Now that you have an understanding of how the Point & Figure chart works (See Day 4 - Point & Figure Methodology), let’s test your knowledge…
Look at this chart and let me know whether supply or demand is in control? If you had this stock in your portfolio, would you want to hold it, or would you prefer to sell it?
Notice this stock’s chart has recently changed from trading above its bullish support line (in red) and in an overall positive trend, to now below its bearish resistance line (in blue) and in an overall negative trend. Additionally, it has completed multiple consecutive sell signals, telling us that not only is supply in control, but it continues to get stronger.
Using the price as our only input, we can objectively identify that this is a problem stock that needs to be addressed.
And what is the mystery stock…?
…It was Citigroup in October of 2007. The Point & Figure chart was clearly signaling you sell or hedge Citigroup before any of the financial crisis headlines broke, and well before the stock was down into the single digits.
This industry is and always has been overrun with buy recommendations. One of the shortcomings of using fundamental analysis alone, is that often as supply carries prices lower, stocks become more attractive from a valuation standpoint. A quote from a New York Times article in early 2009 titled, “Why Analysts Keep Telling Investors to Buy,” reflected on fundamental analysts’ recommendations in the year and a half prior. “At the top of the market, they urged investors to buy or hold onto stocks about 95 percent of the time. When stocks stumbled, they stayed optimistic. Even in November, when credit froze, the economy stalled and financial markets tumbled to their lowest levels in a decade, analysts as a group rarely said sell.”
January 2009 was the worst January on record since 1950, and even then there were a mere 5.9% of stocks possessing a sell rating according to Bloomberg. If the fundamentals in January 2009 didn’t warrant sell ratings, when will they? This is just one example as to why we must always have a handle on the supply and demand relationship for positions in your portfolio.
One of the most effective tools that we have used over the years to explain the importance of incorporating technical analysis in some capacity within an investment game plan is the Anatomy of a Collapse. The concept is very straight forward and leaves one with a very clear understanding of how differently technical and fundamental research is developed.
We begin by looking for a widely-held, S&P 500 type, stock that has endured a substantial decline in recent months with enough headlines such that the average investor has likely read something of the matter. Examples over the years have included Citigroup (C) (above), General Motors (GM), Linn Energy (LINE), and Fannie Mae (FNM), each of which experienced very public un-doings, with the cause of said decline being revealed only after the stock was already un-done. The reality of these collapses runs counter to the way most investors like to envision the stock market which is typically as an efficient machine with information being equally shared and quickly incorporated into the price of a stock. What we find, however, is that the technicals very often foreshadow the coming demise of the fundamental picture in such extreme cases as those mentioned earlier.
A recent example of a "collapse" and where supply is in control is General Electric Company GE. For over five years, the trend of GE was positive and for the most part, demand was in control. However, after peaking in July of 2016 at $33, GE has collapsed. It broke through the bullish support line on October 11, 2017 at $23 and it has since fallen to $13.10. While GE's collapse on an absolute, trend basis is fairly recent, GE has been unfavored against the market for some time. In fact, GE has been on a relative strength (RS) sell signal against the S&P 500 Equal Weighted Index SPXEWI since September 20, 2001, which is the one of the longest running RS signals to date. The stock is also a 0 for 5’er and ranks 68th out of 69 stocks in the Electronics sector. For those tracking GE, it's safe to say that supply has been, and remains firmly in control.
The lesson here is that you must listen to what the Point & Figure chart is telling you in order to unemotionally follow the imbalances of supply and demand. Whatever the reason turns out to be for falling stock prices, the bottom line is that the price of a stock fell because there were simply more people selling the stock then there were people buying the stock. It is this simple economic concept, that drives the price of produce in a supermarket and the price of stocks on Wall Street: Supply and Demand. The Point & Figure chart does not care if the stock underlies a good company or not. There is no preconceived bias and there is absolutely no emotion in the Point & Figure chart. It is only concerned with the price action of the stock in order to record the imbalances of supply and demand.
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any
investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
Until next time, cheers!
Jim