no he expects the stock to go back up. Then the stock declines back to his cost at $50 does he sell, absolutely not. He has tasted a profit and is not going to sell and take a loss. Multiply this investor by thousands of other investors that also bought in the trading range at $50 and a “resistance” line has been created.
Why did the stock go down from $54 to $50? There were some traders more interested in a quick profit, so they sold. Here you have a perfect example of the short cycle (wave) colliding with a longer term cycle (wave) creating turbulence. Remember those waves at the beach. A“support” level has been created at the line of “resistance”.
Let’s give some names to trading patterns as they are as basic as A, B,Cs and are the building blocks to understanding price movement in the market and thus the ability to profit. Start with the area where the stock was initially purchased. This may be a period where stocks trade in a fairly narrow range for a period of days, weeks or even months. This trading range can either be an “accumulation” range or a “distribution” range. An “accumulation” range is where investors, probably thousands of other investors, are accumulating whatever stock is offered to them and will hold their positions anticipating a move up. A “distribution” range is a trading range where investors who own the stock are unloading their positions to whomever will buy their shares anticipating a move down in the stock. A temporary balance of buyers and sellers anticipating movements up or down creates the “trading range”.
Now, let’s take the reverse. A trader buys a stock at 50 in a trading range between 49 and 51. The stocks break down thru the range to 48. Does the investor sell? Probably not, he hopes to at least break even on a recovery. A further move down to 46 reinforces the investors feeling that he is desperate to get out hoping to break even on a recovery.Fear has become king and the investor just wants to break even and get out. Then the stock retraces back to 50. Now the investor sells relieved, to break even. Multiply this by thousands of other investors that purchased in the trading range at 50 and a “resistance” line is created.
To review a few of the most basic and most important concepts discussed:
TRADING RANGE – this can be:
ACCUMULATION range where traders are purchasing stock anticipating a rise
DISTRIBUTION range where traders are selling stock anticipating a drop.
How do you tell whether a trading range is an area of accumulation or and area of distribution? Later, various analytical tools and concepts will be presented that will help point you in the right direction, but bear in mind there is no substitute for experience and this is not a pure science. If you are right more than wrong you should be a winner.
SUPPORT level is a level at which traders will buy whatever shares are offered making further declines unlikely
RESISTANCE level is a level at which traders will sell whatever than can making further movement up unlikely.
There is one indispensable tool – stock charts. A simple bar chart just showing daily price bars indicating high, low and close is all that is necessary. A daily volume chart would be helpful but not essential. These charts are readily available on-line free from numerous sources or they can be obtained from various services. The charts can have various technical enhancements but none are essential.
I know this is difficult to comprehend, particularly if you have been educated in financial analysis. You have to step outside the box and enter another world where you become an observer of what others are doing relative to any particular stock. You do not have to know anything about the company; not what business they are in, not what they are earning, not what there balance sheet or debt may be, not even the name of the company.
How is this possible – PATTERN ANALYSIS. It is almost inevitable that investors will create specific price patterns that will foretell future price movement. This is not a scientific certainty but more of an art. As with any art it is subjective, different people may have different interpretations. Study and experience will improve interpretation, as will study of any art. Maybe your initial chart analysis will reveal nothing comprehensible or maybe your initial studies will have the opposite reaction, a feeling that you have a clear picture. Somewhere in-between is probably reality. This book will introduce you to patterns that will give you clues to future price movement. These patterns are the result of buyers and sellers interacting similar to wave movements. It is only necessary to recognize these patterns regardless of the underlying causes in order to predict future price movement.
Invest in the Best
Before getting into the specifics of chart pattern analysis, let’s look at a more traditional investing concept – invest in the “best” stocks. I use the word “best” in the popular concept of the highest quality stocks at the moment, stocks that traditionally would be put in your grandfather’s retirement portfolio, stocks that have had a great record for growth and/or steady dividends.
Let’s start with the bluest of all blue chips – IBM – otherwise know as Big Blue:
Look at a chart of IBM stock:
IBM
Chart courtesy of TeleChart- www.worden.com
If you purchased the stock on July 24, 2008 at 130.00 and sold on December 20, 2008 at 71.74 you would have lost 45% of your investment in a period of 5 months. But this is Big Blue, how could that happen! In any case you think you would not be so foolish to have bought at the high of 130, but at that moment the stock had been going up and up, everyone was buying. On the other hand you are sure you would not have sold at 71.74, but the poor investor at that point had been watching his investment sink lower and lower and finally in total frustration decides to sell and salvage what he can. Read into the chart and try to picture what the investor is thinking about his investment at each point on the chart.
When an investor purchased on July 24, 2008 at 130.00 it was after a huge rise extending back to August 2006 when it sold at a price of 73. He watched it going up almost every day. Finally he makes his move and buys expecting the stock to continue rising. When it drops to 110 he expects this to be a temporary glitch, the stock taking a rest preparing for the next move up. It does move up to almost 124 confirming his belief that the next big move up is about to start.
Then it drops to 87. He is now seriously worried and decides to get out on the next move up to 110. It does bounce about in a range between 80 and 95 convincing him his target to sell at 110 in correct. Instead the stock collapses to 71.74. At that price he decides to get out with whatever he can salvage from this sour investment. He is devastated having invested in the bluest of blue chips and now having lost almost half of his investment in 5 months.
Now let’s look at another blue chip stock – Microsoft. This certainly is one of the top most celebrated companies in the world.
Microsoft
Chart courtesy of TeleChart- www.worden.com
The stock had a wonderful move up to 36.73 on November 5, 1997. It appeared the stock was headed much higher. This surely was a top company that could be safely invested in for your old age. Well, if you bought it on November 5, 1997 and sold on
