Trade Types and Market Outlook
Stockscores.com Perspectives for the week ending April 29, 2013
In this week's issue:
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Stockscores Market Minutes Video
Not all breakouts through resistance are the same. This week, Tyler discusses other things to consider when evaluating a breakout plus provides his regular market commentary. Watch it on YouTube by clicking here.
This Week's Trading Lesson
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.
Market Outlook
The basics of chart analysis continue to provide good signals on the future direction of the stock market. The S&P 500 tested its upward trend line, an area of important support, on April 18th and held. The following day, the five day round of profit taking was broken and the Bulls took back short term control of the market while retaining their long term control. The market is now testing its all-time highs.
Price volatility during April was heightened, demonstrating the market's uncertainty about the future. This uncertainty has decreased Bullish sentiment among investors, serving to actually accelerate the upward trend in to today. Market's that climb without widespread Bullish sentiment can continue to enjoy a lasting trend because investors who exit positions or short the market ultimately look to buy back again as the market continues to move higher. The fear of missing out on an uptrend or taking a loss on a short sale are powerful motivators for buyers to act.
As I write this, the market is back to its highs of April 11th and the basics of chart analysis tell us that the 7 day rally will likely stall here. However, having achieved the old highs, the market avoids the formation of a falling top, an often seen signal of a trend reversal. Thus, while a short term pause in the rally is likely, an end to the Bulls control of US stocks is not likely imminent.
It is important to clarify that the strength of the US stock market is relatively narrow in scope. Investors are interested in owning dividend paying large cap stocks, particularly those whose earnings originate domestically. There is little in the way of stock speculation and stocks that provide no yield to investors generally lag the overall market indexes.
It is likely that a lid will remain on speculative stocks so long as the market finds its leadership in the blue chip, dividend paying stocks. We saw some pick up in these more speculative stocks when the S&P 500 threatened its upward trend line, perhaps pointing to the future area of stock market strength when the large caps finally suffer a break of their trend. For now, it appears that money continues to seek safety but there are early signs that some capital is starting to rotate in to the Technology markets, lead by the performance of the Nasdaq which is now threatening to break through its Sept 2012 highs.
The commodity heavy Canadian markets have made a good improvement over the past week but we should not confuse the bounce back as a sign that things are better for the TSX. Gold and Oil were heavily oversold and that has brought in bargain hunters and astute traders seeking to cover their short sales to lock in profits. The bounce back is encouraging for TSX investors but it is not yet a sign of optimism, instead it is a reduction in fear.
Look for US markets to likely stall their short term strength and perhaps enter in to a short period of sideways trading. However, the upward trend in place since November of 2012 remains intact and there is not yet any sign of a trend reversal. Therefore, I remain Bullish on US stocks but with the recognition that the strength is primarily in the large cap stocks that dominate the major market indexes.
The TSX continues to bounce back from its bout with fear after the collapse of Gold and the steady decline in Oil prices. This bounce back may continue in the short term as these key commodities recover lost ground but the reality of weak commodity prices should creep back in to the minds of investors soon, putting a cap on the comeback.
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This week, I ran the CDN Strong Yielders Market Scan which looks for stocks that pay a dividend and have a Sentiment Stockscore above 60. While most of the TSX has done poorly this year, the dividend paying large cap stocks have done well, provided they are outside the commodity sectors.
The challenge is to find good dividend paying charts that have not already gone up a lot. Most of the charts found with this Market Scan are well in to their uptrends, I want to find stocks that are just starting to show strength. Here is one that has a good weekly chart:
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1. T.DH
T.DH is breaking out of a long term cup and handle pattern, the break occurred last week and it has continued to follow through on that strength today. Hopefully the stock can make a pullback in the short term to improve the entry price but there has not been any show of weakness recently. Support at $21.30.
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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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