The trend is your friend, even in this market
A reader of my last post on Google’s current stock performance, took issue with my statement:
It is interesting to note that, in the area marked in the above graph, all short term indicators were overwhelmingly positive just before Google’s swift and violent correction over the last month.
The reader was clearly a technical analysis skeptic and questioned whether or not one should use indicators at all. While I admit that technical analysis has its limitations (particularly for long term investors), I’d like to write a quick response to this reader’s contention and share it here.
When I noted that Google’s near short term indicators were overwhelmingly positive, I was speaking in reference to the following Google chart:
In the marked area, you’ll see that MACD had bullishly crossed into positive territory and diverging positively. RSI was making higher highs in conjunction with relative highs in the stock chart. Positive volume was ascending both in daily magnitude and regularity. Add in that the stock had strongly crossed its 50-day moving average and quickly ascended to the top of its Bollinger Band, and you have all the makings of a potential trend reversal and formation of a new uptrend.
The one thing people forget in technical analysis, however, is that it is governed by the principle that price movements are ultimately governed by a long term trend, or continuum, and short term movements will ultimately conform to this trend. In the case of Google, a stock for which value is predicated more on growth than intrinsic value, the use of trend analysis can be used to establish disciplined entry and stop loss points and still allow you to take advantage of long term value creation.
Take a look at Google’s yearly chart with weekly bars. The stock clearly peaked in late 2007 and started a down trend – a series of lower highs followed by lower lows. It’s bearishly crossed its 50-week moving average and its 200-week moving average. Worse yet, the 50-week moving average has recently crossed the 200-week moving average signalling a potentially deepening downtrend. With this kind of negative bias surrounding the overarching movement of Google’s stock, is it any surprise that the stock recently failed to test support at its 50-day moving average?
As a rule of thumb and to protect against whipsaw losses, buy with the trend. Even when near term indicators based on 50-day and 200-day moving averages signal potentially positive price moves, a stock in a long term downtrend will usually find its rallies ephemeral. Just as Google’s recent rally did not last more than a month.
So, how would a long term investor use this strategy? As mentioned above, I typically use technical analysis to guide my long term growth plays. Growth stocks can offer very high rates of return, but very little downside protection. Furthermore, multiple compression or expansion is nearly impossible to predict. This is where an understanding of relative value and relative supply demand allows you to better control your risk/reward. Yes, you might miss out on a little return as you wait for trend confirmation, but I’m willing to lose a little upside for some peace of mind.
For those of you interested in learning about using technical analysis for short term and day trading, check out The Curious Investor‘s affiliate, the MarketClub Trader’s Blog.
Full Disclosure: Author is long shares of GOOG at the time of writing.
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
