It's that time of year again -- every January, scores of investors flock to the "Dogs of the Dow." But this year a twist on the typical Dow Dogs strategy is providing a big opportunity for investors who are paying attention to the price action.
For the last two decades, the "Dogs of the Dow" has been one of the most widely circulated investment strategies out there, offering individual investors a simple formula to beat the market: Simply buy the 10 highest-yielding Dow Jones Industrial Average stocks at the start of each year, and hold on.
It may be simple but it's effective.
When Michael O'Higgins introduced his strategy in 1991, it took the market by storm -- backtesting showed that the Dogs of the Dow strategy significantly beat the broad market from the 1920s on. The justification was that the big names of the Dow don't kowtow to market conditions, so their high dividends reflect strong businesses trading cheaply.
But that's not the whole story. As every investors knows, cheap stocks can get even cheaper -- and that's why it makes sense to overlay some technical analysis on the classic Dogs of the Dow approach. The results are pretty compelling: Of the 10 highest-yielding stocks in the Dow right now, five also look attractive from a technical standpoint. Put simply, these big stocks are teetering on the verge of breakout territory.
Today, we'll turn to the charts for a closer look at which of the Dow Dogs you should buy in 2017.
First, a quick note on the technical toolbox we're using here: Technical analysis is a study of the market itself. Since the market is ultimately the only mechanism that determines a stock's price, technical analysis is a valuable tool even in the roughest of trading conditions. Technical charts are used every day by proprietary trading floors, Wall Street's biggest financial firms, and individual investors to get an edge on the market. And research shows that skilled technical traders can bank gains as much as 90% of the time.
Every week, I take an in-depth look at big names that are telling important technical stories. Here's this week's look at five big stocks to trade.
Leading things off is oil and gas supermajor Chevron (CVX) . Chevron may only offer the third-best yield in the Dow right now, at 3.7%, but it's showing off one of the most compelling chart patterns. Shares have been rallying hard in recent months, leading the rest of the energy sector 31% higher in the last 12 months. And now, a classic price setup is signaling a second leg higher for Chevron.
Chevron's price setup is an ascending triangle pattern, a bullish continuation pattern that's formed by horizontal resistance up above shares at $119, and uptrending support to the downside. Basically, as Chevron bounces in between those two price levels, it's been getting squeezed closer and closer to a breakout through our $119 price ceiling. When that breakout happens, we've got our buy signal.
Evidence of Chevron's price leadership comes through in the form of relative strength, the indicator down at the bottom of CVX's chart. Relative strength measures Chevron's performance versus the rest of the stock market, and the fact that it's still holding onto a series of higher lows means that this energy giant is predisposed to keep on outperforming in 2017. Shares are within grabbing distance of their $119 breakout signal as I write...
Pharma giant Pfizer (PFE) is showing off a similar setup right now, albeit with a bit of a twist. Pfizer hasn't been an outperformer lately -- quite the contrary, in fact. Shares have handed back more than 10% of their market value since peaking back in the summer, which makes this stock a notable drag on investors' portfolios as we head into 2017. But now, a not-so-standard ascending triangle setup in Pfizer is signaling that shares are within mere cents of a breakout.
For Pfizer, the breakout level to watch is resistance at $33.50.
What makes that $33.50 price tag so important for Pfizer? It all boils down to supply and demand for shares. Since bottoming in November, the $33.50 resistance level has been a price where there has been an excess of supply of shares. In other words, it's a spot where sellers have been more eager to step in and take gains than buyers have been to buy. That's what makes a breakout above $33.50 so significant - the move means that buyers are finally strong enough to absorb all of the excess supply above that price level.
As I mentioned, the price pattern in Pfizer isn't exactly "textbook" -- typically, an ascending triangle pattern is a continuation pattern that comes after an initial up-move, not a setup you'd expect to see at the end of a selloff. But even though the price action isn't typical, it's tradable. A breakout above $33.50 is our signal that buyers are back in control of this financial company -- and that it's time to join them.
International Business Machines
The setup in International Business Machines (IBM) is another ascending triangle -- only this Dow Dog is already breaking out. IBM has been a market-beating tech stock in the last year, handing investors total returns of about 29% during that stretch when its 3.3% dividend yield is factored in. And now, investors are getting a second shot at buying a recent breakout in this stock.
IBM bumped its head on resistance up at $165 several times in the second half of 2016, but shares only just broke out above that price ceiling in December, signaling the potential for higher ground ahead. Even though this breakout is a month old, a "throwback" in shares is creating another low-risk entry opportunity in IBM.
A throwback happens when a stock breaks out, and then moves back down to test newfound support at that former price ceiling level -- in this case, our $165 price level. While throwbacks look ominous, they're actually constructive for stock prices because they re-verify the stock's ability to catch a bid at support. For that reason, it's best to think of a throwback as a buying opportunity in IBM, not a red flag. From a risk/reward standpoint, yesterday's bounce off of $165 is creating a buying opportunity today.
You don't need to be a trading expert to figure out what's happening on the chart of $56 billion heavy equipment maker Caterpillar (CAT) . This Dow Dog has been in an exceptionally well-defined uptrend for the better part of the last year. In 2017, as Caterpillar inches its way back towards the bottom of its price channel, it makes sense to buy the next bounce higher.
Actually waiting for that bounce is important for two key reasons: It's the spot where shares have the most room to move up before they hit resistance, and it's the spot where the risk is the least (because shares have the least room to move lower before the channel breaks, invalidating the upside trade). Remember, all trend lines do eventually break, but by actually waiting for the bounce to happen first, you're ensuring Caterpillar can actually still catch a bid along that line before you put your money on shares.
This is a long-term trend. Because of that, the 200-day moving average has started acting like a good proxy for support in recent months. If you decide to buy Caterpillar, consider parking a protective stop on the other side of that red line.
Last on our list of Dogs of the Dow showing bullish chart setups is beverage behemoth Coca-Cola (KO) . Coke is another stock that's had its 3.4% dividend yield padded by a struggling share price - since peaking back in April, Coca-Cola has lost about 11% of its market value. But shares are finally looking "bottomy" this winter. Here's when to buy:
Coca-Cola has spent the last few months forming an inverse head and shoulders setup, a classic technical reversal pattern that signals exhaustion among sellers. Coke's pattern is formed by two swing lows that bottom out at approximately the same level (the shoulders), separated by a lower low (the head). The buy signal gets triggered on a move through Coke's neckline just below the $42.50 level.
If you think that the head and shoulders is too well known (or hokey) to be worth trading, the research suggests otherwise: a recent academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in "profits [that] would have been both statistically and economically significant." That's good reason to keep this stock in your crosshairs in the trading sessions ahead.