If you have purchased or held shares of Apple over the past year, you are more than likely feeling a bit discouraged, as shares have experienced violent 20%+ swings four times and 10% moves nine times. My goal in this Instablog Post is to identify a strong trend in Apple's chart and to supply a powerful tool for cashing in on these volatile periods.
Below is a 1-year comparison of Apple, Google, Microsoft, and Yahoo!: It is clear that Apple has been left behind, and the aforementioned volatility is readily apparent. If you own shares, the frustration of seeing your holding's value fluctuate so drastically can leave you anxious to arrive at the exit. However, there are ways to determine profitable short-run entry and exit points that exist in this very same chart. Low and behold: The Stochastic Oscillator.
The Stochastic Oscillator is a powerful technical tool that is somewhat surprisingly easy to understand. In a basic sense, it is used by technicians to measure the "speed or momentum" of the price movement. It represents the location of the previous close relative to the price range over a set number of periods. This can be more easily understood, however, by pulling apart the two lines on the stochastic oscillator and explaining the simple underlying mathematical formulas. The first line is called the "%K" line, which analyzes the actual price movements in the shares and can be defined as: %K = (Current Close - Lowest Low)/(Highest High - Lowest Low) * 100. The second line, the "%D" line is simple a 3-day moving average of the "%K" line.
There are three primary ways to read the Stochastic Oscillator in search of entry points, but I will only address the two more easily understood signals. The first way to spot an attractive entry point is when the "%K" or "%D" lines fall below the "oversold" level of 20. On the Stochastic, you will notice the x-axis is measured from 20-80. These levels represent an oversold and overbought condition, respectively. The second way to read the Stochastic Oscillator is to look for the "%K" line to cross the "%D" line from below. When both of these conditions occur simultaneously, a strong bullish setup exists. When the opposite occurs, as you may have guessed, a bearish setup exists.
How does this help you?
Apple has been trading in near lockstep with the Stochastic Oscillator over the past year, and if you had traded on the Stochastic, you would have drastically outperformed a buy and hold investor. Check out the following chart with the buy and sell signals from the Stochastic:
If you were to buy at every entry signal and sell at every exit signal, you would have avoided nearly 50% in downside. Even better, if you were to have gone long at each bullish setup and gone short at each bearish setup, you would have outperformed the buy-and-hold investor by 104% (excluding fees), returning you roughly 123%. Not bad.
I normally use the Stochastic Oscillator to spot reversals, and it is one of the most widely used indicators by chartists and technicians alike. It is, however, a bit rare to find a stock that produces such strong buy and sell signals in the Stochastic. I strongly recommend trading based on this technical indicator to supplement your long position in Apple. In other words, protect yourself a bit by holding a long position while you trade a smaller proportion of your holding (long/short) using the Stochastic. This will help to lower your downside volatility while supplementing your capital gains.
Disclosure: I am long AAPL.