Traits
If you can find at least three of the following characteristics in a stock, the chances are you
will pick a winner:
■ Rising price trend as more and more investors jump aboard.
■ Rising volume as investors become more aggressive in their
purchases.
■ Strong, but not excessive, price momentum.Anything higher
indicates that supply and demand got out of synch.
■ Strong sector. If the sector is doing well, there is likely to be
enough business for all stocks in it.
■ Strong market. A rising tide raises most boats.
■ Supportive environment. Low input prices, high output prices,
low cost of doing business, and favorable supply and demand in
the industry.
Why go up and down?
The majority of investors are usually most optimistic at a market top
and most pessimistic at a market bottom. The more optimistic or pessimistic
the majority is, generally, the more significant the top or bottom
is. Why? This bears repeating: When everyone is so bullish, they
have already stepped up their buying activity, and there are few people
left to buy.Without more bulls, the market cannot go up. The converse
is true at bottoms when the bears become exhausted.
Momentum/support/resistance
When a ball is thrown up into the air, its speed (velocity) declines until
it stops momentarily in mid-air and then starts to fall.While the ball is
still rising, its speed is falling. Markets exhibit this behavior as well.
Determine that the speed of rising prices is declining, and be forewarned
that a market top may be near.
For falling markets, another analogy can be used. Take the same ball to
the top of a hill and let it go. As it rolls down the hill, it gains speed.
When it gets to the bottom, it is still moving, but since the ground is
now flat, its speed starts to decline.
These examples help to show that a market will tend to continue in the
same direction in which it is moving until some force acts upon it.
These forces are called support and resistance. If a market is moving
but does not meet either support or resistance, it will continue to
move in the direction of the trend, but at slower and slower speeds
until it stops, like a tired long-distance runner. The buying or selling
pressures that powered the move have dissipated. If prices make lower
lows but momentum makes higher lows, downside market momentum
is declining.
Sentiment
The least understood area of analysis is sentiment analysis. This covers
such areas as degree of speculation, public opinion, and consensus. It
is measured by relative activities in speculative instruments, such as
options, and polls of bullish opinions. Both rely on the “burning
match” theory in which the flame is passed from investor to investor
until there is nobody left to take the match. The last one holding it gets
burned, literally. In the markets, as bullish opinion spreads, eventually
everyone will have bought. There will be nobody left to whom the last
investors can sell. No demand means the end of the rally. This can also
be measured subjectively in the media as glowing bullish news is
reported only when the newspaper buyer and TV viewer are ready to
receive it. Again, when the public has an overall bullish consensus,
there is nobody left to buy.
RSI vs Stochastics
RSI still yields the meaningful results in trending markets. Stochastics seems to work better
in flat or choppy markets. Although the goal of each is similar, they
were designed with different specific purposes. The RSI, as mentioned,
helps determine when a price has moved too far too fast, and this
implies a trending market. Stochastics helps determine when a price has
moved to the top or bottom of a trading range, which implies a nontrending
(flat or choppy) market.
