(Click on charts to enlarge, then click on them again for further enlargement. Use back arrow to return to narrative).
As technical analysts, when looking for signs that a top of bottom is in (we'll look at signs of a bottom today), we look at some technical indicators for things like (1) positive divergences; (2) indicators crossing above a signal line; and (3) indicators crossing above a zero line. We'll also look at things that measure "overbought" and "oversold."
It's up to the individual technical analyst to decide if/when a signal is buy or sell, and whether he or she wants to act on it. During my many years of analyzing charts and indicators, I've created "what if" scenarios, like this one, to try to determine what happens "if" I acted on various buy and sell signals from various indicators.
In the case at hand (the MACD chart above), we're going to buy this stock based on the facts that: (1) the MACD has shown us a positive divergence, and (2) the MACD has followed through on the postive divergence by crossing above its signal line. For our purposes here, we'll conclude that the MACD is telling us to buy this stock, so let's go ahead with the purchase and see how much money we can make ;)
This looks very nice. "So far...so good."
"This is a 'head scratcher. Don't you hate when this happens? It sure looked like the MACD told us to buy that positive divergence and the bullish cross above the signal line, but what the heck does this cross below the signal line mean? It's probably just consolidating, before another move higher above the zero line, but we'd better look at the price chart. It probably is a good time to consider taking at least 'some' profits."
"WHAT????? We're down 85% on this trade?? I can't believe this! That stupid MACD told us to BUY this stock! I hate technical analysis. It DOESN'T work!"
"Well, okay, maybe technical analysis does work after all. MACD really was just consolidating, and now it has moved up through the zero line. There's no question about it ... MACD definitely is tell us to BUY this stock. It's ready to make a big move to the upside. Anyone with half a brain knows that MACD moving up through its zero line is a stone cold BUY signal. Let's buy DRYS at 12.48 and get our money back. Yeah!"
"Somebody please kill me! DRYS is back to the 3.04 low after the MACD told us to BUY this stupid stock? See? I was right all along. Technical analysis DOESN'T work!"
As tongue-in-cheek as all of that is, over the years I have read comments like that about technical indicators and about technical analysis over and over and over...
One of my favorites is "Technical Analysis SAYS this is a BUY," as though every technical analyst interprets the chart and indicators in exactly the same way.
Sigh...
The problem isn't with technical indicators, or with technical analysis. The problem is that in this example, which is one of MANY similar examples, we're anthropomorphizing technical indicators and technical analysis, that is to say, we're attributing human qualities to them, like TELLING US to buy, that can't possiblity exist. Indicators only can "indicate." They aren't human, so they can't TELL US to do anything.
I intentionally only showed the MACD indicator without the price chart because, far more often than not, when we read things like, "My indicator says BUY," or "My system says BUY," there isn't any reference at all to what the chart is doing, which is of paramount importance. A technical indicator can't possibly know what the chart looks like when it's "telling us" to BUY, and if the technical analyst takes that BUY signal out of hand without looking at the chart, which only HUMANS can do, it could spell trouble, like we've seen here with DRYS.
When any indicator "tells us" to buy or sell, we need to view that as an invitation ONLY, not as an order from some inanimate object, "telling us" to do something. The signal needs to be viewed in the context of what the price chart is doing. If an indicator "tells us" to buy, but the price chart is heading directly into overhead resistance, we might want to ignore the signal, or at least temper our upside expectations.
So that I'm not picking on the MACD (LOL), which is just one of many, many indicators, we'll have a quick peep at the RSI chart during this time-frame. Again, individual technical analysts will interpret indicators in different ways, but like most technical indicators during this time-frame, the RSI going down to a reading of 15 in October, 2008, then rising above 20, or 25 (considered a BUY signal among many technical analysts) wasn't a very good reason to buy DRYS. The stock lost about 80%of it's value after the RSI went up through the readings 20, 25, and 30 (whatever Buy "trigger" we want to use).
My own conclusion, as just one of MANY technical analysts, who might have a different view on this:
PRICE RULES!
When we get buy or sell signals, look at the chart! Buy signals from indicators when the price chart is bearish are highly suspect, if not downright dangerous, and conversely, sell signals from indicators in stocks that are bullish also are suspect, if not downright deadly, because we can got caught in horrible, relentless short squeeze in which our risk is unlimited if we get stubborn and refuse to cover our short position. For example, ask those who shorted AAPL in recent years and didn't cover because it was it was soo-o "overbought." UGH.
6 comments:
In the context of this description, how do we know the DRYS price chart is bullish or bearish at those junctures that you have described?
Priapusmon,
At the first MACD "Buy" signal, price hadn't done anything bullish. DRYS still was well below the Kumo (Cloud), and still was making "lower highs" and "lower lows."
At the second MACD "Buy" signal, when the MACD went above the zero line, DRYS did make "a higher high" and "a higher low," and the stock did move higher from our "Buy" signal at 12.48, to 17.20. At that point, technical analysts might disagree about whether the chart had turned bullish, or not, and there certainly was a case for both opinions.
But, "higher highs" and "higher lows," like we just witnessed in the Bearish Wolfe Wave in FCX, aren't necessarily bullish, especially in a chart that is bearish, or in a pattern that has the potential to turn bearish (like the Bearish Wolfe Wave in FCX). We have to be very careful.
When the Rising Channel in DRYS broke to the downside on January 20, 2009, and when FCX broke the Bearish Wolfe Wave to the downside on April 11, 2011, those events gave us some pretty strong evidence that neither was bullish, and they weren't.
Charts constantly are evolving and "morphing" (changing into something else), so we have to monitor them and try our best to follow what the chart is indicating. There simply isn't any "silver bullet" formula that will TELL US what's going to happen next.
We have to give our best effort to assessing what's going on, and to deciding if we want to play a stock or not, based on that assessment. If our assessment proves to be incorrect, stop out the trade as quickly as possible, and move on.
Hi Melf
I discovered your blog some time ago, and shortly after that you disappeared into cyberspace.
I'm glad to see you returning to posting again. Your posts were very educational and interesting, looks like I have a few months of catching up to do too!
Hi, Dave!
Nice to "see" you. Yes, I got burned out writing, it takes me so danged long to compose, type, do the charts and edit these things. On one hand, I need to stop "over-explaining," but on the other hand, there's a good deal to be considered when analyzing a chart. LOL.
Thank you Melf . . I learn something no matter what stock you are talking about :-) Appreciate your time.
I'm glad, Mary ;)
I've been wanting to write this piece for a long time. I could have been about ANY stock or index that is in a Bear Market.
There's an old market saw: "In a Bear Market, your Buy Signals actually are Sell Signals; the reverse in a Bull Market."
I don't take anything like that out of hand, but we get the general idea. When someone says, "I have a DOUBLE positive divergence and the indicator went up through the signal line, but the stock topped out! Technical analysis doesn't work!" we know that the problem isn't with technical analysis ;)
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