In this post I’m going to show another way you can look at a stock chart to see where a particular stock is trading in relation to its longer term trend by using linear regression channels. These measure a stock’s trend over a certain period of time, as determined by its best fit linear regression line, and the channels indicate one and two standard deviation moves away from the trend. A linear regression line will be different for every time period you look at but will generally track in a similar fashion for longer periods of time (10 or 20 year charts). It is also an ever-changing line as time goes by. The standard deviation channels will often act as support and resistance and can be used for timing when to add to or trim a position.
What I prefer to see is a stock oscillate around its linear regression line while staying within 1 standard deviation. This indicates that the stock price is maintaining an appropriate “value” relative to the underlying growth trend of the business. It’s the outsized moves that push the price of a stock way out to the 2 deviation channel that indicates it might be a short-term opportunity to add if “undervalued” or trim if “overvalued.” You’ll notice how rare it is for a stock to push outside of the 1 deviation channel and reach the 2 deviation channel.
Technology has certainly been the best performing US stock sector this year but most of the big name tech companies leading the way are looking stretched so I’ve been trimming the gains on some of our tech related holdings. You’ll see below how most tech companies are bumping up against the upper 2 standard deviation channel. This doesn’t necessarily mean that the stock is going to top out and fall but is usually a good indication that it needs to pullback or pause at a minimum. I’ll then show a couple other examples of stocks I’ve recently purchased which are currently trading below their linear regression line and near the lower deviation channels.
Guide:
- Linear Regression Line – middle line (purple)
- 1 Standard Deviation Channel (blue)
- 2 Standard Deviation Channel (red)
- All charts are log based price charts to illustrate a smooth rate of growth
Apple (AAPL)
Alphabet/Google (GOOGL)
Amazon (AMZN)
Microsoft (MSFT)
Check Point Software (CHKP)
Intuit (INTU)
And here are some examples of stocks that have underperformed recently, allowing what I believe to be a good entry opportunity.
General Mills (GIS)
Remember last summer when I cautioned on the anything-with-higher-yield craze and pointed out GIS in particular as it was going parabolic? It stopped right at the 2 standard deviation channel… and has since fallen about 20% making now a much better time to buy than last summer.
Tanger Factory Outlets (SKT)
I think the hard part for most people is that a stock generally will not push all the way up to the 2 deviation channel unless the company is doing really well and people don’t want to sell stock if a company is doing well. Conversely, a stock typically doesn’t fall all the way down 2 deviations unless the company runs into a major roadblock. But this is contrarian, value investing at its heart. This isn’t a means to decide whether to completely sell out or buy a stock – that should be done based on the fundamentals and long-term outlook for the company. This works best as a way to jump on short-term opportunities created by overreactions in the market that push a stock too far beyond “fair value.”
Thanks for following and have a great weekend!
-Nick