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.

Phelps Dodge (PD Quote) had churned for the last couple of weeks after jumping out of congestion in late July. That changed Friday when the stock again jumped out of congestion on heavy volume. The problem is that the stock closed near the low of the day, indicating waning buying pressure.

Still, until it falls back beneath $87.50 or so, Phelps Dodge looks like it's still a good stock to buy on pullbacks. If you're long now, you might stop yourself out if the stock falls beneath the breakout level.

This monthly chart shows how far Knight Capital Group (NITE Quote) has advanced over the past year or so. The uptrend still appears to be intact, but I'd like to see it rest a bit more at this level to absorb some of the profit-taking that is natural for a stock that has advanced more than 50% this year.

This weekly chart of Safety Insurance Group (SAFT Quote) shows a prolonged uptrend marked by a pullback to a well-defined support line. Last week's pullback was on heavy volume, but the stock is still well above support. If you're long, you can see where my suggested stop is. And if you're looking to buy, consider waiting a bit longer -- the stock is still a few points above the ideal entry level.

NVE Corp. (NVEC Quote) consolidated within a very tight range for quite a while before breaking out a couple of weeks ago. Last week's pullback is still unresolved. A fall back below $17.50 would put the uptrend in jeopardy, but if sufficient buying soaks up all the supply at current levels, the coast is clear for additional advances.

A reader who likes the fundamentals of DRS Technologies (DRS Quote) asked for my technical take, and I'm happy to oblige. If the fundamentals are attractive to you, the stock is on sale right now. Five days of high-volume declines abruptly ended Thursday as the stock bottomed out at $36. That establishes short-term support; I'd put my stop just below that level.

Be careful out there.