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 u ward 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).
Figure 17
Figure 18
Trends
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 20
Even 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 ison 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 22
Moving 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
Candlestick Line Time Frames
One of the beautiful attributes of the candlestick line is that the same analysis can be applied to multiple time frames.
The time frame of a candlestick line is the time duration between the candlestick's opening price and closing price.
For example, a daily candlestick chart would consist of candlestick lines with opening prices corresponding with the day's opening price, and closing prices corresponding with the day's closing price (Figure 25).
A 5-minute candlestick chart would have candlestick lines with time duration of 5 minutes between each candlestick's opening price and closing price.
Most good computer charting software allows easy conversion from one time frame to the next.
As we will see in latter examples, utilizing several different time frames in viewing a stocks candlesticks pattern is a very effective way to read the underlying sentiments behind a stocks movement.
Figure 25
Dissecting a Candlestick
Changing time frames when viewing candlestick patterns is useful tool when looking for patterns leading up to good trading opportunities.
For example, consider the Bullish Harami Pattern that is manifested on the Daily time frame chart (Figure 26).
The same stock plotted on a 15 min time frame chart shows that the stock is actually setting up for a Bullish Reversal Consolidation pattern.
Using the Daily chart and the 15 min chart together make it easier to find possible trade opportunities.
For example, the trader can scan for Harami setups on the Daily chart, and then pull up a 15 min chart to confirm the stock is experiencing a consolidation pattern preparing for a break out.
Figure 26
Figure 27
