Penn Wealth Publishing

2020.05.17 Penn Wealth Report Vol 8 Issue 03

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10 penn wealth Report voluMe 8 issue 03 17 May 2020 Copyright 2020. All Rights Reserved. investMent intelligence You go in to see your primary care physician due to some pain in your shoulder. After peppering you with a litany of questions about your symptoms, the doc tells you that an operation is required. You sheepishly ask, "Don't you want to look at an x-ray first?" Apply this scenario to investing. You can—and should—scour a company's financials, weigh its products and services, rate its management, and con- sider any number of other fundamental questions before taking a position. But an evaluation of the charts should always take place before any investment is made. is disconnect—reviewing the funda- mentals of a company but not the technicals of the stock—has led many investors down a financial rab- bit hole, only to see the light once their position has dropped dramatically. Many tend to shy away from technical analysis due to its convoluted and seemingly complex nature, but taken in bits and pieces, this analysis can be greatly simplified, and should become an important diagnostic tool in your financial workshop. With the goal of understanding how to read a chart, let's begin with one of the most basic of patterns: the cup with handle. What can the Cup with Handle tell us about a stock? Certain patterns have a tendency to repeat themselves time after time on the charts of various investments, from stocks to commodities to indexes, and these patterns can portend what is to follow. One of the most common is the cup with handle pattern. Just as anyone familiar with basic astronomy could immediately identify patterns in the sky such as the Big Dipper, with a little practice an investor can look at a stock chart and see a cup with handle pattern. Like the name implies, the shape resembles a tea cup with a little handle on the right side. Certain condi- tions must exist, however, before this pattern can be confirmed. When we think of the role emotions play in the stock market, we may think of fundamental analysis. But the cup with handle pattern is all about investor sentiment and emotions, beginning with the great run-up to the pattern. Before the left side of the cup takes shape, there should be a 25% or greater uptrend in share price, accompanied by improving relative strength and nice volume. en, a selloff begins, with shares falling anywhere between 15% and 33% from their high. At its trough, average investors are busy throwing in the towel while institutional investors begin slowly building new positions, eventually forming the right side of the cup's structure. As the share price gets back up to near where it was at the beginning of the selloff, less committed shareholders who may have bought in near the end of the prior run-up will often sell their shares to cut their losses. is action forms the cup's handle, which should transpire over a period of at least five trading sessions but generally last no longer than a month, occur with light volume (meaning big shareholders aren't selling), and not push the handle down below the halfway point in the cup. As for the entry point, this can be pinpointed by drawing an imaginary line straight across from the top of the cup's right side, which is the start of the handle. e pattern has been confirmed, and another nice uptrend in the share price will likely take place. What is the duration of a typical Cup with Handle? A cup with handle may form within a period as short as a few months, or it may take shape over the course of a year or longer—while most develop within three to six months. At the bottom of the cup, we are look- ing for a nice, slow "U" shape to form rather than a rapid "V," meaning the process takes some time. Also, the pattern should look like a cup, not a beer mug (my go-to reference for most everything). is means that the bottom shouldn't be excessively deep. A typical pattern will go down 12-15%, but gener- ally not more than one-third of the price should be lobbed off from the top. e cup with handle pattern can be a power- ful tool to help time your entry into an investment. However, if the other metrics aren't flashing green, stay away! Look for rising earnings, good relative strength (RS), and strong institutional ownership. Your discipline will separate you from the pack. Fundamental analysis is the first step in identifying a potential investment, but always listen to what the charts are saying with respect to timing entry. Technical Analysis Analyzing a Cup with Handle Pattern to Mark Entry Position A deeper discussion of the cup with han- dle pattern can be found in the book How to Make Money in Stocks by William J. O'Neil. O'Neil, a master technician, is credited with first identifying and defining the pattern.

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