Saturday, February 13, 2010

Steps to Success

Charting is a great way to spend a cold, snowy winter day, or night especially if your stuck with two feet of snow. If you can learn to read charts you might develop a great feel for the direction of the general market and individual stocks. So, you are asking yourself. why do I need to know this? Isn't  it more important for Dan to know it rather than me? Yes. Charts can show us what is going on today, what has happened in the past and they can also be a great indicator of the future direction of the market or a stock or literally anything that can be charted. If you can better understand that investments have patterns and you can understand what these patterns mean then the more you will be in tune with what I'm thinking. As I have said to you in the past a big part of my job is educating you my clients.

Let’s take a look at the chart below. It is the past 90-days price action on the SP 500 Index.

The blue dotted line is the 50-day moving average of the S&P 500 index. You can have moving average for any number of days. I like to use the 50 and the 200-day moving averages because they give me both a near term and a longer-term view of what is happening in the markets. On January 21 the S&P 500 Index broke down through the 50-day moving average. From a charting standpoint this was a very important change in the market direction you see the index had been above its 50-day moving average since last November 5th.

If we look at what has happened since January 21 we see that we have experienced a series of lower highs and lower lows. The market seems to be churning, up big one day down even bigger on another day. Breaking the moving average line indicates that the market is loosing directional momentum and may be in for a correction. If you are still with me and not a sleep, breaking the 50-day moving average doesn’t tell us how far the market might decline or when, just that the market has lost some momentum.

We can see this loss of momentum in that the S&P 500 in another section of this chart. Three times the market stalled at the 1148 to 1150. The index failed to push though the level on January 11, 14, and 19 and could go no higher. It attempted 3 times to break through the 1150 level and failed. Once it could not breakout the market began to turn and it broke down. If we were to draw a line along the most recent bottoms we might be able to project out were the index might fall too --we see the next indicated low is 1044 down from 1075, which was last Fridays close. There is no guarantee that we will get there, but unless we see some significant good news this coming week I would expect to test the 1044 level soon.

Keep in mind that markets do not go straight up or straight down. What we are trying to understand by looking at charts is to try and to the momentum of the market. I use this moving average and momentum indicators for entry and exit points to buy or sell investments. for you and me. Common stocks trade in a ranges between highs and lows. Look at the stock quote section of you local newspaper or on line and it will give you the current price and the high and the low for the last 12 months. If you are looking to buy a stock you want to be somewhere closer to the low and if you want to sell you would like to be closer to the high for the year.

When I make the decision to buy a stock I do not commit all of the money I have allocated to that particular stock at one time. Let’s say for a client, I want to commit $40,000 in one position. My initial investment might be between 25% to 50% of what I want to invest. No one can pick tops and bottoms in stocks. We only know the top or bottom for a period of time after the fact. The use of moving averages and highs and lows are all tools that can help us achieve better returns with lower volatility. I know this is not one of my most exciting posts, but for some of you it may be helpful. Sometimes going to school can be fun other times its just work.

Dan Perkins

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