IN THIS CHAPTER

Watching for those big moves

Using volatility to your advantage

Finding the best deals

The only guarantee you have about the stock market is that there will be crazy days. You want to use charts to tame those crazy days by anticipating the swings, buying at good entry points, and selling at good exit points. Notice that we didn’t say the best entry or exit point. No one can consistently do that, but using stock charts wisely, with the help of this chapter, can help you manage your portfolio more prudently when the market goes wild.

Being Prepared for Big Moves in a Short Time

Financial reporters enjoy talking about stocks on a panic run. Don’t join the panic; instead, try to understand the ways these stocks trade to maintain your financial health.

One key example in 2017 was a Bitcoin trust (GBTC). From April to September it rose over 1,000 percent. Within seven trading days in May, it rose $275. Within 20 days it rose $400. The final three days of the surge in May, it was up 127 percent. Within three weeks, it had lost almost 50 percent from the highs.

In mid-July, the Bitcoin trust plummeted to $250. It took off to the upside, and in 30 trading days, it had gains over 300 percent from the lows. Yes, it tacked on $760! Within three days it lost 40 percent from August 31 to September 4.

Picking the top when a big move is happening can be difficult. Take off money on the way up by selling some shares to preserve gains, then try not to enter when the price is moving 10 percent a day. Wait for very small bases in the chart where the candles aren’t so long. You can review Chapter 9 on bases to get a better handle on big movers and shakers.

Understanding That You Don’t Have to Be First to Buy

Don’t jump in on a ballistic rocket. Moving into these stocks when they don’t have a base is wilder than kids on a sugar high.

When a stock is moving straight up or straight down, there are no horizontal support/resistance levels (see Chapter 9). In an initial public offering (IPO), as the stock starts to trade, the charting software picks the high and the low of the chart and plots them. That can make the first few initial bars very long. It can be helpful to use 30-minute bars for the first few days as the stock starts trading and then expand to 60-minute and then to daily. On the 60-minute chart, plotting the 100-period moving average can be helpful, but that is very short-term.

In general, the 20-day moving average supports the stock on a quick rise. It is still in a good uptrend when it trades above the 50-period moving average after the stock has traded for three months.

If you are in a parabolic stock, the whole thing usually ends in less than two to four months. The Internet blow-off in 1999–2000 went almost a year, which is very rare. You can use a moving average convergence divergence (MACD) indicator on a 60-minute chart or daily chart to help with momentum trend lines, but the bottom line is that all the indicators will be very short-term until the stock has some trading history.

Review Chapter 8 for more on charting different time periods, Chapter 10 for more on moving averages, and Chapter 11 for more information on MACD.

Waiting on the Big-Name IPOs

Every now and then, a highly touted stock, such as Snap or Spotify (two highly anticipated public offerings in 2017), has an initial public offering (IPO) and the media talks through the deal a thousand times more than the average investor needs or wants. The conversation becomes all-consuming during the weeks leading up to it, when it first starts to trade, and during the weeks that follow.

With all that hype, who can resist owning such a wonderful stock? While every one of these stocks will have a different start, Facebook represents one of the largest-ever IPOs. On the first trade at $38, the company was valued at $104 billion. The stock soared on a weekly chart on the first day, and by the end of the week, the entire surge was gone. Within a month, the stock was 30 percent off the IPO price, and within four months, the stock was 60 percent off its highs and less than half of the first trade on IPO day. This is a very common pattern for IPOs.

Don’t get caught up in the IPO hype. Wait for a small one-month base to set up.

Seeing Huge Gaps on Earnings

Earnings gaps on charts range from little to huge. The big earnings gaps are great to watch for. An example might be a stock that rises 5–7 percent on big earnings and changes the chart trend by breaking above a previous level of resistance.

You can tell they are earnings announcements because they usually occur in three-month increments on a chart — most likely January, April, July, and October, but they can be any three-month intervals.

Putting stocks with big earnings gaps in a separate watch list and trying to find attractive entry points is a worthwhile endeavor. If the stock gapped up and then continued up throughout the day, the bottom of that bar is your support. The bottom level of the price bar on the day of the earnings announcements should hold. If price doesn’t keep closing above the level, be cautious. It may close below by one day, but it shouldn’t close the week below.

Earnings gaps that occur on high-leverage businesses like Internet software can really start a new trend. Use the Predefined Scans for Gaps. You can review information on scans in Chapters 14 and 21.

Watching for Crisis in a Stock

All companies face a crisis at some point. For example, a competitor may make moves to acquire the company; there could be a company scare, such as Equifax announcing millions of records were compromised; or there could be a shakeup, such as a change in CEO.

These crises can impact more than just the company involved. The entire industry may be impacted. The companies that fall will likely have some sort of bounce. After the crisis, other news may break about the stock. Watching the amount of selling that happens on the next piece of news is more important.

When the crisis is built into the stock, two obvious things will happen. First, the company will go into a tailspin with the stock making lower lows and lower highs. In that light, you need to wait for a proper base to set up (see Chapter 9 for more about bases).

You may also start watching the stock for the sign of a support level. For example, after the first sell-off, the stock rallies. On the second sell-off, it makes another low near where the first sell-off went. This is now a support level. It may have gone slightly below the previous levels, but when this support level has held for multiple pieces of bad news, it is much stronger as a place to enter. If the price falls below it in a few weeks, sell the stock and step aside until better price action occurs.

The second news event is better to trade on than the first. When the second or third set of bad news fails to change the stock and the recent lows hold, this can be a great opportunity. Use the recent low as your stop-out point, and enter the stock with a small position. If the stock starts to improve, that’s a good trade entry that could be the start of a very strong run.

Using Volatility to Warn the End Is Near

Volatility can be measured in different ways. Volatility is how much the stock price moves around. Does it trade in a range of a few dollars per week or change dramatically as discussed about Bitcoin in the earlier section “Being Prepared for Big Moves in a Short Time”? The higher the volatility of a stock, the more difficult it is to own large positions.

A simple way of monitoring volatility is to watch the length of the price bars or candles. It’s not quite as obvious on a daily chart, but the weekly chart really shows the changing character of a chart. (Review Chapter 4 on candlestick charting for more information.)

Seeing increased volatility at the end of a major run is very normal. It’s a good clue to be aware of the change in investor stability. It also happens in the index sometimes. It’s more likely to be seen on sector charts or industry group charts.

After a nice long uptrend, when you suddenly see the largest down candle in years, that’s usually a significant trend change and the new direction should be assumed to be down. It’s a great place to make decisions.

Measuring Volatility with the Average True Range

One of the indicators that you can plot on stock charts is the average true range (ATR), which can help you see changes in volatility of the stock or commodity. Select it on the Indicators drop-down menu on StockCharts.com. (For more information on indicators, review Chapter 11.)

Do a little research to find some major stocks that topped out a while back, and look to see whether any clues were provided by the ATR indicator. Sometimes the volatility picks up because of a bad earnings call. When the ATR is relatively constant, it’s normal for the stock to bounce around a little. While the stock is trending higher or sideways, the ATR can change somewhat. When the true range shrinks or expands meaningfully, try to do more work on the stock chart by analyzing other indicators for other potential sell signals.

Realizing That the SCTR Won’t Help Find Exits

Because the two main components of the StockCharts technical ranking (SCTR) are based on longer-term moving averages, in a fast-rising stock, the SCTR will be slow to turn down. You can review details on the SCTR in Chapter 12.

The SCTR is much better at finding entries than exits in fast-moving stocks. If your goal is to outperform the market, you usually have to be in high-performing stocks. This doesn’t mean that the volatility has to be higher. A strong stock can trend higher with the same sort of percentage move each week for months. The stock doesn’t have a sudden change in volatility, so it is still smooth.

In combination with the relative strength (see Chapter 12) compared to the S&P 500 using the ratio tool, and the volatility picking up on a weekly chart, these can be additional tools. Using the ATR can also help (see the preceding section), but the SCTR will be too slow to help find exits on rapidly rising stocks.

Working with Bollinger Bands

Bollinger Bands (covered in Chapter 10) are also associated with volatility as they flare out and narrow based on the recent volatility of the stock. While this can be helpful to look for, sometimes the Bollinger Band width (the distance between the Bollinger Bands) is more important than the actual Bollinger Bands.

Bollinger Bands can be selected as an overlay on the stock price on StockCharts.com. Bollinger Band Width is an indicator selected in the Indicators drop-down menu and plotted as an indicator below the stock on a separate panel.

When the Bollinger Bands pinch in, that’s a reduction in volatility. When a stock or an index trades in a tight range for a few weeks and suddenly breaks out to the upside, that’s usually a positive signal of increasing volatility.

Conversely, trading in a narrow sideways range and then breaking down is usually due to a lack of momentum to push it higher. This sudden change in volatility based on the price change may also show up in the volume, where it accelerates as the Bollinger Bands expand.

The Bollinger Bands are a great indicator of volatility. The best clues appear from a long narrow channel of the Bollinger Bands. A sudden breakout or expansion can be very meaningful. This may happen because of earnings-related gaps or sudden industry problems, but these narrowing bands that suddenly expand are available in the Predefined Scan results. The Predefined Scan Name is “Moving Above Upper Bollinger Band.” There is also a bearish scan for a volatility breakdown called “Moving Under Lower Bollinger Band.” Review how to set up scans in Chapters 14 and 21.

Using the U.S. Dollar as a Guide

When the U.S. dollar is dropping, that favors exporters as their goods are less expensive for other countries to import from the United States. For importers, the goods that they resell have higher costs because they bought them from other countries in a currency that is rising. That makes their profit margins thinner unless they have some ability to raise and lower prices to reflect this.

For industrial manufacturers that export, a falling dollar is helpful. For retailers that import, a falling dollar is a headwind. On a macro picture basis, a falling dollar is helpful for commodities. That does not make the day-to-day correlation work, or even the week-to-week correlation fit perfectly. However, on a big macro trend, expect weakness in the dollar to help commodities. Review Chapter 13 to see how to organize your charts by industry groups or sectors.

Obviously, the dollar is always moving around, but in general it trended up from 2011 to the end of 2016. For most of 2017, the dollar has been getting weaker. A major trend change in the dollar can affect the sectors that are sensitive to the value of the dollar.

While the SCTR (see Chapter 12) helps point out strong-performing industries all the time in real time, watch for correlations across industries that may also be because of the direction of the dollar.

One of the common themes is international investing. When the U.S. dollar is falling, these other markets will perform fabulously in U.S dollar–priced exchange-traded funds (ETFs). For example, EWG is the ETF for Germany traded in U.S. dollars. If the German stock market is going up in local currency, the $DAX index is going higher. But if the U.S. dollar currency is falling, a U.S. investor will get the currency gain on top of the stock market gain by owning shares of EWG.

If the U.S. dollar is rising but other markets are outperforming the U.S. markets, then you need to use ETFs that have the word “Hedged” in the name to actually get the gains (for example, HEWG). This removes the impact of currency for the most part, and you just have the performance of the ETF.