After a massive run for a year, the market is down today, led by Tesla, which dropped about 200 points before bouncing back. As I write this, the Nasdaq is down 1.73%.
There is no question that the market is overvalued in terms of historic measurements like market cap-to-GDP, margin levels, and number of stocks without earnings.
The question is does the end of the pandemic, the reopening of the markets, and low interest rates justify this lofty valuation? One can only speculate, but rising interest rates — like we’ve seen over the past few months — have killed off more than one bull market.
That said, you should have some basic tools that help you avoid the next market crash. So today, I give you five simple and easy-to-understand technical signals to gauge any market.
1) Double Top and Double Bottom
The double top is one of the simplest technical patterns to pick up. It happens when a stock’s price bounces off the same resistance line twice.
You can see both double tops and double bottoms in the Dow Jones Industrial Average chart above. And it was right both times.
The double top is a sell signal. A double bottom is a buy; it means there’s a strong support level that the stock’s price will have trouble falling below.
2) MACD
Many people don’t know the MACD, but it is one of my favorite tools — and you should never buy a stock without looking at it.
MACD stands for “moving average convergence/divergence” and was created by Gerald Appel in the late 1970s. I find it a handy and simple guide for timing my buys and sells.
The MACD is an oscillator, or a collection of three signals calculated from historical price data: two moving averages — a long-term one and a short-term one — moving over a centerline.
I won’t bore you with how these are calculated but will rather tell you how you can trade using MACD…
Here is the Broadcom (NASDAQ: AVGO) chart:
You see where the blue line crosses the red line last May?
This signals a turnaround in the share price. At the right side of the graph are numbers from -20–40. The farther the blue and red lines cross away from the centerline (zero), the more powerful the turnaround.
3) Doji Master
Dojis are fantastic when they appear after a long trend. If you get seven up days in a row with a doji at the top — sell, because she’s gone.
“What’s a doji?” you may ask. Well, I’ll tell you.
Dojis are a candlestick chart pattern that was developed more than 1,000 years ago by traders on the Japanese rice markets. Dojis are powerful reversal signals, like stock ninjas.
A candlestick is a visual representation of a trading session. You have an open, a close, a high price, and a low price.
If the candlestick is white, the price closed higher than it was when the market opened.
If it is red, the price ended the day lower than it started.
The vertical legs are the highs and lows. Doji candlesticks are black because they closed at or near where they opened.
In other words, dojis are formed when the candlestick opens and closes at the same level, implying the fight between the bulls and the bears is at loggerheads. Dojis signal turning points.
Dojis come in four types:
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Standard doji — This candlestick looks like a cross, inverted cross, or plus sign. At the top of a trend, it can indicate a reversal is near.
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Long-legged doji — Long-legged doji formations occur when the stock opens at certain levels, trades in a wide trading range intraday, and closes at the same level that it opened. These become better predictors when preceded by small candlesticks. Long-legged doji formations can imply a change in trend.
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Dragonfly doji — The bearish dragonfly doji can usually be found at the market top or during an uptrend. This candlestick tells us the bulls may be losing their way, and it casts doubt on the market’s ability to continue north. Confirmation is essential. You can confirm with a gap down or a lower close on the following day.
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Gravestone doji — Gravestones are the opposite of dragonflies. These dojis look like gravestones and can signal the death of a stock.
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4) The Bollinger Bands
Bollinger Bands allow users to compare volatility and relative price levels over a period of time. They consist of three bands:
- A simple moving average (SMA) in the middle
- An upper band (SMA plus two standard deviations)
- A lower band (SMA minus two standard deviations)
Standard deviation, a statistical term that provides a good indication of volatility, ensures that the bands will react to price movements and reflect periods of high and low volatility. Sharp price increases (or decreases) will lead to a widening of the bands.
For our purposes, let’s make this a bit simpler…
When we use the Bollinger Bands, the closer the market prices move to the upper Bollinger Band, the more the stock market is considered overbought. The closer the prices move to the lower Bollinger Band, the more the stock market is considered oversold.
But the crux is when it narrows. A narrow Bollinger Band means a turning point.
Here is the Tesla (NASDAQ: TSLA) chart. Notice how when the share price bounces along the lower bands and the two bands narrow, the share price lurches higher. The exact opposite happened over the last two months, and TSLA has broken down.
Again, simple is good.
5) Volume
Volume is the number of shares traded in a session, and it represents the interest level in a stock. If a stock is trading on low volume, there is not much interest in the stock. On the other hand, if a stock is trading on high volume, there is a lot of interest in the stock. Volume gives you a good read on the hype in a stock.
Note the volume surging last year and then fading in the TSLA chart above.
Momentum traders like high-volume stocks. Another benefit of a high-volume stock is that it will be easy to buy or sell. The spread will be lower.
A volume spike can signal a reversal of trend, such as a capitulation low or a blowoff top. If a volume spike comes before a known event, like an earnings announcement or a Phase 3 trial announcement, it means there has been a leak and insiders are loading up.
In other words, volume precedes price.
Best regards,
Christian DeHaemer Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
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