How to Grab Significant Short-Term Profits From Technical Analysis
by Mark Skousen, Advisory Panelist
Thursday, August 27, 2009: Issue #1077
“The overwhelming majority of economic theories, market forecasts, trading strategies, investment systems, hot tips and sure-fire speculations never pan out.” ~ Alexander Green
In the August 14 Investment U issue, Alexander Green urged you to stick with the tried-and-true method of fundamental analysis.
He did so using this mantra: “There is only one thing that dictates where a stock will go: earnings.”
I agree that earnings are the ultimate determinant of stock prices in the long run. But that’s not the only way to gauge where a stock is headed next.
I firmly believe that technical analysis – volume, trading patterns and historical trends – can enhance your returns tremendously and can keep you out of trouble in many cases. Here’s why…
The Problem with a Straight Earnings Approach to Investing
The problem with taking a straight earnings approach to investing is that stock prices aren’t determined by current or past earnings, but by future earnings in relation to the current price.
Throughout the past decade, for example, earnings looked great for Bank of America (NYSE: BAC). In June 2008, it earned a record $3 billion. You’d have made a bundle of money investing in BAC during the new millennium. Factoring in rising dividends, stock splits and share price appreciation, you’d have tripled your money.
But over the next year, Bank of America’s earnings plummeted, and by the end of 2008 it had lost $2.3 billion. The stock followed, collapsing from $50 to under $3 a share, wiping out all of the previous eight years’ worth of profits (although the stock has since rebounded to $17 a share).
By time the bank announced a sharp drop in earnings, the price was way down – and investors who bought based on earnings had lost their shirts.
So how does one anticipate an earnings collapse like that?
Use Technical Analysis to Prevent Pain – And Profit
Needless to say, sound economic analysis doesn’t hurt. Many economists (including our own Alex Green) predicted a real estate collapse and the subsequent financial trouble.
But using technical indicators and historical trend analysis can also prove extremely helpful in improving your investment results.
For example, many technical analysts have fared extremely well over the past decade (and more), using chart patterns, volume and historical trends. And investors like Bert Dohmen, Jim Dines and Dennis Slothower profited from major trends in commodities, stocks and foreign currency, while avoiding most of the financial crises in 2008, because they used an advanced version of technical analysis.
Here are two other simple tools that have proven very effective…
- The 200-Day Moving Average: Developed by Doug Fabian and his father Dick, this system has worked well for over 40 years, with only a few whipsaws. It was effective in both keeping investors out of the market during 2008 and getting them back into the market now.
- The New Highs/New Lows Index: This divides the number of stocks hitting new highs each day by the number of stocks hitting new lows. I’ve illustrated this on the red line in the chart below and it has worked especially well over the years.
If you used these two technical tools together, you’d have got out the stock market in October 2007 and not re-entered until April this year – without being whipsawed back into the market. Not bad.
Using Technical Analysis For Gauging Investor Sentiment
Put simply, technical analysis isn’t a crystal ball, but it’s a good way to measure the psychology of the market.
When new highs and new lows are at all-time highs, it suggests a strong bullish trend. Conversely, if the indicator is at an all-time low, it signals incredible pessimism.
The new highs/new lows indicator gave a sell signal in October 2007 and a buy signal in April 2009 it’s still bullish.
According to the chart, the market is headed higher, so investors should consider several choices…
- Buy an ETF (exchange-traded fund) such as SPDRs (NYSE: SPY), which tracks the price and yield performance of the S&P 500 index.
- Buy a five-star, no-load mutual fund such as the Janus Triton Fund (JATTX).
- Buy individual stocks, such as Bank of America (NYSE: BAC).
Of course, technical traders use a variety of ratios, indicators and charting patterns to make their buying and selling decisions. Their systems are never perfect because human action is not always predictable, but human behavior and the herd instincts are sometimes quite apparent and experienced traders can make a great deal of money and avoid the worst of bear markets.
Good trading – AEIOU,
Mark Skousen
Editor’s Note: No matter what investment system you use, the bottom line is that you’re looking for stocks that have the best chance of making strong short-term moves. Investment U advisory panelist and Oxford Club Investment Director Alex Green shows you exactly how to spot these stocks – and ride the wave to profits – in his Momentum Alert service.
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4 Responses to “How to Grab Significant Short-Term Profits From Technical Analysis”
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August 27th, 2009 at 6:59 am
In reading Mark Skousen’s article and trying to replicate the charts to see it better,I find I am not able to do so on stockcharts. The weekly cumulative index is 10530 as of 8/26 not -49994 and there are other problems, so I must not understand it properly. Could you describe the process of graphing it in some more detail to help us better understand this. Also is the 200 day moving average on another chart not shown on this chart it appears?
thank you very much
Reply
August 27th, 2009 at 7:01 am
$nahl centers on the 1 line. how do you make
it cumulative
thanks
bill
Reply
August 27th, 2009 at 7:47 am
The chart with NHNL and 200 day MA seem to show the Oct 07 sell really happened in Jul 07. How does the 200 day MA give the sell and buy signal?
Reply
August 27th, 2009 at 1:23 pm
Question:
I am a Stockcharts.com subscriber, which is where you produced the chart in the above article. Because the print is so small, I cannot read the length of the moving average you are using–it appears to be a 20-week moving average? Is that correct?
Thank you
Reply