"The trend is your friend."
As you're getting ready to rip into those presents, and watch
your friends and family tear into theirs, I've also got a gift that
should attract your attention.
But it's not going to be wrapped up with a bow. It won't have
any tinsel on it, no Santa Clause motif paper, and no neatly folded
Your significant other likely won't care to hear about the
features of my gift. They won't want to share in the experience as
you put it to use.
But they will likely love to be the beneficiaries as you use my
My present to you is a breakdown of a select few technical
analysis patterns. And while these aren't exactly holiday
morning-type conversation topics, they'll help you make money. And
money will help you buy more of those gifts.
Yesterday we went over the concept of technical analysis, and
why it's relevant to any investor's strategy.
missed yesterday's issue, view it on our blog website here
. Today I'll go one step further and explain some basic
technical indicators, and next week I'll get into further
specifics, including head and shoulders, triangles and
If these sound like cheerleading formations, don't worry -
you'll understand them and how they can help you make money in the
stock market before the calendar flips to 2011.
***Technical analysis isn't just a tool for advanced day-traders
and high-flying hedge fund gunslingers. Strong fundamental
analysis is always crucial, but technical indicators can sometimes
give you an added edge for specific entry and exit points.
As I said yesterday:
"fundamental analysis helps you decide what to buy; technical
analysis helps you decide when."
So let's unwrap this sucker.
The most basic premise in technical analysis is that
specific patterns have meaning and tell you what the price is
going to do next.
If the price of a stock moves toward new upper or lower levels
and breaks through (on the stock chart), this often implies that a
new trading range is being established. Or that a new short-term
trend is occurring, and that prices are going to continue to move
in the newly established direction. Equally important, if a price
range test is made but fails, that often indicates that the price
is now going to move in the opposite direction.
The first important technical indicator is called the trading
range. This is the space between the highest and lowest price that
a stock typically reaches within a period of time. The trading
range defines volatility and also serves as the benchmark for most
When a stock trades within a very narrow trading range
volatility is said to be low - meaning the market risk is
But risk has a flipside, called opportunity. So a narrow trading
stock has both lower risk and lower opportunity.
The broader the range and the greater price movement within the
range, the higher the volatility.
The top of the trading range is called resistance, because it is
known as the price limit within the current trading range. It is
the highest price that buyers have recently paid.
In the two year chart of
Westport Innovations (Nasdaq: WPRT)
below you can see an example of two trading ranges. The range that
was established in 2009 got much wider in 2010. The upper line is
resistance, and the lower line is support. In 2010 there are two
resistance lines, and the upper one has not been challenged since
the end of July.
The more times a price touches resistance or support points, the
stronger the level of support or resistance tends to be. If, in the
chart above, the price now moves above the first resistance line,
then finds support at that line it is more likely that that prior
resistance line could become support.
***An important distinction has to be made between
stationary and moving ranges. A stationary range remains level over
time, and the moving range demonstrates an evolving price
Another way that trading ranges evolve is in the breadth itself.
If a trading range of the recent past covered about $4, like
Westport's 2009 range, but then expands to around $6, like Westport
did in early 2010, volatility is said to increase (it has wider
If a stock's price range is trending upward, but the breadth of
the range remains the same, then the stock is not becoming more or
less volatile. This was the case with Westport in 2009. The same is
true if price is trending to the downside; as long as the trading
range's breadth is unchanged.
As you track the stocks of growing small-cap companies a rising
price level with unchanged trading breadth is a very strong sign
and can indicate that future growth will continue to follow this
The following illustration below from my book,
The Small-Cap Investor: Secrets to Winning Big with Small-Cap
shows an example of a rising prices without a change in breadth.
Note how the breadth of this evolving range holds the same range
even as prices grow. Resistance and support both rise, but the
breadth does not show any increase or decrease in
volatility. Note how this is similar to the two periods in
Westport's chart: 2009, and the second half of 2010.
There are two types of breakouts that you should be on the
lookout for: the downside break-down, and the upside breakout.
These occur when a stock breaks its established trading range,
and can signal either a shift to a lower trading range (stock
breaks down) or a higher trading range (stock breaks higher).
The chart below of
Transcend Services, (Nasdaq: TRCR)
, a medical records transcriptions company, shows an example of a
channel breakdown. In early March, 2010, this stock broke through
the channel, and didn't stop falling until it had shed $4 per
Conversely, the three month chart below of consumer goods
National Presto (
, shows a breakout. The stock broke above resistance in the
beginning of December, and hasn't looked back since. Watch this
stock to see if resistance become support now - if it does it
should be around $125, and that would be a good price at which to
pick up some shares.
We'll get back into this some more on Monday. We won't be
publishing tomorrow, so if you don't receive this letter, don't
Have a great, safe, and relaxing holiday weekend.