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The ABC’s of Reading Stock Charts

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"All advances are not created equal," says legendary chart guru Louise Yamada. This is important to remember, even if obvious, during what has been the largely indiscriminate rally of 2012. From Tech, to Energy, to Banks; if a stock has remotely decent fundamentals and it isn't overly defensive, it's probably higher in 2012.

It's enough to lull investors into a cozy, complacent sense that their diversified portfolio is full of nothing but winners destined to shoot higher for the balance of the year or even longer. Which makes this a perfect time to start "culling the herd" by taking some short-term gains where appropriate.

How can you separate the stocks likely to be rising with the bull market tide from those looking good for the longer term? Yamada gives us three basic patterns to look for to help decide if a particular name in this rally is a stock to stay long, take profits, or run and hide.

Yamada has guidance on how to let the charts be your guide. Her rules of thumb are easy as ABC, literally. She breaks up basic chart patterns into 3 categories.

A. All Stars

Charts rising above years of resistance with little in the name of headwinds.

MSFT (MSFT), Intel (INTC), and Qualcomm (QCOM) are her faves. The stocks have all broken above long, loooong, periods of range-bound trading and finally are breaking higher, suggesting anyone who was going to sell out of them already has.
The fact that they're all traditional NASDAQ names is no surprise. Tech stocks have spent a decade in the penalty box after the tech bubble. That kind of base means good things if or when resistance gives up the ghost.

As long as the uptrends don't break just hold the names and buy the dips.

B. Disappointments

These are stocks simply pushing into overhead and/or in danger of collapsing after sharp rallies. They may look good on the surface but there's nothing particular you'd want to be involved with for the long haul.

Names like Urban Outfitters (URBN) or Johnson Controls (JCI) made inspiring runs but couldn't get above resistance. In other words, long-term holders started taking gains on the rallies. For the newer buyers, these stocks tend to be traps; like buying a used car where the seller is more than happy to find a sucker to buy his damaged product.

C. Take the Money and Run

Sharp rallies straight into overhead resistance and showing few signs of recovery. The rallies here have looked impressive short-term but are still chopping along and seemed destined to do so for years. The tech sector is just breaking out of this kind of brutal range, making head fakes over prior resistance only to be battered lower over and over again.

Financial stocks (XLF) and the home builders (XHB) are the easiest examples. These bubbles popped roughly five years ago; which is nowhere near long enough to repair the damage that has been done. Rallies are to be taken by successful traders before long-suffering owners start dumping the names.

Are these perfect? Of course not, nothing is. Still, as the stock market starts pausing after a torrid run, now is when you step back and review your holdings as dispassionately as possible. The best way to do so is letting the charts be your guide.