The word "Mayday" is used internationally as a distress signal
in radio communications. I'm sure we've all heard it used in movies
and on TV. Here I'm going to give you some things to look for from
a technical perspective that could be telling you that it's time to
jump ship on your stocks.
Lower Highs, Lower Lows
A stock that can't break through to higher levels should be a
warning. This can start off very innocent and end very painfully
for investors. Stocks move in cycles or waves not in a straight
line upwards. When a stock runs out of gas before taking out the
previous high it means there is a lack of buyers at the high. This
implies that the market believes that higher level is too pricey
for the stock. Overall a very bearish sign.
Lower lows show sellers taking control, coming in with volume
and forcing the price down. This side of the chart is even more
significant than the lower highs. There exist bullish patterns with
lower highs and higher lows where a stock can dig out and thrust
higher. If the support levels for the stock keep on giving way,
it's tough to convince buyers to step in with force.
Look at how lower highs and lower lows began to occur on the
) stock chart months before the real pain began. After hitting a
new high of $28.87 in July 2013, FWM went on to make a lower high
of $27.31 on August 8
, before heading down to carve out a lower low at $22.01 in
The next attempt higher stalled out not only short of the
52-week high but also short of the August high. This was a big
warning sign that many investors missed. Early November kicked off
a period of huge losses for FWM. In less than 12 months this stock
has shed over 75% of its value.
Trading Below a Medium Term Moving Average
Don't ever forget the phrase "The trend is your friend." I've
found that determining the trend is as easy as comparing a stock to
its medium term moving average. I like to use the 25 day simple
moving average shifted to the right by 5 days (25x5). The shift
helps me avoid whipsaws in my trading. Whipsaws occur when a stock
changes trend several times very quickly. This forces traders to
switch sides from long to short and back. Whipsaws are a great way
to lose money fast.
I compare price to the 25x5 to give me a clear cut definition of
the trend. If the stock is trading above the 25x5 then it's in an
uptrend. If it's below, then it's in a downtrend. One big "no-no"
when it comes to trading is being long a stock when it's in a
downtrend, hoping that it turns around. You're much better off
selling when it begins its downtrend and buying it back when the
) as an example. If you sold AAPL when it dropped below its 25x5 in
October 2011 you would have avoided the slippery slope that drove
the stock all the way down below $400. Along the way, if you bought
on what you thought was the reestablishment of the uptrend and the
price came back down like it did in December 2012, March 2013, and
April 2013, you would have only lost a few points if you closed
your positions when the stock ducked back below the 25x5. Then as
the trend finally reversed, you would have been in at a cost in the
mid-$400s, a far cry from the $700 you would have ridden it down
from had you ignored the trend along the way.
Breakdown of Long Term Support
It's very important for you to map out exactly where the levels
of support and resistance are for every stock you buy. Prior to
entering any trade you should know where a potential stop loss
level is and where you'll likely exit the trade. Without this
information you have no way of knowing if you have a good risk
versus reward ratio for your trade.
There are a few ways to determine where these levels of support
and resistance are for your stock. One of the oldest ways to do
this is using a point and figure chart. Point and figure (PnF)
charts differ from most charts in that the horizontal axis does not
divide time evenly. Price movement dictates how wide each chart is.
The chart is made up of X's and O's that tell the story of the
A stock on the way up is marked by an X. As price moves up,
another X is placed on top of the first X and so on and so forth
until the stock reverses by a set amount, most of the time $3. When
the stock goes down by $3, then a new column is started using O's.
For each dollar the price goes down an O is placed below this O
until price goes up from the lowest point by $3.
It's easier to see when you look at the chart. What's also easy
to see by the chart is levels of support and resistance. For
example look at the
) chart. The PnF chart shows the $130 price level as a long term
support level for the stock. If you were long FedEx, a stop placed
just below $130 makes a lot of sense. This way if support is
broken, you're not along for the ride back down to the next level
of support the chart shows at $118.
By incorporating these three techniques you can help cut your
losses short and enter trades with the highest likelihood of
success. While longer term buy and hold techniques can still make
money, adding these tactics to your arsenal can help increase
your returns that much more.
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