Sponsored

What the simple beauty of technical analysis tells us about the tech stock bubble

The Nasdaq stock index is in an almighty bull market and may well be overvalued. But it could also go much higher. How does an investor decide what to do? Just trust in technical analysis, says Dominic Frisby.

“Oh, my goodness, the Nasdaq won’t stop going up. You’re missing out on one of the great bull markets of our lifetime if you’re not long on this one. It’s Covid-19, stupid! It’s made us use tech all the more. Google, Facebook, Amazon, Netflix – Covid has accelerated their adoption and that’s why they are going up.”

Then again… “The Nasdaq’s an almighty bubble. Prices bear no relation to earnings. Just half a dozen stocks account for more than 50% of the index. It’s way too geared. It’s going to crash.”

What’s an investor to do? That’s why I like technical analysis.

The Nasdaq might well be overvalued and it might also go a lot higher

Both of the above arguments about the US Nasdaq stockmarket index are almost certainly true.

The Nasdaq is in an almighty bull market. Forget your V-shaped recovery. It has recovered, “V-d”, then exploded higher. Every day seems to bring another new high. And new highs lead to more new highs.

Tech stocks are so scalable. Why can we not reach the point at which 90% or more of the world’s population are using Google, Facebook, Amazon and Netflix? This enormous potential is reflected in their share prices.

And yet prices bear no relation to earnings. Tesla in particular is like a cult. It’s one of the greatest promotions mankind has ever seen. One day it is going to go belly up – manias don’t end well. So we use technical analysis. We find a trend, buy, ride the trend, and when the trend ends we get out. Technical analysis is our means.

It can be as simple as you want it to be. Just draw some lines on a chart. If the market is rising, draw them below the price. Find two or three lows, and draw the lines off those. If the market is falling, draw the lines above the price, off two or three highs. As long as the market stays above your trend line, you stay long. If the market is below your trend line, either be short – or just stay out of the market.

You place your stops below the line (or above if you’re short). But give yourself a bit of margin. Sometimes the price will violate the line, but then the uptrend will resume. If you do get stopped out and the uptrend resumes, so be it. Just go long again.

How technical analysis can cut through the arguments over fundamentals

Here we see the Nasdaq over the past year.

You were long. Then the trend line broke in February. You got stopped out. In March the downtrend broke, so you went long again. That uptrend broke in April-May. If you were running tight stops, you got stopped out. If not, you held on for the resumption of the trend.

This resumption has left a very clear trend in place. As long as the Nasdaq stays above that line, you can be long. That is all you need to know.

You can leave the worrying about bubbles; the worrying about prices not reflecting earnings; the worrying about missing out on the bull run, cult-like followings, and all the rest of it to some other guy. Above the red line, I’m in. Below it, I’m out.

Trend lines are just one method. You might prefer moving averages. I love moving averages, as regular readers know. Or you can use momentum indicators and oscillators, or you can study volumes or stochastics.

It doesn’t really matter what the method is – as long as it helps you to identify the trend, keeps you in when it is going up, and gets you out when it is going down.

Often technical analysis will bear no relevance to the underlying asset. You could be long socks, bananas or Outer Mongolian corn futures. Doesn’t matter. Just be long when it’s going up. Be out – or short – when it’s going down.

If you’re geeky like me, you can use combinations of indicators. I like to use moving averages in conjunction with trend lines and support-resistance lines. That’s the most effective method I’ve discovered.

But the beauty is, it means I don’t have to think. I just follow the system. When I start thinking – that’s when the trouble starts.

Best to avoid it.

Recommended

Just how green is nuclear power?
Energy

Just how green is nuclear power?

Nuclear power is certainly very clean in terms of carbon emissions, but what about the radioactive waste produced as a byproduct? It’s not as much of …
22 Jan 2022
Why GSK should turn down Unilever’s billions
UK stockmarkets

Why GSK should turn down Unilever’s billions

Unilever has offered GSK £50bn for its consumer division. But while the cash will be a temptation, the deal is not in the interests of shareholders or…
22 Jan 2022
The charts that matter: the start of the big crash?
Global Economy

The charts that matter: the start of the big crash?

US tech stocks fell further this week, more than 10% down on their November high. There’s what happened to the charts that matter most to the global e…
22 Jan 2022
Cryptocurrency roundup: authorities tighten the screw
Bitcoin & crypto

Cryptocurrency roundup: authorities tighten the screw

Saloni Sardana looks at the cryptocurrency stories that caught our eye this week.
21 Jan 2022

Most Popular

Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Temple Bar’s Ian Lance and Nick Purves: the essence of value investing
Investment strategy

Temple Bar’s Ian Lance and Nick Purves: the essence of value investing

Ian Lance and Nick Purves of the Temple Bar investment trust explain the essence of “value investing” – buying something for less than its intrinsic v…
14 Jan 2022
US inflation is at its highest since 1982. Why aren’t markets panicking?
Inflation

US inflation is at its highest since 1982. Why aren’t markets panicking?

US inflation is at 7% – the last time it was this high interest rates were at 14%. But instead of panicking, markets just shrugged. John Stepek explai…
13 Jan 2022