A Look at the Patterns Helps to Differentiate Stock Winners and Losers
Which stocks end up winners and which stocks end up losers are eventually explained by the “news.” In the end, there is always some fundamental factor that ultimately accounts for whether any particular stock is a winner or loser.
However, by the time the “news” is out, a stock quite likely has already made a major portion of its move, up or down. Technical analysis, on the other hand, can play a role in spotlighting which stocks are in the process of becoming winners and what stocks are in the process of becoming losers.
For instance, NS Group was spotlighted in the July 1 Wall Street Journal NYSE Winners listing as being the top gainer over the prior three months, up some 131.7%. Higher net income of this specialty steel manufacturer for the current fiscal year was the reason given.
At mid-September, NS Group was trading over 30, up from 4½ at the beginning of the year, or up some 500%, a pace that, if continued, could well put NS Group at the top of the list for the year. As usual, the better gains stem from low-priced, turnaround situations. Its longer-term and more recent price trends are illustrated in Figures 1 and 2.
At the other end of the spectrum, on the July 1 Wall Street Journal NYSE Losers listing, was Chesapeake Energy, down some 52.5% for the second quarter. The reasons given for the decline were cuts in the exploration budget and declining production. Its longer-term and more recent price trends are illustrated in Figures 3 and 4.
While it is nice to know the reasons for the gains in NS Group and for the loss in Chesapeake Energy, the cat is clearly out of the bag by the time these stocks receive the publicity. That is where technical analysis and trend analysis fit in—being aware of the trend in stocks will afford investors opportunities such as NS Group early on and will help investors avoid the Chesapeakes before it is far too late.
The Winner’s Pattern
By mid-1997, when NS Group was declared the winner, the stock was in the mark-up phase. However, the mark-up phase, while accounting for the majority of the price gains and the most exciting part of the move, is not the best time to accumulate the stock, as buying is more speculative.
The term speculative in this instance means that investors are no longer buying the stock as an investment, or a turnaround, but are now buying on the basis that the price has jumped, in anticipation of further price jumps. Support from such speculative buying is tenuous at best. The proverb “weaker hands” is the operative word.
The “accumulation” phase typically is more orderly and is a safer, more potentially rewarding time to buy. And, as Figure 1 shows, the accumulation phase for NS Group was extremely well defined.
By late 1995 NSS had been in a declining trend for well over two years. There had been rallies from time to time, like the kind shown over the first half of 1995, but they were only spike “bear market” rallies, not the type of zig-zags associated with bullish uptrends.
Then, after bouncing along 3½ through September, support gave way and the stock declined in a typical selling climax panic. Note the extremely high volume (indicated by the bar chart along the bottom of the figure) on the October reversal day.
The stock bottomed out in October at 17/8, but at the time there was nothing to suggest that 17/8 was the bottom, or that the trend was reversing. However, over the subsequent months, there were all the typical tell-tale signs that the trend had reversed and that the trend was now bullish.
First, note the frequent tests of the low. While the January–September decline was characterized by persistent “ground giving” or lower lows, from October on the pattern was characterized by “ground gaining” higher lows.
Indeed, the entire trading range from October 1995 through June 1996 can be characterized by an ascending triangle, where resistance at 3 represented the horizontal tangent, but increasing support resulted in a rising bottom tangent. Then, in July 1996, as the resistance at 3 was bettered, the stock broke out of the ascending triangle on heavy volume.
From July through November, the stock traded in a relatively tight range, with support at 3 and resistance at 3½. In November the stock traded at 3 frequently. Note the heavy volume in mid-November as sellers attempted to take the stock lower, but support at 3 was more important.
In the last few days of November the stock again rose to the top of its trading range, to 3½, and then bobbed about for a couple of days. In mid-December the stock broke out sharply higher, over 3½, on heavy volume.
Does the action of NS Group at its lows give any indication that it was a stock that was going to rise to the top of the Wall Street Journal’s Winners listing? No.
Does the action of NS Group at its lows give any indication that it was a stock that had bottomed out and was beginning to trend higher? Yes, indeed it does.
While the extent and duration of a trend cannot be forecast (although the degree to which a stock is depressed will give some idea as to potential rebound: NS Group’s pre-1987 high was 157/8), trend characteristics, such as those determined by a stock’s interaction with its support and resistance levels, are as typical, and repetitious, as one can ask for.
The Loser’s Pattern
Chesapeake Energy, likewise, shows many typical trend characteristics, but in a downtrend, not an uptrend. While the selling panic in late June earned the stock the dubious distinction of being the worst New York Stock Exchange performer during the second quarter, the selling panic was just an extension of the normal trend development of a downtrending stock.
First, note in Figure 3 where Chesapeake had come from. Up until January 1994, CHK had been trending lower. Was there any indication that the low of ½ in January 1994 (the actual low was $4.20, before adjusting for subsequent stock splits) was the final low before the stock’s reversal and subsequent advance throughout 1994, 1995, and 1996, an advance that would ultimately carry the stock to $35? No.
However, when the stock began to rise during 1994 in a series of minor bullish zigzags during February through July, and then rose decisively through the resistance in August, the trend was clearly bullish. Chesapeake Energy showed all the typical patterns of a low-priced stock beginning to rebound. Note the perfect uptrend in the stock as it advanced 200% between July and December. Who said that low-priced stocks were volatile?
The stock’s momentum continued to build, with the stock’s rise becoming steeper as the issue rose in price, which is why it is best to buy during the accumulation phase, not the mark-up phase. The advance in the stock would carry the issue into the mid-30s by late 1996.
The stock’s reversal pattern, as shown in Figure 4, is also typical of most stocks. First, there is a break in the trendline, with the decline in late July and early August of 1996 breaking a March-July trendline.
Following most price breaks there are buyers who take advantage of the lower price and buy into the stock. However, these johnny-come-latelies are usually met with resistance around the prior highs, as buyers around 30-35 in mid-July were anxious to unload their positions. Notice how the prior rising trendline, which had represented support, coincides with resistance.
After the August break there were at least two attempts to punch past 35, in September, and then in November. There was a weaker attempt in January.
However, support during these attempts to push past 35 grew weaker. Buying power was being spent. Support in October was at 28. Support in December dropped to 26. By the following February support had decayed to the August support lows of 21. Subsequently, when the key support level at 21 was taken out, the stock plunged.
So, while the Wall Street Journal’s listing finds Chesapeake Energy showing the biggest New York Stock Exchange decline in the second quarter, the listing is just a snapshot, just part of an overall trend.
The bigger picture shows a massive distribution pattern over the prior year, leading into a very well-defined downtrend in the stock, which in turn is made up of the typical series of lower highs and lower lows.
The major downtrend in the stock is made up of declining zig-zags, which in turn reflect support level after support level giving way, followed by the typical selling panics, which intensify as more important support levels give way.
There is really nothing unusual about Chesapeake Energy or NS Group. While Chesapeake was in a downtrend, and NS was in an uptrend, other than direction, the other trend characteristics, such as phase, support and resistance levels, interaction with trendlines, were the same.
The company names may change, the time periods may change, the “fads” may change, the market levels may change. The patterns, though, remain the same.