by Nilus Mattive 10-27-09
Two weeks ago, I told you why a quick look at Colgate’s chart led me to believe that its run was going to continue through the early fall. And I also said that I had a few reasons to be wary of the stock’s ability to continue rising going forward.
If you’re a Dividend Superstars subscriber, you should have closed out that position based on my recommendation in the issue that just went to press. I’m tracking a gain of 32.7 percent. Great!
Now today I want to talk about a couple of the other things I look at on charts … and how they apply to some of the other investments that I’ve mentioned before here in Money and Markets.
Let’s start with …
The Importance of Support and Resistance:
Understanding Investors’ “Lines in the Sand”
Investors have a tendency to get hung up on certain numbers … quite often round ones. You know, like Dow 10,000.
I’m not a psychologist, so I’m not going to hypothesize on why it happens. But from many years of following the markets, I can tell you that it does happen with alarming regularity.
This is precisely why I pay close attention to clear levels of support and resistance whenever I look at any investment’s chart.
Let me explain with a real-world example …
Here’s a chart from Vanguard’s Inflation-Protected Securities fund (VIPSX), a good stand-in for the TIPS and I-Bond inflation hedges I’ve been regularly suggesting here and in Dividend Superstars …
In my past discussions of this particular fund, I pointed out that the low $12 level seemed very important psychologically to this particular investment. That’s because — as my trendline demonstrates — the fund had repeatedly bumped against this level before the credit crisis began … and again after the market rally started in 2009.
As you can see, once it recently broke through that level, it swiftly moved up another 4 percent. While that move might not sound huge, you have to remember that this is a mutual fund based on government bonds!
Are there fundamental reasons behind the move? Absolutely. Worries over a falling dollar and renewed inflation are obvious catalysts spurring investors to move into these hedging investments.
But that’s the point: These charts reflect the market’s collective thoughts and opinions. When events are enough to push an investment through a level that previously presented resistance … it means a certain critical mass has been achieved … and momentum quite often takes over from there.
Obviously the opposite is also true. When a level has previously held on countless downdrafts — forming a strong area of support — you better look out below the first time that level is seriously broken!
Now I’ll be the first to say that you never know when an important level is going to hold or not. However, simply being aware of critical breaking points — along with the fundamental reasons moving a market or an individual investment — will help you make more educated (and hopefully more profitable) decisions.
Of course, it never hurts to layer on one more relatively simple technical indicator that also measures levels of support and resistance …
Moving Averages: Another
Favorite Technical Analysis Tool
During my last analysis of Colgate in this column, I pointed to trendlines as a way to get a sense of an investment’s general direction.
Well, moving averages take trendlines to the next level because rather than being constructed somewhat arbitrarily (i.e. “pick a couple points that look important to you”), they are computed automatically based on a preset series of data. Specifically, a moving average is a line based on the arithmetic average of the prices it’s drawn against.
What’s the benefit? This way smoothes out all the little movements and creates a line that you can compare them to. Common moving average periods include 200-day, 90-day, and 60-day periods.
I like moving averages as another way to gauge general uptrends and downtrends, and to spot major market reversal points.
Speaking of which, here’s a chart of the S&P 500 with a 60-day moving average thrown in for good measure …
As you can see, the market is well above its moving average, and thus remains in an uptrend. Only a drop below the 1040 level would signal a change in that trend.
And perhaps the best part about technical analysis tools like moving averages is that they are no longer only available to professional investors with thousands of dollars in trading software. In fact, most online chart providers — including free websites like Yahoo Finance — now allow you to overlay these tools to whatever investment you’re viewing.
If you don’t already use these indicators, I encourage you to play around with them … they can give you another interesting way of viewing your investments.
Best wishes,
Nilus
P.S. In addition to that Colgate sell order, my latest Dividend Superstars issue also contained a brand-new dividend stock to buy (in the tech sector no less!). If you’re not yet a subscriber, and you’d like to get that hot-off-the-press recommendation, consider taking a risk-free subscription to my service for just $69 a year.
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