Chart School: Learning to evaluate a stock's chart will improve your selling.

By Michael Cintolo, Chief Analyst, Cabot Growth Investor and Cabot Top Ten Trader
From Cabot Growth Investor, January 13, 2010

Year after year, one of the most frequently asked questions we get from subscribers is how to sell better. And we often reply, in one way or another, "Learn to evaluate a stock's chart." So today we're presenting a lesson on charts, with a focus on determining where a stock may be within its overall advance. Knowing this can help you realize when a stock may be living on borrowed time, and thus, can help you make better sell decisions.

Before we get into the lesson, we want to start with a reminder: Charts are very valuable, but in the market, there is no surety; you'll never know exactly where a stock is in its overall upmove (or downmove). Nevertheless, recognizing repeating patterns can help put the odds in your favor.

Using some weekly charts, we want to illustrate the difference between three scenarios. The first is illustrated by (AMZN), a Model Portfolio stock. While the stock had a big run from its lows, notice how it really didn't do much of anything from late April (when it hit 85) through late October (when it was trading in the low 90s). But then the firm blew away earnings estimates, and the stock gapped to new all-time highs on huge volume.

After that breakout, AMZN advanced as high as 145 in early December. At that point, it was extended to the upside in the short-term; it was 26% above its 50-day moving average! However, longer-term, the stock was really just a few weeks into its advance. Thus, it was fair to expect near-term weakness, but higher prices over time. So far, we've seen that near-term consolidation (AMZN is nearly six weeks into a consolidation), but we remain optimistic higher prices are to come, especially if its earnings report proves terrific.

Backing up to early December, you could have sold a little AMZN in the 135-145 area, thinking a pause was overdue. But with the stock likely early in its advance, you'd want to keep most of your shares, and you could even add a small amount should the stock break out from here.

The next chart to examine is that of (CTRP), the so-called Expedia (or Priceline) of China. The stock had a long advance without much consolidation, with a few weeks of sideways action here and there, but nothing as long as was seen in Amazon. Thus, longer-term, we would say that Ctrip is extended or "later stage"—a lot of buying pressures have already been exhausted pushing CTRP nearly straight up during the past many months.

Yet, in the shorter-term, CTRP is constructing a new, relatively tight launching pad. So this would be an example of a stock that's probably in the later innings of its intermediate-term advance but could be setting up for another run higher. If you own it, CTRP would be a stock to hold, and possibly even buy more of if it decisively breaks out on the upside. But you should also be watching closely for a breakdown (which may be happening now), which would signal it's time to abandon ship.

The third example is that of Cree Inc. (CREE).  We'd consider this stock  to be both short- and long-term extended to the upside—not only has it enjoyed a big move for many months, but it's also moved sharply higher in recent weeks. How should you handle CREE? We suggest you lean against the wind somewhat; you might book some profit ahead of its earnings report (January 19), or sit tight for now, but look to sell on any spike higher, which would really put the stock out of trend. Again, you're simply playing the odds-maybe CREE will just move sideways and eventually continue higher.  But another quick run-up would likely provide a good time to take some profits.

The moral of the story is that you can often use charts to determine what inning of the ballgame a stock is in; some could be near a short-term exhaustion point, but still OK longer-term, while others are stretched far from any recent consolidation and could be ready for a multi-week rest.  And knowing that can give you more insight on whether it's better to sit tight, or to sell some (or all) your shares to lock in gains.

(To view the charts mentioned above, log into the Cabot Growth Investor member section to view the January 13, 2010 issue.)

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