Chartman's Techniques: Breakout, Drawing Trend Lines and Astrology

Many, many technique questions in the past few days, so I thought I'd take a brief time-out to wrap up some of your queries.

The first question, sent in by quite a few readers, revolved around the "breakout" of the downtrend by the Nasdaq Composite Index this past Friday. Recall, I said I'd be bullish only if the downtrend was broken, and not a moment before.

It turns out the downtrend was, indeed, broken Friday afternoon, but there was a fly in the ointment, which many of you noticed: The volume was a bit on the light side.

This, of course, generated the question: "Gary, are you still bullish, even though volume didn't confirm the "move?"

OK, now that you know the question, let's start with some background, and then I'll get to my answer. As many of you have already learned -- and bravo, by the way -- it's always best when a chart or index confirms a breakout or breakdown, with heavy volume. And, by heavy volume, I generally mean volume that's at least above the 50-day moving average of that chart's overall volume. Ideally, though, we'd like to see a volume surge even greater than that.

The flip side is that low-volume breakouts are often suspect: There's just not a lot of commitment behind the move, and they end up failing.

So, given all this, did I still feel bullish about the Nasdaq breakout? The answer is yes. In fact, for those of you who saw the "TheStreet.com" on the Fox News Channel, not only was I bullish, but I called for the Nasdaq to move to 4200. (After that, who knows!)

How did I reconcile the low volume on the Nasdaq and not only become bullish, but forecast a rise to 4200? Here was my thinking:

When you look at charts, and especially at indices, you have to always view things in context. In that vein, the Nasdaq breakout had a few things going for it: One, I always feel if a stock or index should go down -- but it doesn't -- it must want to go up. When that GDP number came out last Thursday, I thought I had died and gone to heaven. I was net short by a fair amount, and could see my ship coming in.

Instead of dropping off a cliff, the Nasdaq and my stocks opened down, but then made a steady, nauseating, retreat back north. I got so frustrated, I finally covered about midday. You could just tell nothing was going to stay down. That was bullish indicator No. 1.

Indicator No. 2 was the volume itself. Now, I will grant you volume was not higher than the 50-day moving average. But that 50-day moving average is skewed by some of the most volatile, high-volume days in the history of the Nasdaq! However, if we incorporate a longer period of time -- say a 200-day moving average -- which takes into account a more normalized time period, we now find the volume surge last Friday compares favorably with other time periods and actually appears to be a bit of a surge.

Finally, even if you argue that the Nasdaq index call was iffy, there were still plenty of individual charts which did show heavy-volume surges. BroadVision (BVSN Quote) is a good example.

So, looking at the Nasdaq chart alone, I might not have been so eager to be a bull. In context, though, I felt I had no choice.

So, that leaves the 4200 call, but that was an easy one. I simply eyeballed a good round number that also appeared to be resistant. 4200 looked good, so that was my target. (However, 4300 or 4100 would work just as well!) Call that "forecast" the prerogative of someone trying to be educational and make good TV!

Okay, next topic, and for many a source of real concern: Drawing trend lines!

Many people write asking if I use highs or closes or both to draw trend lines. Others note that if I had used an equally valid, but different trend line, I might have come to a completely different conclusion.

Therefore, let me give you my philosophy of trend line drawing. One, that should answer the questions.

In short, when I draw a trend line on a chart, I am simply trying to draw a line that best captures the "essence" of the chart. Consider it more art than science, for sure, as I'm happy to use all highs, all lows, and/or any combination between!

About the only thing I will not do, is cut right through the middle of a candlestick. No, strike that: I've even done that on occasion if I think the trend line looks best that way.

So, others may have exact rigorous rules to drawing trend lines, but I don't. My philosophy is to take the chart in as a whole, and then find the best trend line that fits the picture.

Of course, if one could draw any old line and justify it on a chart, then why bother at all? Well, for one reason and one reason only: to give us a guideline -- nothing more -- to establish our reward-to-risk ratio when trading! Let's look closer at that Exodus (EXDS Quote) chart again.

So, that leaves us with the final question. Since we're only using our trend lines to help establish our trade-management guidelines, and drawing trend lines is more art than science, then how do we know if we're doing everything "right"?

Well, as they said in All the President's Men, "just follow the money." That is, you'll know you're doing it "right" when you start making more money than you're losing. It's as simple -- and as hard -- as that, I'm afraid.

And finally, on a different note, let me quote from one of my favorite movies of all time, Diner: "Do you ever get the feeling there are things going on here we don't know about?"

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Yeah, I know, I do. And one of them is astrology and any effect it may have on the market. Huh? What? What's Gary got in his pipe now?

Okay, hear me out. I know at first blush astrology and trading make about as much sense as, well, technical analysis and trading.

Still, I was intrigued when a kind reader directed me to Robert Hitt's most excellent site, AstroEcon.com. Now, I don't profess to know a conjunction from a sextile (although, I do remember a song by The 5th Dimension that said something about Jupiter aligning with Mars!), but I found Robert's discussion of the market each day intriguing, to say the least.

If I had to net it out, each day's discussion blends some pure technical analysis, some Elliott Wave aspects and a good dose of astrological ramifications, to come up with some unequivocal market forecasts. As an example, Robert said this weekend: "The Nasdaq is being supported in its relief rally by the very stocks that will suffer the most in any downdraft to come. As soon as the 38% retrace is completed at 3955 we should see a resumption of trend back down to at least a better long-term downside target at 2800."

Hey, you can't get any more straight forward than that.

So, do I believe in astrology? Do I think that where the sun is in the sky has one whit to do with Cisco's (CSCO Quote) price direction? Well, intuitively it makes no sense. On the other hand, like a lot of things quite frankly, I don't know enough to make an informed decision and rule it out.

More importantly, as Robert says himself:

"Astrology is not stand-alone and that is unfortunately how many are trying to use it. For instance, astro techniques in the hands of a trained counselor is dynamic and unbelievably effective at getting to the root of someone's problems. In the hands of a housewife trying to counsel friends, it is usually a disaster.

"The trick with using astro properly is to know when inflection points are and have that little jump on the rest if things go as planned. One of my best clients, a former economist, has a mathematical model that is extremely good (at least 80%) at picking off trades of 20-50 points. It only works on price and not time, so when he gets a high-quality signal and the astro concurs, he is putting on a larger trade. If there is a conflict between his model and the astro he goes lighter. He says it works well in that way."

So, if you're interested, an informed opinion is always the best opinion. If nothing else, Robert has a neat site and you'll get a kick out of his writing and wit. As he recently pointed out, "The next few weeks are one of the best astro times personally during my lifetime and I hope to make the most out of it!"

And that, folks, does it. Capricorn One, signing off!