Tuesday, November 4, 2008

Election Break: A quick lesson in chartology

In the September 5th blog, we looked at how the 99 Cents Store's stock (NDN) was on a roll. It was on the eve of a major price restructuring announcement and it was anyone's guess how it would affect the stock. Apparently, shareholders seemed pleased with the news since the stock gapped up on heavy volume on the next trading day. Looking at this chart again this morning, I thought that it would make a ideal candidate for a lesson in basic chart reading.

What the daily chart tells us

[Click on the charts for a larger view.]

The daily chart above shows two horizontal lines, line A at $9 and line B at $11.20. You can see how line A provided support for the stock back last spring. It broke through that level on heavy volume on May 19th, and if you had been long the stock, that was your signal to either sell it of protect it with a put. Those with more risk tolerance might have shorted it then which would have paid off very well. The signal to cover your short position came on July 15th when a bottoming tail formed. If you weren't convinced that a bottom was put in on that day, the large up bar the next day should have convinced you to exit.

From the bottoming tail, the stock continued to rise just as fast as it had fallen. It broke through minor resistance at $8 in mid-August where it spent a week or so consolidating before breaking through major resistance at $9 in September. From there, it continued upward where it hit a ceiling at $11.20. Unable to break through it, the stock retreated testing the $9 support level twice. Finally, it broke through the $11.20 ceiling last Thursday and is in the process of consolidating at this level. (Now would be a good time to pick it up if you're interested.)

What the weekly chart tells us
So, the next question is: If we're now long the stock, how much profit can we reasonably expect? The answer can be found by looking at the weekly chart below. The stock formed a double bottom in January and July. A general rule used by technicians is that when a double top (or bottom) is formed, the amount of expected profit is the difference between the center of the formation and the top (or bottom) value. (This is exactly the same calculation as in the head and shoulders formation.) On the chart, these values are $10 at the middle of the double bottom and $6 at the bottoms giving us a $4 estimation for profit. The profit is measured from the center value so that we can expect the stock to rise to $14. There is resistance at this level and if the stock can't break through it, I would definitely exit the play.

I hope you were able to follow this example. I know it's a piece of cake for all of you seasoned technicians but many people don't understand the basics of chart reading and I'm here to help with that. I'd say that today looks like an excellent time to buy the stock, but I do have reservations about how the market might react should a democratic president and a democratic Congress be elected. You might wish to wait until tomorrow before making any market commitments. However, if you do buy at this level, I'd set a protective stop at $10.56 which was the low of the pre-breakout bar on October 29th.

Now back to my research on dividend stocks...

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