3 useful trends to pick the best stocks to buy

Trend patterns can help investors spot potential stock moves.

  • By Debbie Carlson,
  • U.S. News & World Report
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Looking at trend patterns on Wall Street can help investors on how to pick stocks.

A recent trend change that caught many people's attention was when the Treasury yield inverted and shorter-dated Treasury notes had a higher yield than longer-dated bonds. Normally yields rise for debt instruments that have a longer maturity. An inverted yield curve is often thought to signal that a recession might be near.

Markets trades in several ways. Continual rising prices are in uptrends, markets with continual falling prices are in downtrends. Those with fluctuating price movement with no clear direction are consolidating and preparing for the next trend, whether up or down.

With fluctuations in markets, here are a few ways investors can examine trends when it comes to buying stocks:

  • Momentum trend.
  • Trend lines.
  • Relative strength.

Momentum trend

Stocks with upward momentum make higher highs and higher lows, while downward trending stocks make lower highs and lower lows, says Dave Toth, a market insight senior analyst at R.J. O'Brien & Associates. While there are several momentum indicators out there, momentum can be easily spotted with the naked eye. The stronger the momentum, the more clearly defined a trend is on a chart. One stock with a strong upward momentum is Anglogold Ashanti (AU).

The key is when the rate of ascent slows, momentum starts to slow.

"Just like freight trains, momentum also slows," Toth says, and that's when investors should watch if the stock price falls through a corrective low, which is when a stock makes a low price but then rises to resume the uptrend.

A fall under a corrective low can break the trend, he says. An example of a stock that fell under a corrective low is Adtalem Global Education (ATGE), which had a sharp move lower when it broke through support around $47.50 and continued to fall through another support level just under $44. It is now near 52-week lows, with the August uptrend broken.

As trading days go by, data grows. If the stock price is going higher and the on-balance volume rises, that means more shares being traded on the up days than the down days, known as accumulation. When it comes to momentum indicators, Andrew Thrasher, portfolio manager for Financial Enhancement Group and founder of Thrasher Analytics, uses the average directional index, known as the ADX.

The ADX measures trend strength. It will rise when the trend is strong, whether prices are rising or falling. When the trend begins to weaken, the ADX will begin to decline, he says.

He uses it to confirm trends such as when the price rises or falls and the ADX rises. When those diverge, such as if the price rises and ADX falls, it might be a sign that the stock price will fall.

A past example is Apple (AAPL). In late September into October, Apple was attempting to make new highs, but the ADX was falling. This is also an example of how momentum begins to fall, the stock fell under its corrective low just above $200 made in August 2018. Apple, like many other stocks, swooned in the fourth quarter 2018 sell-off.

Trend lines

Trend line analysis can help investors visualize support and resistance price levels and give a clearer picture of a trend's momentum, says Jim Wyckoff, principal of Jim Wyckoff on the Markets, a trading advisory service.

To draw an upward trend line, draw a straight line up to the right along with a stock's successive reaction low prices, which is a low price that is lower than other low prices clustered together. Downward trend lines are drawn to the right along successive rally peaks. Because trend lines rise in time, Wyckoff watches to see whether or not a price breaks through the trend line to gauge if it's a sign of a trend change. A trend line breaks when prices either continue the trade through the trend line the next day or if the initial breakout is a significant difference.

A stock that showed a significant breakthrough in a trend line is Ulta Beauty (ULTA), which broke through a long term upward trend lines drawn off the 2018 low of around $192 and the December low of $224 when it fell about 30% last week.

An example of a stock that's holding well above its upward trend line is Fiserv (FISV). Traders could draw a trend line from its June low of $82.84 and its August low of $92.86. The stock is consolidating at a higher level right now, so investors should watch to see if it dips below about $102, where the trend sits now.

Moving averages are a common technical analysis tool, and they help to smooth out price fluctuations, Wyckoff says.

Thrasher says he also watches certain moving averages to see how well a stock trades around certain prices. Simple moving averages are calculated by adding the most recent closing price over several time periods. Two popular moving averages are the 50-day moving average and the 200-day moving average.

Stocks that touch those moving averages and bounce from are finding support.

“If a moving average breaks, then that can be telling because there’s no more demand at that level,” Thrasher says.

A stock near that recently touched its 50-day moving average is Starbucks (SBUX), which is very close to its Sept. 4 low of $93.03.

Relative strength

Bob Bacarella, founder and chairman of Monetta Financial Services, uses relative strength as a primary technical analysis indicator. Relative strength measures the price trend of an individual stock to the broader market.

If the S&P 500 (.SPX) is up 1% and a particular stock is up 1.2%, then you have a favorable outcome, Bacarella says. "If it's lagging the market, something might be going since it's not meeting overall consensus expectations."

Relative strength should be measured over an extended period such as a month or longer, rather than just a day or a week.

Relative strength compares one security to another, but it shouldn’t be confused with a common technical indicator, Relative Strength Index, known as RSI.

Technical analysts point out there is a difference between a stock’s relative strength, such as a stock that is making a 52-week high, such as Infosys (INFY), and the RSI, which measures the magnitude of a price move and whether the move up has gone on too long and is overbought, or if the downtrend is oversold.

While some technical analysts will look to the RSI to get a sense if a stock is overbought or oversold, many dismiss it unless the move is accompanied by a change in momentum or trend.

“Any market can sustain very frothy levels or very low levels indefinitely. It isn’t until there’s a momentum failure to break the trend because markets can just keep on keeping on,” Toth says.

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