I conduct a few “Technical analysis 101” lectures every year for investment clubs and university business students. At the end of the class, I like to put up a chart and ask the students (or investment club members) to use the lessons they have just learned to analyse the current market. Given that many of my readers will be somewhat comfortable with the basics of technical analysis, I thought a quick review of these basics followed by my Pop Quiz might be useful. Interestingly, there are too many seasoned individual investors, and – astoundingly – professional Technical Analysts who don’t always follow the basics when looking at a chart. So this basic summary might be helpful to many investors, and even a few professionals, as a reminder of the basics of analysing a chart.
Here are the basics when looking at a market chart:
- Identify which of the 4 Phases of the market we are in (base, uptrend, top, downtrend)
- Identify chart patterns within the phase for trading clues (consolidation patterns or trending patterns)
- Identify key support & resistance levels including 50 and 200 day MA’s.
- Examine volume: is it increasing, decreasing, or flat?
- Identify cycles – periodical or seasonal
Here are the refining tools that should only be used AFTER you have identified the above:
- Dow Theory
Read my book Sideways to get detailed explanations of how to identify the above factors. By the way, feel free to contact my assistant Cindy McIntyre if you wish to book a speaking engagement for a club or organization (of 20 or more people). She’s available at 1-888-721-8736.
Here’s today’s chart, followed by my analytics on each of the above points. See if you agree with my prognosis.
- Phase: Uptrend – identified by higher highs, higher lows.
- Patterns: Currently appears to be rounding over after approaching the top of the trend channel.
- Support & Resistance: S&P didn’t hit the top of the trend channel (resistance), but close enough. First support may come in at 50 day MA (1970-ish) – next support near the bottom of the rising bottom trendline, about 1930-ish. We don’t want to see the last low of 1910 taken out if the uptrend is to continue.
- Volume: Fell on last rally, currently rising on recent decline. Suggests this decline will continue for a while longer.
- Cycles: Seasonal patterns for September can often be bearish – it’s the weakest month of the year, statistically speaking.
- Sentiment: My favorite indicator (although there are many I use) is www.sentimentrader.com “Smart/Dumb $ index”. It tracks what the institutions and other smart traders are doing vs. the retail mutual fund buyers and other less sophisticated investors. It’s in neutral territory, although dumb (unsophisticated $) is approaching the “overly optimistic” zone.
- Momentum: Note the Stochastics, RSI, MACD indicators have all rounded over from an overbought position suggesting further near termed downside.
- Moneyflow: Positive Chalkin moneyflow, and uptrending Accumulation/Distribution line suggest that big money isn’t selling this market at this stage.
- Breadth: Not shown, but I use a 40 week MA of the Advance/Decline line on the NYSE – its rising, and bullish.
- Dow Theory: There are many rules within Dow Theory, but I focus on confirmation of the transports vs. industrials. The two sectors have been confirming the new highs lately, with no divergences in pattern. This is bullish.
Conclusion: The uptrend is strong, we’re making higher highs and higher lows consistently. Moneyflow, breadth and Dow Theory supports the strength of that uptrend. Sentiment is neutral but leaning towards over-optimistic. Momentum is rounding over. Thus , I’d expect September to be “typical”, in that we continue to see a corrective movement from a short termed oversold condition. I don’t think this correction will penetrate the old lows of 1910 – it will likely find support at or above the 50 day MA(1970) , or the trendline (1930 or higher). I’ll be using this correction as an opportunity to add new stocks to our portfolio using our 20% cash position.
Great overview. Thanks. You mention that the money flow is strong suggesting that the smart money has not given up on the S&P500. I was wondering if you factor the $VIX into the overall picture? It looks like the pros (smart money) are starting to take control of the $VIX in the short term.
I do look at the VIX and have noted it on this blog in the past, but I don’t consider it part of the ” basic essentials”–thus, I didn’t mention it in this writeup. There are tons of indicators that are of use, but most of them are not always important or useful–VIX is a good example–its good info, but not always too accurate
I wanted to stick with the basics for this article. BTW–this blog outlines the very essence of what I look at when making decisions–they are my “go-to” indicators–especially the first 5 “basics”
ACCORDING TO JOHN MURPHY (STOCKCHARTS), THE DOW TRANSPORTS HIT NEW HIGH RECENTLY (SEPT. 5) AND THE INDUSTRIALS ARE TESTING THEIR JULY PEAK. THE UTILITIES ARE RISING AS WELL: SO ALL THREE DOW AVERAGES ARE RISING TOGETHER: A GOOD SIGN! BUT WHAT ABOUT THAT LONGER TERM TRENDLINE (2011-2014) SUPPORT AT 1950 FOR S&P500, REPRESENTING THE LOWER LIMIT OF A RISING WEDGE, TYPICALLY A BEARISH SETUP? AVERAGE VOLUME CURRENTLY ARE LESS THAN HALF OF WHAT THEY WERE IN 2011. AS BOB FARRELL WOULD SAY: “IS THIS TIME DIFFERENT?”
JP–for whatever reason, I find that rising wedges are not always accurate predictors of gloom. Same with expanding patterns-I find these patterns relatively useless for predicting anything. Besides that, I will not make any call until a pattern completes itself AND BREAKS OUT (!). The formation of any pattern is meaningless until it breaks out, and it must take out a former low or high to signal the end of a current trend – up or down. None of that is happening right now.
-Having said that, I don’t see a rising wedge pattern on the S&P500.
Finally–Getting back to basics: higher highs, higher lows = uptrend. That’s what we have been seeing. There is no sense projecting a change until proven otherwise. As is said, it ain’t over ’til the fat lady sings…
This market should be considered in an uptrend, albeit due for a corrective move within the uptrend per this blog.
How much does a market have to decline before margin calls make a pullback a more significant correction?
that is a question I cant answer Bert