- Do not rush to buy Chipotle without considering the overall market.
- Don't try to anticipate whether or not Chipotle will move higher.
- Just because a bullish pattern is developing, it is not guaranteed to workout.
It goes without saying that true fundamentalists tend to look at company financials to make a decision about whether to buy or sell a stock. Whatever their reasons may be, not paying attention to the charts could prove fatal. For instance, if you are bullish on Chipotle Mexican Grill (NYSE:CMG), you may want to look at the charts before you get too excited.
First, look at CMG's chart on a daily time frame. (Do not worry too much about weekly or monthly since market psychology is in tune with the daily chart, meaning the majority of market participants key off of this time frame.) What is the trend? Do not make it complicated and start assuming that the stock is basing, turning, or could be making a move higher or lower right off the bat. Go in with the mind of a four year old. The stock is currently in a strong down trend.
Now here is where things get a bit interesting. Just because CMG had some minor rallies in a downtrend, it did not indicate an imminent reversal. I have put the SPDR S&P 500 Trust ETF (NYSEMKT:SPY) and CMG chart side by side below. Also, note that the SPY is very close to price resistance levels. It does not matter why that area is being held because the reasons keep changing (At the time of this writing, it is due to Yellen's speech on Friday). Just know if the SPY fails to move higher, then CMG most likely will be unable to move higher. You need to look at the overall market before attempting to jump into a stock like CMG.
Even though the SPY has been range bound, notice that CMG has been unable to recover. Could it go down further? It could, but we don't want to go in with a preconceived notion. What I want to show you is when the SPY took an initial dive CMG fell as well, as indicated by the first rectangles on each chart. Now the second rectangle on the SPY shows trending higher, while CMG fell apart. This was due to earnings and its aftermath, but there is no way to anticipate this. However, you now have new information CMG is refusing to move concurrently with the market. There is no reason to buy. While the stock had a tremendous fall, that was no reason to assume that it could not go any lower. The third rectangle shows this occurrence, and its a concept most investors tend to forget. So, when the market fell, CMG fell further indicating that CMG is a weak stock. The fourth and final box on both the SPY and CMG supports this notion. When the market rallied, CMG failed to rally. Weak stocks tend to stay weak. They may get pulled up when the overall market rallies, but when the market declines, these stocks tend to fall apart.
An ideal stock to buy would be one already in an uptrend. The concept may be foreign because we, as a society, are used to buying things at a discount. However, this is not a very good approach at all.
For instance, look at FB, even with the slight pullbacks you would not have been hurt. I am making this a bit simplistic, so you can understand the idea.
Also, you don't want to even attempt to buy something like Dollar Tree because you are pretty much guessing the direction. We are trying to avoid that and put the probabilities in our favor.
Now the question that arises is: "how do you know when there might be a possibility to consider buying CMG?" There is one pattern I see developing, an inverse head and shoulders. Now this is not perfect. Just because the pattern is forming, it does not mean you should go and buy CMG. This pattern takes a while to develop and there are plenty of fake outs that will happen if you try to be precise. It is important to note that bullish patterns tend to fail with stocks in a down-trend. That is why it is important to wait for an actual break. You may miss a couple of points, but you will have confirmation that CMG may move higher.
It might be tough to look at a naked chart and make a decision. That is where other indications such as market sentiment, option activity, moving averages, etc come into play. If this is a true bottom, and the SPY blows past its all-time high, this pattern may work out. However, if the SPY falls, this bullish pattern will not play out. Look at the market first before you make a decision to buy CMG. Again, the most prudent action is to wait and see if this pattern does break out before making a decision.
Remember technical analysis is not about trying to time the market and perform an absolute precise analysis. It is about putting the probabilities in your favor. CMG is a better buy at a higher price than at current levels. Let the stock show you it is moving up rather than trying to assume you are getting a good value. The stock can always continue to go lower. Don't try to buy weakness. Instead, buy strength.