Professor’s Comments September 1, 2013 chart reading

Posted by professor  at September 1st, 2013

One of the things I wanted to do this weekend was talk about the process I use to read a chart.   I went through this process at the Update Classes last week, and I thought it might be a good idea to review it today, so you have it fresh in your memory as we look for trades in the weeks ahead.

Back in the mid-60s, when I started trading, I didn’t have a computer to produce the charts of stocks I was trading.  Computers weren’t invented yet.  So every morning at 5am, I went out to the mailbox, got the Washington Post, and plotted the price of the stock I was trading on a piece of graph paper.  It wasn’t easy, but it was effective.  We didn’t have MACDs, or volume information.  Heck, even calculating a 10-day moving average was difficult. 

So all I had on my chart was price.  It was all I needed.

Today, too many traders get hung up with indicators.  Indicators are great trading tools, but they are not the reason you should be interested in a stock.  Indicators are only used to trigger a purchase or sale.  They are never the reason for the basic decision to buy a stock.

When I do my analysis on a stock, it is always done on a Daily chart with one year’s worth of data.  This allows me to see whether the stock is in an up trend or a downtrend.  It also allows me to see the patterns that are currently moving the stock price, and any new patterns that could be developing.

The first thing I always want to know about a stock is whether it is in an up trend or downtrend.  Knowing the trend is the single most important piece of information about stock.  It determines everything else you do.

To determine the trend, I use the 50 and 200 period moving averages.  If the 50 is above the 200, then by definition in The Professor’s Methodology, the stock is considered as being in an up trend.  If the 50 is below the 200, the stock is in a downtrend.   Once I determine the trend, I want to know the strength of that trend, so I look for well-defined parallel lines made by the 50 and 200 day moving averages.  I call these parallel lines made by the moving averages, railroad tracks. These ‘tracks’ are a clear sign that the stock is in a strong trend mode.

Once I know the stock is trending, I can then use my Rifle Trading Techniques to buy additional shares of the stock, whenever it becomes oversold on the Daily’s. When I see an Up tend, and a pull back, that‘s when I look at an indicator.  That’s when I use a 2-period RSI Wilder to tell me when the stock is on sale.

When I’m looking for turn around candidates, I use the price chart to tell me if a stock is forming either a Three Lows to a Bottom (TLB) or Three Highs to a Top (THT) Pattern.  If the stock has been in a downtrend, and has formed a TLB pattern, I wait until I see three distinct lows and then trade the DMI turn.  I say trade, because at this point, with the stock in a downtrend, I don’t know if it is going to turn around or not.   So I buy the stock after the TLB Pattern when the DMI turns positive and wait.  If the DMI turns negative, I get out.   By selling on the DMI turn, I won’t be part of any significant move down if the downtrend is not over.  And at this point, with the 50 still below the 200, it is very possible that this could happen 

On the other hand, IF the stock continues to move higher and ‘Jumps the Ropes”, it tells me that a real reversal could be taking place.  When I use the term “Jumps the Ropes”, I mean that the stock price has moved above the 50 and the 200.  This is usually a sign that the move off the bottom is a wave 1 up. It is a very valuable piece of information.  And once again, you get it from the stock price, not the indicators. 

So now at this point, I’m assuming that the stock price is above both moving averages.  But it’s still not in an Up trend yet.  The 50 is still below the 200.  So we CANNOT use Rifle Trades even though it might be oversold at some point.  The stock is still a trade.  We can’t even begin to think about having a long-term relationship with it yet.  We can never fall in love with stocks that are still in downtrends.  If the DMI turns negative, we MUST sell the stock!

There are two reasons why selling at this point is mandatory.  The first was mentioned earlier.  With the 50 still below then 200, a DMI turning negative could be signaling a resumption of the downtrend.  On the other hand, even under the best possible conditions, the fact that the stock ‘Jumped the Ropes’ for a wave 1, a DMI turning negative at this point is likely signaling the start of wave 2 down.  In either case, I don’t want to be associated with the stock.  I know that wave 2s are unpredictable, and could retrace the entire move of wave 1 up if they have a mind to.

But let’s suppose the stock is really in the process of reversing.  In this case, the stock will likely trade sideways to slightly lower while developing its wave 2.  As long as the price remains above the 50, it will allow the 50 to move up so it can cross above the 200.  When this happens, the stock starts to move into an up trend.  And when all of the PT indicators turn positive, we can start establishing our Basic Positions.

This is when I use The SIGN.  Because the stock or ETF has showed strength causing it to move it into an up trend, it will likely appear on the Dean’s List or the Member’s Watch List.  It will also have a pattern, only now because a wave 1 ‘Stick’ and a wave 2 ‘Blade’ have developed, the Pattern will be a Hockey Stick.  And as we know from Class, the Hockey Stick Pattern can be used to project price targets for the stock.  Targets I use to manage money and help reduce risk.

Anyhow, I hope this quick review provide you with a better understand the Professor’s Methodology.  One thing you should note from the above discussion is how little I talked about using the indicators.  Almost everything in the Professor’s Methodology is based on the movement of the stock’s price.  The basic analysis is still done the same way I did it almost 50 years ago, using a price chart. You don’t need a bunch of fancy indicators to make basic buy and sell decisions.  The indicators only make the timing of trades easier.

Have a great weekend,

TWID,

h

BTW, the markets will be closed on Monday for the Labor Day Holiday.  Trading will resume Tuesday morning.  I plan to watch the open on Tuesday and start running my algorithms when enough data comes in (about 11am).   If the Professor Algorithm starts to highlight more than 50 longs, I’ll post it as soon as it happens.  Otherwise, my next Update will be on Wednesday morning.

Not sure of the terminology we use? Check out these articles

The Hockey Stick Pattern
The Creation of Waves and Trends
FAQ

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