Technical Analysis - Identifying Bearish Stocks
In a previous segment we discussed stage one (I), commonly known as the basing stage and stage two (II), which begins with the transition to a bullish cycle and often results in a sustained uptrend. Today's narrative offers a brief description of stages three (III) and four (IV), including some hints for timing exit and adjustment transactions. First on the agenda is stage three, which is depicted as a "topping" or consolidation phase.
Obviously, this is not a "perfect" stage III chart, but it's fairly close. The first sharp decline (to the $75 range) probably shook out many long-term shareholders and the issue eventually began to trade below its 30-week MA (the 50-week MA is off the bottom of the chart) for extended periods. Technically, a support area has been established near $80 but a break below that range would signal a move towards stage four. On the other hand, a lateral trading pattern after an extended rally can last a long time and the uptrend will occasionally resume after a lengthy period of base-building. Remember, technical analysis is not an exact science and this is a good example because stage three formations can exist for several years before the issue returns to a directional trend.
Stage Four (IV)
This chart provides an excellent example of how abruptly the trend can change from stage III (lateral activity) to stage IV (bearish decline) in a relatively stable stock. The "key" signal for this transition occurs in conjunction with a broad sell-off in equities and the resultant move below a multi-year support level (near $30) is simply too much for the stock to overcome. All of the subsequent "recovery" rallies fail to inspire any sustained buying pressure in the issue, thus the downtrend continues and eventually lasts for almost two years. Only near the end of the chart does the issue show a few early signs of stage I (basing stage) however once the selling subsides, the cycle will begin all over again.
Diversity and Timely Portfolio Management are Prerequisites to Success
While even the most catastrophic events can generally be managed to reduce the effects of the shortfall, there are occasions when issues plunge without warning, leaving no opportunity for exit or adjustment. Unexpected events simply occur; earnings warnings, shareholder lawsuits, negative news in the industry or sector and changes in public sentiment. All of these activities can affect the success of an individual position but with a well diversified portfolio, the long-term effects are minimal. Experienced traders know that losses are inevitable with any strategy. Instead of being surprised, they anticipate them. Statistics dictate that a percentage of the positions you select will be unprofitable thus, when the situation arises, it should not be regarded as a failure but rather an integral part of investing activity. In all cases, your portfolio should be evaluated based on the sum of its positions rather than each specific transaction. In this manner, success is gauged by growth in portfolio value and individual losses become less significant. That is the primary reason for maintaining a balanced portfolio with several positions; it becomes easier to identify and act on a potentially negative play when it doesn't have a significant effect on your overall success.