Charting a Course (3)

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

In the last blog, we talked about a stock's "price range", the band within which recent prices are trading.  If this band continues for a period of time, technical analysts refer to this as consolidation.  During a period of consolidation, buyers and sellers seem to be indecisive as to which way the stock is going to move in the future, either up or down, since the trend line is flat.  The stable price range might last for days, weeks or months.  During this period of neutrality, chartists look for indicators as to which way (up or down) the stock price might break out of the consolidation, which would signal the next trend.

If the trend is going to resume the past direction, technical analysts believe the chart will show a pattern which looks like either a flag or a pennant.  A flag forms a rectangle of prices, usually with a slope in the opposite direction from the previous rise or decline.  A pennant is a triangular band, starting with wide price swings and converging at a point of small price changes, with no apparent directional slope.  Each of these indicators tells the chartist that the stock is taking a break before continuing to resume the previous price direction.  This link to the website StockCharts.com provides additional explanation and examples of flags and pennants.  If the flags and pennants persist over a long period of time, the chartist may view the flag as a rectangle and the pennant as a symmetrical triangle, two other indicators.

If the trend is going to reverse itself and head in the opposite direction (a point of inflection), the chart might show a price pattern over time which looks like, first, a left shoulder, then a head and, finally, a right shoulder: the head and shoulders pattern with alternating price rises and declines of varying heights and lengths.

A head and shoulders indicator, viewed in the normal pattern, is seen as a reversal from a trend of increasing prices to a trend of declining prices following the final movement of the right shoulder (downward).  This link to the website StockCharts.com provides additional explanation and an example of the top (reversal) head and shoulders indicator.

 A reverse head and shoulders indicator, which looks the same, but upside down, is viewed as the reversal from a trend of declining prices to a trend of increasing prices, following, again, the final movement of the right shoulder (upward).  This link to the website StockCharts.com provides additional explanation and an example of the bottom (reversal) head and shoulders indicator.

These are but a few of the more widely studied indicators used by chartists.  In the next blog, we will continue our study of charts and technical analysis.


As always, comments are welcome.