The Mac Observer: The Apple Trader – Every Picture, Or Chart, Tells A Story, Including Apple’s

Technical analysis (TA) is the fine art of predicting the future price motion of a stock by analyzing the stock’s price and volume chart. Sometimes it’s called visual analysis; sometimes it’s called voodoo.

Many investors make light of the arcane science of technical analysis. That’s understandable because most sources on TA never explain the actual activities of investors and traders that account for the pretty little chart formations. Most of the time the ‘chartists’, as TA geeks are called, merely label a formation with little arrows pointing to buy or sell points.

Stock, options and futures traders are time constrained and it’s enough to know what the patterns looks like to turn a profit. Contemplating the market mechanics and psychology behind the charts seems to make little difference to successful trading.

Without the story of the trading activity underlying the charts, TA appears to the uninitiated to have about as much validity as tea leaf reading. Of course, the big mutual and hedge funds know different, but they don’t believe it’s in their interest to advertise that they regularly consult in-house technical forecasters.

So, I’m going to tell you about a formation I see unfolding in Apple’s chart pattern because I intend to trade on it. Moreover, I’m going to attempt a full explanation of what is going on in the market to produce the pattern.

First, please note that TA can only indicate probabilities so nothing is ever a sure thing. Much depends on the news from Cupertino and whether the schizophrenic stock market can avoid a breakdown. But setting aside for the moment those two admittedly crucial variables, the price movements of AAPL seem to be trying to tell us something.

Condensed within a simple daily chart of AAPL is the combined judgment of thousands of investors. Stock charts are the most powerful tool a trader has. In fact, while fundamental analysis, (the study of a company’s financial history) is important as a foundation from which to evaluate a corporation’s long-term future, it’s less than half the battle in determining where the price will be in a few weeks or months. Knowing the short term direction of a stock is as important for investors scouting for pleasant entry or exit points as it is for traders.

The daily struggle on Wall Street is for a view of the future—that place we can never be but are always moving towards. Opinions about the future are the key to all stock motions and only by gazing into the graphic image of millions of shares in flux can anyone guess what that future might contain.

Fundamental analysis is based upon the patently false view that a stock has an intrinsic value that can be calculated by adding up assets, subtracting debt, multiply by the growth rate, etc., ad infinitum.

The problem with fundamental approach is that human beings, in all their glorious imperfection, ultimately buy and sell stocks. Thus we can witness a business like RealNetworks (RNWK) sport a price to earnings ratio of 2814 while their closest competitor, QuickTime, hasn’t contributed a nickel to Apple’s miserly PE ratio of 31.

It’s not particularly useful to assign a statistical price value to a stock. "The real value (of a stock certificate) is determined at any given time solely, definitely and inexorably by supply and demand." says TA guru, Robert Edwards. This single fact is probably the most important and counterintuitive point for beginning investors to grok.

Apple’s Ascending Triangle

AAPL’s chart pattern has traced a textbook example in the last few weeks of what technical analysts call an "ascending triangle".

I consulted that ancient tomb on the shelf of all serious traders, Technical Analysis of Stock Trends by Robert Edwards and John Magee, to discover how these old school masters describe this well known sign of an impending break out to the upside.

Edwards and Magee call the relatively flat top line of the triangle (at about $119) the Supply Line because this is where the supply of AAPL shares have consistently overwhelmed demand and pushed the stock lower.

Apparently a group of investors, who are most likely totally unaware of each other’s activities, have decided to "distribute" their shares of AAPL whenever the stock gets close to $120. No conspiracy theory is needed to explain this coincidence. Wall Street types tend to think alike, they read the same newspapers and attended the same schools. Edward and Magee call this group of investors the "distribution pool." For whatever reason they feel that at $118 to $120 it’s time to take profit in AAPL and move on.

The ascending triangle’s bottom line is formed by other investors who are absorbing the shares the distributing pool is dumping at the supply line. Each decline is becoming shallower because demand is building while the supply of shares the distributing pool has to sell is finite and shrinking.

In the words of Edwards and Magee:

Once the supply has all been absorbed, the market will advance rapidly and easily. As soon as prices break out above (the supply line), those who took over the supply at that figure will feel their judgment has been vindicated and will not be disposed to sell until they, in turn, can register a good profit.

The crux of the matter is, of course, contained in the two preceding sentences. Demand must continue to come in at higher and higher levels; otherwise our formation will cease to be an Ascending Triangle. And the overhead supply must eventually be absorbed, permitting an upside breakout. If demand begins to falter any time before the Supply Line has been broken through, the ensuing reaction may drop prices down ‘out of pattern’, and then the chart technician is faced with the necessity of revising his chart picture.

One might think that such a development, blasting the earlier promise of the chart, would occur fairly often, but, as a matter of experience, it is surprisingly rare. We say "surprisingly" because it is obvious that in many cases of Ascending triangle development, the group whose selling creates its Top boundary or Supply line must believe that level to be just as high as the stock has any right to go. As holders of a large enough block to influence the market for several weeks, and sometimes for months, their judgment is hardly to be scorned.

And finally the kicker,

Yet, once it becomes evident that the lower boundary or Demand line is slanting up, the odds are certainly somewhere in the neighborhood of 9-1 that new buyers will eventually have the best of it.

Volume of shares traded is often very significant in determining a chart’s formation. AAPL’s volume is behaving perfectly for the ascending triangle formation. Once again, Edwards and Magee, "Activity (volume) tends to lessen as prices moves out towards the apex. In the Ascending Formation, there will usually be a pick up on each rally and an ebb in turnover on each decline within the pattern."

As you can see the AAPL demand line is definitely slanting up and could be only days away from a break out above $119. Edwards and Magee warn, "Do not forget the important qualification that the Triangle has somehow lost a part of its potential strength if the breakout is delayed until the prices are crowded into the apex."

Hmmm. The "somehow" part has a bit of voodoo ring to it, I’ll admit. But the rest is the type of common sense study of supply and demand that rings true.

The only question is can AAPL muster the demand to break out at this time? It seems like some current event catalyst is needed to keep that up trending demand line from flattening out. Moreover, without the broader market’s cooperation Apple’s little ascending triangle will rapidly become a not so significant ‘bull flag‘.

This would be an ideal time for Apple to lay some hyped news on the market; something designed to feed into a momentum trader’s vivid imagination. Or a wily analyst could make him/herself look rather clever by announcing a target price upgrade on Apple with a strong buy recommendation. Either, or both, are likely to happen this week.

Edwards and Magee recommend caution. They would wait for the break out above the supply line before buying into an ascending triangle. Of course, they traded in a time before the modern electronic markets and hyper volatility we see today.

As a final point, many TA experts use the base of the triangle to determine how far a stock will rise after the break out before reaching the next consolidation pattern. Not only that, but the rate of price increases will approximate the previous uptrend’s angle of ascent. In Apple’s case, this criterion would put AAPL at about $145 well before MACWORLD rolls back around in July.

Is TA voodoo or does every picture tell a story? One real world test case doesn’t make a study. Nevertheless, we’ll be watching closely to see how this awesome prediction plays out!

Your comments are welcomed.