Technical Analysis III: Using Charts to Time Selling Economics 98 / 198 Decal Spring 2008

CURRENT EVENTS / STOCK DISCUSSION Using Charts to Time Selling

Current Rally’s FTD (Dow Jones)

S&P500 (Recent Activity)

LECTURE CONTENT Using Charts to Time Selling

Summary of last lecture Technical Analysis Using stock charts to time market bottoms Rally, follow-through, counting days Using stock charts to time buy points Stock formations / bases Cup with handle / double bottom / flat base Strong characteristics of bases Additional buy point: 50 Day moving average

Rally Attempt Day 1 Follow-through Day 5 (+1.75% on on high volume) S&P 500 (Early 2007 Follow-through) Failed Rally Attempt Day 1 Prior Downtrend

ROLL – Pullback to 50 DMA Pullback Bounces off 50DMA on above average volume

SPAR SPAR – Ascending Triangle Volume perks up on breakout

Today’s lecture General principles for selling stocks whether for a loss or for a profit Key Selling Indicators Market direction Cutting losses short Individual stock chart analysis Signs of weakness (churning, breaking support, resistance) climax tops changes of trend

Why knowing when to sell is so important Nasdaq (2000) Let’s say you bought an index fund or ETF 3,500

Why knowing when to sell is so important Nasdaq (2000) Within a year and a half, you would have lost your profits plus more!

Why knowing when to sell is so important Yahoo! (1997 – 2006) Peak of $120 Bottom of $ % loss here To recover from bottom, YHOO would have to increase 2600%

Fundamentals can look great at the top

Sell Decisions Sell decisions should be based largely on technical analysis Don’t wait for fundamentals to deteriorate Market Conditions Climax Tops Signs of Weakness Change of trend

#1 Selling Rule: Cutting losses early Set yourself a maximum sell rule How much you set depends on your risk tolerance (5 – 10% a good #) Why do it? Use stop-loss orders if you don’t have time or control with emotions

#1 Selling Rule: Cut Losses Early Source: “How to Sell Stocks to Limit Losses.” IBD Online | Learning Center

Why cutting your losses is important Chicago Board of Trade (CBOT) -Great fundamentals (strong earnings, sales growth, ROE, etc.) -Cup with handle base -Strong accumulation in base -Break out on strong volume Buy $128

Why cutting your losses is important Chicago Board of Trade (CBOT) -Action of the stock doesn’t go according to plan and eventually, reverses to below breakout point -What do you do here? Cut your losses early Sell when 7% (or less) below buy point I might be wrong and I should be cutting my losses here $119

Why cutting your losses is important Chicago Board of Trade (BOT) Now I don’t know what to do with a 34% loss!!!! Bought $128

MARKET ANALYSIS: TIMING TOPS / DOWNTRENDS Using Charts to Time Selling

Market Direction: Downtrends / Tops Always preceded by signs of weakness (heavy selling) in major market indexes Distribution Day (4 or 5 within 4 weeks) raises red flags Other market weakness signs Days when market starts strong, but ends very weak (low on the intra-day) Leading stocks start to deteriorate

Let’s look at the NASDAQ during the 2000 Bubble as it happened Many distribution days within short time: more selling than buying. Furthermore, many leaders were peaking as well. Clearly, institutions were getting rid of shares. It went from good to bad to ugly Market Direction: Downtrends / Tops

2000 Market Top 4/5 distribution days can tip a market over, so 7 within 4 weeks screams out that the market is heading for the gutters

2000 Bubble: Leaders Breaking Down The 2000 bubble went down in history as having the most climax tops at a market top (we’ll discuss this later). Essentially, this means GET OUT!!!!!

The Aftermath

2000 Bubble Yahoo Inc. DOWN 88% in 12 months Qualcomm Inc. DOWN 88% in 31 months 2004 Market Downtrend CSCO. DOWN 38% in 8 months Leading stocks of current market uptrend usually fall the hardest when market tops occur Market Direction: Downtrends / Tops

Dow Jones 1929

PROFIT-LOSS PLAN Using Charts to Time Selling

Profit & Loss Plan Most stocks after bases move up %, build bases / patterns, and then in some cases, resume advances If all goes according to plan, take your profit at this 20-25% gain point the exception to this is…

Exception… If stock rises 20% in 1-4 weeks on heavy volume, then hold on for at least another 8 eight weeks Why do this? Quick, strong advance shows unusual strength in the stock. Potential to be a great winner. After that, re-evaluate to see if stock should be held for longer term

“Bulls make money and bears make money, but pigs get slaughtered.” INDIVIDUAL STOCK CHART ANALYSIS: SELLING Using Charts to Time Selling

General Signs of Weakness Downward Reversals Stock begins to move up, only for a sudden change downwards in price Even worse, when volume is HIGH Distribution Stock closes at a lower price than prior day/week on above-average volume In general words, big selling

Change of Trend Long-term uptrend line is broken on overwhelming volume Greatest one-day price drop 200-day moving average line turns down Living below 10-week moving average

Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center The stock cuts the 50 DMA on heavy volume. It’s not getting support at this level Rallies back on light volume Example 150DMA Violation

Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center Example 1 50DMA Violation The stock cuts the 50 DMA on heavy volume. It’s not getting support at this level Rallies back on light volume

Example 2 Stock cuts 50DMA on heavy volume and struggles to rally above that line. 50 DMA becomes level of resistance

Example 2 Stock cuts 50DMA on heavy volume and struggles to rally above that line. 50 DMA becomes level of resistance

Example 3 The stock had already a big move up. If a stock closes with its largest one day gain in the entire move, watch out. This usually occurs at the peak. Largest one day drop (-3.50) If a stock has its largest one day drop, then consider selling if confirmed by other signals (distribution, reversals, climax activity)

Example 3 Largest one day drop (-3.50) Big reversal Gap-down The stock had already a big move up. If a stock closes with its largest one day gain in the entire move, watch out. This usually occurs at the peak. If a stock has its largest one day drop, then consider selling if confirmed by other signals (distribution, reversals, climax activity)

Example 4 Weekly Trendline Broken If you connect lows of weekly closes, can identify a major trend line here Consider selling if confirmed by other signals when stock breaks major trend line on overwhelming volume NOTE: Don’t draw too many lines. Trend lines drawn on too short of time periods aren’t valid

Example 4 Weekly Trendline Broken If you connect lows of weekly closes, can identify a major trend line here Consider selling if confirmed by other signals when stock breaks major trend line on overwhelming volume NOTE: Don’t draw too many lines. Trend lines drawn on too short of time periods aren’t valid

Climax Tops Explosive price / volume action of leading stocks and/or industries Indicate trouble ahead for the stock Occurs at end of the stock’s run Traits Exhaustion Gaps Excessive Stock Splits Huge price spreads with reversals Extended +100% over 200-day moving average Huge price-run up at end of movement (25% - 50% in 3 weeks or less)

Example 1 Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center Climax top shows abnormal activity after stock’s previous run-up. Notice the BIG reversal at the peak on extremely high volume. Can you see the difference in price movement behavior? NOTE: Climax tops occur at end of a stock’s run. Increasing price movements at beginning of a stock’s move is positive.

Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center HUGE REVERSAL on explosive volume (ended on the bottom of the intraday spread)

Example 2 Notice the explosiveness of the price movements at the end of the stock’s move. 60% gain in 8 days. Exhaustion gap to finish the climax top off

Example 3 Telecom stocks enjoyed huge up-trend ride during late 1990’s Climax action by leading stocks gave sell signals for the industry and the market in general Notice the explosive action by the leading stocks Source: “Topping Action By Industry’s Leaders Flashes Sell Signal.” Investors Business Daily Online

Other Signs of Weakness (secondary indicators) Heavy volume without further upside price progress (churning, sign of distribution) Accumulation days with larger distribution days New highs on low volume Big buyers lost appetite for rise Signs of poor rally (decline on big volume, and then rally on low volume)

Notice how the stock reaches new highs and the advance is on very tame volume. This is a sign of weakness and raises a red flag.

Rally on light volume Notice a sharp decline from the first peak And then, a rally on very light volume

Rally on light volume Notice a sharp decline from the first peak And then, a rally on very light volume

Churning Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center If you look at the arrows, you’ll notice this stock acting quite volatile (major price increases / decreases) on huge volume without really making any significant moves. This shows that buying action is being met with selling action. This should raise a red flag. Sellers eventually may overwhelm buyers.

Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center

Other points Don’t let the stocks that rise 10-20% to drop back into loss column Be patient for advances to complete “It never is your thinking that makes big money. It is the sitting.” - Jesse Livermore

EXAMPLES Using Charts to Time Selling

Example Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001. From peak, QCOM traced a downtrend and went 68% below its all-time high Very apparent here that QCOM experienced a climax top at the end of its run We can see an exhaustion gap, and many instances of churning.

Example Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001. From peak, QCOM traced a downtrend and went 68% below its all-time high Very apparent here that QCOM experienced a climax top at the end of its run We can see an exhaustion gap (2), and two instances of major churning (4).

Example Price had increased eightfold from At peak, 85% above 50-day and 294% above 200- day (2) From peak, fell as much as 61% Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001. Also, see instances of churning on heavy volume (2) See a climax run towards the end of the run (1)

Example Price had increased eightfold from At peak, 85% above 50-day and 294% above 200- day (2) From peak, fell as much as 61% Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001. Also, see instances of churning on heavy volume (2) See a climax run towards the end of the run (1)

EBay – 2005

Down 80% over next 6 months

FRE – 2005

Summary Cut losses short Know the market and when it is topping! Distribution days can tell you a lot Have a profit & loss plan Watch for any abnormal activity Price and Volume Climax Top Changes in Trend Weak action

Next week’s lecture If you don’t have the time or don’t have the skill to constantly monitor your portfolio or manage your own investments… Wait until next week’s lecture!

Homework Final Stock Analysis 2 pages Analyze your simulated portfolio Just talk about your favorite buys and sells and back up your case with fundamental/technical reasoning