Stock Market Viewpoint

Stock Market Viewpoint
Reading the Tea Leaves...

Monday, August 23, 2010

"Is your stock overextended?"

click on above images to enlarge
INVESTORS - These charts will help you to decide for yourself whether the stock you are holding may be getting to be a little too high in the chart, or whether your financial planner may have put you into a stock when it is already near the top of its chart.
The charts I am showing tonight are 20 year charts. Each single price bar represents 3 months of trading. The red line is another special moving average line that serves as sort of an anchoring point for all stocks and indexes. You can think of the current price bar as being tethered to the red line with an invisible rubber band. The higher the current price goes the more stretched out the rubber band becomes and the pullback tension increases proportionally. Most stocks generally only get so far stretched away from the red line before the tension becomes too great and the big pullback sell off happens.
The purpose of viewing a stock like this is to look at its history and see how far it typically gets up away from the red line before it gets pulled back down. If the current price is about as high above the line as it ever gets, then there is a good chance it may not get stretched any higher up this time also. If you are holding a stock that is in that situation it might be good to give it a second look.

Granted sometimes a stock stretches even higher up than it has in its 20 year history, but as it continues to go higher the pullback tension on the rubber band becomes higher also.
For the past 2 years as long as the indexes are going higher, most all stocks go higher, even those stretched really high above the red line already. The problem with holding one of these overstretched stocks comes in when the market starts a sustained leg down. Those overstretched ones usually have huge sell downs, whereas the ones that are not that high above the red line have relatively modest percent losses in a market down leg.
Its called "being high in the chart". If you are picking a stock or a broker is putting you in a stock it's a good idea to be sure it's not already too high in the chart for comfort just in case the market starts a long leg down.
This view of stocks is only good for identifying the ones that look too high already, you cannot assume that if the price is down at the line it necessarily will turn back upward, nor can you assume that if the current price is below the line, or even overstreched down below the line that this gives any indication that it will get pulled back up. Many stocks are low in the chart for good reason.
The only other thing this view tells you is to be aware that quite often after a stock's rubber band pulls it back down to the red line, it may bounce back up from the red line and go higher again. Just how high it can go up from the line again is not something you can project from this view. A whole host of other technical analysis determines that and I can, over time, go over a lot of it.

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