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Charting Strategy For The Long Term Investor
Education | 08 January 2010
By:

By Soh Tiong Hum

Spot Base Building In Blue Chip Stocks

Some investors believe that technical analysis can be used for short term trading only. This is a myth because chart reading is a skill that is equally important to long term investors as short term traders.
In this article I would like to share a chart-based strategy for the long term investor. This is a strategy that looks for base building action in fundamentally strong stocks. The strategy will allow the investor to buy into and hold on to strong growing stocks for any period of time exceeding one year. What we will do is to look out for a type of chart pattern in fundamentally strong stocks.

The article is organized in the following manner:

  1. Defining the long term investment
  2. Laying out the charting software
  3. Hunting for chart pattern
  4. Illustration with Singapore Exchange and Keppel Corporation

The Long Term Investment

Long term investors favor a ‘buy-and-hold’ approach for two reasons. Firstly, they are attracted by long term price appreciation that tracks or outperforms an underlying market index. Secondly, they may be attracted by regular dividends. It is no surprise that investors in the Singapore stock market typically look to blue chip stocks that make up the Straits Times Index.

Apart from their fundamental strength and the size of their market capitalization, blue chip stocks have one more reason for long term investors to cheer. Blue chips are often bought and held by managed funds. These funds buy blue chips for the same reasons as individual investors. In return, when funds buy into a stock, their process of accumulation leaves a ‘footprint’ or pattern in the charts. Individuals can spot such chart patterns to buy into stocks that are being accumulated because price typically rallies steeply once large players finish their accumulation.

Chart patterns are powerful and simple to spot. All the investor has to do is to get a charting software and set it up with the correct layout.

Laying Out The Charting Software

It is easy for investors to get hold of charting software as they are plentiful. Paid software is sophisticated but for the strategy covered here, a free service from Yahoo! Finance is sufficient. (http://finance.yahoo.com/echarts)

Once you get a chart, do the following:

  1. Set the chart so that you can see at least two years of daily candles
  2. Put in a 200-day exponential moving average (EMA) line

Hunting For Chart Pattern

The chart pattern that we are going to study here is taught to my students who attended my technical analysis class and is found very often in Singapore stocks. I am going to call it a ‘W’ formation because it does not really fit the description of more commonly encountered chart patterns. Its defining characteristics are:

  1. It is a continuation pattern and is excellent for making a long term investment on a fundamentally strong stock by buying its retracement (at temporary low).
  2. It is W-shaped but unlike the double bottom, it is not found at the bottom.
  3. On a daily chart, price travels above the 200-ema and retraces to touch the 200-ema twice thereby forming the ‘W’ shape.
  4. Each touch at the 200-ema can be an exact or near touch; a bullish candlestick pattern such as the morning star is formed.

The psychology behind this setup is this: the 200-ema is a line that is used by investors to signify long term trend. When price is above this line and the line is pointing up, the trend is up. In addition, the line itself provides the best value to buy in. Now when the ‘W’ pattern is formed, the two legs of the W shows price testing the line. Each time price bounces away, it is a sign that the market is enthusiastic and quickly buying in. I call this ‘base-building’ because when the W is completed, price has a good base to rally strongly.
The long term investor should buy in when there is a bullish candlestick at the second leg of W.

History Repeats Pretty Often

The strategy describe above is straight forward and effective. It meets the needs of long term investors who are patient enough to wait for a good signal for a fundamentally strong stock. There is no need to trade often and yet many such signals come up at just the right moment. Nevertheless, the W-shaped test-retest is not the only base-building pattern that investors can find. Investors who are curious can read up more on traditional chart patterns such as the ‘Cup-and-Handle’ and the ‘Double-Bottom’.

Soh Tiong Hum is a director with TerraSeeds Market Technician Pte Ltd (http://www.terraseeds.com). The creator of Forex Tflow® System, he trains many investors and traders on sophisticated trading strategies. He also works with trainers to develop learning programs on technical analysis for both corporate and retail clients. He can be reached at paperandpencil@terraseeds.com


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