Keep It Simple
Stockscores.com Perspectives for the week ending December 19, 2004
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In this week's issue:
The analysis of stock charts can seem quite complicated. Flip through a book on the subject, and you will read about MACD, RSI, VWAP, CCI, ADX or OBV. This alphabet soup of technical analysis indicators is supposed to make stock analysis simpler, but I think that many technical analysis tools only serve to confuse the average investor. They place a reliance on an indicator that many investors just don't understand, and cause the investor to miss the point of what chart analysis is all about.
To be clear, we look at stock charts to understand the psychology of investors and the flow of fundamental information to the investment community. These considerations are important because investors do not always act rationally and not all investors have the same access to fundamental information about companies. Markets can be emotional, and the dissemination of fundamental information is not always fair.
This is why technical analysis can work. By focusing on stocks that are trading on private information or situations where irrational investors are causing a stock to trade outside its fundamental value, we can identify investment opportunities that have a higher probability of success. Most of the time, the stock market is efficient, but when the assumptions of market efficiency break down and stocks trade on private information or with emotion, there is an opportunity to beat the market.
From an analytical perspective, achieving this aim requires an understanding of six technical analysis concepts:
Support
Resistance
Optimism
Pessimism
Abnormal Activity
Price Volatility
All technical analysis indicators somehow reflect one or more of these six things. For example, Bollinger Bands really focus on Price Volatility and Abnormal Activity. The MACD indicator aims to measure Optimism and Pessimism. However, using these indicators can lead the investor to lose sight of the dynamic behind the market action, and thus, not achieve success.
Resistance is a psychological barrier established by the market, and it represents the most investors are willing to pay for the company's fundamentals for a period of time. Thus, breaks through resistance imply that investors have found justification in the fundamentals of the company to pay more for the stock. This is often caused by a change in the fundamentals that may not be widely appreciated by the investment community. This makes breaks through resistance important.
Rising bottoms on the stock chart are a sign of optimism, since they show that sellers are losing their enthusiasm to accept lower prices over time. Breaks through resistance from a period of optimism have a greater potential than those coming out of pessimism.
These two chart pattern characteristics demonstrate how predicting the future movement of a stock chart can be achieved simply looking at the chart, without any other technical analysis indicators. You just don't need to make technical analysis any more complicated than that.
Keep your analysis simple. Doing so will allow you to get a clearer picture of where a stock is going. With simple analysis, you can focus on what is really important for success in the market; discipline.
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With the slow down in the markets that comes at this time of year, I thought I would provide a few examples of how to read a stock chart using some of the six chart pattern characteristics discussed above. Consider how these factors come together to highlight trading opportunities:Back To Top
1. VRSN
For a long time, investors agreed that VRSN was not worth more than $21 a share, but in October some investors found the motivation to pay more for the stock, likely because they were aware of significant fundamental change that made the stock worth more. As a result, the stock made an abnormal breakout through Resistance from a period of general Optimism. This move from low price volatility told us that VRSN was likely to go higher in the months to come.
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2. T.BBD.B
The latest move lower in this stock started in May, when the stock made an abnormal break to the downside through Support, out a period of Pessimism and from low price volatility. The market was telling us that there was something fundamentally wrong at Bombardier, that investors were not eager to own this stock and that it was likely to go lower.
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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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