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.