Don't Get Out of Dodge
This column was originally published on RealMoney on Aug. 14 at 10:03 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.
A reader has asked for clarification about a comment in Friday's column that an uptrend on a chart had been "consistently capped by ample supply."
Do we know that a supply imbalance stopped the uptrend, or could it have been caused by something else? This is an important question because it pinpoints some of the confusion in the study of charts.
An uptrend can only be halted by excess supply at a particular price level. Only when supply outweighs demand will an uptrend stall. There can be no other reason.Now, there are myriad factors that affect the supply of stock at a particular price level, but it's the supply itself that affects the trading price of a stock, not the factors influencing that supply. Some people operate under a simpler approach to chart analysis. They might see that Stock XYZ last reversed its uptrend at $40 and then fell back. They then assume that any return to $40 will result in the same outcome: a trend reversal. They don't think about the dynamics that create the price pattern; they only focus on the pattern itself. To the casual observer, the analysis is the same, especially when the stock behaves as expected. But if you focus only on the lines and curves on a chart, you'll miss the most valuable information to be gleaned from chart analysis. Look at the picture using supply and demand as a frame of reference. Accept the tenet that the dynamic relationship between supply and demand is what drives price change. All successful businesspeople have a deep understanding of the dynamics of supply and demand in the marketplace. When you start approaching chart analysis in terms of supply and demand, you move away from tea-leaf reading and toward commonly accepted business practices. Let's look at some reader picks.
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