This Day On The Street
Continue to site
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Apprenticed Investor: Tracking Elephants, Part 2

Early Warning Signals

Savvy traders know that charts reveal a wealth of data, including early caution signs of potential underlying problems -- in real time.

To be more precise, charts reveal the behavior of those institutions that have already discerned a problem, long before the crowd has. Good chartists are out of the way before a disaster occurs -- or at least in the very early stages -- and not after.

Why? Because a chart that's rolling over reveals that better-informed, more-connected institutions with deeper fundamental knowledge than you or I have are selling.

There, I've said it ... it's out in the open now: Technicians free ride on the sweat of fundamental buy-side analysts.

The phrase "it's already in the price" means that people with superior knowledge have already bought or sold. It is the same thing with charts -- very often, it's in there.

Sell Signals

It's not just about avoiding disasters. Stocks give several loud and clear signals on charts when an uptrend is over. A new phase of sideways, range-bound trading may not be a debacle, but there are better places for you to put your money.

Breaking a long-term uptrend, as shown in the accompanying chart of Apple Computer (AAPL - Get Report), falling below a significant moving average, or breaching key support, as evoked in the chart of General Motors (GM - Get Report). These are all ways an equity reveals to you that it's time to head for the exits.

Why? It shows that fewer and fewer institutions are buying the stock. And as we have seen, this tends to take more than an afternoon to play out. That's why momentum strategies work -- at least for a while.

Bruised Fruit
Apple's chart shows a clear break of its uptrend, a classic sell signal.
Click here for larger image.
Source: Barry Ritholtz

No Brakes
Prior to its recent upturn, GM repeatedly failed to hold at important support levels.
Click here for larger image.
Source: Barry Ritholtz

Risk/Reward Analysis

Charts help savvy traders determine what their possible upside is vs. their probable downside. Finding good risk-reward scenarios (i.e., up $4/down $1) means that even if you are wrong half of the time, you will still be making money.

This is accomplished by figuring out where the likely resistance is, and where likely support is. I avoid stocks where resistance is $1 away (reward) and support is $5 below (risk). For example, with support at $30 and resistance at $39, eBay (EBAY - Get Report) offers a good risk/reward as it approaches $32.

Hitting the Bid
Technical analysis shows the spots where risk/reward favors eBay's stock.
Click here for larger image.
Source: Barry Ritholtz

Assume that you will hit .500. That means for every winner you pick, you also find a loser. This explains why you want the risk/reward ratio in your favor. I will buy a stock with a 3-to-1 risk/reward ratio -- potential to make $3 for a $1 of risk -- but 5-to-1 is ideal.

2 of 3

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG
DELL $0.00 0.00%
COCO $0.02 0.00%
AAPL $124.75 0.00%
EBAY $55.79 0.00%
GM $36.64 0.00%

Markets

DOW 17,826.30 -279.47 -1.54%
S&P 500 2,081.18 -23.81 -1.13%
NASDAQ 4,931.8150 -75.9760 -1.52%

Partners Compare Online Brokers

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs