Most people (myself included) are bullish on the markets: we buy stock and very seldomly short the market. But it would be foolish to believe that a stock (or market) will go up forever without pullbacks and the odd Bear Market.
It’s part of the game.
So whenever I buy an equity investment, I’m continually looking for signs of a trend reversal or when pullbacks become more of a correction. With every position, I’m thinking, “When will this leapfrog end?”
Take, for example, IJT. It’s a no brainer of a chart. Since 2003 this stock has only been going upwards. If I draw the trendline connecting the lows, it’s very easy to see the 3-plus year run. Drawing the support levels, it’s even easier to see how each pullback was buying opportunities, as the stock kept reaching upwards.
So what’s the bearish case here? Do you see “leapfrogs”? Leapfrogs are points when the stock touches the trendline and bounces upwards, and lands again at the trendline – like a frog.
The first jump was the strongest, from March 2003 to August 2004 (when it touches the trendline again). The leap was impressive!
Jump#2 went from August 2004 to August 2005 – again, a great price appreciation, but notice: the leapfrog wasn’t as strong as the previous jump. It’s becoming more like a stone skipping water, with each leap getting smaller and smaller than the former.
Finally, there’s the last jump in August 2005. While bullish, notice how the rise was not nearly as impressive as the previous two jumps. Remember, just because the jump was smaller, doesn’t mean we have to start panic selling – nothing bearish has occurred (as yet). I’m just keeping this information stored in my mind.
What do I do with this information?
There are two things I’m watching:
Firstly, I’m watching the two-year trendline. If the stock breaks this trendline, this would be a warning. Even price cracks the trendline, I’m not overly worried, because you can see something similar in 2003 when price broke the trendline and still went on a tremendous run (which we would have missed).
Breaking the trendline would be my first warning sign.
Second, (and in my opinion, a stronger warning sign) would be if price broke not only the trendline but also the support of the last low in February 2005.
That’s when I would have to evaluate if this trend is now officially over.