Learning to listen to the market – the messages in the charts

Two days ago I warned that the direction of travel for Adobe shares was down with a danger of a further chart breakdown. Today after slightly disappointing results and the announcement of a $20bn acquisition for cash and shares the price is down by 16.4pc to a new bear market low.

It provides a vivid example of how treacherous this stock market still is. Bear markets keep going until they stop and that can be longer and deeper than anyone expects when they begin. There are lot of charts that look like Adobe before the breakdown including charts of the indices. For the moment we must assume that many consolidating shares will break down.

I think of charts as a way of listening to the stock market and letting it tell us where it is going to go. The future is a mystery. We all know that. I watched Chelsea play Salzburg in the Champions League yesterday evening. My son-in-law is a massive Chelsea supporter. Could anyone predict that the result was going to be a one-all draw? No, nobody could. Well, the stock market is like that; we don’t know what is going to happen just that millions of buy and sell decisions are going to make something happen.

But if we listen carefully to what the stock market is telling us we can make some educated guesses. First we can look at all my benchmarks looking for signs in the tea leaves, nothing esoteric, just ways of presenting the information about what is happening. In my case we can draw trend lines, plot the moving averages, look at Coppock indicators, tot up the number of strong performers v weak performers, draw the obvious conclusions from fundamentals like the trend in inflation and long-term interest rates. Then we can make some guesses about what is going to happen with sufficient probability of being right to use them to make money.

The first conclusion is that we are in a predominantly falling market, popularly known as a bear market. If the stock market was a river it is flowing with considerable force downhill so any share trying to rise is swimming against the current.

Second we can look at individual shares. We can assess them on the basis of the indicators used above but we can also stand back and look at the chart as I did two days ago with the chart for Adobe. I said the shares were consolidating but given what was happening on the Adobe chart and elsewhere the direction of travel was down and the shares were likely to break down from the latest consolidation.

So it has proved and as I write today the shares are down sharply. It is not rocket science it is common sense and sensible chart reading. I have been reading charts for many years, going back to the early 1960s. There may not be any reason why they should work but my experience is that they do.

I remember going to work for an Australian stock broker in the late 1960s when what was known as the Poseidon nickel boom was raging. There was no rule against buying shares so shortly after I joined the firm I bought some shares, using a chart which I had painfully drawn myself. Two days after I bought the shares they doubled. It was like Einstein had arrived in their midst. My amazed colleagues treated me with great respect after that achievement and watched carefully what I did.

You would think it was harder now because chart use is so widespread but there are at least two reasons why they still work. One, is that many people don’t use charts or at least give far more weight to fundamentals, whereas my mix has shifted to 20pc fundamentals and 80pc charts or fundamentals for choosing and charts for timing.

The second is that we all use different chart teechniques. I have my own proprietary indicators which I have used for years and learned to read with the emphasis on signals that are obvious rather than dependent on arcane calculations. The second and even more important factor is that my time horizon is much longer that that of most participants in the markets. There are people out there, including all day traders, using charts plotted hourly or even in intervals measured in minutes. My charts are plotted monthly. I am not looking to profit from share price fluctuations. I am looking for multiyear moves which helps me because if I don’t like the market I stay out.

At least that is not quite true. If I don’t like the market, as now, I have periodic little nibbles and if I keep losing that reminds me that we are in a bear market. As I write my latest nibbles are winning so we will see how that goes. Just so you know I don’t do things I don’t tell you about. Read my alerts and you will have an excellent idea of what I am doing.

Strategy

Microsoft is an excellent proxy for the technology revolution with a finger in so many pies and a hugely powerful brand name. It is obviously a great company, one of the greatest on the planet. But charts have no respect. This chart shows a share heading lower. Like Adobe it has formed a consolidation. The odds must favour that a further breakdown is coming and even if it isn’t we need to be cautious while the Coppock indicator is in free fall and not yet quite negative.

I have just been reading the latest results from Microsoft, published on 27 July, and it was all systems go. It is incredible that such a large business can be growing so strongly on so many fronts but from a timing point of view the charts are still saying – watch out.

There will be good times again; just not now.