This column was originally published on RealMoney on Oct. 5 at 11:03 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.Today, I'm going to look at the chart of SanDisk ( SNDK), without those darned distracting secondary indicators. But before doing that, let's briefly consider exactly what it is that these nasty indicators do ... and don't do. These are very, very simplistic explanations, but they'll work for now. First, Wilder's Relative Strength Index (RSI) is a simple measure of momentum. Within a specific period of time, RSI compares the gains of a stock against the losses of that stock. When the average gains within the period under study (say, 14 days) outweigh the average losses, RSI moves higher. If this imbalance continues, the RSI moves higher still -- the upside momentum is stronger. That's pretty much it for RSI. Would I base a trading decision on RSI? Nope. But I like having some empirical data on momentum. It's also really easy to use when I search for stocks with particular momentum characteristics. Money flow is a measure of buying and selling pressure within a specific period of time. This pressure is calculated by putting in a volume component. Assuming that the close is dominated by the professionals (while the open is dominated by the amateurs), then the location of the closing price relative to the day's range can be informative. Are the pros buying or selling? High-volume days receive a greater weighting than low-volume days because more volume means more pressure; light volume means minimal interest in the stock. In the final analysis, does the degree of money flow impact my P&L? Nope, but it gives me some kind of idea what the pros are doing relative to what they were doing the last time the underlying stock was moving in the same direction. It's a small piece of data but it's free, so I'll take it. The Accumulation-Distribution, or A-D, Line that I use (there are a few different versions) is a lot like money flow, only easier to understand. Rather than using only that price and volume data within a defined period of time (say, the last 20 days), the A-D line just sums the data, packing new data onto existing data. As such, it's slower to react to quick changes. That's all I have to say about the A-D line because Barry Ritholtz has
- 1. The crowd was pretty benign from March through July. There were just random price movements because of an absence of a catalyst to get the crowd emotionally involved. The long horizontal "price-by-volume" bars in the mid-$20's indicate the large number of trades at that wide level. There is lots of financial/emotional commitment.
- 2. Big earnings and very aggressive buyers. In fact, the price-by-volume bars show that no trades occurred around $30 due to the aggressive buying of the crowd. Those who are waiting for the stock to drop to more favorable prices continue to be disappointed with each passing day ... as the price moves higher still. One-by-one, these reluctant buyers capitulate, paying up for the stock and pushing prices ever higher.
- 3. The crowd is now milling around. Look at the increased length of the price-by-volume bar at the $45 level. Some folks are prudently taking profits, thus creating enough supply that new buyers won't have to pay $50 in late September -- they bought stock for $45. This "churning" at the end of September is important. It effectively gives the crowd a higher basis in the stock, reducing the crowd's tendency to take profits. The longer a stock churns at the same level, the greater the number of folks who have the same basis in the stock -- thus making it a bit easier to apply an "If..., then...." analysis.
- 1. If aggressive buying drives the stock up another several points, then the $45 crowd will probably start taking profits, thus halting the uptrend.
- 2. On the other hand, if supply so outweighs demand that the price begins trading down to $45, then the crowd will become nervous. Many folks sitting on paper profits will be mad because they didn't sell at $52.
- 3. If even more supply pushes the price down to around $43, then many folks with a $45 basis will rush to cut their losses and sell. They won't buy more because panicky crowds don't do that. Significantly, those who use stops will probably have put them right around $43. So a decline to this level is likely to trigger stops, thus exacerbating the price decline. The stock will then fall further as more and more stockholders watch their paper profits dry up and become losses. They'll sell in frustration, because that's what crowds do!
- 4. With earnings due to be announced on Oct. 20, buying pressure should continue to outweigh selling pressure for the next couple of weeks as the crowd grows increasingly enthusiastic about the company's prospects. After all, the strength of SanDisk Tuesday, relative to the broad-based afternoon selloff, indicates solid demand for this stock. If the price continues to advance between now and earnings, then many in the crowd will likely sell, no matter how good earnings are. After such a prolonged uptrend, most folks will already own the stock. With no one left to buy, the demand dries up and the uptrend ends.
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