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Deemer Chapter 6

Deemer Chapter 6

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Published by ritholtz

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Published by: ritholtz on Mar 22, 2012
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11/02/2012

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C
H A P T E R
 
6
 
T
HE
I
MPORTANCE OF
 
C
HARTS
 — 
A
V
ISUAL
 
C
ON
fl
UENCE OF
P
RICE
,
 
T
IME
,
 
AND
E
MOTION
 
Why Charts?
 
Which conveys more information about a specific oak tree, apicture of the tree or a 1,000-word description? Now supposethat you have just five seconds to assimilate the information.
 
According to an old Chinese proverb, a picture is worth1,000 words. To which I add: A chart is worth 1,000numbers. A chart takes a jumble of numbers and makesthem workable, and your mind makes visual connections thatare not apparent in a list of numbers.
 
Remember, the primary number to chart is
stock price 
,which is in constant fl ux. Each price is set where the supply andde-mand lines meet, where willing buyers meet willing sellers.Each time a buyer and a seller meet, the price can be different
 
81
 
 
D
EEMER ON
T
ECHNICAL
A
NALYSIS
 
from the last. It can go up and go down. You track thatchange in price
 — 
that junction of supply and demand.
 
So the static number
 — 
the price on any given day
 — 
is notas important as the direction and rate of change. And chartslet you understand them much, much more easily thanlooking at a list of numbers.
 
When charting, always remember two things: KISS and
the 90/10 rule. KISS, of course, stands for “Keep It Simple,Stupid.”
The 90/10 rule, meanwhile, states that you can get90 percent of the information from something in about 10percent of the time, but it takes the remaining 90 percent of the time to get the remaining 10 percent of the information.
 
A Basic Chart
 
Befo
re we go any further, let’s defi ne the elements of a basic
chart. Figure 6-1 is a daily chart that shows the emerging-markets exchange-traded fund (EEM) from July 2008through April 2009 and is from the invaluableDecisionPoint.com site that I use regularly.
 
The most basic thing on the chart, of course, is the priceitself. Since this is a daily chart, each vertical line or bardepicts the trading for a particular day. The high and lowprices each day are connected with a vertical line, and theclosing price is represented by a little cross-tick.
 
The solid line on the price chart is a moving average. Thisone happens to be a 50-day exponentially smoothed movingaverage, but there are many, many different moving averagesin use among market technicians. Moving averages are used
 
82
 
 
T
HE
I
MPORTANCE OF
C
HARTS
 
Figure 6-1: A Basic Chart.
 
Chart courtesy of DecisionPoint.com 
 
to measure both trends and momentum. If the stock price is
above its moving average, it’s in an uptrend, and if it’s belowthe moving average, it’s in a downtrend. In addition, if the
price is above the moving average and moving further andfurther above it, the stock is gaining momentum, whereas if the price is above the moving average but getting closer andcloser to it, the stock is losing momentum.
 
The same works in reverse, of course, when the stock is be-low the moving average. In addition, if the stock price is way,
way above the moving average (over 30 percent, let’s say), it’s
overbought
 — 
extended on the upside
 — 
which makes it vulner-able to at least a short-term correction. The opposite is true if 
 
83
 

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