Increasing the odds
As we learned in the last section, the best trading opportunities
present themselves just after a breakthrough in price consolidation.
Not every consolidation pattern; however, is tradable.
There are additional patterns, which significantly increase the odds of
the trade following through in the desired direction.
The tools, which we present, are 1) support/resistance 2) trends, 3)
moving averages.
Support and Resistance
Support and resistance are general price areas that have halted the
movement of stock in the past.
Support lines are horizontal lines that correspond with an area where
stock previously bounced.
Resistance lines are horizontal lines corresponding with an area where
stock resisted moving through.
Support and resistance lines are used to help access how much the
stock price will remove before it is halted.
There are two main types of support and resistance; 1) Major price
support/resistance, and 2) Minor price support/resistance
Major Price Support/Resistance
Major Price Support is an artificial horizontal line representing an area
where a stocks downward movement was halted to give way to a new
upward movement (Figure 16).
Therefore, the price level is supporting the price of the stock.
Similarly, Major Price Resistance is an artificial horizontal line
representing an area where a stocks upward movement was halted to
give way to a new downward movement.
Therefore, the price level is resisting the price of the stock.
When considering a stock as a trading opportunity it is important to
note the location of the nearest support and resistance levels.
Stocks near areas of support make for better buy opportunities and
stocks near areas of resistance make for better short opportunities.
In the same way, the trader should be more cautious about shorting
stock above areas of support, and buying stock near areas of
resistance.
Figure 16
Minor Price Support/Resistance
Minor Price Support is an artificial horizontal line representing an area,
which previously served as price resistance, but has now transformed
to price support (Figure 17).
Likewise, Minor Price Resistance is an artificial horizontal line
representing an area, which previously served as price support, and
has now transformed to price resistance (Figure 18).
When considering a stock as a trading opportunity it is important to
note the location of the nearest support and resistance levels.
Stocks near areas of support make for better buy opportunities and
stocks near areas of resistance make for better short opportunities.
In the same way, the trader should be more cautious about shorting
stock above areas of support, and buying stock near areas of
resistance.
For an in-depth analysis of how minor support & resistance works, see
the free "Educational Section" of our main website at
http://www.candlestickshop.com
Figure 17
Figure 18Trends
Every stock is in one of three states: 1) Up Trend, 2) Down Trend, and
3) Sideways Trend (Figure 20).
An Up Trend is defined by a series of higher highs and higher lows.
A Down Trend is defined by a series of lower highs followed by lower
lows.
A Sideways Trend is defined by a series of relatively equal highs and
lows.
Figure 20Even the strongest stocks will need a period of rest through a pullback
in price or a period of marking time with little to no price movement.
A strong stock will often pull back in price as short to medium term
traders take their profits off the table, and in the process, increase
selling pressure, which will temporarily push the stock lower.
A strong stock, after rest will often resume its rally after these slight
pullbacks.
The trader has better odds in his favor by playing the stock in the
direction of the trend.
For example, stocks in and up trend can be bought, and stocks in a
downtrend can be shorted (Figures 21& 22).
A stock in a sideways pattern can be either bought our shorted if the
stock is on strong price support or resistance.
In otherwise, the trader should enter long positions only on up trending stocks that have pulled back for rest ready to resume the rally.
Likewise, the trader should enter short positions on down trending
stocks that have pulled back for rest ready to resume the decline.
Figure 21
Figure 22Moving Averages
The most basic form of moving average, and the one we recommend to
all our traders is called the simple moving average.
The simple moving average is the average of closing prices for all price
points used.
For example, the simple 10 moving average would be defined as
follows:
10MA = (P1 + P2 + P3 + P4 + P5 + P6 + P7 + P8 + P9 + P10) / 10
Where P1 = most recent price, P2 = second most recent price and so
on
The term "moving" is used because, as the newest data point is added to the moving average, the oldest data point is dropped.
As a result, the average is always moving as the newest data is added.
Moving averages can be used as support and resistance levels.
Stocks tend to rebound off of moving averages much in the same way
that they rebound off major and minor support and resistance lines.
A moving average can be plotted using any period; however, the
periods that seem to provide the strongest support and resistance for
short term trading are the 10MA, 20MA, 50 MA, 100MA and 200MA.
Figure 23
Figure 24
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