Stock Diamond - Technical Analysis Education

The Dow is falling! The Dow is falling! Like Chicken Little, we can easily get caught up in the daily turmoil of volatile markets. Volatility is not bad. In fact, price changes over time are the bread and butter of the markets. And our bread and butter if we succeed in getting on-board the right trend at the right time.

In this issue of ChartFilter Newsletter we'll examine mid- to long-term trends and how to spot them using some of the tools at our disposal. And, once again, I will be reminding you of the usefulness of some of the simpler tools.

CURRENT TRENDS - Learning from the Long Term Picture

"Ignore the long-term trend at your peril!" Was it Napoleon who said that? (Just kidding!) I don't know who said it first, but I'll take the credit if this one is up for grabs. And then there's "The trend is your friend." There's a lot of truth in these words.

For example, let's take a look at the Dow over the past few years. You might be surprised to see the number of clues that suggested a year ago that these markets were running out of steam. If you are regretting your current position in the market these days, these charts may provide some good lessons for the future. Of course, you can always take comfort in the knowledge that the markets will turn around some day. And we'll even take a look at some of the first signs... read on!

In the chart below I've plotted the Dow Jones Industrial Average over the past 5 years, using weekly data. I've also plotted the 20 and 50 week Moving Averages as well as the MACD indicator.

As we know from previous newsletters, MACD is a lagging or trend-following indicator... or, in other words, it helps to confirm a trend once established. In the chart above MACD gave two clear sell signals (red arrows) - with the first in late 1998, after more than 3 years of steadily upwards trending markets. We had another clear indication of a weakening trend in early 2000 (2nd red arrow).

These signals were confirmed by the 20 & 50 week (one year) moving averages. Notice how the 20 week MA stayed above the 50 week MA during most of the uptrend, dropping below in late-98 and again in early 2000.

If you're interested in going with the long-term trend (as I am), this type of perspective is invaluable. Whenever you're in doubt about the overall health of any market - or wondering what the major trends are - I advise you to check a similar view. Plot the particular index you're interested in, using at least 5 years of weekly data. In the day-to-day markets, it's easy to lose sight of the big picture.

How do you know when a market is showing signs of turning around?

The first signals will likely be given by a lead indicator; such as MoneyFlow. In the charts below you can see that MoneyFlow is still strongly downtrending. When the Dow turns around, MoneyFlow will lead the way, followed by the MACD, which can be used to confirm the trend reversal.

I don't think you can expect these markets to turn on a dime. There will, in all likelihood, be a couple of false starts before a true bottom is established (and we might not even be close at this time because some serious support levels have been broken recently). However, we do know that the Dow will turn around... and a long term perspective using weekly data with MACD and Moneyflow should give you an edge in determining a good time to buy into some nicely devalued stocks.

Speaking of which... here's another view -- of a stock this time (Nortel) -- showing the Money Flow Index in action. Notice how the price is still sideways/downwards trending, while Moneyflow has reversed and made a sudden upswing. If Moneyflow continues to gather strength, price can be expected to follow (and will likely be confirmed by MACD).

Moving averages, MACD, and Moneyflow can provide many clues about the direction a market is trending. I find patterns are also particularly useful in determining market reversals (tops & bottoms). Retracement tools, such as Fibonacci retracement lines or Gann fans, are also very handy - but we'll save those for a future edition.

Putting ChartFilter into Context

ChartFilter is meant to complement your overall trading knowledge and decision-making. This newsletter focuses on applying technical analysis (TA) methods to various markets; but this is not to say that you shouldn't be considering important fundamental criteria, such as EPS or revenue, as well. Think of ChartFilter as your TA assistant; not as your overall trading strategist.