Trading Channels with the Stockscores Indicators
Stockscores.com Perspectives for the week ending January 8, 2012
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In this week's issue:
The stock market todayis more efficient than ever. That means the market is extremely good at pricing in all available information about stocks, the economy and politics. Using information to pick stocks provides only random results. To beat the market, investors must focus on the emotional side of investing, gaining an understanding of human psychology and how it affects price. Simplified, success in the market requires that we:
Buy optimism.
Sell pessimism.
When pessimism turns to fear, buy.
When optimism turns to greed, sell.
When there is doubt in optimism, buy.
When there is doubt in pessimism, sell.
This makes a lot more sense when we look at a chart of something that has both trended up and down in the past. The TSX over the past 18 months provides a very good example of how the market has cycled between optimism and pessimism, fear and greed.
During the bullish trend of 2010 in to April of 2011, the bottoms were rising in an upward sloping channel and the Sentiment Stockscore was consistently above 60. When the trend turned bearish in May of 2011, the Sentiment Stockscore fell below 50 and the tops began to fall in a downward sloping channel. This provides us with six trade set ups:
1. Buy optimism - define the mood of the market by the slope of the channel. A channel is a price trend with parallel upper and lower boundaries. If the channel is moving up, optimism exists. During times of optimism, the Sentiment Stockscore (green line) is above 60. Between 50 and 60 is a transition zone.
2. Sell pessimism - define the mood of the market by the slope of the channel. A channel is a price trend with parallel upper and lower boundaries. If the channel is sloping downward, the market is pessimistic. During times of pessimism, the Sentiment Stocksocres is below 50. Between 50 and 60 is a transition zone.
3. When pessimism turns to fear, buy - in a downward trend, prices will oscillate between the upper and lower boundary of the channel. At the lower boundary, fear has caused investors to accept too low of a price and a bounce up to the upper boundary is likely. At this point, the Signal Stockscore will spike below the Sentiment Stockscore and price will be at the lower boundary of the channel.
4. When optimism turns to greed, sell - In an upward channel, greed can cause investors to pay too much, taking price to the upper boundary of the upward sloping channel. This presents a selling opportunity as price will usually fall back to the upward trend line. At this point, the Signal Stockscore will spike above the Sentiment Stockscore and price will be at the upper boundary of the channel.
5. When there is doubt in optimism, buy - during an upward sloping channel, the best buying opportunities occur when price pulls back to the lower boundary of the upward channel. Momentum of the long term upward trend typically brings back buyer interest at this lower boundary. At this point, look for a downward spike of the Signal Stockscore below the Sentiment Stockscore, which should still be above 50.
6. When there is doubt in pessimism, sell - during a downward sloping channel, the best selling opportunities occur when price rises up to the upper boundary of the downward channel. Momentum of the long term downward trend typically brings back seller interest at this upper boundary. At this point, look for an upward spike of the Signal Stockscore above the Sentiment Stockscore, which should still be below 50.
You can apply these set ups to charts of any time frame as long as you can identify price channels. Stocks do not always establish price channels in all time frames, however, if you don't see one on one time frame, you may see one on another.
Now that Stockscores.com allows you to look at intraday, daily, weekly and monthly time frames, we can always find a channel to trade. Here is an intraday example of Microsoft from the last two weeks:
A new channel was defined for MSFT on January 3 and has been carrying the stock higher since.
Use these concepts to evaluate the stocks you are considering. Use Stockscores.com to search for stocks that have Sentiment Stockscores of 60 or higher and then inspect their charts to see where price is relative to the current price channel. Look for new channels that are beginning or opportunities to trade doubt inside a channel. When taking profits on buys or shorts, look for signs of greed in upward channels and fear in downward channels.
Emotion still plays a role in the stock market and provides an opportunity to the trader who knows how to read emotion in the chart. Use the Stockscores and price channels to translate the message of the market.
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We can use the Stockscores Market Scan tool to search for trading opportunities using the Stockscores indicators. If we want to find stocks that may be starting new channels, we could do a search for:
Sentiment > 50, < 75
Long term moving average = Bearish
Short term moving average = Bullish
Number of trades > 100 (or more if you want only the most liquid stocks)
Look for stocks that are moving through the upper envelope of a downward or sideways sloping channel.
If we want to search for pullbacks in upward channels, we could search for:
Sentiment > 60
Signal < 60
Long term moving average = Bullish
Number of trades > 100 (or more if you want only the most liquid stocks)
Let's look at a few examples of trading opportunities based on the concepts shown above.
When inspecting the charts, look for the current price to be near the lower boundary of an upward sloping channel.
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1. T.TCM
T.TCM has been in a downward trend for the past year but this week, was able to break out of that downward trend after building rising bottoms over the previous three months. The Sentiment Stockscore is climbing up through 60 after being below for nearly a year. This chart is a good position trade set up with support at $7.10.
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2. MENT
MENT has been trending upward in an orderly channel for three months. Over the past four days, the stock has pulled back from its local highs and is now at the upward trend line where it should bounce. Watch for a price move up through $13.35 as confirmation.
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3. TYPE
The upward trend in TYPE moving up for four months and got ahead of itself, causing the recent correction back to the upward trend line. Watch the 15 minute chart for a break of the intraday downward channel as a sign that the stock is going to bounce up off of its longer term upward trend line.
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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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