174 Investing like a Professional
How to Read Charts like an Expert and Improve Your Stock Selection and Timing
ued the display and discussion of certain of these predepression era,
failure-prone price patterns.
Triple bottoms and head-and-shoulder bottoms are also structures
widely mentioned in several books on technical analysis. These we have
found to be weaker structures. A head-and-shoulders bottom may suc-
ceed in a few instances, but it has no strong prior uptrend, which is a
necessary element for most powerful market leaders.
While head-and-shoulder bottoms are not as sound as previous writers
have claimed, head-and-shoulder top price structures are one of the
more reliable price patterns signifying a top in a stock. But be careful—
with just a little knowledge of charts, you can misinterpret what is a cor-
rect head-and-shoulders top. Many professionals do not properly inter-
pret the price structure.
Head-and-shoulders top price pattern
A triple bottom is a looser, weaker, and less-attractive base pattern
than a double bottom because the stock corrects and falls back sharply
to its absolute low three different times rather than twice, as with a dou-
ble bottom, or one time, as in the strong cup with handle.
Look for Volume Dry Ups
Near Lows of a Price Pattern
Nearly all proper bases will show a dramatic volume dry up for one or
two weeks along the very low of the base pattern and in the low area of
the handle. This means that all of the selling has dried up and there is
no more stock coming into the marketplace. Healthy stocks under accu-
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mulation almost always show this symptom. The combination of tight-
ness in prices (daily or weekly price closes being very near each other)
and dried-up volume is generally quite constructive.
How to Use Relative Strength
Correctly
Many fundamental security analysts think technical analysis means buy-
ing stocks with the strongest relative strength.
You do not buy stocks that show the highest relative price strength on
some list of best performers. You buy stocks that are performing rela-
tively stronger than the general market just as they are beginning to
emerge from a sound base-building period. The time to begin selling is
when the stock advances in price rapidly, is extended materially from its
base, and is showing extremely high relative strength.
Analysts have a great deal to leam if they believe all diat technical research
amounts to is the buying of high relative strength momentum stocks.
What Is Overhead Supply?
A critically important concept to learn in analyzing price movements is
the principle of overhead supply. It is really quite simple. If a stock
advances from $25 to $40, then declines back to $30, most of the people
who bought late in the upper $30s and at $40 will have a loss in the stock
unless they were quick to sell and cut their loss (which most people don't
do). Therefore, if the stock later increases in price back to the high $30s
or $40 area, all the investors that had losses can now get out even.
Human nature is pretty much the same most of the time. So it is nor-
mal that a number of these people will sell when they see a chance to
get their money back after having been down a significant amount.
Good chartists (a typically tiny group of investors) know how to rec-
ognize the price areas that represent heavy overhead supply. They will
never make the fatal mistake of buying a stock that has a large recent
amount of overhead supply. This is one type of serious mistake many
inexperienced fundamental analysts tend to make.
On the other hand, if a stock is able to fight its way through all its
overhead supply, it may be safer to buy even though the price is a little
higher because the stock proved itself to have sufficient demand to
absorb the concentrated supply zone. Of course, a stock that has just
broken out into new high ground for the first time has no overhead
supply to contend with, which adds to its appeal.