Education & Information
Major Trends
Supply in Control
Characterized by
- Strong sell signals beneath the bearish resistance line
- Weak buy signals beneath the bearish resistance line
- Mostly lower columns of Xs and Os
- Balance patterns broken by supply winning the battle
The chart on the previous page is an example of a point & figure chart showing supply in control of the major trend. It is characterized by generally lower columns of Xs and lower columns of Os. Remember, the Xs represent demand and the Os represent supply. The lower columns of both Xs and Os indicate supply continues to control trading while demand is weak. This major trend is in force only when the stock is trading below the bearish resistance line.
Stocks that have supply controlling the major trend will often times make strong declines, consolidate that decline, then make another strong decline. The cycle could repeat itself several times before the trend is finally over. The strong declines are characterized by lower columns of Xs and Os. Usually, there will be multiple double bottom sell signals during this phase of the decline. In the chart above, you can see this pattern on two different occasions. First when the stock declines from the low $20’s down to $8 and again when it declines from $14 down to $3.50. Notice how, with few short exceptions, the columns of Os decline below the previous columns and the columns of Xs are mostly lower than the previous columns of Xs. This phase represents supply is much stronger than demand.
There are a couple of brief periods in which the general decline appears to temporarily stop. When the stock first drops to $14 we see the columns of Os stop declining. In fact, there are three columns of Os that stop right at $14. This indicates the demand for the stock at $14 is now a little stronger as more investors are buying as the price has declined from $23. The P&F chart has entered a balance pattern. As the supply and demand have somewhat equal strength at this time.
Once a stock enters a balancing pattern one of two events will eventually happen. Either, all the supply that pushed the stock lower has been exhausted and the demand will persist. As the supply fades it’s like taking the lid off the stock and the demand will push it higher. You will then see a column of Xs exceed the previous columns of Xs in the balancing pattern. You will also see the Xs penetrate the bearish resistance line and the main trend will then be up with demand controlling the action. The balance pattern is a battle between supply and demand. In this scenario demand has won the battle. In the chart above, we do see a column of Xs exceed a previous column of Xs giving a buy signal on the chart. This is the column that advances to $18. However, the bearish resistance line contains this advance and the shares begin declining again. Buy signals while the major trend is being controlled by supply are often weak and will be resisted at the bearish resistance line (hence the name of that trend line). Before concluding that a balancing pattern is broken and the major trend is changing, wait for the bearish resistance line to be penetrated.
The other potential scenario is the supply is not exhausted and is able to meet the demand until all the buyers in the $14 range have bought. If the demand gets washed out and the supply persists you will see the balance pattern broken by a lower column of Os. On the chart above, that happens when the stock is finally able to decline to the $13.50 level breaking below the balance pattern. This action indicates the stock is likely to make another strong decline as removing the demand near $14 is similar to taking the floor out from beneath the price. See how the chart then goes into another strong decline down to $8. Supply is taking over once again.
Demand surfaces again in the stock at $8 meeting the supply. In fact, the stock begins to rise back up toward the bearish resistance line giving a couple of weak double top buy signals along the way. In this case, there wasn’t even a balancing pattern formed. It was pretty much straight down to $8 and straight up to $14.50. Sometimes you will see weak buy signals while the major trend is down. By weak we mean there is no follow through after a buy signal is given.
An investor looking at a position like this should not consider these buy signals as a chance to take a position in the stock unless they are short-term trading oriented investments. You would want to make sure you sell at the bearish resistance line. Longer-term investors should not attempt purchases in buy signals that occur below the bearish resistance line. In order for the major trend to change we need to first see a balancing pattern followed by a definitive break of that pattern to the upside and penetration of the bearish resistance line. The major trend will then be controlled by demand and long-term investors’ chances of being successful will be greatly increased. .
Many investors try to buy stocks at their lows. To us, this is a foolish strategy. Stocks tend to go to extremes, both on their way up and on their way down. I would like to have a dollar for every investor who thought Lucent was a good buy just because it was at its low when it dropped from $80 down to $50. Then it dropped to $40, $30, $20, etc… Finally it dropped below $1 as of this writing and its fate is unknown. You can make the same case for almost any other popular technology stock. If a bottom is in place, you will see it on the P&F chart as the balance pattern will be broken with a column of Xs exceeding the other Xs in the balance pattern, followed by a sure break of the bearish resistance line. Sure, you won’t buy the stock on its low, but you won’t get caught in a stock that is still in a major down trend.