Greetings, fellow Pro-fundity team members -
1-19-01 Page

This Week's Guidepost

Ticker Analysis - A fire-side chat

In recent guideposts we have shown why a collective analysis of all picks is not productive. Since we trade short-term, often with rolling stocks, it is not important where the price is four weeks later compared to where the pick was made. What is important is what went on in the meantime. That is, the price may be unchanged a month later from where we bought in, but it might have rolled three times in between, signaling success for our strategy. It is productive, however, to look at tickers one-at-a-time, learning how to react to indicator messages, those tell-tale signals from chart patterns that help us trade smart. We will take such a look this week, following the performance of a Breakout ticker offered on 12/15/00; CANI.

1. The watchlist for the 12/15/00 Breakout is shown for the close 35 days later on 1/19/01:

   

2. The CANI selection provides some good lessons for us to review. First, why did we make the pick? Here is what the basic chart looked like on that Friday:

   

3. We see a strong positive trend for this ticker. We said last week the strongest indicator in technical analysis is the price itself. For instance, a trend is a powerful indicator of where price is likely to go. That works for both bullish (+) and bearish (-) trends. It takes powerful action to reverse a trend. That said, looking at the pattern above is a slam-dunk, the price is likely to keep going up. Right? But let’s look at a “weekly” chart to expand our view, to see where the price has been:

   

4. This chart shows us the current trend started in the August time-frame, after building a base since April. Notice the increasing volume driving the trend. There were pull-backs as it made its rise, however. These are easy to see on the previous chart, which we now copy including the Stochastics oscillator to help tell our story.

   

5. We see the pull-backs as the price trended up, in early October and mid-November. This is a normal pattern in a bullish trend. We have included the stochastics indicator which is an over-bought/over-sold oscillator (See Section V - Technical Analysis in our book Provident Investing). The stochastics is a popular entry and exit marker for rolling stocks. It is effective with price patterns in the “trading range,” but a recipe for disaster in trending markets. The example above shows why. When the stochastics oscillator rises above the 80% line (the line in the chart above between $25.07 and $26.75) it is in an overbought condition and represents a selling opportunity. When the oscillator falls below the 20% line (the line between $13.26 and $14.94 in the chart above) it is considered over-sold and a buying opportunity. We can see in the trending market there are no over-bought signals. That is because the oscillator tends to be skewed in the direction of the prevailing trend. This produces many false sell signals as witnessed above. Knowing that, we would not be tempted to sell on the last date on the chart, 12/15/00, even though the stochastics has crossed above the 80% line. In fact, that is the date we select as a “Breakout-buy.”

6. There is no perfect indicator! What we seek is consensus between and among different indicators. That is, let’s strengthen our case with as many indicators as possible. There is indeed strength in numbers. Since we know CANI is in a trending pattern, we must discount stochastics as a valid message. Here are a couple of others we find useful, Moving Averages (MA’s) and On Balance Volume (OBV). These are covered in our book Provident Investing. The following chart is helpful in their use:

   

7. Each of the colored lines represent a moving average, Red 200-day, Blue 100-day, Yellow 50-day, Purple 20-day. When an up-trend is in place, moving averages provide buy signals anytime the price falls to the MA. The choice of which MA to use depends on the traders time frame. Shorter term traders will use the shorter time averages. In the preceding chart, using the 20-day MA, the spike down on 12/15/00 is our entry signal. To strengthen our position, the On Balance Volume indicator (green line) has shown strength from the volume point of view, with its moving average continually below the OBV line through the past two months of the trend. Here’s the key, we want the MA to be below the price/volume, signifying the trend is still up. That is, the trend remains in place so long as its values are larger than the rear-ward looking moving average.

8. These indicators told us the trend was not over and the pullback on 12/15/00 provided a buy opportunity. Could we be wrong? Of course, nothing is certain in the market. However, we attempt to increase the number of correct calls by getting as much information as possible, by seeking consensus among indicators and by protecting any position we take with rigorous stops. Let’s see how we did.

   

9. We see the increase in price to Friday’s close at $38.75, a 46% gain. We left the stochastics lines on the chart to reinforce the message with trends; they do not help! Look at the next chart which shows us the MA and OBV values:

   

10. The point here is the trend is still very well in place. OBV suggests even stronger action and the MA’s tell us we could have increased our position the first week in January. This is a great example of a breakout price pattern. When do we take profit? Remember the adage, Cut your losses short and let your profits run. These guys don’t come along often, but they serve to pay for the losses that occur when we make bad decisions. We do not have to always be right! In fact, we don’t even have to be right half of the time. If we carefully tend and nourish tickers like CANI, we can make a lot of money so long as we get out of losing positions quickly and in accordance with stop rules we have determined even before we take a position. So, your assignment is to watch this ticker carefully with paper trades and determine the appropriate time to exit. It will not rise forever. Let us know your strategy. 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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