CHARTS - Using Charts to Determine Market Direction

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6. Using Charts to Determine Market Direction

Once the basics of chart reading are understood, we can get a good handle on what our investments are doing at any time with just a glance. No matter how busy we may be, no matter how long it’s been since we last looked, one peek at a weekly chart will bring us right up to date. Since we want to invest with the current market trend, knowing what that trend is solves half the battle!

The guidelines we use here for determining market direction are pretty basic. Here’s what we look for:

> If the price bars on a weekly chart are above the 50-day moving average and that average is above the 200-day moving average, we consider that to be a Valid Uptrend (bullish).

> If those S&P 500 price bars are below the 50-day moving average and that average is below the 200-day moving average, we consider that to be a Valid Downtrend (bearish).

With those general guidelines in mind, let’s look at a weekly chart of the S&P 500 and see what it tells us:

Reproduced with permission of Yahoo! Inc. ©2013 Yahoo! Inc. YAHOO! and the YAHOO! logo are registered trademarks of Yahoo! Inc. Reproduced with permission of CSI ©2013. Data Source: CSI www.csidata.com

2008 was a pretty bad year for buy-and-hold investors, as is evidenced by this chart. Prices fell, the moving averages reversed and the volume was heavy most of the way down for almost 15 months.

The market bottomed in March of 2009 and began an off-and-on multi-year uptrend as prices rose and the moving averages aligned again. Despite the rising market, investors were reluctant to get back into stocks, as is evident by the lower volume seen across the bottom of the chart during that period.

In addition to markets like the S&P, the Dow, etc, charts can be used with individual investments as well. Here’s a weekly chart of Netflix (NFLX), with the same guidelines and indicators we used on the S&P chart:

Netflix stayed in a Valid Uptrend from early 2009 until mid 2011. Share prices rose from $40 to around $300. Once prices and moving averages “rolled over” early autumn of 2011, the stock stayed in a Valid Downtrend through early December 2012 (as of this writing). During these 14 months, the share price dropped back to almost $50.

We can use charts on mutual funds, too. Check out this weekly chart of T. Rowe Price’s Mid Cap Growth Fund (RPMGX):

weekly chart of T. Rowe Price Mid-Cap Growth Fund

Similar to the S&P chart above, RPMGX dropped in 2008, then rebounded in early 2009 to start a multi-year uptrend. Again, the moving average lines smoothed out some choppy price bar action to give us a clearer view of market direction.

Note: since mutual funds are traded differently than stocks, we don’t get volume data on these charts.

Guess what? Markets don’t always trend up or down. Have a look-see at the weekly chart for Steel Dynamics (STLD):

For almost 4 years, this stock has traded sideways with no definite trend - hey, it’s trending sideways! This chart represents a lot of indecision on the part of investors regarding STLD. In addition to moving sideways, it has been a choppy ride, too: note that the moving averages crossed back and forth 6 times (the purple circles) during the period.

Outside of getting a 3% dividend (at the time of this writing), STLD has been “dead money” for investors for almost 4 years. The current share price is about where it was at the first crossover back in 2009! For the most part, we avoid investments with sideways/choppy price action on their charts.

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