Look at a 2 year chart with the 20-day and 200-day moving averages in place.
1) Look for the stock to remain above the 20-day moving average to confirm accumulation. If the stock falls beneath the 20-day moving average, and the 20-day moving average then falls beneath the 200-day moving average, this stock is being liquidated, and the weakness is likely to persist. You do not want to own the stock; sell it if you do. If the stock sets a 52-week low, it is likely to set more 52-week lows, so this is not a buying opportunity, this is the reason why you do not want to own the stock during this phase. On the upside, anticipating this pattern and buying immediately at the time the stock crosses above its 20-day moving average can get you into the stock at a much lower price, but you risk getting into it on a false signal, and the stock can fall back into a weak pattern.
2) Look for the stock to climb above the 20-day moving average. If the 20-day moving average then crosses above the 200-day moving average, this is usually a breakout, and support is coming into the stock. It is likely to continue to move higher. Setting 52-week highs, is likely to result in further setting of more 52-week highs. These are NOT selling opportunities, these are holding opportunities. When the stock ceases setting 52-week highs, watch for decay. If the stock falls below the 20-day moving averages, this may signal a sell. Anticipating this pattern and selling immediately at the time the stock dips below the 20-day moving average can get you out at a much higher price, but you risk getting out on a false signal, with the stock resuming its climb higher.
Example: Burlington-Northern, Santa-Fe
Buy signal at roughly $85 in mid-February, 2008 when the 20-day moving average crosses the 200-day to the upside. Notice that the stock had already crossed the 20-day moving average in mid-January at roughly $80 before the moving averages crossed to confirm the accumulation. The stock goes on to set multiple 52-week highs.
Next, the stock breaks the 20-day moving average at roughly $110 in mid-June. Early reaction would have you sell. Waiting for confirmation, the stock holds support on the 200-day moving average, now roughly at $90, but as it bounces, can only move marginally above the 20-day moving average, and never set any more 52-week highs. This is a warning signal. Even if you did not sell here, you were very watchful. Then, in early September, the stock again falls beneath the 20-day moving average. Quickly, the 20-day moving average now crosses the 200-day moving average to the downside by late September. This is a clear sell signal, now with the stock at roughly $95. Result could be one of four scenarios:1=Early Buy and early sell, 2=Late buy and late sell, 3= Early buy, late sell, or 4= Late buy and early sell.
Scenario Buy Date Buy Price Sell Date Sell Price Gain/Loss Holding Period Raw (Ann.) %
1 Mid-Jan $80 Mid-June $110 +$30 5 months 37.5% (90)
2 Mid-Feb $85 Late-Sept $95 +$10 7-8 months 12% (17.6)
3 Mid-Jan $80 Late-Sept $95 +$15 8-9 months 19% (25)
4 Mid-Feb $85 Mid-June $110 +$25 4 months 29% (88)
Continuing this pattern, if late September was a clear sell signal, was it also a signal to short the stock? Possibly, but the company’s fundamentals and their trend need to be more involved with judging a short potential. Why? Two reasons: 1) What is the potential profit on a short compared to a long? 2) Few “investors” short securities. But using ONLY the chart, shorting in late September 2008 at $95, you would hold the short as the stock sets consecutive 52-week lows through March 2009. When the stock climbs above its 20-day moving average at roughly $58 in late March, early April, prudent short positions would cover with a $37 profit on $95 entry point for a 39% return in 6 – 7 months, or an annualized 67% return. If you did not cover here, you could have waited until the 20-day moving average crossed the 200-day moving average to the upside at roughly $72 in mid-June and experienced a $23 gain on the $95 entry point for a 24% return in roughly 9 months, or an annualized return of 32%.
Last, if these crossing points to the upside (either the early one at $58 in late March-early April, or the later, safer one with the 20-day moving average crossing above the 200-day moving average at roughly $72 in mid-June) were considered short covering points, they could also have been considered long entry points. From $72 in mid-June to the present price of $100, you have a $28 gain or 39% return in 6 months (78% annualized), or from the early entry point of $58 in late March, early April, have a $42 gain or 72% return in 9 months (97%annualized) return.
Now go look at another stock in this framework. If you feel comfortable identifying buy and sell points in the past, where are you now with it? Are you currently a hold, a “watch it” while it’s bottoming out, or waiting for a pullback to test support to buy it???