Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

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Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008

Transcript of Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Page 1: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Technical Analysis III:Using Charts to Time Selling

Economics 98 / 198 DecalSpring 2008

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CURRENT EVENTS / STOCK DISCUSSION

Using Charts to Time Selling

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Current Rally’s FTD (Dow Jones)

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S&P500 (Recent Activity)

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LECTURE CONTENTUsing Charts to Time Selling

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Summary of last lecture

• Technical Analysis

• Using stock charts to time market bottoms• Rally, follow-through, counting days

• Using stock charts to time buy points• Stock formations / bases

• Cup with handle / double bottom / flat base

• Strong characteristics of bases• Additional buy point: 50 Day moving average

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Rally AttemptDay 1

Follow-throughDay 5

(+1.75% on on high volume)

S&P 500 (Early 2007 Follow-through)

Failed Rally Attempt

Day 1

Prior Downtrend

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ROLL – Pullback to 50 DMA

Pullback

Bounces off 50DMA on above average volume

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SPARSPAR

SPAR – Ascending Triangle

Volume perks up on breakout

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Today’s lecture

• General principles for selling stocks whether for a loss or for a profit

• Key Selling Indicators• Market direction• Cutting losses short• Individual stock chart analysis

• Signs of weakness (churning, breaking support, resistance)

• climax tops• changes of trend

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Why knowing when to sell is so important

Nasdaq (2000) Let’s say you bought an index fund or ETF here @

3,500

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Why knowing when to sell is so important

Nasdaq (2000)

Within a year and a half, you would have lost your

profits plus more!

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Why knowing when to sell is so important

Yahoo! (1997 – 2006)

Peak of $120

Bottom of $4.50

96% loss here

To recover from bottom, YHOO would have to increase 2600%

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Fundamentals can look great at the top

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Sell Decisions

• Sell decisions should be based largely on technical analysis• Don’t wait for fundamentals to deteriorate

• Market Conditions• Climax Tops• Signs of Weakness• Change of trend

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#1 Selling Rule: Cutting losses early

• Set yourself a maximum sell rule• How much you set depends on your risk

tolerance (5 – 10% a good #)

• Why do it?

• Use stop-loss orders if you don’t have time or control with emotions

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#1 Selling Rule: Cut Losses Early

Source: “How to Sell Stocks to Limit Losses.” IBD Online | Learning Center

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Why cutting your losses is important

Chicago Board of Trade (CBOT)-Great fundamentals (strong earnings, sales growth, ROE, etc.)

-Cup with handle base

-Strong accumulation in base

-Break out on strong volume

Buy here @ $128

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Why cutting your losses is important

Chicago Board of Trade (CBOT)-Action of the stock doesn’t go according to plan and eventually, reverses to below breakout point

-What do you do here?

Cut your losses early

Sell when 7% (or less) below buy point

I might be wrong and I should be cutting my losses here at @ $119

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Why cutting your losses is important

Chicago Board of Trade (BOT)

Now I don’t know what to do with a 34% loss!!!! #$!@#$!

Bought here @ $128

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MARKET ANALYSIS:TIMING TOPS / DOWNTRENDS

Using Charts to Time Selling

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Market Direction: Downtrends / Tops

• Always preceded by signs of weakness (heavy selling) in major market indexes• Distribution Day (4 or 5 within 4

weeks) raises red flags

• Other market weakness signs• Days when market starts strong, but

ends very weak (low on the intra-day)• Leading stocks start to deteriorate

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Let’s look at the NASDAQ during the 2000 Bubble as it happened

Many distribution days within short time: more selling than buying. Furthermore, many leaders were peaking as well. Clearly, institutions were getting rid of shares.

It went from good to bad to ugly

Market Direction: Downtrends / Tops

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2000 Market Top4/5 distribution days can tip a market over, so 7 within 4 weeks screams out that the market is heading for the gutters

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2000 Bubble: Leaders Breaking Down

The 2000 bubble went down in history as having the most climax tops at a market top (we’ll discuss this later).

Essentially, this means GET OUT!!!!!

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The Aftermath

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2000 Bubble

Yahoo Inc. DOWN 88% in 12 months

Qualcomm Inc. DOWN 88% in 31 months

2004 Market Downtrend

CSCO. DOWN 38% in 8 months

Leading stocks of current market uptrend usually fall the hardest when

market tops occur

Market Direction: Downtrends / Tops

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Dow Jones 1929

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PROFIT-LOSS PLANUsing Charts to Time Selling

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Profit & Loss Plan

• Most stocks after bases move up 20-25%, build bases / patterns, and then in some cases, resume advances

• If all goes according to plan, take your profit at this 20-25% gain point

the exception to this is…

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Exception…

• If stock rises 20% in 1-4 weeks on heavy volume, then hold on for at least another 8 eight weeks

• Why do this? Quick, strong advance shows unusual strength in the stock. Potential to be a great winner.

• After that, re-evaluate to see if stock should be held for longer term

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“Bulls make money and bears make money, but pigs get slaughtered.”

INDIVIDUAL STOCK CHART ANALYSIS: SELLING

Using Charts to Time Selling

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General Signs of Weakness

• Downward Reversals• Stock begins to move up, only for a

sudden change downwards in price• Even worse, when volume is HIGH

• Distribution• Stock closes at a lower price than prior

day/week on above-average volume• In general words, big selling

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Change of Trend

• Long-term uptrend line is broken on overwhelming volume

• Greatest one-day price drop

• 200-day moving average line turns down

• Living below 10-week moving average

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Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center

The stock cuts the 50 DMA on heavy volume.

It’s not getting support at this level Rallies back

on light volume

Example 1 50DMA Violation

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Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center

Example 1 50DMA Violation

The stock cuts the 50 DMA on heavy volume.

It’s not getting support at this level Rallies back

on light volume

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Example 2

Stock cuts 50DMA on heavy volume and struggles to rally above that line.

50 DMA becomes level of resistance

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Example 2

Stock cuts 50DMA on heavy volume and struggles to rally above that line.

50 DMA becomes level of resistance

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Example 3

The stock had already a big move up. If a stock closes with its largest one day gain in the entire move, watch out. This usually occurs at the peak.

Largest one day drop

(-3.50)

If a stock has its largest one day drop, then consider selling if confirmed by other signals (distribution, reversals, climax activity)

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Example 3

Largest one day drop

(-3.50)

Big reversal

Gap-downThe stock had already a big move up. If a stock closes with its largest one day gain in the entire move, watch out. This usually occurs at the peak.

If a stock has its largest one day drop, then consider selling if confirmed by other signals (distribution, reversals, climax activity)

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Example 4Weekly Trendline Broken

If you connect lows of weekly closes, can identify a major trend line here

Consider selling if confirmed by other signals when stock breaks major trend line on overwhelming volume

NOTE: Don’t draw too many lines. Trend lines drawn on too short of time periods aren’t valid

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Example 4Weekly Trendline Broken

If you connect lows of weekly closes, can identify a major trend line here

Consider selling if confirmed by other signals when stock breaks major trend line on overwhelming volume

NOTE: Don’t draw too many lines. Trend lines drawn on too short of time periods aren’t valid

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Climax Tops

• Explosive price / volume action of leading stocks and/or industries • Indicate trouble ahead for the stock• Occurs at end of the stock’s run

• Traits• Exhaustion Gaps• Excessive Stock Splits• Huge price spreads with reversals• Extended +100% over 200-day moving average• Huge price-run up at end of movement (25% -

50% in 3 weeks or less)

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Example 1

Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center

Climax top shows abnormal activity after stock’s previous run-up.

Notice the BIG reversal at the peak on extremely high volume.

Can you see the difference in price

movement behavior?

NOTE: Climax tops occur at end of a stock’s run. Increasing price movements at beginning of a stock’s move is positive.

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Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center

HUGE REVERSAL on explosive volume

(ended on the bottom of the intraday spread)

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Example 2

Notice the explosiveness of the price movements at the end of the stock’s move. 60% gain in 8 days.

Exhaustion gap to finish the climax top off

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Example 3

Telecom stocks enjoyed huge up-trend ride during late 1990’s

Climax action by leading stocks gave sell signals for the industry and the market in general

Notice the explosive action by the leading stocks

Source: “Topping Action By Industry’s Leaders Flashes Sell Signal.” Investors Business Daily Online

Page 48: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Other Signs of Weakness (secondary indicators)

• Heavy volume without further upside price progress (churning, sign of distribution)• Accumulation days with larger distribution days

• New highs on low volume• Big buyers lost appetite for rise

• Signs of poor rally (decline on big volume, and then rally on low volume)

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Notice how the stock reaches new highs and the advance is on very tame volume. This is a sign of weakness and raises a red flag.

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Rally on light volumeNotice a sharp decline from the first peak

And then, a rally on very light volume

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Rally on light volume

Notice a sharp decline from the first peak

And then, a rally on very light volume

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Churning

Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center

If you look at the arrows, you’ll notice this stock acting quite volatile (major price increases / decreases) on huge volume without really making any significant moves.

This shows that buying action is being met with selling action. This should raise a red flag. Sellers eventually may overwhelm buyers.

Page 53: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center

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Other points

• Don’t let the stocks that rise 10-20% to drop back into loss column

• Be patient for advances to complete• “It never is your thinking that makes big

money. It is the sitting.” - Jesse Livermore

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EXAMPLESUsing Charts to Time Selling

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Example

Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001.

From peak, QCOM traced a downtrend and went 68% below its all-time high

Very apparent here that QCOM experienced a climax top at the end of its run

We can see an exhaustion gap, and many instances of churning.

Page 57: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Example

Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001.

From peak, QCOM traced a downtrend and went 68% below its all-time high

Very apparent here that QCOM experienced a climax top at the end of its run

We can see an exhaustion gap (2), and two instances of major churning (4).

Page 58: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Example

Price had increased eightfold from 1999-2000

At peak, 85% above 50-day and 294% above 200-day (2)

From peak, fell as much as 61%

Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001.

Also, see instances of churning on heavy volume (2)

See a climax run towards the end of the run (1)

Page 59: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

Example

Price had increased eightfold from 1999-2000

At peak, 85% above 50-day and 294% above 200-day (2)

From peak, fell as much as 61%

Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001.

Also, see instances of churning on heavy volume (2)

See a climax run towards the end of the run (1)

Page 60: Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008.

EBay – 2005

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EBay – 2005

Down 80% over next 6 months

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FRE – 2005

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Summary

• Cut losses short• Know the market and when it is topping!

• Distribution days can tell you a lot

• Have a profit & loss plan• Watch for any abnormal activity

• Price and Volume• Climax Top• Changes in Trend• Weak action

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Next week’s lecture

• If you don’t have the time or don’t have the skill to constantly monitor your portfolio or manage your own investments…

• Wait until next week’s lecture!

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Homework

• Final Stock Analysis• 2 pages• Analyze your simulated portfolio• Just talk about your favorite buys and sells

and back up your case with fundamental/technical reasoning