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2-23-01 Page

This Week's Guidepost

TA to the rescue!

Last week we considered the price pattern for a Breakout pick chosen 1/19/01, SBIB. The price rose a healthy 12% in twelve days, then sunk to nearly a 4% loss in the next seven days. Emotions run amuck as we watch such market swings, which we discussed in the last Guidepost. Our ability to profit under stress depends on how well we control these emotions and what rules we use for that purpose. Lets look at one possible set of rules, Technical Analysis!

1. Technical analysis is the study of individual stocks and the overall market based on supply and demand. What does that mean? It means the market reflects the actions and perceptions of people, of their collective optimism or pessimism. If demand is greater than supply, prices will increase, and vice versa. The technician studies what the market is doing now, looking at price and volume patterns, without concern for company fundamentals. That’s it. Price and volume. Many other technical indicators are derived from a clever use of price and volume (for example, see the discussion on Stochastics in chapter 5 in our book “Provident Investing”), but price and volume is all we have to work with.

2. A study of market behavior proves the following: a) Increasing price with increasing volume is bullish. b) Decreasing price with decreasing volume is bearish. Simply, volume is supportive of the price action. A divergence occurs when price and volume go different ways. An increasing price with decreasing volume is bearish and the price increase is very likely short-lived. When price and volume start to move differently, volume is usually the stronger predictor of the two. Let’s use this principle with our study of SBIB.

   

3. This chart shows SBIB with the dark marker located on the date of the pick, 1/19/01. The price drifted to the right for about eight days.

   

4. Now see the marker moved to $20.75 on 2/5/01. Notice how the volume tracked price during this period, going up with price, and down with price. The spike in price had a comparable spike in volume on the last day. Move ahead one day in the next chart and look at the volume action.

   

5. Price on this last day increased $.25 from the previous day, but notice the volume divergence. Price went up but volume decreased. That should be our first clue that the momentum of this price increase is losing steam.

   

6. The next day confirms the divergence with a sharp drop in both volume and price. Depending on our ability to pull the trigger on the message volume is sending, we might have bailed out on the 6th at $21.00 or on the 7th at $20.00. This is how a technician might react. The next chart shows the wisdom of adopting TA for short term trading signals.

   

7. The chart shows the price and volume action up to last Friday’s close. This is a simple example showing how TA might be used. Does it always work? Look at the divergence seven days before Friday’s close; an increase in volume with a sharp decrease in price. But it didn’t move the price up. There is obviously much more to it than this. Remember, for every buyer there must be a seller. Volume may reflect optimism or pessimism. We will work to shed more light on the difference in future Guideposts. Stay tuned.

It is our intent to help our subscribers understand market strategies well enough to make informed decisions and understand the risks.

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