Seven Reasons Why The Trend Is Your Friend

I will often joke about market technical analysis.

Daytraders often live and die by minute-by-minute moves and magical voodoo terms. Technical analysis is no more the holy grail than buy-and-hold investing. The presumption that the tail waggs the dog is dangerous and not grounded in any scientific evidence. Yet, my experience says it's of as much value as fundamental analysis in helping you determine if a stock could rise or fall. Above is the most recent analysis of the S&P Trend line which can help one reduce risk and increase profit opportunities. The idea is simple. Know when to plant seeds. Know when to harvest profits.

I was trained in Modern Portfolio Theory (MPT) in my business BBA program in the 70's.

Naturally at a University you'll learn what is believed to be the best researched and scientific based thinking of the time. Most often based upon utilizing mathematics to identify correlations and relationships in search of the holy grail of reducing ones risk while increasing the probability of maximizing your returns. So, all the Professors contributing to the knowledge of MPT, were strong mathematicians not past professional money managers.

The founding fathers of MPT, people like: Harry Markowitz Nobel Prize in Economics, 1990. Diversification reduces risk. The Role of Stocks James Tobin Nobel Prize in Economics, 1981 Single-Factor Asset Pricing Risk/Return Model. William Sharpe, Nobel 1990 Prize in Economics, for Capital Asset Pricing Model. Efficient Markets Hypothesis, Eugene F. Fama, University of Chicago. Fama was first to get access to using a Mainframe IBM computer to analysis massive amounts of historical data that had been collect in print.

Fama's, extensive research on stock price patterns was the foundation for Efficient Markets Hypothesis, which asserts that prices reflect values and information accurately and quickly. This was among the easiest of concepts to grasp. Yet, to this day this is the most misunderstood theory. Often those with no formal investment training such as journalist, will imply Fama's theory means the market must always be rational.

But the most valuable concept that I learned outside of the class room in real life money mangement pertaining both to the market and individual stocks was how to spot a simple trend and capitalize on that trend.

We spend a great deal of time trying to spot stocks heading in the right trend, or direction. Careful attention needs to be given to the support and resistance lines. These lines are also called trend lines.

Here are seven reasons why the trend can be your friend in investing:

1. These lines draw the general trend, or direction, the stock is heading. They’re not used for daily tracking, they’re more of a longer-term direction that the stock, mutual fund or commodity is heading. If you are using a longer term approach, the trend is what you really want to know, not necessarily the day to day wiggles in a stock.

2. Often times, the trend line will give you guidance in a stock for years, not just weeks or months. But these support and resistance lines are often bumpers, or guardrails, along the way. Stocks often drift toward their support or resistance lines and then bounce back in the opposite direction.

3. If you can pick off a stock you find attractive as it is bounces off the support line, it could be a terrific time to buy. The reason is you have a strong, logical place for your stop point...just under the support line, which is really close by. This helps minimize the amount you have at risk.

4. Some of the best winners come from stocks that are purchased just as the stock breaks through overhead resistance and forms new patterns. Holding the stock until it breaks support line (which might be possibly many months, or even years later) can really help your overall performance!

5. The reasons behind why a stock jumps through a brick wall are often not clearly visible. The reasons for the move may emerge days or weeks (or even a year!) down the road. But when a stock or a mutual fund breaks through the trend line, either up or down, it’s important news.

6. If a stock or mutual fund we are following breaks through it’s overhead resistance, we have a high level of confidence that the stock will continue to climb upward.

7. Lastly, if the support line of your mutual fund or your stock is broken, beware! This is a very clear signal we should consider selling a portion (or maybe even the entire) position. Breaking the support line is the ultimate sign that supply is now clearly in command. Your principal is now at risk.