice ascending triangle pattern with resistance at $1.50, I would really like the stock if it can make a break through that resistance price with strong volume supporting the breakout. A recent Sentiment Crossover above 60 indicates that optimism is starting to come in the stock.
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2. RGEN
RGEN made a good break through resistance on Friday with higher than normal volume, and looks like it can start to work against the longer term pessimism that has controlled this stock. This looks like a decent bottoming pattern.
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3. RIGL
This is a great chart set up waiting to happen. RIGL is forming a rising bottom consolidation with resistance at $20. I would like to see the stock breakout through $20 with higher than normal volume on the breakout day. If that can happen, I think the stock will have good potential to run up to $25.
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References
Get the Stockscore on any of over 20,000 North American stocks.
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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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