Hello Fellow ChartWatchers!
Are you a watcher of charts? By that I mean how much do you trust what you see on price charts? Do you trust the charts more than the commentary/opinion of others? Do you trust stories in the financial press more than what you see on the charts? The reason I'm asking these seemingly straightforward questions is because last week was the kind of week that separates the true chart watchers from the rest.
If you trust the charts, you probably took action last week.
Last week we had the breakout to new highs that we have been waiting for for months. Did you see it? Did you take action? If so, terrific! If not, ask youself very honestly why not? Here's the chart of the Dow:
Seriously, it doesn't get any clearer than this folks. A big breakout to new highs with increasing momentum. Moving averages in the right position and turning up. Six straight days of gains. The only thing that isn't 100% bullish about this chart is volume - it didn't increase significantly.
Again, if you didn't do something in response to this week's price action, ask yourself why and be clear with yourself about your answer. Situations like this - a clear breakout after a long considation period - are rare. Here's the longer-term picture:
This chart confirms that, in terms of price action, last week was huge. Now, let me address some of the reasons some people are throwing around for still being skeptical of these charts:
1.) "The breakout makes no sense given <insert favorite news story here>."
Folks, let me be clear - as investors, we do not need to understand why something is going up in order to profit from the move. We do not get extra money if we know the reason for a stock's rise. Similarly, we do not get punished any less if we can "prove" that a stock "should not have gone down." Being a true chart watcher means that you are watching for trends and riding them effectively - usually without knowing (or caring) about why the those trends exist.
2.) "The market is clearly overbought right now."
Last year I wrote an article about momentum investing. In that article I said that "In order to be a momentum investor, you must be willing to buy stocks 'at the top'." By that I meant that in order to ride a big trend, you need to buy after the trend has been established but before the trend ends. Think about what such a chart would look like. It would look "overbought." It would look like you have missed the move. But now think about it a little more. The idea that you can buy a stock right at the start of a big uptrend is unrealistic/impossible therefore you will always be buying after the first (or second or third) move up and therefore the chart will almost always look "overbought." (For more on the "overbought" fallacy, please see Greg Morris' thoughts on that subject.)
3.) "Volume didn't spike."
I will admit that volume is a concern however there are some mitigating factors to consider. First off, it is the summer and volume is usually light in the summer. In addition, there have been lots of non-stock-related news events recently that have (correctly) overshadowed the markets. In the past, whenever the Dow was setting new highs it was often the top story on the nightly news. Unfortunately, that wasn't the case last week. Regardless, the fact that volume didn't increase is a reason for caution, but it doesn't negate the price action. Volume is just one piece of the puzzle.
4.) "But what about <insert favorite economic/fundamental metric here>?"
Again, technical investors don't care about "why?" They focus on "what is happening now?" Momentum investors use technicals to identify stocks with strong uptrends that are more likely than not to continue moving higher. They also use solid risk management techiniques to limit their losses if things don't work out. That strategy can work in any market (there's always something going up!) but it works really well in a rising market where most things are going up.
(For a different perspective, check out our latest DecisionPoint article on S&P P/E Ratios).
5.) "I missed the move! I should have done something last week but I didn't and now it is too late."
It is never too late and you haven't missed the move. Chart watchers live in the present, in "the now." It is the only time period you can control. Successful technical traders are constantly asking themselves "What can I do right now based on what the charts are saying?" You should do that too.
Breakouts to new highs after a multi-year consolidation period are rare. When something big like this happens, technical investors constantly re-evaluate their positions and their strategy and adjust it as needed. Last week's price action should challenge everyone to re-evaluate things.
Stay focused on the charts!