Thursday, October 20, 2011

Technical analysis..

I make most of my trading decisions based on technical analysis of stock charts. I would like to present a case for bottom picking in a coal stock. "Bottom picking" doesn't mean buying the low of the move. To me bottom picking means trying to identify those areas where a stock has MADE a bottom and has potential and momentum in an upward direction. It also is often where the shorts find themselves to be wrong..
Here is my technical take of Patriot Coal.

As a general rule stocks experience three stages of decline before they get set up to rise. In the chart above I have identified three areas that represent these declines in PCX. Notice the volume at the bottom of the chart. In the first decline the volume only picked up right at the bottom of that decline. The bulls were still in charge,(or so they thought), and the stock rallied back, but the volume remained low except for a couple of days.
The stage 2 decline was on huge volume, and the stock was halved in price. A sideways consolidation pattern then occured. The volume declined.
The stock had a chance to break out on the upside during it's consolidation after decline #2. If you look close you will see that it just barely broke out of the sideways channel that it was in, but each was a "false" breakout. The buying was quickly overwhelmed and the stock went down.
The stage 3 decline was on the largest volume so far. At point #2 (bottom chart) it must have been a "throw in the towel" moment for anyone still holding on. Also a good sign when looking for a potential bottom.
Let's take a closer look:
As the stock plunged to point #1 the volume surged. A rebound on heavy volume, and then another plunge to #2. The rebound from #2 was on the heaviest volume yet, and took the price up to #3. And volume has remained heavy in sideways trade from then, with the heaviest volume on the up days.
One of the key things I look for in a bottom is heavy volume in a sideways pattern signalling accumulation. ie, big buyers. The kind who tend to keep what they buy, and the kind who tend to be right. (Notice the decline in volume in the consolidation decline 2.) The volume has remained heavy since the selloff at #1.
To complete this bottom we need to see the stock (1) move above the highs at #3 on higher volume. If they do that then they will need to (2) break through the floor of the consolidation from the second decline, then to the top of that range, and (3) break through that to keep going up.
For a long term hold the stock would have to do the above three things.To limit risk on any trade the long term trader could buy at each of these milestones. As always, limit your risk by selling if the stock falls below the support areas offered by the consolidations.

A note on technical analysis. I don't have the money to do the research that the multi-billion dollar funds do. So I look for their footprints. When they buy or sell they tend to move markets on larger than usual volume. And they can't put on their position in one day. So they will tend to do their buying and selling over weeks. By interpreting the signals that price and volume give, the astute technical trader gets an indication what the "smart money" is doing. And the small technical trader has a huge advantage if he chooses to use it: He can put a position on in one mouse-click, or take it off just as easy. And his volume doesn't move the markets. (Well, most of the time!) So limiting risk is as easy as controlling your ego and admitting you were wrong. LOL!

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