Trading With The Trend
Intuition and mechanical signals supported by scientific research are both important factors. Despite good fundamentals, a company must meet certain technical standards to qualify as a buy candidate.
For example, never buy a stock that is trading below its decreasing 200-day moving average, not even if its revenue growth, EPS and return equity are attractive. This is because you should look for some interest in it from big institutional investors. You should not be the first one to buy, but to make sure that buying is already on.
Buying stocks in long-term downtrends will considerably lower your chances of winning. To increase the possibility, you should focus on stocks that are in a confirmed uptrend.
The perfect scenario is to buy stocks when they come out of the first stage and begin to move higher, which is the second stage. Then selling them as they reach the peak of the cycle, which is the inception of the third stage. The fourth stage is a full-fledged drop that you have to avoid or when you go short.
The four stages of a stock price action are:
- Stage 1—Neglect phase: consolidation
- Stage 2—Advancing phase: accumulation
- Stage 3—Topping phase: distribution
- Stage 4—Declining phase: capitulation
Stage 1—The Neglect Phase: Consolidation
Stage 1 is when nothing significant is happening and you should avoid buying here. This phase can persist from a few months to years.
Characteristics of stage 1
- Stage 1 shows a sideways price movement with a lack of any sustained price movement.
- The stock price wavers around its 200-day or 40-week moving average. However, it lacks any kind of trend during such wavering. This stage can stay for months or even years.
- This stage often occurs after the stock has collapsed during stage 4 for several months or more.
- Volume is contracted and light compared with the volume of previous stage 4.
The goal is to buy at the correct price and not at the lowest or cheapest price. Trying to pick a bottom is a waste of time as it misses the whole point.
Transition from Stage 1 to Stage 2
A stage 2 advance may begin with little or no warning.
The transition criteria are:
1.The stock trades above both the 150 and the 200-day moving average.
2.The 150-day moving average is above the 200-day.
3.The 200-day moving average has turned up.
4.A sequel of higher highs and higher lows has emerged.
5.Large up weeks on volume spikes are contradicted by low-volume pullbacks.
6.There are more up weeks in terms of volume than down weeks.
Stage 2—The Advancing Phase: Accumulation
The advance of stage 2 gives a sign of clear sailing ahead. The stock price begins to escalate with a buildup in earnings momentum because of a rise in demand as big institutions buy the stock. The daily and weekly price chart will show big up bars depicting unusually large volume on rallies, differentiated with the lower volume on price pullbacks. These signs of accumulation should happen during every stage 2 advance.
Stage 2 Characteristics
- The stock trades above its 200-day moving average.
- The 200-day moving average is also in an uptrend.
- The 150-day moving average is over and above the 200-day moving average.
- The stock price is in an obvious uptrend, characterized by higher highs and higher lows.
- Short-term moving averages are above long-term moving averages.
- Volume spikes on big up days and big up weeks are countered by volume compressions during normal price pullbacks.
- On above-average volumes, there are more up days and up weeks than down days and weeks.
Stage 3-The Topping Phase: Distribution
As all good things come to an end, so does the momentum of the stocks in the market. During stage 3, the stock is changing hands from strong buyers to weaker ones.
This distribution phase displays a topping pattern. The stock becomes more volatile compared to stage 2.
Stage 3 Characteristics
- The stock moves front and back in wider, looser swings and volatility increases. Although the comprehensive price pattern may look similar to stage 2, with the stock moving higher, the movement is much more unstable.
- Usually, there is a prominent price break in the stock on an increase in volume. Often, it is the largest one-day decrease since the inception of the stage 2 advance. These price breaks occur on overwhelming volume.
- The stock may trade under its 200-day moving average. Price volatility around this average is very common.
- The 200-day moving average will flatten and lose upside momentum and then turn into a downtrend.
Stage 4—The Declining Phase: Capitulation
During stage 4, earnings measures are normally revised downward, which puts more selling pressure on the stock. As a stock deteriorates, it’s back to stage 1. Stage 4 is the opposite of stage 2 in terms of price and volume characteristics. You should certainly avoid buying a stock while it is in stage 4.
Stage 4 Characteristics
- The huge part of the price action is below the 200-day moving average.
- The 200-day moving average, which was flat or turning downward in stage 3, is now in an obvious downtrend.
- The stock price is near a 52-week low or hitting new lows.
- The stock price pattern is defined by lower lows and lower highs.
- Short-term moving averages are below long-term moving averages.
- Volume spikes on big down days and weeks are contradicted by low-volume rallies.
The four stages are greatly useful for attaining a view on where a stock is in its life cycle price-wise and then comparing that with where the company is in its earnings cycle. A stock can go through the cycle several times.
Mark applies the Trend Template criteria to every single stock he considers. The Trend Template is an eight criteria qualifier that a stock must meet to be considered in a confirmed stage 2 uptrend.
1. The current stock price is above both the 150-day (30-week) and the 200-day (40-week) moving average price lines.
2. The 150-day moving average is above the 200-day moving average
3. The 200-day moving average line is trending up for at least 1 month (preferably 4-5 months minimum in most cases).
4. The 50-day (10-week) moving average is above both the 150-day and 200-day moving averages.
5. The current stock price is trading above the 50-day moving average.
6. The current stock price is at least 30 percent above its 52-week low. (Many of the best selections will be 100 percent, 300 percent, or greater above their 52-week low before they emerge from a solid consolidation period and mount a large scale advance.)
7. The current stock price is within at least 25 percent of its 52-week high (the closer to a new high the better).
8. The relative strength ranking (as reported in linvestor's Business Daily) is no less than 70, and preferably in the 80s or 90%, which will generally be the case with the better selections.
You should align yourself with this powerful force. Stick with stocks that are in a solid uptrend and it will be probable that you own a stock that has the potential to skyrocket and become a super performer.