Evaluating Opportunities
When the software issues a signal, it's very easy to take it at face value and look for data that supports it. Computers are good at correlating large numbers of values, but they are notoriously bad at doing things that require judgment. Our program scans thousands of stocks and reports on combinations of facts that conform to identifiable patterns.
I have been working on this program since 2001, so at this point I have a good deal of confidence in it. It is really good at finding conditions that are potentially profitable; however, its capabilities are dwarfed by the power of the human mind.
The real purpose of the program is to save you from having to wade through stock after stock looking for possibilities. It finds the possibilities for you. Then it's up to you to consider the factors that are beyond what the program can analyze. Is the entry signal in a rising channel, but are all the other channels headed down? Was the signal triggered by an anomalous news event? Is there an earnings announcement coming up?
Price Jumps
A price jump is defined as a one-day move of more than two times the average close-to-close price change. In other words, jump means an extraordinarily large one-day move in price. This large price change may occur as an exceptionally large price movement during one market session or a gap between the close on one day and the open on the next.
Either way, a price jump tells you that the old frame of reference no longer applies and something new has replaced it. When this happens, it means that the previous analysis no longer applies and you have to wait until this price shift plays out. A signal triggered by a price jump should be ignored because one of two things has happened. One, the big move has no substance and price will return to the previous level. Two, the consensual market value has undergone a major shift. When you see a jump occur, sit back and watch the stock for a few days and see where the price action settles.
Here, Cisco stock leaps more than 10% between the close on May 15th and the open on May 16th, forming a major gap.
When you see this you might be tempted to buy Cisco, thinking that it will go higher. Don't do it. In fact, if you are a trader and are lucky enough to be holding Cisco, it is probably a good idea to sell it and take your profits. After a big gap upward it is unlikely to climb much further in the near term, and gaps have an unfortunate habit of closing — i.e., falling back to their pre-gap levels.
On August 7th of last year, First Energy had a big jump down day (one day decline). After a 6-month rally, it suddenly fell apart. Some people gambled that this was a temporary setback and rushed in to buy near $46. They were badly disappointed as FE proceeded to fall below $40 in the next 8 months.
Reports of a Buyout
A report or even a strong rumor of a buyout can cause price to jump to the expected buyout level and then trade in an extremely tight range near that level. If this happens there is no point in buying the stock because it will not go up from that level. If you were holding the stock before the jump then you may want to sell at the new high or you may want to hold it until the buyout materializes. Research what is going on. There may or may not be an advantage in holding. These situations have to be analyzed on a case-by-case basis.
Earnings Announcements
In general, avoid opening a position on a stock that will have an earnings announcement within your average holding period. These days, if a company misses analysts' estimates by so much as a penny, the stock may be savaged so you don't want to be holding it on the day of the earnings announcement.
Technical analysis offers no help in divining what will happen as the result of an earnings announcement. Many people (including fund managers) are so nervous about their stock positions that they will dump a stock if there is even a hint of bad news in an earnings report.
Because of the importance of earnings reporting dates, we have just added a new feature to the chart page for each stock. Near the top of the chart page is the scheduled earnings reporting date. If we cannot find the scheduled date but we can find the previous reporting date, we provide an estimated reporting date by adding three months to the last reporting date.
Support + Resistance = Impedance
There are price levels at which there are observable distortions in what is termed "supply and demand" (the desire to sell and the desire to buy). This is evidenced by the appearance of an increased number of buy or sell orders at these levels. These distortions can cause a slowing in price movement or even a reversal of direction. In other words, the resulting order imbalance impedes price from continuing to move in its current direction.
When price is approaching a level of impedance from above, technical analysts commonly refer to it as "support". When price approaches an area of impedance from below, most technical analysts refer to it as "resistance". However, it is easier to think of them simply as areas of impedance because the same level that offers "support" when price is above it turns into "resistance" once price falls below it. (In the last few years, some technical analysts have started to use the term "S/R levels" to refer to impedance. Regardless of the terminology used, the concepts are the same.)
"Psychological Impedance" refers to the clustering of orders near round numbers like multiples of $100, $50, $20, $10, and so on. It is called psychological impedance because it is based on the way people tend to think. Lots of people think about things like, "if price gets to $40 then I'll sell it". Not many think, "if it gets up to $37.43 then I'll sell".
"Historic Impedance" refers to the clustering of orders around price levels where there has been a lot of trading activity in the past. You can see a plot of these levels by going to the website StockCharts.COM, bringing up a "SharpChart" and in the "Overlays" box select "Volume By Price". With some practice you can learn to mentally locate areas of historic impedance on almost any price chart just by looking for the levels where the most price bars are found.
Trendlines represent a third, more sophisticated kind of price impedance. Psychological and historic impedance are always horizontal. Trendlines dynamically adapt to the slope of price action so they are not limited to being horizontal. (For more details on impedance, see our article named "Supply and Demand".)
The reason it is important to know about these three types of impedance is that any one of them might get in the way of profits. For example, if you get a signal on a security whose price is at $99, you may want to wait until price breaks through psychological impedance at $100 before taking a position. Sometimes price will slice right through that level, but at other times it will bounce off that $100 level and cost you money.
Similarly, if you get a buy signal when price is only a percent or two away from a high trendline, you probably should pass on that signal. Look for trades where there is nothing in the way of profits.