Charting 101 – Beginner

Technical Analysis Spot

Welcome to Charting 101…

Many investors believe in technical analysis or fundamental analysis. Although I am a fan of applying both to my investment strategies, it is my purpose here to only discuss pure technical analysis. I will identify stocks to watch, setups for possible entry positions, and buy or sell recommendations based on my favorite indicators (RSI, MACD, and DMI).

What is TA all about?

Technical Analysis is the study of historical stock price data in the form of trends, volume, indicators, etc. One uses TA in trying to predict future movement. In many cases, patterns are formed which often tell stories about recent price movement and where future prices are likely to do.

Many people use candlestick charting when viewing stock charts. For example, if you go to Bigcharts and click on interactive charting, you will be taken to a page where you can alter how you view your stock, what time frame you would like, and compare it to other stocks or indicators. Click here to learn more about candlesticks and how to read them.

When individual candlesticks are placed after each other in their respective time frames we can sometimes begin to see the patterns discussed previously and attempt to time investment decisions based on their confirmations. Some patterns are indicative of consolidation and may take a long time to fully develop, depending again on what time frame you are viewing.

If you are new to Technical Analysis and would like to better understand some of the concepts I discuss in this blog, then it is recommended that you take the following steps:

• Research Technical Analysis to better understand what it is and how it can be applied
• Learn how to read basic candlesticks and work with them on different time frames (hourly, daily, weekly, monthly, etc.)
• Study patterns and be able to pick them out in any stock chart
• Know how to play breakouts from patterns and be prepared to utilize stop losses in case of a “false breakout”

I will explain TA more in detail as we go forward. I also appreciate comments, so let me know if you would like me to address a question or explain something in a different way. My purpose here is to share my knowledge of TA and ramp you up to speed. Like a foreign language or programming code, technical analysis can be difficult to pick up at first, but it will certaintly assist you in becoming a better investor.

The Business Cycle

Over time you will be able to look at a chart of a stock and recognize what part of the business cycle it currently is. The business cycle is divided up into four parts or stages. During stage one; stocks should be monitored to make sure that the stock does not go any lower. The types of stocks to look for are ones that have been basing anywhere from four to six weeks. When these stocks are appear to be breaking out of this stage, forming a bullish trend along with our other indicators, we jump in and buy it!

It is during the stage two that a short term trader will take the “sweet spot” of profits out of the stock. Buyers, driven by greed and indecision, begin to purchase the stock at low prices. Position traders will ride the stock all the way to the end of a stock’s stage two. This process may take anywhere from weeks to years.

During stage three, step aside, and look for better opportunities. This is the part of the chart where the stock seems to base sideways, just like in stage one, and begins to fall aimlessly to the ground. Stage three is the point where buyers refuse to pay higher prices and fear begins to set in. Stocks fall about three times faster than they rise. As one can see, fear can be a very powerful ingredient in the steep decline of a stock. Just remember, there are thousands of stocks with numerous opportunities out there waiting to be played.

Stage four is the final stages of a stock’s decline. Here, you should again stay out of the way. Step aside and watch as others pour their money into a stock that they think they are getting a bargain for. Days later they run for the exits as their cheap stocks runs even cheaper, extinguishing those buyers that are left. Finally, the decline starts to wear off and more buyers come back into the picture. This begins a sideways basing pattern that will develop into a new business cycle.

Support and Resistance Levels

Understanding support and resistance levels is very simple. A stock will trade in a range, fluctuating up and down until it finally makes a definitive move up or down. When a stock rises and then suddenly hits an imaginary price ceiling, we call that price ceiling a resistance.

Resistance is a term people associate with “holding back,” because that is the basic principle of what is happening to the stock. It is being held back from making more gains. Now, if you can imagine a ball that bounces off the ground and propels itself higher. The ground acts as a support for the ball. The same idea applies to stocks when they are declining and then suddenly hit an imaginary ground, or support. A very important point to remember is that when a stock breaks through its support or resistance, In order to continue the trend, the breakthrough has to be on strong volume. Volume is the measure of how strong the push is behind the movement of a stock. Note that when a stock either returns to a support or resistance three or more times, we would refer to that as a “major support” or “major resistance.” These levels tend to be a little tougher to break through.

Once a stock breaks through support or resistance on high volume it will trade in a new range. If the stocks breaks through support and begins to fall. The old support level now becomes the resistance, or ceiling, and the stock now makes its way to a new support.

On the other hand, say a stock breaks through its resistance on high volume and now looks to begin an upward climb. The stock’s old resistance now becomes a price support as the stock looks higher for a new resistance.

Candlesticks 101

Candlestick charting techniques were introduced by a world renowned seventeenth-century Japanese rice broker, Munehisa Homma. This man was among the first of his kind to look at price history and then use this information to predict future prices. It is said that Homma made 100 consecutive profitable trades. Since the invasion of this powerful trading tool, many investors have turned to candlestick charting to begin to understand a stock’s past and future movements a little better. Here are some examples of how a candlestick stem might look.

Candlesticks can symbolize minutes, days, and weeks, etc. This depends on the time frame you wish your overall chart to display. In this graph we notice three displays. In the first, a clear, white, body is shown. The white means that in the given time period, the stock traded higher. The straight lines or “shadows” represent the trading range for that same time period as well. In the second display, a black body has formed indicating that the stock traded lower. Again, the lines extending from this body represent the overall range that the stock has traded. In the third display, one can see that the stock opened and closed on or around the same price. This type of symbol is called a “doji” and indicates that a change in trend or a reversal is about to happen. This symbol is very important and should be easily recognized.

Trend Lines Part I

Drawing trend lines is a skill that will help determine the true aim of a stock in the long run. From trend lines we can tell if the stock is taking a temporary dip, telling us it’s time to buy. On the other hand, if the stock is overextended and surging too far above its trend line, it’s a safe bet that you should pull your profits out because sooner or later the stock will begin to gravitate back to its trend line. The major or “primary” trend line is the line that is a long term one. Often, a stock will have temporary reversal trends that form lines as well. These “secondary lines” should only be temporary and a matter of time before the stock returns to its primary trend line. The last kind of trend line is one that forms on a daily basis. Together these daily lines form the primary trend line when looking at the greater picture.

An upward trend line can be drawn when three or more pivot lows can connect in an orderly fashion. An upward trend should continue if the stock has higher highs and higher lows. Another point to add here is that the best uptrends are formed when the stocks climbs at a 45 degree angle.

Remember that once the stock pivots its way to a lower price the trend has been broken. You should try to draw a trend line as soon as the stock has established two “higher” lows. Try extending the line to view a probable future movement in price of the stock.

Trend Lines Part II

In a typical downtrend we see that the stock has broken through its support and begins a trend characterized by lower lows and lower highs. Note that when the stock will break this trend by making a higher high and a higher low.

Trend lines help us to get a general overview of how healthy the stock is technically. These lines help buyers find dips and excellent buying opportunities. On the flip side, once a downtrend begins to emerge, shorting (selling first, then buying to cover position) may be the best strategy for short term traders.

Do not base your trades on trend lines only. Trend lines are simply a tool to help you become a smarter and more intelligent investor. Information is a bonus if you know how to apply it. Try finding stocks that have up or down trends. Remember to spot higher highs and higher lows in an uptrend and lower highs and lower lows in a downtrend. Practice drawing and applying these lines correctly so that you will be able to make making solid investment decisions.

Volume Volume Volume Part II

Volume is one of the ultimate indicators. Volume can be associated with the amount of emotion that goes into a direction that the stock takes. If a stock has high volume on either a positive or negative move, chances are that direction will continue because investors have strong emotion towards that particular direction. However, if a stock makes a move in either direction will low volume we would believe that movement in that direction is only temporary and viewed upon as a weak move.

In this graph we notice that when the stock started to top off and begin to pull back, the volume stayed relatively low. This means that the dip was weak and would not last long. If the pullback volume is low this means that many previous buyers are holding their positions. On the other hand, if the pullback in volume is high, buyers are selling just as fast as they bought in. When in a position long and you notice selling on high volume, it might be wise to take profits and get out. There are always better stocks out there to choose from.

For you swing and position traders, look at the volume spikes and locate a stock going through an increase in volume while the stock continues to trade in the same, tight range. This indicates a string possibility that institutional buyers are quietly accumulating the stock and hoping that no one will notice.

Volume Volume Volume Part II

In another example, a two to three day climb occurs with a star doji forming at the peak. This indecision coupled with low volume is a good indication that the price will come tumbling down.

Another tip to consider are huge volume spikes, whether in a downtrend or uptrend, can prove to slow down or completely halt the current trend.

The Time Periods of a Trading Day

The following are very important shifts in trading throughout the day. Although this outline is geared for the day trader, longer term investors may be able to place orders at optimal times and get a better sense of market consistencies.

9:30 a.m. eastern time – market opens
9:50-10:10 – first reversal period
10:25 – milder reversal
11:20 – market tends to retreat, investors head out to lunch
1:30 p.m. – post-lunchtime market begins to improve and some stocks start to move
2:30 – stocks break out (or down) with more conviction
3:00 – Treasury bonds stop trading, possible market reversal
3:30 – mild reversal possible
4:00 p.m. eastern time – market closes