Five Trades
Stockscores.com Perspectives for the week ending October 28, 2011
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In this week's issue:
A considerable effort is being made to get Stockscores back to normal (and improving it!) after our move last weekend. It is a time consuming process but we are getting there, thanks for your patience.
Remember, when you see a man at the top of a mountain, he did not fall there.
Achievement requires effort, but there are many paths to the top. In stock trading, our goal is simple; beat the market and make money. There are many ways to do that, as a trader that uses chart analysis as my chosen path to success; there are also a number of methods. Here are my Five Typical Trades, each a strategic method for putting money in your account.
Reversals
The first variety of chart pattern set up is the reversal. This class of strategies look for a shift in control from buyers to sellers, or sellers to buyers. I look for two different things when seeking reversals. The first approach is to find stocks that are in sustained price trends and then break their trend line. This can be the break of an upward trend line, telegraphing a downward move, or a downward trend that is broken as the stock makes a bottom.
The other set up is a shift from rising bottoms to falling tops (a topping pattern) or from falling tops to rising bottoms. This second approach to reversals is more conservative but also more reliable. You will get in later on the reversal but the success rate will be higher.
Generally, I prefer waiting for a move from falling tops to rising bottoms when looking for a bottom but I will short sell a simple trend line break on a strong stock rather than wait for the break down from a falling top.
Breaks
There are a lot of stocks that trade in boring, sideways trading ranges that show little price volatility. These stocks are marking time, investors having little new fundamental information to motivate strong buying or selling and a upward or downward trend. Stocks in these situations are opportunities waiting to happen, for abnormal price breakouts with abnormal volume signal that well informed investors have found a fundamental reason to buy or sell the stock aggressively. Since the spread of information in the market is not always fair, these well informed investors are leading the crowd. When the wider market learns of the information that caused the breakout, the stock will be accumulated by many, initiating a money making trend.
But buying breakouts alone is not effective. You have to be sure that the break is a signal that there is something going on with the company, that there is a significant change in company fundamentals behind the break. Understanding chart patterns is key to doing this.
Run Aways
Once a stock gathers momentum and starts moving up, the emotion of the market may cause it to move too quickly. A stock that goes up or down too fast has a greater potential for a short counter trend, caused by investors who take profits. If you bought a stock and make a very good return in a short amount of time, you will likely want to exit the trade to lock in profits.
One trading strategy is to play this process, shorting a stock that goes up too quickly or buying a stock that goes down too fast. This trade goes against the longer term momentum of the stock and is only a short term trade. For savvy swing traders, it can be a lucrative move.
Where do you choose to go against the grain? Look for stocks that are trading with emotion, high volume and a very steep trend. Recognize that these stocks will find barriers at historical support and resistance and will like begin their counter trends there. Anticipate a counter move at these price levels.
Pull Backs
Stocks have momentum once a stock has been in a trend for a while, and that momentum will dominate to bring the stock back on course when there is a short counter trend. Pull Back strategies look for stocks that have a long term trend in one direction and a short term trend in the opposite direction. Playing Pull Backs require you enter the trade when the stock pulls back to the trend line and give some sort of confirmation that it is likely to bounce off of the trend line and continue with the longer term momentum.
Anticipations
Some chart patterns show a mood but lack a trend. For example, those familiar with charts will know that ascending triangles show optimism, and descending triangles pessimism. However, they are consolidation patterns, which means price in general is going sideways over time.
One strategy is to anticipate a breakout by buying stocks in ascending triangles or shorting stocks in descending triangles. Since price volatility is low, the risk of the trade is less and the upside greater if the stock does what we expect of stocks in these patterns, breakout.
I have mixed feelings on this strategy. It makes good logical sense but in my own trading I have not had great success anticipating breaks. While the risk reward trade off is better, the probability of success is lower. I think you can trade this way, but my preference is to wait for the break with the understanding that the probability of a trend developing is higher.
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A common theme among Head and Shoulder Bottom, Ascending Triangles, Pennants and Rectangle Consolidation patterns is a break through resistance from low price volatility, usually with volume supporting the breakout. Rising price bottom formations in to the breakout point are common, but what market dynamic do these patterns really represent?
Rising bottoms are a sign of growing optimism among investors. As time passes, they demonstrate a weakening of selling force and increase power among buyers. As a stock moves up toward a resistance price point, the market is faced with the upper limit on what investors believe the company to be worth. We often see that stocks will go in to narrow trading ranges under resistance as investors come to a consensus on the value of the company. When stocks break out from this condition, they may be signaling significant new fundamental information at work in the market since resistance has been broken from strong consensus out of a period of optimism.
The Sentiment Stockscore is useful for finding optimism in the market, and the Signal Stockscore is heavily weighted on the abnormal market activity that comes with breakouts. By looking for stocks that have a Sentiment Stockscore of 60 or higher, and a Signal Stockscore of 80 or higher, we can consider charts that may have a good chart pattern set up. The Stockscores Simple Market Scan adds in some other technical filters to shorten the list of potential candidates further.
This strategy is not solely about finding stocks with good Stockscores. The most important step is visually inspecting the charts to ensure that the chart patterns are what we are looking for. A good chart pattern will have the following characteristics:
A break through resistance
Abnormal activity, in terms of price and volume activity
The break through resistance should be from a period of low price volatility. Low price volatility is characterized by the price range of trading on each day (how tall the trading range is on the chart) and by the range of trading over a number of days (are the trading days side by side on the chart, or is there a price trend?)
A show of optimism leading in to the break through resistance from low price volatility.
Since the market is turning around after five months of bearish trend, this is a good strategy to apply. I ran it on the US and Canadian markets and found 2 charts that I like:
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1. T.PWF
T.PWF is breaking from a rising bottom after breaking its downward trend early in October. The stock's Sentiment Stockscore has just crossed above 60, a sign of optimism. Support at $26.
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2. VPHM
An inverse head and shoulder breakout pattern on VPHM today as the stock moves through resistance at $20. Support at $19.
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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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