Greetings, fellow Pro-fundity team members -
6-4-99 Page

This week's Editorial Guidepost:

1. Last week we considered the On-Balance Volume indicator which added volume to our previous discussions about price. Price is the key... we make money by watching the price and making our buys & sells accordingly. However, OBV brought us into the world of "cause & effect" by looking beyond the effect (price) and into the cause (volume). This is simply an example of the supply/demand forces active in the market. We can use this relationship to anticipate price moves in some cases and make smarter investment decisions.
2. The greatest value in the OBV indicator lies in its ability to spot divergences between price and volume. The assumption here is that rising volume will occur first, with price following close behind. The opposite would seem to follow, volume will fall before the price drops. There are exceptions to this line of thought but in general its a good way to follow market action. A divergence occurs when we see an increase in volume while the price drops or remains flat. OBV flags the divergence by uncovering hidden accumulation and distribution patterns. We left a question last week about a recent pick and the price/OBV patterns. Lets review the question again and see what happened in the ensuing week.
3. ".....As an example looking forward, consider the price chart below with OBV on a recent pick to see if the signals we are receiving work out. The OBV strongly suggests accumulation the price hasn't responded to yet. Let's watch this in coming weeks....."
PMRY Price chart with OBV
4. The Friday 6/4/99 version of the PMRY chart is shown below. The vertical line on the chart shows where last weeks chart ended. Six days have been added to the chart with little change in price. The OBV told us the price should follow suit, but it has not met our expectations!
   PMRY Price chart with OBV

5. But lets look a little closer. What we saw on last weeks chart was a rising OBV from the seventh entry in May. It was a sharp rise, with small dips toward the top but with each succeeding peak higher than the previous peak. OBV was truly on the rise. But careful scrutiny of the price pattern shows the price actually increasing along with the OBV, even though the increases are small. Remember, in last weeks editorial we showed with an example how it is the direction and not the size of the OBV that is important. The size of the OBV line may cloud our insight. Its size may suggest more than is really there. We must be very careful as we interpret OBV messages. The chart below is good example of a divergence on one of last weeks picks.
SCSWF Price chart with OBV
6. In this example, the OBV is on the rise from the last week in March through the middle of April. The price is clearly not reflecting this price increase until it catches up in mid-April. Point: OBV is considered in a rising trend as long as each new peak is higher than the previous peak and each new dip is higher than the previous dip. In our example, the saw-tooth occurring the first few days in April does not break the rising trend. A trend is broken when a clear reversal is evident or when the pattern becomes "doubtful" for more than three or four days.
7. On the Home page under Technical Analysis we have a short tutorial on the stochastics indicator. Let's revisit this very important technical indicator before we summarize our technical study of recent weeks.
8. Stochastics: The “Stochastics” is a very useful indicator with rolling stocks. It will predict price movements quite reliably and help us determine buy and sell signals. It uses price velocity, or momentum, as follows. Notice the price bar chart below. Each bar represents the price range a stock traded on that particular day. The top of the bar is the highest price reached that trading day and the bottom of the bar is the lowest price. The small nub on each bar is where it ended the session, the closing price.

9. Notice how the closing price moves to the top of the price bar (the daily high) as the trend is moving up. On the downswing, the closing price moves toward the bottom of the price bar. The stochastic understands this pattern and shouts, when it sees the closing price move away from the top on the upswing; “Hey, this stock is oversold, get ready for a decline!” Likewise, as it sees the close back away from the bottom of the price bar as the price moves down; “Hey, get ready for an increase!
10. The stochastics oscillates between a high and a low, from 0% to 100% as shown below:
Stochastics: A measure of the over-sold and over-bought condition of a stock.
11. When the stochastics cross above the 80% line, the stock is considered overbought (get ready to sell). Below the 20% line, an oversold condition exists (get ready to buy). This is very effective with a rolling stock, as opposed to one with a pronounced trend. This indicator is the most consistent technical predictor for buy and sell signals on rolling stocks.
12. On the stochastics chart above, a second dashed curve is shown which is a moving average of the solid curve. It is an important action signal when the moving average crosses the solid stochastics. Many technical investors use this crossover point as their signal to buy at the bottom and sell at the top.
13. This technical indicator works best with solid rollers, less well with what might look like a saw-tooth. That is, a rapid rise from the bottom to the top, in a few sessions, then a slow return back down in many sessions. The statistical nature of the indicator finds greatest predictive value when the stock price follows regular price movements.
14. A caveat; While the stochastics can identify over-bought or over-sold conditions, it can not tell us how much further the price will go, either up or down. It can tell us when the market is about to correct, but not tell us exactly where to buy or to sell. That still requires our best judgment.
15. Stochastics are shown on most good charting services. We use TeleChart 2000^TM with many useful features, allowing us to update nearly 10,000 stock charts as required and to conduct our own personal screens and searches.
16. Let's review the several technical indicators we have studied to bring it all together.
1. Stochastics - A momentum indicator used to identify over-bought and over-sold conditions. This is very helpful in timing buy and sell points on rolling stocks. It can be over-sensitive at times depending upon the stochastic parameters chosen in the program. Proper selection is a matter of choice coupled with experience.
2. Moving Averages - By finding the average of a set of numbers we get a feel for the weight or strength of the data set. By finding the moving average of a price chart we smooth the dips & peaks and understand better where the price is centered. The MA can identify trends much better than the price line. We discussed how a single MA line can suggest buy and sell timing by watching for when the price line crosses its moving average. Shorter MA's are more sensitive but provide false signals more often. By using a second moving average line with a longer period, watching for cross- overs of the two MA's, we can avoid some of these false signals. This combination is the MA indicator of choice. While the MA can signal changes in trends, it is a lagging indicator. Using this solely, we will always buy and sell late.
3. Trading Bands - An envelope created by adding parallel moving averages above and below a center MA will help define the normal trading range for a stock. When the price reaches the upper band, a sell signal is given. Likewise, as the price falls to the lower band, a buy is suggested. The width of the parallel line envelope, with bands mirroring the center MA, must be chosen carefully for the volatility of the specific stock. We prefer the Bollinger Band technique where the width of the channel is calculated as the standard deviation of the price changes. The Bollinger Band indicator is one we use often.
4. Oscillators - The Stochastics indicator considered in this editorial is one of a group of indicators that derive their value from the momentum of changes in the stock price. The market continually cycles through an over-bought/over-sold conditions which these oscillators identify. This provides buy/sell signals to catch the "buy low/sell high" paradigm at its best. Two additional oscillators make up the group in Wilder's Relative Strength Index and the Moving Average Convergence/Divergence (MACD) indicator. The value in the oscillator technique is the ability to anticipate price movements, making them "leading" indicators. All three of these oscillators play an important role in timing the market. As we have said, no single indicator is perfect. By using the several indicators to confirm a price decision we can increase our chance of success markedly.
17. Next week we will discuss the TC-2000 proprietary indicators; Balance of Power (BOP), Time Segmented Volume (TSV), and Cumulative Money Stream (CMS). Additionally, we will include step-by-step guidance on how to set up each of the indicators on TC-2000 and set the stage for a week-by-week study of specific price charts utilizing the technical indicators we will have studied.
18. Study Schedule:

June 11 - TC-2000 proprietary indicators (BOP, MS, TSV) - A special guide on how to utilize all indicators we have studied on TC-2000.

Each week thereafter we will discuss specific price charts utilizing the indicators studied.

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

We provide TC-2000 tutorials to members. See the Member Login page.