I have outlined how we can spot
market plunge using TA and I use it to monitor the market every three months or
so (recommend to do it every month). Here is an example on how to use it to
trade individual stocks. I have to admit I do not use TA that much on
individual stocks and clearly I am not an expert in TA. If this article and the
last two stir up your interest, read more books or attend seminars / classes on
TA. Personally I prefer to seek fundamentally sound companies at bargain prices
and wait for their full appreciation. It is only me.
TA is very useful for momentum
and day traders. With the rising volume, you can detect while stocks are traded
by managers of mutual funds, hedge funds, insurance companies and pension funds,
and profit by riding on their wagons.
Some stocks are good for TA.
Usually they are larger companies with above-average volumes and are
fundamentally sound. Let me pick CSCO (a
cyclical stock) for illustration. I bought it several times in 2012 but save it
for the long term. This is quite different from what traders would use the
following information for.
The green line is 50-day simple
moving average (SMA) for the following chart using one year data.
If it does not display clearly on a small screen, type the
following on the browser on your PC.
Buy the stock when it is above
its SMA and sell when it is below. Following the chart would make good money
based on this simple rule. Sell on May 1, buy back on around August 1, and so
on.
Not all stocks follow this
profitable pattern. Fundamentalists may try to pick the bottom in late July
while chartists pick the bottom later. The chartists have an advantage to stay
away from stocks in their downward trend.
Table: CSCO 50-day SMA Source: Yahoo!Finance
We can improve the trades by:
·
Use different moving average in number of days
(50 in this example) and other indicators such as EMA (a moving average that
weighs higher with recent data). It may prove accuracy and/or cut down the
number of trades.
·
Instead of selling the stock for cash, consider
selling the stock short. Selling short is not for beginners for sure.
·
The accuracy is usually improved by a separate
chart for its sector and another one for the market. For CSCO, you can use an
ETF for network companies and SPY (or similar ETF) to represent the market. In
theory, when both the stock, the sector that the stock is in and the market all
move down, it has a high chance to move down, and vice versa.
We use 50 days
(in SMA) for the stock, 90 days for the sector ETF and 350 days for SPY.
TA is not for most
fundamentalists but it should be used
For a bargain hunter like me, TA
would not benefit me for picking stocks at the bottoms. I would try to pick up
CSCO with prices ranging from 15-17 and all below the moving average line that
TA would not show me a Buy signal. However, for very short-term swing trader TA
is a Godsend.
To me, TA is good indicator for
growth and momentum for short-term traders. Some fundamentalists may use TA for
entry and exit point. It is good for ‘Buy High and Sell Higher’. One’s opinion.
In selecting a tool, you have to
understand how, why to use it and whether it fits your investing style. I use
TA for market timing for the entire market rather than on individual stocks.
TA is good indicator when a value
stock is trending up in a rising market and a rising sector that the stock is
in. Most of us cannot spot the bottom of a stock; I had but most likely they
were due to luck. When a stock is moving up from the bottom, there is a good
chance it will move further up. TA shows it and its volume confirms it.
Conclusion
Even a fundamentalist like me can
benefit by using TA. This book touches the very basics of TA but the most
useful TA indicators.
Besides
monitoring the fundamentals of the stocks you bought once every 6 months, you
should analyze their technical more often (1 month to 3 months depending on
your available time).
Using TA for sectors
There are 3 uses of TA for sector rotation.
1. Detect
sector plunge and when to reenter the market after plunges.
2. Regular
use (usually after its recovery from a plunge).
3. Detect
market plunges and/or sector plunges.
#3 has been described in Chapter
2 and it will not be repeated here.
The difference in #1 and #2 is in
the number of days in SMA (Single Moving Average). Use 350 for sector plunge
and reentry.
Use 30, 60, 90 or 120 for regular
use (i.e. after the reentry from a market plunge) depending on how frequently
you rotate. If you rotate in 60 days, use 60 for the average of number of days.
Since it is same as #1, it will not be demonstrated.
Exit / Reenter a sector
ETF
To illustrate, the following
example uses XHB (an ETF for the housing sector). Use the same chart for other
sector ETFs such as VGK for Europe.
Produce the following chart by
using Yahoo!Finance. Enter XHB and select Interactive Chart. Select SMA and 350
days. Select Max for ‘From’.
Source:
Yahoo!Finance. XHB on 350 SMA.
·
Exit when the price falls below the red,
single-moving average (the SMA) and enter when it is over the SMA. All the
dates and prices are approximate and for illustration only.
·
I use Max for the period. It seems XHB starts in
2006. Let’s assume the chart instructed us to exit at $45 around 2006 and
reenter on August, 2009 missing a loss of about $30 per share. Not too bad!
·
There are brief exits and reentries before 2012.
I call it noises. The gains and losses are negligible. However, make sure you
exit and also reenter. If you use 60 days instead of 350 days in this example,
you have more noises. If you trade the ETF more often, then you use 60 or 90
days. It depends on your risk tolerance and your time. Sometimes the
performance makes a difference, but not all the time.
·
From the end of 2012 to today (10-2013), it
gains more than 40% compared to -32% for the period for buy-and-hold. A difference of 62%! Even a difference of 10%
would be great.
·
The chart works at least for this period. It is every one’s guess whether it will still
work in the future. I bet it will but as in life nothing is guaranteed.
·
When a housing stock, the housing sector (XHB)
and the stock market all above the SMA, the stock most likely will appreciate
(again nothing is guaranteed).
·
From my other chapters, the offending sector
(housing and finance for 2007 market plunge) takes about two years to recover
from the bottom. I interpreted the bottom was 10-2007, so the recovery would
start in 10-2009. If you bought XHB in 10-2009, you would have gained about
100% today (10-22-2013).
·
Some sectors never recover such as the internet
and some high tech companies in 2000.
Now, it
is your turn to try out the chart. This time, use 60 for the number of days in
SMA.
Overbought and peaking
The following technical
indicators could detect these conditions and a big plunge could be coming. They are readily available in finviz.com. The
predictability improves or confirms when the trade volume is far higher than
the average.
1. RSI(14).
Relative Strength Index. When it is over 70, overbought condition may exit.
2. SMA200.
Single Moving Average for 200 days. When it is over 50%, be careful that the
sector (or stock) may be peaking.
SLV SMA-200 Soucre:Yahoo!
On
April 28, 2011, the stock price of SLV (an ETF for silver) was more than 50%
above the SMA-200. Within 30 days, SLV plunged. It is similar in August 22,
2011. ‘Buy above the SMA and sell below it’ still works, but more profits can
be made in detecting these conditions.
Afterthoughts
·
We have discussed how to use TA to spot market
crashes and individual stocks. TA can help us to determine a sector. For my
purpose, I usually use 90-day moving average on an ETF for that industry.
When the TAs for the stock, its sector and the general
market are all green (i.e. above its selected moving averages), most likely the
stock will move up.
·
The big boys (hedge
fund managers) moved their money into GOOG and AMZN solely to make a ton of
cash when AAPL reached $700 and they will move their investment out of AMZN
(too high value as of 1-2013) or GOOG back into AAPL.
Instead of fighting the big movers, join them by using the tool
of TA. Make good money by winning the second place of a horse race.
·
A stock will always
go up and down for more than several days in a row. Take advantage of the trend
and make some quick money.
·
If all the following
are above the single moving average (SMA) line, most likely (most and not all)
the stock price will rise in next month:
1.
350-day SMA of SPY
(representing the market).
2.
60-day SMA of the
sector ETF that represents the sector the stock is in.
3.
30-day SMA of the
stock and it passes our (or your) scoring system.
Most technicians use 20, 50 and 200
days for moving averages for stocks. To save you time, use finviz.com to obtain
the % of the stock deviates from its moving averages. When it is positive, it
is usually a buy.
·
Norman:
With cyclical dividend paying
stocks, entry and exit points can be equivalent to yield. For example buy CAT at 3% yield and sell it
at 1% yield.
·
A book mentioned to
me on TA: Stan Weinstein's book, "Secrets for Profiting in Bull & Bear
Markets”.
·
If you are a customer
of Fidelity, try the option to include all indicators in charting a stock.
·
When TA tells you to
sell a stock, try to find the reasons by using google, SeekingAlpha,
Yahoo!Finance board, calling the company, etc.
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