Would You Buy The Breakout?

Consider this chart:  If it was an index or an individual stock, would you buy it?
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Breakout

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I know I would.

The chart, courtesy of Charles Kirk, poses an interesting trick question: Its actually an inverted chart of the Dow over the past year. It is presented upside down, so last week’s market break and turmoil shows up as a breakout — not a breakdown. In the original Dow chart (invert the one above), it is an obvious breakdown.

The psychological question Charles poses is this:  If you would buy the inverted chart, then wouldn’t you most certainly sell the inverted version (if not outright short it)?

Its a very clever way to check your own biases. The dip buyers today are somewhat equivalent to the sellers of the above breakout.

Nicely done, Charles!

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Discussions found on the web:
  1. SINGER commented on Mar 8

    pretty undeniable there!!!

  2. MarkM commented on Mar 8

    The counter argument being that the LT and intermediate trends of the chart have been UP so why not buy a dip. Just sayin’ and I’m no raging bull here.

  3. TheFinancialPhilosopher commented on Mar 8

    I am a new and now regular visitor of your Blog. Good work! While thought provoking, intelligent, and quite often useful, I find it interesting and, at times, troubling that many of the Blogs I read imply that stocks are a tool to be used for short-term gain. I tend to lean in your direction that the long and steady trend upward in stock prices over the past few years increasingly points to downward pressure going forward; however, why would a prudent investor, using stocks appropriately as a long-term instrument, not buy on a 5% “dip?” As you stated yesterday, these dips are extremely rare. If that’s not a time to buy, then what is? Unless an investor wishes to “time the market” or they have short-term objectives, moving some but not all of his or her cash to stocks is absolutely a good move regardless of market conditions. I will “compromise” and say that leveraging short-term movements to benefit long-term strategies works extremely well. Building cash for more buying opportunities in the next 12 to 18 months and slowly moving defensive are wise “long-term” moves now…

    Keep up the good work…

    Kent, aka “The Financial Philosopher”

  4. Michael C. commented on Mar 8

    Ticket Sense had an interesting piece yesterday regarding a 90% down volume day then a 90% up volume day following. He had to go way back to 1967 to find an instance.

    “Digging a little deeper however, we found a paper (pg 14) which shows that in 1967, the NYSE actually did have a 90% downside day (6/5) followed by a 90% upside day (6/6)…Following that period, the market never looked back.”

    I’m not sure what his definition is of “never looked back” but when I pull a chart up of the Dow or S&P, I find that, unless my charts are wrong, the market went nowhere, nowhere, for 15 years. In other words, if you had bought and held, 15 years later you would have made 0%.

  5. Michael C. commented on Mar 8

    MarkM said “The counter argument being that the LT and intermediate trends of the chart have been UP so why not buy a dip. Just sayin’ and I’m no raging bull here.”

    Because it is no longer a trend when it breaks.

    Of course, you can bring in the ultimate argument, that the market over its entire history is uptrending, but if that is the case, then just buy every down tick of every second. Why not? Because of money management? That’s exactly the point.

  6. Neil Sambol commented on Mar 8

    I would add one more point. While increased volume is critical for an upside breakout, it is not required for a breakdown. However, high volume will make the breakdown that much more significant.

    We have had heavy volume on this breakdown.

  7. wcw commented on Mar 8

    Not a chartist my answer is: probably not, unless I knew the stock and its fundamentals, wanted to buy, recognized a downtrend in place, disagreed with the market thinking that generated the downtrend, and had been waiting for this setup.

    So, sure, I think there is risk in the market, mostly having to do with the “landing” part of “soft landing” (who needs a recession when you’re priced for growth you’re not going to see?) and with the cyclicality of corporate earnings (it is the ‘golden age of profits’ after all). I’ve been net long, but had hedged with shorts in some groups. However, I covered some of those the last two weeks and actually went long index futures to put myself not just my usual cautious net long but (very slightly) levered. I plan to scale back either today or after the close on globex, though — that jobs report promises to be a doozy, and I don’t want to be too exposed when it comes out.

  8. Ollie commented on Mar 8

    I can’t believe anybody is seriously considering buying right here. Why would you ever buy a trend breakdown? I mean, look how badly people got hurt who bought the breakdown of May 2006! They had to endure an excruciating 2-4% further downside! Throw your money away if you must. Now gold on the other hand…

  9. msecc commented on Mar 8

    I knew that chart looked familiar… Just like my “double short S&P ETF” Ticker SDS…

  10. trip commented on Mar 8

    Ollie,

    Don’t forget that most people are regular Joes (like me) contributing to a 401k a couple times a month. That said, I just shifted my new contributions from cash to 60%/40% Intl/Domestic stocks. I might be wrong (most likely I am), but I am going to buy every couple of weeks all the way down.

  11. Michael C. commented on Mar 8

    Interestingly, the Vix is again sinking like a rock. The Vix is now at it’s lowest point since the decline, yet the S&P is over 10 points off its rally high.

    I guess complacency is still lurking out there…

  12. C. Maoxian commented on Mar 8

    Looks like a minor countertrend move within a monster downtrend… no way would I buy that.

  13. winjr commented on Mar 8

    VIX down again today, below 14 and dropping fast. Fear is dwindling. Soon, the markets will forget that last week even happened.

  14. jmf commented on Mar 8

    good one!

  15. Craig commented on Mar 8

    Sure! I’m taking days like today to buy on the ultra-short dips. QID is on sale today.

  16. my1ambition commented on Mar 8

    Barry, I must say that was a good one. I do analysis flipping often when trying to come to decisions.

    Reminds me of when Warren Buffett mentioned that he lost faith in technical data when he flipped the charts and got the same answers. lol.

    By the way just pointing out to everyone that the Dow has barely lost a dime if you’re counting in ounces.

  17. Steve Goulet commented on Mar 8

    I wouldn’t buy on a long term down trend when there is a minor blip to the upside. Isn’t that a classic shorting opportunity?

  18. tcc commented on Mar 8

    The May and June months on the chart are a similar breakdown of a previous uptrend….and look what happened during the next seven months.

  19. David commented on Mar 8

    Interesting observation. But from a trading perspective, is buying a breakout really just the inverse of shorting a breakdown? Especially if we’re talking stocks (as opposed to say, forex)?

  20. Craig commented on Mar 8

    Huh?
    It isn’t a minor blip, it breaks the channel which unless it corrects indicates a change in trend or at minimum a significant up or down move (depending on if the chart is right side up or not).

    The channel marks the trend. It stops being a blip when it rises or drops above or below the trend lines.

  21. Fred commented on Mar 8

    Ok…I’ll step up as piñata (sp?)…look at a weekly chart of the S&P, and draw the top channel line from 2/04 through 5/06…that prior resistance (channel line) became new support. My fat crayon line has the market holding (closing above) this support, and now soundly above it. Certainly we could/should retest last weeks lows (double bottom)….but Mr. Chuckles (the market) will usually try to hurt the most players it can….right now that’s the crowded cult of the bear den. Massive bets/hedges are placed against a successful test….we’ll see.

  22. Charles commented on Mar 8

    Barry, if I saw that chart, I would ask WHY the move broke through the channel, especially whether the product line, management, industry conditions, or economy had substantively changed.

    Which explains, I suppose, why I am not a chartist. ;-)

  23. David Merkel commented on Mar 8

    Charts don’t mean that much to me. I look at what the financiers of speculation are doing. The CDO market is still getting deals done. Corporate bonds are getting issued. Companies are proceeding with buybacks. Marginal IPOs like Clearwire are getting done. VCs are still spending money; any hiatus is short -term.

    Now we still face real problems, I just see us skating past the near term ones.

    Just my two cents… I get it wrong often enough.

  24. Steve Goulet commented on Mar 8

    It does break the channel pictured above, but a wider perspective (1.5 years for instance) would reveal this to be just a blip within a wider channel.

  25. Craig commented on Mar 8

    Absolutely. A down move within a overall up trend, so far. We would have to break 10700 to break the overall trend.

    You all may want to chart money flow-A/D of this same period of time.

    A line across the peaks will clearly show a downward trend to the A/D. When combined with the chart it would be a better indicator than just the squiggly lines.

  26. angryinch commented on Mar 8

    Good point about the 1967 “90%” example. The Dow bottomed around 840 in June and “never looked back.” For three months.

    Then it was right back at 840 in November. And below 840 again in March 1968. Then it rallied but was right back below 840 from late 1969 to early 1971. Not to mention from late 1973 thru all of 1975. And 1978, 1979, 1981, 1982.

    Guess I have a different definition of “never looked back”.

  27. Manny commented on Mar 8

    An instructive tweak to our biases for sure. But in fact it IS important to know whether we are truly entering a long or short trade. Our markets are upwardly biased and for good reason. Our monetary policy is better than it was a generation ago, and the world’s monetary policy is more coordinated than it was in the past. Inventories and deliveries are better controlled than they were before computers . Corporations, Governments and Central banks are not “neutral” toward success and failure. They want success. Workers are not neutral between wanting to work hard to keep their job and failure. They want to keep their jobs. People are not neutral between wanting self-actualization and self destruction. Except for rock stars and senior Al Qaeda, they want self-actualization. Thus, there is good reason to favor the long side over time.

    Nevertheless, my trend indicators topped the day before the 400-pointer and still say “downtrend” today. Oops.

  28. Agent00yak commented on Mar 8

    Well, considering that the long run difference between going long and going short has been an average of 0.05% a day or so I might be a bit hesitant to equate long and short positions if I were using evidence based TA.

  29. Dogstar commented on Mar 8

    Another useful chart would be the 21, 50 and 200 sma’s overlaid. You go back a couple of years and will see the norm for these breakouts/breakdowns is pretty consistent:

    1) Retrace up over or close to the 50 day line to get everyone back in, then another down leg below the 200 day line for the panic bottom.

    2) Then there is the relief rally and a lower volume/successful retest.

    3) A rally then starts which either takes off for a major bull leg or fails around the 200 day line and takes another down leg.

    4) Etc.

  30. DavidB commented on Mar 9

    If that chart flipped back again had a trailing and forward PE of 2 a PS of .01 and a PEG of .02 for the next five years in an industry with no competition. If they also had a debt free balance sheet and a pricing margin of 50% and if the reason the chart broke down was because a hedge fund holding the entity went bust and was forced to liquidate then, yes, I’d probably be buying with both hands no matter what the break down looked like.

    Just because a champion quarter horse trips on the way to the track does not mean it has a broken leg and should be shot. There is a lot more to trading than basic charting.

    That being said I would want to know if there are fundamental reasons behind a chart breakdown as there well may be in the market’s latest stumble.

    I don’t trade markets though, I trade stocks

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