Trading Systems Series - How Do I Trade Stocks

Trading Systems Series
HOW DO I TRADE STOCKS.COM
Copyright 2012
CHANNELING STOCKS – SUPPORT AND RESISTANCE
ESISTANCE
Channeling stocks are stocks that are range bound and have a clearly defined support and resistance level,
and they tend to be a reflection of crowd psychology.
Support and Resistance
In the stock market, stock prices are driven by supply and demand. Too much supply is synonymous with
selling and leads to the price dropping, while over demand in buying leads to the prices rising. When supply
and demand are equally balanced the stock will move sideways, often in a tight range called a channel, as the
bulls and the bears vie for control.
Support is always below the current price, and when the price reaches this support level it is expected that it
will bounce back up into the price range where it came from. It consists of buyers who are waiting to take
action when the price reaches a certain level, or traders in short positions who may be forced to cover if the
market goes against them. This is how support comes to be.
Resistance is always above price, and when the price reaches this resistance level it is expected that it will turn
around and head back down. It is the exact opposite of the above, as it consists of would be sellers who are
waiting to sell when the price reaches their target, or traders looking to short as it comes into resistance levels.
This is how resistance comes to be.
So how do you know when a stock is likely to drift between support and resistance levels? It is my view that
when a stock has turned at a certain price and gone back up twice in the last 6 months from the same level,
then there is clearly support (demand) to buy the stock at this level. The same goes for resistance, if a stock
has hit a certain high and turned around twice in the last 6 months, it is a confirmed resistance level or
selling/shorting point.
Trading Systems Series | Copyright 2012
Of course, support and resistance can indeed be found going back many years. Let’s assume a stock has
reached a new 52 week low of $40.60, however, when we go back in our charts we see that it was last at this
price 2 years ago. If it bounced of this low 2 years ago and went straight back up, then there is a good chance
that other traders will see this previous behaviour too and put in buy orders to turn the stock around.
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My own personal preference when
trading using support and resistance is to
look for more recent confirmations rather
than going back too far hence my
comments regarding the last 6 months.
Trendlines
endlines
Trendlines can be useful tools, but it is
worth noting that they are really only
there as a guide, as they cannot be
completely relied upon to pick winning
trades. However, like all good technical
analysis tools they can be used to give
you an edge when picking stocks to
invest in. As far as where to put them on
a chart goes, it’s down to your own
interpretations and there are no right or wrong answers, you simply have to place the lines of the most obvious
places.
For the example below, notice how easy it was to clearly identify support and resistance levels.
So, do support and resistance levels need to be on horizontal lines?
No, they do not, however, studies have shown that charts were you can draw horizontal lines are more reliable
than angled trendlines. The main reason I believe is the clarity that horizontal channels give you at first sight.
Most people can spot horizontal support areas at a glance without having to draw a line on the chart,
compared to inclining or declining trendlines which are harder for the naked eye to see. For this reason, as
there will be more believers out there, horizontal trendlines tend to fair better in predicting future price moves.
Below is a definition of the three types of price channels:
- An inclining or rising channel will makes consecutive higher highs and higher lows.
- A declining or falling channel will makes consecutive lower highs and lower lows.
- A horizontal channel will makes horizontal highs and lows. (Also known in technical analysis as a rectangle
pattern)
Trading Systems Series | Copyright 2012
See below for an example of an inclining channel.
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So how do you trade it?
Trading using support and resistance is very popular, particularly with swing traders as opposed to trend
trading. Swing traders are looking for short term swings in the market to grab some quick profits, trend traders
don’t like sideways channels and often wait till the price has broken up through the resistance level and
created a new trend before they will invest in a stock.
In trading support and resistance, my own view would be to wait for a confirmation of support. What I mean by
this is to wait till a stock has re-reached a price level that previously showed it hitting and going higher in the
last 6 months. As per the example below once it hits the support price, buy when it closes above the following
day. See chart for a visual view:
Trading Systems Series | Copyright 2012
It is common for traders to only view a channel to be trade-able if it has two confirmed support or resistance
bounces. In the example above, the stock has re-visited a level that it had previously bounced off of in late
February, and also touched on the same level in mid-March. So is support going to hold? Below is the same
chart a few weeks later:
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As you can see it did indeed rebound off of the previous support level, dipped and bounced again a few days
later, but never really broke through the support level. This example ultimately shows a nice 10%+ swing.
Exit Strategy
As far as stops are concerned, in the past I have used a trailing stop of 5% and sold it when it reaches my
targeted price, which in this case would be a resistance level that has been a previously confirmed turning
point.
In conclusion
There are many traders that use support and resistance as their trading grounds. I myself have a very good
system for trading ranges which I will share in coming reports. However, as with all technical analysis, nothing
is ever set in stone and stocks frequently break through support and resistance levels to create new trends all
the time. So, buyer beware!
Trading Systems Series | Copyright 2012
May today be a profitable day...for all of us.
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