Using Floors and Ceilings for Selecting a Buy Price for the Purchase of Shares

Using charts as criteria for buying and selling stocks is foolish.  Charts give a lot of information on where you are but give little information on where you are going.  Humans innately look for patterns even where there are none, and just because a pattern resulted in a certain price movement in the past does not mean it will repeat the same way again.  Good stock selection starts with good fundamental analysis of the company.  Still, there is some merit to using charting once you have selected a stock to buy for setting a buy price.  The same techniques can also be used to determine a good exit point if the fundamentals of the company you have purchased begin to change or you just need to raise cash for some purpose.

Continuing the series of posts on how to use charting in your stock trading, today I’ll discuss how to use charting to determine how to set a buy or a sale limit price for a stock.   To see the start of the series on charting, go here.

In previous posts I discussed floors and ceilings, as well as trends.  As said, floors tend to offer support for the price of a stock, particularly if the stock price has bounced off of that floor several times.  The reason is that people trying to value the stock tend to see the fact that the stock tends to trade no lower than a certain price to indicate that the floor price is at the low range for the stock.

Likewise, if a stock has traded within a given range for a long period of time and then drops in price, a lot of people will have bought the stock while it was trading within the upper range.  these individuals will sell the stock as it gets back to that price again since they’ll want to get out without a loss.  They also will begin to think that it is unlikely to go past the ceiling price because it did not in the past.

Realize also that there is a fair market price for a stock at any given time.  This price is based on the expected return which is a function of future earnings and the risk of the company not meeting those future earnings.  If a stock drops too far in price below that fair market price, it will be bought up by value investors who recognize the bargain price.  Likewise, if a stock moves too far above that fair market price, value investors will sell the shares, rightly seeing that the potential return on the stock is no longer worth the risk.

To use a floor in setting a buy price, first determine a round number around the average price of the floor.  No calculators are needed here – just eyeball the chart and round to the nearest 1/2 dollar.

Next, pick an odd amount somewhat above the average price.  For example, if the floor price is $21 per share, you might pick $21.07 as a buy limit price.  The reason to pick an odd value goes into the way order are executed.  If a trader enters a sell order at the market, the brokerage house will match it with a corresponding buy order with the highest offer price.  If there is more than one order at a given price, the first order at that price is executed first.

If you were to set a limit price of $21 even, there would probably be a lot of other buy orders at that price.  Even though the stock trades at that price, your order may not be executed.  By setting an odd number for a limit, it is unlikely that there will be other orders at the same price.  By setting a price above the floor price, it is more likely that yours will be the high offer.

Placing a sell price is exactly the same except you would set a price just below the ceiling price.  Use caution, however, when setting a sell limit because if you miss it, you could see a lot of your profit evaporate as the stock falls in price.  When it is time to sell, it is often wise to simply enter a market order and get out.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Chart Stocks – Part 3, The Trend is Your Friend

In this third installment on how to chart stocks, we’ll discuss how to spot trends and what they mean. Common Wall Street phrases are “Trade with the trend,” and “The trend is your friend.” To see the start of the series on charting, go here.

To understand trend analysis, the first thing to understand is that there are trends corresponding to all of the different time frames and these trends may or may not be moving in sync.   Short term trends are price movements that last a few days to a week or two.  Medium term trends last weeks to months.  A long-term trend lasts for years.  Really long-term trends may last for decades.  The trend you are looking at depends on the time increment of your chart.  A weekly chart is good for spotting short-term trends.  A yearly chart is good for looking at medium term trends.  A 5-year chart is good for long-term trends.

The trends that will be of most use to this audience are the short and medium-term trends.  The long-term trends for any stock you are considering should be upward since you should only be looking at stocks that are growing and have regularly increasing earnings.  The short and medium trends are most useful for spotting opportunities to buy into a stock (or sell) and set a limit price.

To find a trend, first start with a chart of the appropriate time increment.  For example, let’s look at the Aflac 1 year bar chart:

A trend is created by drawing a straight line from either troughs to  troughs (in the case of an uptrend), or peaks to peaks (in the case of a down trend).  Aflac was in a downtrend from  March through September. This downtrend steepened in slope during the May period.  The trend lines would look as follows:

Notice that the price of the stock broke through the trendline in early November.  This is the first sign that the medium-term trend was changing.  The other two things that would need to happen are 1) The stock must set a new high above the previous high set in August and 2) the next low in the stock (before it goes up again) must be above the October low.  It is questionable whether the stock will do this given that it seems to be meeting some resistance at the ceiling set at about $45 per share.

Let’s look at the short-term trends on the same stock.  these are seen here:

Notice that the short-term trend changes much more often than the medium-term trend.  Notice also that there are periods like the late June period and the November period where the stock is not really going anywhere.  This is called “drawing lines.”  If a stock draws lines for a long period of time, it becomes a floor if the stock moves up out of the range. or a ceiling if the stock moved down below the range.  Floors and ceilings were discussed in the last post.

In the next post in the series, I’ll discuss using trends and floors and ceilings to determine limit prices.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Clipart from clker.com

How to Chart Stocks – Part 2, Ceilings and Floors

In this second installment on how to chart stocks, we’ll discuss ceilings and  floors.  These are patterns of interest to those who chart stocks, and therefore have an effect on the psychology of the market.  To see the start of the series, go here.

The first pattern is a ceiling.  When a stock attains a price point and then falls from it – particularly when it stays at that upper range for a while – it is called a ceiling.  The longer the stock stays in the upper range, the stronger the ceiling becomes.  The significance of a ceiling is that it becomes an effective upper limit for the price of the stock.  The reason is that people think the stock is expensive if it approaches the ceiling price because last time it traded there it sold off.  In addition, if there are a lot of people who bought shares at the ceiling price, they may sell off if the stock gets near that price again because they feel like they are getting their money back.  The longer the stock stayed at that level, the more people bought at that price, and therefore the more people who are ready to head for the doors if the stock reaches that level again.

An example of a ceiling can be seen in the late July/early August  period on the candlestick chart for BJ’s Restaurants, International.  Note that the stock reached a new high of about 56, then fell back down to the low 40′s.  A ceiling then existed at around $56 per share.  Note that when the stock rebounded several months later, it touched the ceiling and then fell back.

A floor is the exact opposite of a ceiling.  It is a price at which the stock traded for a while before moving up in price.  Once again, the longer the stock stays at that price, the stronger the floor becomes.  This is because people begin to think of the floor price as a fair price for the stock.  After all, if it traded there for a long time they are used to it being at that price.

To look at a non-market example, think about the price of a can of Coke in a vending machine.  For a period of at least 15 years the price was 50 cents per can.  People therefore expected a can of Coke to cost 50 cents in a vending machine.  If the price is higher, people would feel it was expensive (like a $1.50 Coke at a Disney World hotel).  Likewise, if the price were less than 50 cents, people would see it as a bargain.

Stocks are just the same way.  If GE normally trades between $20 and $25 per share, people would think of that as a fair price.  If the stock falls to $18, it would be seen as a bargain and people would be ready to scoop up some shares.

Looking at the BJRI chart again, notice that the stock hit about $40 per share, then bounced back.  It did this two more times before finally moving back up.  A floor of about $40 therefore exists for the stock.  Note also that whole numbers of dollars and especially round numbers like $40 are especially powerful price points because people tend to set values at whole numbers.  Think of the $7.99 meal.

If a stock moves above a ceiling it becomes a new floor, and likewise, if it falls through a floor it becomes a new ceiling.  If BJ’s were to fall below $40, that would be a good indication that the stock was suffering a serious selloff and was likely to go much lower.  Looking further back in its price history, it looks like the next floor is at around $35 per share.  If you were short the stock and saw it drop below $40 per share, putting in an order to cover the stock at a little about $35 would be a good idea.  (Here again, remember that people like round numbers, so if you put in a cover order at $35.26 you would be more likely to be the only one at that price and therefore ahead of the crowd than if you put it at $35.25 or even worse, $35 even.)

So, let’s see how to put this knowledge to work.  Let’s say that you had $5000 to invest and were interested in getting into BJ’s restaurants.  (First of all, you would look at the PE of 50 and say “Whoa, that’s way to pricey,” but let’s say you aren’t one to worry about the fundamentals.)  Looking at the 6-month chart, you would see that the stock created a bit of a recent floor at around $48 per share, and a larger, more stable floor at $40 per share.

If you were really excited about getting into the stock, or you didn’t feel like spending a lot of time waiting, you could place a limit order to buy 100 shares at maybe $48.17.  Make the order “good ’til canceled,” and the order would stay there until the stock retreated enough to hit your limit or 30 days passed and the order was cancelled.  If you were less eager to get in, you could place a buy order at $41.32 or $40.62 and wait a bit longer, hoping that Greece will threaten default again and cause the stock to sink.

In the next post in the series, I’ll discuss trends.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Clipart from CLKER.com.

How to Chart Stocks – Part 1, Selecting a Chart

Some individuals use what is called “technical analysis” to select stocks and determine when to buy and sell.  I would put this more in the realm of “fooling around” than “serious investing” since it causes you to trade too often.  Also, frankly it does not predict the future direction of stocks all that well.    It really is a bit like trying to drive a car by looking out the side windows and the rear view mirror.  You get a good sense of where you have been and where you are, and you can kind of guess what the road looks like a short distance ahead if you assume the grade and the curve in the road will remain about the same, but there is nothing to say that the road won’t change.  You might see a descent starting and decide to jam on the brakes – jump out of the market – only to see it was a minor dip before a long ascent resumes.

Serious investing, in contrast, is like starting out in Los Angeles and looking for places on the map like Denver that are much higher and heading towards them.  You don’t know how many ups and downs will be involved in the mean time, but you expect to get to a much higher elevation eventually.  The trick is keeping yourself from second guessing and jumping out in the middle of Death Valley.

While I do not believe in using charting to select stocks, charting is useful to determine how well stocks you have picked are doing and also somewhat useful in picking entry and exit points.  That is to say, if you have some cash and are looking to buy, or need to raise some cash and are looking to sell some stocks anyway,  looking at charts to determine a good day to buy or sell, or a good price to set as a limit, has some merit.  Note also that a lot of the reason that charts are important is that other people are looking at them.  If you can understand how others are likely to react it helps you determine the best strategy to take, particularly when you are looking to buy or  sell anyway.

The first thing to understand about charting is what kind of charts should be used.  Most people look at charts that have little or no value because they come up as the default on Yahoo and other sites.  These charts just plot the closing prices for a given day, week, or month.  For example, see the 1-year chart for Home Depot.

The reason this type of chart is not useful is that it only gives the price for a small fraction of time – the end of the day.  Note that if you did need to only pick one time to plot. this is probably the most important point in the day to pick.  The reason is that most people look at the closing price even though it is only one point in the day (or week, or month).  Note that the news also gives the closing prices for the markets.  Likewise, when papers did print prices for stocks, they typically would only print the closing prices.

A better chart to use is the OHLC chart, which stands for Open, High, Low, Close.  As the name implies, it plots the opening, high, low, and closing price for a stock.  If you select “Bar” on Yahoo, it will change to an OHLC chart.  Here the opening price is shown as a line extending to the left and the close is shown as a horizontal line extending to the right.  The high and low are shown as the vertical bar.  Note now that you get a sense of what happened during the whole day instead of just where the stock closed.  This means that if the stock was down most of the day but rallied at the end to close unchanged, you would see it.  Because your eyes naturally compare the centers of the lines – the median prices – you get a better idea of where a stock is now trading versus where it traded the last few days.  Obviously it is more important if a stock spent the whole day higher than if it only shot up at the end of the day.

Another type of chart that is of interest is the candlestick chart.  This is the same as the OHLC chart, except the area between the open and the closed is boxed in.  If the stock closes above the opening, the box is left open.  If it closes down, the box is filled in.  In this way, you can also see if the stock is closing up or down during a period of time easily.  For example, notice in the late July period in the HD chart that the stock had several big down days with just a few small up days in the middle.  It then rallied in August with a bunch of large up days.  Note also that there is a gap upwards in the middle of August, probably indicating that some big news came out about the company.  The fact that it was rallying before then means that some people probably knew about the news before it was widely released.  Despite laws against insider trading, you’ll notice a lot of this activity if you pay attention to charts.

In the next post I’ll discuss trends and drawing lines.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Dow Signals a Market Top

I don’t typically use charting because I tend to find that it tells you where you are but not where you are going.  For example, if you’re in an uptrend (a common charting term meaning basically a stock or market is making higher highs), there is nothing to stop the market from starting into a down trend in the next week.  By the time the market has done all is necessary to signal a down trend, however, the market will have already declined so much that you really can’t take advantage of it.  It will have already lost a large amount of value.

It is important to understand a bit of charting, however, because other people use it and it may affect their behavior, and therefore the behaviour of the whole market for short periods of time.

A chart of the Dow can be found here:

http://finance.yahoo.com/q/bc?s=%5EDJI&t=1y&l=on&z=l&q=c&c=

Today the Dow declined more than 1% – a fairly significant decline.  Note on the chart that it had not yet reached its previous high.  The fact that it is starting into a decline now before setting a new high is a classic “topping” pattern in charting.  In theory the idea is that prices tried to rise but the market ran out of people who were willing to pay more for the shares.  In order to sell shares, sellers had to reduce the amount they were willing to take for them to find buyers.  This means that the price began to decline.  Now that it failed to reach the previous high, it will be difficult for the market to move past that previous high.  This is because people will see that it topped there before and will therefore be reluctant to pay more than the previous high because they’re afraid no one will be there to  pay them a greater price.  This is called a “ceiling.”  To draw a common example, think of a year ago when gas prices went to around $4.00 per gallon and then declined.  As they are rising again now, you would consider $4 per gallon to be very expensive and about as high as prices will go.  You therefore probably wouldn’t decide to load up on gas at $4, hoping to sell some to your neighbors for $4.50.

The other thing to notice is that the last time it was in decline, it bottomed and spent a considerable amount of time around 11,000.   Chartists would call this a “floor”.   Because people consider this price “cheap,” people are likely to start buying again if the market hits that level.  Again with the gasoline analogy, because people haven’t seen gas below about $2.30 per gallon in a while, if gas fell from the current levels to that point, people would probably consider it cheap and decide to take more road trips.  Note that this is the case even though gas is still more than 100% above the price it was just a few years ago.

 What this means for followers of this blog is that if you have some cash sitting around and have been looking for a good time to load up on more shares, if the market falls to around 11,000 it might be a good time to load up on some of your favorites.  Note that you aren’t trying to time the market, expecting the market to turn immediately after you buy the shares.  You are still making a long-term buy (because investing long-term is so much easier than speculating short-term.  You’re just taking advantage of market psychology to pick an entry point.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing