Knowing markets only do two things, the first thing I want do before I take a position in an investment is to determine if it is trending or consolidating. The goal is to find something in a trend, hop on board and ride it as long as it continues to rise. That sounds great in theory and when put in practice is easier said than done because of the finite time periods of trends. The hardest part is to find a balance between entering a trend early to capture the most out of the eventual move against getting in too early and find it wasn’t a new uptrend at all, rather just a corrective move in a downtrend. I find the most effective way to determine if something is trending is to look at a weekly chart of the investment as the longer time frame tends to smooth out daily price noise and presents a much clearer picture. A good example is the chart below of the health care ETF, IYH. Even if you are not a technician or have much experience looking at charts it should be pretty easy to look and say this has been in a very nice uptrend since the August, 2011 low where it has since gained nearly 150%. Just because a stock is trending up does not necessarily make it a good use of your investment dollar. What I find helpful is to look at its performance and compare it against say a broad market index like the SP500 or the US total Stock market index. If it is not outperforming the index, why not just invest in the index? The bottom pane of my chart shows the ratio of IYH’s performance against the US broad market (SP500) and shows a similarly attractive uptrend reflecting a significant out-performance against the index.
Since this meets the criteria I have laid out is now a good time to buy? When entering a long term position once I have determined it is trending up I look at shorter term daily charts and wait for either the breakout from a short term consolidation or pull back. Entering then provides a better risk/reward than just randomly buying. Additionally on that pullback I would like see it be confirmed with an increase in volume to prove that there are others who are seeing this as a buying opportunity too, not just me. While that always does not present itself, when it does, it is icing on the cake.
Taking a look at a second, shorter term daily chart of IYH below you can see we created a double bottom pullback buying opportunity back in the 3rd week of October. Notice how the (blue) uptrend line that acted as support in December of last year and April of this, provided it once again as prices trampolined higher once hit. Also, note the massive volume increase which provided that confirmation I desire (it was more than 10x the average volume).
One final note, you can also see how price has consolidated these past few weeks (red box) and the bulls once again won control as prices are pushed higher. While I am not a buyer here (it’s too far away from the support line and the negative momentum divergence is a red flag to me) this is an excellent example of a very strong stock in an uptrend that when pullbacks and consolidation occur, have provided excellent buying opportunities.