Technical Analysis III:
Using Charts to Time Selling
Economics 98 / 198 Decal
Spring 2008
Using Charts to Time Selling
CURRENT EVENTS /
STOCK DISCUSSION
Current Rally’s FTD (Dow Jones)
S&P500 (Recent Activity)
Using Charts to Time Selling
LECTURE CONTENT
Summary of last lecture
• Technical Analysis
• Using stock charts to time market bottoms
• Rally, follow-through, counting days
• Using stock charts to time buy points
• Stock formations / bases
• Cup with handle / double bottom / flat base
• Strong characteristics of bases
• Additional buy point: 50 Day moving average
S&P 500 (Early 2007 Follow-through)
Prior
Downtrend
Follow-through
Day 5
(+1.75% on on
high volume)
Failed Rally
Attempt
Day 1
Rally Attempt
Day 1
ROLL – Pullback to 50 DMA
Pullback
Bounces off 50DMA on
above average volume
SPAR – Ascending Triangle
SPAR
Volume perks up
on breakout
Today’s lecture
• General principles for selling stocks whether
for a loss or for a profit
• Key Selling Indicators
• Market direction
• Cutting losses short
• Individual stock chart analysis
• Signs of weakness (churning, breaking support,
resistance)
• climax tops
• changes of trend
Why knowing when to sell is so important
Nasdaq (2000)
Let’s say you bought an
index fund or ETF here @
3,500
Why knowing when to sell is so important
Nasdaq (2000)
Within a year and a half,
you would have lost your
profits plus more!
Why knowing when to sell is so important
Yahoo! (1997 – 2006)
Peak of $120
96% loss here
Bottom of $4.50
To recover from bottom, YHOO would have to
increase 2600%
Fundamentals can look great at the top
Sell Decisions
• Sell decisions should be based largely
on technical analysis
• Don’t wait for fundamentals to deteriorate
• Market Conditions
• Climax Tops
• Signs of Weakness
• Change of trend
#1 Selling Rule: Cutting losses early
• Set yourself a maximum sell rule
• How much you set depends on your risk
tolerance (5 – 10% a good #)
• Why do it?
• Use stop-loss orders if you don’t have
time or control with emotions
#1 Selling Rule: Cut Losses Early
Source: “How to Sell Stocks to Limit Losses.” IBD Online | Learning Center
Why cutting your losses is important
Chicago Board of Trade
(CBOT)
-Great fundamentals (strong
earnings, sales growth, ROE,
etc.)
-Cup with handle base
-Strong accumulation in base
-Break out on strong volume
Buy here @ $128
Why cutting your losses is important
Chicago Board of Trade
(CBOT)
-Action of the stock doesn’t go
according to plan and
eventually, reverses to below
breakout point
-What do you do here?
Cut your losses early
Sell when 7% (or less)
below buy point
I might be wrong and I
should be cutting my
losses here at @ $119
Why cutting your losses is important
Chicago Board of Trade
(BOT)
Bought here @ $128
Now I don’t know
what to do with a
34% loss!!!! #$!@#$!
Using Charts to Time Selling
MARKET ANALYSIS:
TIMING TOPS / DOWNTRENDS
Market Direction: Downtrends / Tops
• Always preceded by signs of weakness
(heavy selling) in major market indexes
• Distribution Day (4 or 5 within 4
weeks) raises red flags
• Other market weakness signs
• Days when market starts strong, but
ends very weak (low on the intra-day)
• Leading stocks start to deteriorate
Market Direction: Downtrends / Tops
Let’s look at the NASDAQ during the
2000 Bubble as it happened
Many distribution days within short time: more selling
than buying. Furthermore, many leaders were
peaking as well. Clearly, institutions were getting rid
of shares.
It went from good to bad to ugly
4/5 distribution days can
tip a market over, so 7
within 4 weeks screams
out that the market is
heading for the gutters
2000 Market Top
2000 Bubble: Leaders Breaking Down
The 2000 bubble went down in history as
having the most climax tops at a market
top (we’ll discuss this later).
Essentially, this means GET OUT!!!!!
The Aftermath
Market Direction: Downtrends / Tops
2000 Bubble
2004 Market Downtrend
Yahoo Inc. DOWN 88% in 12 months
CSCO. DOWN 38% in 8 months
Qualcomm Inc.
DOWN 88% in 31 months
Leading stocks of current
market uptrend usually
fall the hardest when
market tops occur
Dow Jones 1929
Using Charts to Time Selling
PROFIT-LOSS PLAN
Profit & Loss Plan
• Most stocks after bases move up 2025%, build bases / patterns, and then
in some cases, resume advances
• If all goes according to plan, take your
profit at this 20-25% gain point
the exception to this is…
Exception…
• If stock rises 20% in 1-4 weeks on
heavy volume, then hold on for at least
another 8 eight weeks
• Why do this? Quick, strong advance
shows unusual strength in the stock.
Potential to be a great winner.
• After that, re-evaluate to see if stock
should be held for longer term
“Bulls make money and bears make money,
but pigs get slaughtered.”
Using Charts to Time Selling
INDIVIDUAL STOCK CHART
ANALYSIS: SELLING
General Signs of Weakness
• Downward Reversals
• Stock begins to move up, only for a
sudden change downwards in price
• Even worse, when volume is HIGH
• Distribution
• Stock closes at a lower price than prior
day/week on above-average volume
• In general words, big selling
Change of Trend
• Long-term uptrend line is broken on
overwhelming volume
• Greatest one-day price drop
• 200-day moving average line turns
down
• Living below 10-week moving average
Example 1 50DMA Violation
The stock cuts
the 50 DMA
on heavy
volume.
It’s not getting
support at this
level
Rallies back
on light
volume
Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center
Example 1 50DMA Violation
The stock cuts
the 50 DMA
on heavy
volume.
It’s not getting
support at this
level
Rallies back
on light
volume
Source: “How to Sell Stocks to Maximize Your Profits: Moving Averages” IBD Online | Learning Center
Example 2
Stock cuts
50DMA on
heavy
volume and
struggles to
rally above
that line.
50 DMA
becomes level
of resistance
Example 2
Stock cuts
50DMA on
heavy
volume and
struggles to
rally above
that line.
50 DMA
becomes level
of resistance
Example 3
The stock had already
a big move up. If a
stock closes with its
largest one day
gain in the entire
move, watch out. This
usually occurs at the
peak.
If a stock has its
largest one day
drop, then consider
selling if confirmed by
other signals
(distribution,
reversals, climax
activity)
Largest one
day drop
(-3.50)
Big reversal
Example 3
The stock had already
a big move up. If a
stock closes with its
largest one day
gain in the entire
move, watch out. This
usually occurs at the
peak.
If a stock has its
largest one day
drop, then consider
selling if confirmed by
other signals
(distribution,
reversals, climax
activity)
Gap-down
Largest one
day drop
(-3.50)
Example 4
Weekly Trendline Broken
If you connect lows of
weekly closes, can
identify a major
trend line here
Consider selling if
confirmed by other
signals when stock
breaks major trend
line on
overwhelming
volume
NOTE: Don’t draw too
many lines. Trend lines
drawn on too short of
time periods aren’t valid
Example 4
Weekly Trendline Broken
If you connect lows of
weekly closes, can
identify a major
trend line here
Consider selling if
confirmed by other
signals when stock
breaks major trend
line on
overwhelming
volume
NOTE: Don’t draw too
many lines. Trend lines
drawn on too short of
time periods aren’t valid
Climax Tops
• Explosive price / volume action of
leading stocks and/or industries
• Indicate trouble ahead for the stock
• Occurs at end of the stock’s run
• Traits
•
•
•
•
•
Exhaustion Gaps
Excessive Stock Splits
Huge price spreads with reversals
Extended +100% over 200-day moving average
Huge price-run up at end of movement (25% 50% in 3 weeks or less)
Example 1
Climax top shows
abnormal activity
after stock’s
previous run-up.
Can you see the
difference in price
movement behavior?
Notice the BIG
reversal at the
peak on extremely
high volume.
NOTE: Climax tops occur at
end of a stock’s run.
Increasing price movements
at beginning of a stock’s
move is positive.
Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center
HUGE REVERSAL on
explosive volume
(ended on the bottom
of the intraday spread)
Source: “How to Sell Stocks to Maximize Your Profits: Climax Tops” IBD Online | Learning Center
Example 2
Notice the explosiveness
of the price movements
at the end of the stock’s
move. 60% gain in 8
days.
Exhaustion gap to finish
the climax top off
Example 3
Telecom stocks enjoyed
huge up-trend ride
during late 1990’s
Climax action by leading
stocks gave sell signals
for the industry and the
market in general
Notice the explosive
action by the leading
stocks
Source: “Topping Action By Industry’s Leaders Flashes Sell Signal.” Investors Business Daily Online
Other Signs of Weakness
(secondary indicators)
• Heavy volume without further upside price
progress (churning, sign of distribution)
• Accumulation days with larger distribution days
• New highs on low volume
• Big buyers lost appetite for rise
• Signs of poor rally (decline on big volume,
and then rally on low volume)
Notice how the stock
reaches new highs and
the advance is on very
tame volume. This is a
sign of weakness and
raises a red flag.
Rally on light volume
Notice a sharp decline
from the first peak
And then, a rally on
very light volume
Rally on light volume
Notice a sharp decline
from the first peak
And then, a rally on
very light volume
Churning
If you look at the
arrows, you’ll notice this
stock acting quite
volatile (major price
increases / decreases)
on huge volume without
really making any
significant moves.
This shows that buying
action is being met with
selling action. This
should raise a red flag.
Sellers eventually
may overwhelm
buyers.
Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center
Source: “How to Sell Stocks to Maximize Your Profits: Churning” IBD Online | Learning Center
Other points
• Don’t let the stocks that rise 10-20%
to drop back into loss column
• Be patient for advances to complete
• “It never is your thinking that makes big
money. It is the sitting.”
- Jesse Livermore
Using Charts to Time Selling
EXAMPLES
Example
From peak, QCOM
traced a downtrend
and went 68%
below its all-time
high
Very apparent here
that QCOM
experienced a
climax top at the
end of its run
We can see an
exhaustion gap,
and many instances
of churning.
Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001.
Example
From peak, QCOM
traced a downtrend
and went 68%
below its all-time
high
Very apparent here
that QCOM
experienced a
climax top at the
end of its run
We can see an
exhaustion gap (2),
and two instances
of major churning
(4).
Source: Saito-Chung, David. “Exhaustion Gap Precedes Energetic Sell-Off.” Investors Business Daily. 07/13/2001.
Example
Price had increased
eightfold from
1999-2000
See a climax run
towards the end of
the run (1)
At peak, 85%
above 50-day and
294% above 200day (2)
Also, see instances
of churning on
heavy volume (2)
From peak, fell as
much as 61%
Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001.
Example
Price had increased
eightfold from
1999-2000
See a climax run
towards the end of
the run (1)
At peak, 85%
above 50-day and
294% above 200day (2)
Also, see instances
of churning on
heavy volume (2)
From peak, fell as
much as 61%
Source: Wise, Christina. “Confirm Sell Signals with Moving Averages.” Investors Business Daily. 07/11/2001.
EBay – 2005
EBay – 2005
Down 80% over
next 6 months
FRE – 2005
Summary
• Cut losses short
• Know the market and when it is topping!
• Distribution days can tell you a lot
• Have a profit & loss plan
• Watch for any abnormal activity
•
•
•
•
Price and Volume
Climax Top
Changes in Trend
Weak action
Next week’s lecture
• If you don’t have the time or don’t
have the skill to constantly monitor
your portfolio or manage your own
investments…
• Wait until next week’s lecture!
Homework
• Final Stock Analysis
• 2 pages
• Analyze your simulated portfolio
• Just talk about your favorite buys and
sells and back up your case with
fundamental/technical reasoning