Investing in Tech Stocks: The Classic Technical Analysis
by Patrick Oberhaensli, on Dec 7, 2020 3:08:00 PM
Investors can easily observe three things about technology stocks: they are strongly impacted by their mega-caps (especially nowadays), they are volatile, and they follow trends. In this article, we will go a step further and show some of the classic technical analysis approaches to actively invest in tech stocks (as opposed to investing passively).
Identifying a Key Trend Reversal
Spotting the newest tech stock climax (at least potentially) can be seen when identifying a radical trend reversal. For example, on September 2, 2020 the S&P 500 index exhibited a high climax at 3’588.11 (its daily high) and the NASDAQ actually had the same pattern on the very same day at 12’074.06. A high such as this comes with an acceleration of the up-move and is almost immediately followed by a fast loss (a retracement).
Since a climax signals a reversal pattern, the active investor would have positioned for this (an expected loss). This type of active position requires investors to use attentive monitoring considering the possibility that the climax might be a false signal, a whipsaw.
We saw the opposite climax happen before, on March 23, 2020 the NASDAQ had a low level of 6’631.42 while the index closed at 6’860.67 that day (which represents the same-day recovery typical of such a low climax). From that point forward, a massive rally took place over the course of a few months and ultimately lead to a new absolute high record for the index. That was clearly a (low) climax. Although no one knows it for sure… we will only know for certain afterwards.
Now, an active approach may actually integrate the climax as an additional element. The more common basis being trend following associated with moving averages…
Moving Averages Technique
The following summary shows how moving averages can be used when investing with trends. Let’s consider a scenario where the investor applied a 50-day Simple Moving Average (SMA) on the NASDAQ index in a long or out of the market approach and therefore did not take any short positions. While investors have the freedom to select the number of days to set as the parameter of the SMA, we selected 50 days based on the typically observed movements of the index. Although the following shows a typical scenario, it should be kept in mind that variations are possible, especially regarding precise entry and exit points and the use or not of closing prices.
With a 50-day SMA on the NASDAQ index we find the following:
- Long position: from the 11th of October 2019 to 24th of February 2020 => +14.4%
- Long but it is a false signal: from the 14th to the 21st of April 2020 => -3.0% (a loss)
- Long: from the 22nd of April 2020 to the 8th of September 2020 => 27.7%
- In between: a rather neutral performance
- Long: from the 28th of September 2020 to the 9th of October but there is no sell signal there (yet as of the 12th of October 2020) => +4.2%
Of course, the results are dependent on the period which in this case the index was trending up. However, there was the significant exception of February-March 2020 where this SMA technique would actually not have strayed but also would not have allowed investors to benefit from the opportunity (due to the "out" position).
The one-month flash crash of February-March 2020 shows the key characteristic of the use of moving averages for trend identification: traders who get into the market late in the trend and late out of the trend. The optimal position would have been to leave the market on the 19th of February instead of the 24th and get back in the market on the 23rd of March (marking the end of the crash) instead of the 22nd of April.
In Fact, the NASDAQ index has been a trending index (signaling trends that are up and down) since at least the 70’s (the NASDAQ was created in February 1971). It is actually a master-up-trending market which covers decades! But investors must be aware that the down moves are often very rapid and large; in other words, it's necessary to apply any adapted approach, such as technical analysis, with a strong discipline.
We clearly see that by applying classic technical analysis approaches to diversified tech stocks, traders can improve the risk-adjusted performance of their investment portfolio. Of course, the ability to use short positions is essential in a truly active approach. In the last article of our tech stocks investment series, we will consider an innovative approach that allows investors to bring the beta close to zero.
EVOLIDS FINANCE LLC, Disclaimer:
- This content is not intended to be a solicitation nor an offer
- The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible