Reading Charts

If there is one way in which the Cabot approach to growth investing (as opposed to value investing) differs from that of most advisers, it is that we pay more attention to what investors are actually doing.  We do that by looking at the chart that shows price movement, moving averages and volume.

Leaving out the double bottoms and tops, heads and shoulders and other classic chart patterns, here are a few basic principles of chart reading.

• Stock with rising price on increasing volume = bullish.  This shows that an increasing number of buy orders are being processed, indicating a positive change in investors’ appetite for the stock.

• Stock with rising price on decreasing volume = caution.  A stock that is rising for a few weeks, but has falling volume, is losing momentum.  You need to be careful about buying into such an advance.

• Stock with falling price on increasing volume = warning.  Once a stock starts to decline, investors can get nervous and sell, swelling the volume and accelerating the drop.  If volume is higher than average, it may also indicate institutional involvement in the flight.  A big decline on volume that’s triple a stock’s average is a classic sell signal.

• Stock with falling price on decreasing volume = mildly hopeful.  This can be a useful signal in deciding whether to sell a declining position.  If volume is dropping, especially if the stock is near a price support level, a downmove may be losing steam.  You don’t want to ignore your loss limits, but if a call is marginal, this can be a good clue.

Remember that high-volume trading often indicates moves by institutional holders, and that they’re the ones who really control the market.  They also tend to take time to enter or exit positions, so intense buying (or selling) tends to persist.

It’s always useful to go back and look at the charts of stocks that have made big moves, either up or down, looking for the volume clues.

This is taken from the July 17 issue of Cabot Wealth Advisory written by Paul Goodwin.