The Charts Don't Always Do the Dougie

 | May 23, 2014 | 2:30 PM EDT  | Comments
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Stock quotes in this article:

hd

,

ocn

This commentary previously appeared on Real Money Pro -- Click here to learn about this dynamic market information service for active traders. 

I'm going to pick on Dougie for one second for one of his tweets yesterday, because it may teach a good lesson for everyone. First, let's start with the tweet in question:

"Douglas Kass @DougKass 

"If you are a technically inclined investor/trader - Home Depot has among the worst charts extant. $HD"

On Home Depot (HD), I analyzed both the daily and weekly charts. The daily chart is encapsulated well in the weekly chart, so there is no need to break down both of them. At first glance, I didn't see anything bearish. I asked several other folks their views, and they came to the same conclusion, so I went back to the chart.

HD Weekly
Source: StockCharts.com

Well, the stock was below the 20-week moving average, so that is a bit bearish. However, the stock was still hanging around the 40-week moving average, and the 20-week moving average was over the 40-week moving average. While they are fairly flat moving averages, I would call them bearish. Furthermore, the price is in a pretty clear channel here, one that is somewhat rising. Unfortunately, that isn't bearish at all. Furthermore, not only is there support around $76, there is strong support at $72. That doesn't imply that Home Depot can only go up or that support cannot be broken, but it does say to me that the price action isn't bearish.

The secondary indicators are mixed here with some weakness in the relative strength index (RSI). However, that is offset by a bullish breakout in the money-flow index (MFI). Again, nothing overly bullish here, but certainly not bearish either. In the end, it is hard to call this chart bad, let alone one of the worst charts that has yet to be destroyed.

But should the chart matter? I have to ask why a mention or tweet is necessary on Home Depot. Before I answer that, though, let's look at another before-and-after chart.

Ocwen Financial (OCN) is currently one of Doug's best long ideas. Home Depot sits on the other side of the tracks as a short. Ironically, these two have charts which sit on the opposite side of the tracks too. Back on April 14, when Ocwen was introduced as a long, I looked at the chart and got the chills (not in a good way). However, I realized that Doug's investment selections are not driven by the charts, and there was no mention of the technical picture as was made with Home Depot. Let me explain why the chart below gave me the chills.

OCN Weekly 1
Source: StockCharts.com

From the perspective of a non-extant position, this was actually one of the worst charts out there, even back in April. The stock had a clear rounding top forming a huge head-and-shoulders pattern. The stock was trading below both its 20-day and 40-week moving averages, with the 20-week simple moving average actually below the 40. The secondary indicators gave some hope at a bounce, but in my experience the action there was more a situation where an oversold move was being removed from the price.

OCN Weekly 2
Source: StockCharts.com

In early 2014, we witnessed a volatility squeeze break violently to the downside. Those squeezes, after explosion, do need time to consolidate a bit. But from a chart standpoint, there was still lots of resistance to be had between $39 and $41, so why not sit it out another week or two just to let the picture become a bit clearer? Support was around $36, then again just below $34, so it was actually farther away than resistance. Well, if charts don't matter to you, then they don't matter.

Unfortunately, when we fast-forward one month, Ocwen gave up more than 20% to the low and is down 15% from the close that week, and it is now sitting under former support, which has now become resistance. We are back into oversold territory again, and only the MFI really implies any optimism.

So back to the question at hand and the answer on why Home Depot's chart mattered while Ocwen's chart remains in a cave. Well, it's a trap that we all can fall into and one that becomes a vicious cycle.

While most people I talked to did not see Home Depot as a bearish or terrible chart, Doug was already short the stock, so if someone mentioned it as a possibility, then he may have fallen into the trap of "subjection validation." This is a perception where we believe something is true if our belief demands it to be true. On the flip side, a bull on the stock might see that chart as super-strong. Why? Because, that bullish investor needs it to be strong in order to validate his or her position. Selective perception, expectations affecting perception, is the original concept that leads to this subjective validation.

From that point, the short position suffers from a confirmation bias of a bearish chart. A bear in Home Depot would likely favor a technician who cites the chart as bearish rather than one who deems it bullish or neutral. This creates the circle: selective perception, subject validation, confirmation bias and selective perception.

In the end, this causes a Home Depot bear to see the chart for, maybe, something more than it actually is. Ironically, this all affects Ocwen as well, with a small twist.

If the view on Ocwen is bullish, I mean very bullish, on the basis of fundamentals, then anchoring takes effect. Anchoring is the tendency to rely too heavily on one trait (i.e. fundamentals) or one piece of information when making a decision. Therefore, the charts don't matter. Furthermore, the expectations for Ocwen were that fundamentals are all that matters in the decision to buy the stock. Therefore, once again, charts don't matter.

Again, the same circle spins round and round, but the conclusion this time is that the chart simply doesn't matter, so there is no need to mention it if it goes against one's theory. Remember subjective validation? It can work in reverse where there is a perception that something is false or not important if the person's belief needs it to be false.

Anyone who trades battles these cycles. It doesn't make you a bad trader, nor does it always result in a losing trade. However, it can often answer the question of why something may matter to someone at one point in time but not matter to them at another point in time. That is the question I see most often. Why mention that now when you didn't mention it last month or last year? It isn't that it matters more now, simply that it matters more to support a person's position now.

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