Do Stock Charts Have a Place for Long-Term Investors?

I believe that charts can help long-term investors. In particular, I believe they can give us a general sense of what the market is doing to help understand how our own stocks might be performing. In essence, if the market is going down then there is a good chance that your long-term dividend stock is heading down with it. If the broad market is going up your stock should be heading up with it. Let’s deal with each of these scenarios separately.

Market is Heading Up but your Stock is Not

Most investors who are watching their portfolios get a general sense of which way the market is going. We all hear reports of what the Dow did on a particular day. One day it is down and the next it is up. However, what is difficult to get is a general sense of what the market is doing over time. Assume you have pulled the attached chart from StockCharts.com which shows the general trend of the market over the one year period July 2005 to July 2007:

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It is clear from this chart that the general market is heading up at this particular point in time. Now let’s assume that you owned Nortel and ran a second chart which overlays that stock with the general market direction. This picture tells a much different story for the same time period as the chart above.

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There are obviously problems with this stock. The general mood of the market is positive but your stock is not. Next steps for an active investor is to figure out why this is and to determine if it is some short-term issues the company can fight through or if it reflects deeper problems that you as an investor needs to act on. Although I try never to sell a stock, that does not mean I can sit on my laurels once I bought the stock and not monitor it. If I did that then I might as well index and save my time. Running charts like this can help you see how your own stock is performing relative to the market and gauge where you need to spend your analytical time.

Market is Heading Down Taking Your Stock with It

The other scenario is the market is heading down taking your stock with it which in my opinion is not as serious. General market declines happen and in bear markets it will take most sectors down with it. As a long-term investor this is not the time to act and consider selling. As long-term investors we just need to sit tight and ride the wave, knowing that history tells us that the market will once again go up.

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This chart is pretty clear – the market trend is down and Procter and Gamble is heading down with it. Not much an investor can do and it probably would be best to site tight and wait for a recovery to happen.

In summary, I want to provide some Pros and Cons that in my mind, fit in with the above two scenarios.

Pros
* Investors can get a general sense of the market direction
* When you buy a stock can influence your long term results. Buy it low and you look like a hero. Buy it at a top and you look like a zero. Properly read charts can help you understand the general stock and stock market patterns.
* Understanding the direction of the market can help with your confidence in stock selection
* Watching the market direction and comparing your stock can inform you of potential problems with your company

Cons
* Chart signals can be tough to read and if read improperly can lead to bad decisions.
* The use of charts tends to imply a short-term focus on the stock market. As long-term investors are invested for 20+ years, the daily or monthly swings of a stock can be inconsequential.
* We are focused on reinvesting our dividends into more shares, which means when the stock is down means we buy more and when it is higher then we buy less. This dollar-cost averaging averages out our returns over time.

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