Inflection Points
Stockscores.com Perspectives for the week ending March 11, 2007
In this week's issue:
I really don't know a lot about technical analysis, at least not in the traditional sense. I have never read a book about stock charting and I don't have any accreditation from a body governing technical analysis. So, although I use stock charts for every trade I make, I don't consider myself a technical analyst.
When I was young and broke, I would spend my days looking at countless stock charts. I would make a list of the stocks that had done well and then print out their charts to see if there were consistent signs that occurred before the stocks went up. I was looking for patterns that repeated themselves in the hope that I could find the keys to making money in the market. Eventually I realized that the market did give the clues and today the Stockscores Approach to investing and trading the stock market is based upon those initial tests.
My first great leap forward was to see the key signals that a stock had good potential to go higher and I became pretty good at predicting which stocks would do well. But, it was not until much farther through my stock market education that I realized that risk management was even more important than knowing what stocks to buy. My search for predictable patterns had to evolve from just the entry pattern.
One concept that I have developed which I think is very important for trading success is the idea of inflection points. They tell us where our entry decision is wrong and where the trend is likely to stall. In doing so, they provide the key elements of risk and reward for each trade.
I define an inflection point as follows. It is the point where a stock price stops falling and starts rising or, a stock price stops rising and start falling. Simply put, it is where the trend changes direction with the inflection price at the extreme of the trend reversal.
This means that an inflection point occurs when the buyers lose control of the market to the sellers or the sellers lose control of the market to the buyers. This makes inflection points very critical because they represent the limit on what any one side of the market thinks the fundamentals are worth. When an upward trend reverses to a downward trend, the inflection point represents the maximum amount the buyers willing to pay for the company's fundamentals.
This also means that a move through a previous inflection point is a sign that investors have found new fundamentals to justify paying more or selling for less than at that point in time when the market previously made a high or low.
It is easy to see why an inflection point is so important. If a stock has never traded below $10 and has consistently reversed from a down trend to an up trend at that price point, what does it mean when the stock falls to $9.50?
The implication is that the sellers have found a reason to sell for a lower price, perhaps some new information about the company that justifies a lower price. Not all investors get new information at the same time so a move through an inflection point can often be followed by a price trend as more and more investors learn of the new information.
Go look at some stock charts and count how often stocks get stuck, either at highs or lows, at more or less the same price points. It happens over and over again because the market remembers what it was willing to buy or sell the company for in the past. Unless the fundamentals change significantly, the price levels that occur at inflection points will hold up over time.
Now, here is how the application of inflection points plays a critical role in your trading decisions. If you buy a stock, you want to be close to a lower inflection point and far from an upper inflection point. That way, if you are wrong about the decision to buy a stock you will only take a small loss by selling the stock if it falls below the lower inflection point. If you are right you will find the stock rises to the upper inflection point which should be a distance that is at least twice the distance to the fall to the lower inflection point. If you have at least twice the upside as you have downside, you don't have to be right most of the time to make money.
It is not enough to pick the right stock, you also have to trade opportunities where the entry price relative to the inflection points put the probability of consistent profits in your favor.
This week, our Stockscores Pro members will receive an exclusive link to an online video where I explain this concept in more detail using charts and graphics.
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I don't think this is a good market for longer term investors. The breakdown that we saw in the market two weeks ago now has investors very uncertain and we are coming to the end of what is normally the strong time of year for the market. Since stocks tend to do poorly from May to November, I think it is time for investors to be defensive.
At times like this it can be better to focus on short term swing trades where you try to extract a few points out of a stock over a week or two hold period. This week, I ran the Pull Back Plays Market Scan to find some stocks that I thought had good short term potential, here is what I found:
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1. TXRH
Abnormal break a couple of weeks ago followed by a pull back. The pull back lost its momentum last week and it now looks like the stock may start to move higher gain. Consider the stock if it can get through $15. Support at $14.23.
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2. FCH
FCH is breaking from a short consolidation and has good upward momentum, the long term weekly chart is really strong so this could be a short term trade that turns in to a longer term hold. Support at $22.64.
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3. BOBE
Great weekly chart on BOBE, the stock broke from its pull back on Thursday so we are one day late on this but I think it is still worth considering, support at $35.10.
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References
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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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