Chart Smarts for Value Investors—The Line Where Bulls Get Tired By Lynn Carpenter  This is it. The Narnia of trend lines is chronicled to its happy end right here. We are in the final installment today. We’ve covered three of the four major trend lines.
There’s a world more that could be said about reading charts, but we’ll have mercy on the folks who cringe every time they see an article with a chart and some doodles drawn on it. The trend lines are basic and if you ever squint at a price chart trying to figure out what it means, this is the one thing you can learn most easily that will give you the most help understanding the information a chart has for you. We started with bull support three weeks ago. Today we end with its running mate—bull resistance. To refresh: the support line goes under prices to prop them up. This bull resistance travels above the peaks in a bullish (rising) stock to keep prices in bounds. “Bull resistance” sounds like an oxymoron, doesn’t it? Bulls like rising stocks so much that the higher and faster a stock rises, the more the bulls are inclined to pour in. Resistance, on the other hand, implies the opposite mindset, an aversion to buying. Yet if you put those notions together, you will get a line that follows the waves of serial enthusiasm that bullish stocks often travel. You might say that this line is formed—not by bulls in general—but by different herds of bulls. The first thrust of buying and the first peak is apt to come from the so-called smart money—the people who smell out new ideas early. This is often institutions, large investors and industry insiders. Once these buyers have all they want, the price drops back as their demand tapers off. After that, the buying catches the attention of more people, especially speculators and traders who follow trends. And a new set of bulls comes into the pasture. The momentum “investors” are likely to get in the stock now because they follow price action avidly. When this bunch has loaded up and bought all they desire, the price backs down once more. But now, the wider media have made note of this wonderful stock, and people who are neither insiders, institutions or other early movers, nor pure trend followers begin to hear stories about the stock. They think it sounds good. That little dip when the last bunch of bulls quit, looks like a good buying opportunity. Surely all those people who pushed the stock up so far must have known something? And yet another wave of bulls begins yet another push. This is a simple three-wave story to explain the way a bull resistance line is formed. If cynicism were my style, I’d call the process smart money, clever money, dumb money. That oversimplifies, but it remains true that very often the last buyers are much less informed than the earlier ones and do not know it’s too late and the price is already too high. In a long-term trend, the process may go on for dozens of ups and downs. But you can still get a notion if you are at a dangerously high buying point by looking at the bull resistance line that exists at the time. By the way, I’ve mentioned in each of these articles that this series is chart smarts for investors. I’m assuming that you are also looking at the company and its quality, not just relying on charts alone. For investors, charts are a nice help, so let’s see what the bull resistance line can do for you. We’ll look at Steel Dynamics, a good case for why you should track the company as well, and not just the chart by itself when using bull resistance: 
Steel Dynamics makes basic steel products such as beams and structural steel, but it also processes and sells scrap metal. That scrap business has gotten more and more valuable with rising ore prices and is part of the reason for STLD’s upward trend. In fact, the stock has been on a bullish trend since 2002, as you can see on the monthly chart below: 
In both of these charts, we have the same problem/challenge—where to fit the line. We can tell where to start, you choose the first significant peak after the stock makes its low. Of course, that’s not easy. You only know a low point is either a bottom or a significant low after the stock has gone up again and then backed down at least once without going back to its old low. It’s one of those things that is only visible in hindsight. But if you get that starting point ironed out, you are constantly coming to a situation like the one both of these charts show at today’s price. Up to this point, on both the weekly and monthly charts, the trend line has a nice fit. The line touches peaks in the price chart in multiple places and comes close additional times. Everything was behaving nicely until the middle of March. Then the stock did not “respect” its bullish resistance trend line. It went above it. INTERNAL ENDORSEMENT Winners Cherry Pick!
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| Do you call it a breakout and redraw it as I showed with the dotted yellow line on the first chart? Or do you consider that price has gone too far and stay away? This is a quandary if you are looking at a bullish stock for a nice place to get in. If you don’t buy today and a new, higher trend line really has begun, you might miss something. If you get in at the top, though, you might wish you’d missed it. Don’t bite your nails over this. The line has done its job. You are warned to look and be careful before rushing in to buy. And that’s enough. This is one trend line I would always heed as a warning to be careful if I were considering a buy, but I’d still base my decision on the stock. For instance, this is how the thought process would go for me: “Steel Dynamics is a great company, very profitable. It rose again suddenly this week when scrap steel prices set new highs. That’s good. But at the moment, the stock looks overpriced to me. It’s going for a P/E ratio of 18, which is high for a steel mill of this type. This stock’s comfort P/E range is 8-12. In addition, analysts are not expecting earnings to rise much next year, except for an increase caused solely by acquiring another company. The company isn’t saying differently. That’s another reason not to buy at this high price.” Sure, analysts are wrong in their penny estimates all the time, but they are often right about direction. Putting this line together with the stock’s fundamentals tells me it’s risky. This company is not in the high-value-added end of the steel business. It fabricates structural steel and beams. It doesn’t do high-tech alloys or specialty finishes. The other part of its business is scrap, and while it can now sell that material at a higher price, it must also pay more to acquire those old fenders and girders it resells. But suppose you don’t agree with my analysis and you still think this is a great company (you could be right). This is a good case for a stop loss. In fact, you can even use a bull support line to set it—though with Steel Dynamics, you’d suffer a big setback before you get to it. So, let’s take a better case. 
Here you have a beautiful bull support line running almost perfectly parallel to the bull resistance line for Gilead Sciences. You can use a break through bull support for your exit point and set your stop loss at $41. Or, for less risk, you could use a shorter-term bull support line—the yellow line I drew. This is still a significant chunk of trend, since this is a weekly price chart. The yellow line would suggest a stop loss at $45. Now you can take your fling even though Gilead is all the way up to its bull resistance line with very little risk. The $45 stop is just 14% below the current price. In addition to keeping you from going crazy when a stock is getting too high, the bull resistance is useful at keeping panic away and it can be helpful when you are holding a stock… Look at the Gilead chart again. Notice that in October last year, the stock kept hitting the resistance line and backing off. Some investors were no doubt already seeing a ghostly head and shoulders pattern threatening an imminent breakdown in the stock. Watching three peaks in a row fail to move the stock much higher would have convinced many people that the stock was finished. It wasn’t. It was only respecting its bull resistance. The basic trend was still rising. After backing off three times, Gilead gathered strength and made a much stronger and higher move from February to April. So if you own a stock that keeps backing down, relax if you can see that it’s only hitting its bull resistance. There’s some profit taking going on at the new highs. Nothing serious has gone wrong as long as it’s still above its bull support as Gilead is. To sum up: - Use the bull resistance line to be cautious about buying at high points that touch or break the line. Evaluate the stock extra carefully.
- Relax if you own a stock that falls back a bit from the bull resistance line as it hits new highs; it’s normal profit taking in most cases.
- And don’t over interpret – bull resistance lines were made to be broken by great stocks.
That’s as far as we’re going to travel in this series. I am writing a special report with more examples and some extra tips and guidelines for your personal use if you want to know more. But we’ll spare the folks who’ve had enough. Send your questions and comments on charting trends so I can address it in the special report. I’ll let you know when it’s ready. Have fun with lines. Respectfully, Lynn Carpenter P.S. To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com. First there Were the Beatles…. By Lynn Carpenter England has its own mortgage and housing market problems, for all the attention we pay to U.S. woes as if they were unique. And I am surprised more American businesses haven’t copied an obvious get-rich-quick idea growing from the crisis that is going strong in the U.K. It’s called “sale-and-rent-back.” The sale-and-rent-back companies, mostly small real estate speculators and landlords buy up distressed mortgages then rent the properties back to the former owners. The owners get a quick sale, the buyers get a valuable property (with a willing tenant in place) that pays income for now and will look like a steal a few years down the road. In fact, many of these deals are a steal from the start. The sale-and-rent-back companies generally buy the homes for around 60% to 70% of their values. Sometimes it’s less. In addition, they often have their own appraisers to estimate the market value in their favor. The loss to homeowners is steep. The average home put up for sale in the U.K. gets about 95% of its asking price—if the owner has the time and means to wait for the sale. Why would any homeowner go this route instead of selling on the open market at a better price? The sale-and-rent-back companies prey on people who need out quickly such as those facing foreclosure, those whose other bills are over their means, and those who want to stay where they are with no embarrassment. The deals can be done quickly and quietly. Will the idea cross the pond? All I can say is that the activity is fueled by private equity and hedge funds in the U.K. It gives hedge funds a whole new avenue to explore. INTERNAL ENDORSEMENT Just this Once BELIEVE THE HYPE! It was the email that shocked the investment world. One noted investment authority told his readers to take seven huge stock market gains on one day… SEVEN HUGE WINNERS on one day that ranged from 526% to 102%... seven, and on stocks… not options. But that was just the beginning! It now looks to be setting up to happen again this year, too. That’s why you must check out the whole story right here. | If you enjoy IDE's daily investing advice, you'll definitely be interested in checking out our sister publication, Early to Rise. Each morning, you'll get powerful wealth-building advice covering real estate, entrepreneurship, personal finance, marketing, and much more.
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