How to Trade Support and Resistance in Stocks

How to Trade Support and Resistance on a stock chart

Trading happens over exchange with various participants punching the orders round the clock. This cumulative activity creates some price zones or levels. Those levels signify something and are used as a reference by many traders. Those levels are called Support and Resistance levels.

The Invisible magic of price action?

You must have felt that a stock sometimes rebounds from a certain price zone or level many times and you wonder what makes it do so? Most of the times stock reverse from a particular price and you again fail to know why this is happening. This is not a magic. These price levels are called as the support and resistance levels.

How are these support and resistance created?

When trading action takes place in a new script. The psychology of the traders helps create those price zones where they feel the stock is either overbought or expensive(Resistance levels), Price at which stock is cheap and oversold( Support level). As the trading involves a large number of traders the probability of what they think is right level is going to be high. Simply, because of the Wisdom of the crowd principle.

After some time of trading activity, that stock develops a price pattern based on the psychology described above. Now, the new traders or investors base their future prediction of price movement based on the historical price pattern they just saw. They Just see left and find out where the price has normally taken reversal. They utilize Technical Analysis to gauge the price action and predict targets. Continue reading “How to Trade Support and Resistance in Stocks”

Top Five Technical Indicators to use

Top Five Technical Indicators are the best friends of a Trader

Technical analysis represents the sentiment of the market at a particular time period or during the stretch of a time. Technical analysis has been improving and adding in new things for its followers. As we have already discussed that technical indicators analyze the psychology of investors in a stock market, it is important to understand that dependence on one particular technical analysis indicator won’t be recommended at all. Here are top five technical indicators that can help ascertain the possible direction of the market.

Volume

The volume of a stock traded in a market speaks volumes for that stock. Volume shouldn’t be looked at in isolation. Usually, it has to be associated with the price in the market at that time. If you can tightly monitor and correlate the movement of each with the other, this can also help you in determining the probable course the market is going to take.

Top Five Technical Indicators are best friends of a Trader

Stock Price

Continue reading “Top Five Technical Indicators to use”

The Assumptions in Technical Analysis of the stocks

In technical analysis, we project the possible future trends based on the past performance of the stock. Since its inception, a lot of theories relating to technical analysis have emerged. Extrapolating past trends into the future are based on three simple assumptions in Technical Analysis. These assumptions are known as pillar assumptions on which all the technical analysis is based.

These three Assumptions in Technical Analysis are

1. Market Discounts Everything
2. Price follows trend
3. History Repeats itself

The Assumptions in Technical Analysis of the stocks1. Market Discounts Everything

The technical analyst assumes that the stock price of a company reflected on the stock exchange at any time reflects the true value of the stock. This means that the stock’s price has adjusted itself by incorporating all the information that could affect the price of the stock. So the price of the stock on the stock exchange reflects all the information affecting the stock in its price.

Continue reading “The Assumptions in Technical Analysis of the stocks”

An introduction to moving averages

The following article is an introduction to moving averages for those new to technical analysis. After trend lines, moving averages are probably the best known of the tools used by the technical analyst. This is in part due to the fact that their concept is easily understood by the novice trader or investor and also because their usefulness (in a trending market) can be easily demonstrated. In its basic form, a moving average is no more than a smoothening of the closing price line chart. It is a trend following indicator which means, firstly, that its action lags behind price action, and secondly, that its direction reveals the direction of the trend.

Calculation of a Simple Moving Average

A moving average is described by the number of periods being averaged (the length, or speed, of the moving average). For example, if you wanted to calculate a 10 day moving average of the closing price of a stock, you would add up the last 10 days of closing prices, and divide by 10. That would give you your first point on the chart. To obtain the second point for the moving average line, you would drop off the 1st day and average the 2nd to 11th days. And so it goes on, the average “moving” so that the last 10 days of price are averaged.

Excel exercise: Take Last 10 days close prices of any stock and use the function =AVERAGE(Your range)

In practice, your charting program does these calculations and the moving average is usually plotted as a line on a price bar chart.

Other Types of Moving Average

Continue reading “An introduction to moving averages”

Price Trends: There is more than just up and down!

Price trendsPrice trends: There is more than just up and down!

One of the biggest challenges people face as they attempt to make decisions about the markets is which way the price trend is heading. But this is only part of the story. Much more important than defining up and down trends is the ability to define a sideways market. Why? Because they can occur as often as 70% of the time.

Defining Price trends or the story so far

Ask someone which way the Price trends are going and they will generally take one of two approaches. They will either wimp out and say that there are a lot of factors which need to be considered in determining the trend’s direction, or they will simply give a direction. When challenged to support their belief, often they stumble around in the world of generalities rather than being specific. They can’t define it.

While there are almost as many variations on the concept of defining a price trend as there are people in the markets, you, as a trader/investor, need to have some idea of what constitutes a price trend.

Some of the ideas different people use are Continue reading “Price Trends: There is more than just up and down!”

The 50 and 200 Day Moving Average Trading System

The 50 and 200 Day Moving Average Trading System

I have always been interested in mechanical trading systems and I began to use different systems to trade the markets in the 90s. Later on, when I had access to a good computer, I back-tested the most promising systems for 10 years of price data for the BSE SENSEX. The Sensex is ideal for back-testing because it does not trend as smoothly as many things you could trade. If a system works with the Sensex, it has to be pretty good! Most of the trading systems I tested showed poor results against this data series. The short-term trading systems fared the worst.

The only system I tested, which is good enough to actually use in the stock market is the 50 and 200-day moving average crossover system. The rules are simple: when the 50 days moving-average of the NIFTY crosses above the 200-day moving average, buy the NIFTY at the open the next morning; stay long until the 50 day moving average crosses below the 200, then liquidate the position the following morning. This is a long-term trading system which gives infrequent signals. It keeps you in the market during protracted rallies but gets you out soon after a serious correction gets underway. And if the correction turns into a multi-year bear market, the system will keep you on the sidelines for the duration.

The 50 and 200 Day Moving Average Trading System does not do quite as well as a buy-and-hold strategy, but it does capture most of the upside with a lot less risk.
During the 10 year test period there were several lengthy whipsaw markets, which resulted in 3 or 4 unprofitable trades in a row. It would have been hard to stick with the system during one of those difficult periods, but if you had, you would have done quite well in the end.

50 and 200 Day Moving Average Trading System

 

Nifty is the ideal vehicle to use with the 50 and 200 Day Moving Average Trading System, but it works well Continue reading “The 50 and 200 Day Moving Average Trading System”

Simple Moving Average (SMA)

What is a Moving Average?

In simple words, the name is self-explanatory. Moving Average: An average, which is moving. So as the data is added, the average also moves and adjusts itself to the data. Simple enough?

There are various types of Moving Averages, Few are:

  • Simple Moving Average (SMA)
  • Exponential Moving Average (EMA)
  • Weighted Moving Average (WMA)

Etc.

Today’s topic is Simple Moving Average (SMA), I would try to explain as simply as I can :D.

Simple Moving Average

A simple moving average is made by adding the closer together, For however many days you want to be in the moving average, and then dividing by that number of days. So for a 5 day moving average you would add up the last 5 closes, and then divide by 5 to give you today’s moving average number.
Each day moving average number is plotted and forms a moving average line on the chart. Other Moving Averages, There are also other ways to calculate a moving average by giving the most recent close more importance and those are called exponential and weighted moving averages, which we will look at later, but for now let’s just stick with simple moving averages.

Reasons to Use Moving Averages

  • 1 – Smooths out price data

If a market is moving in a choppy manner a moving average will help you to see the trend. Continue reading “Simple Moving Average (SMA)”

3 Ways to approach Technical analysis

3 Ways to approach Technical analysis

So, You heard of Technical Analysis. But do you know about Ways to approach Technical analysis? The extent of studies and approaches are becoming more vivid and widespread because of the continuous evolution of breed of traders. There are classical two systems to trading, (as most of you will be familiar with).
I. Technical Analysis                    &                          II. Fundamental Analysis.

 

Today, we are going to talk about Technical Analysis approach. Popular ways to approach Technical Analysis are as follows:

1. Chart Analysis
2. Pattern Recognition
3. Trend and Momentum Analysis Continue reading “3 Ways to approach Technical analysis”

Head and Shoulders pattern

Head and Shoulders pattern – Trend Reversal Pattern

I) Regular Head and Shoulders Pattern

Bearish, reversal pattern signaling the end of the current uptrend
Basically looks like the silhouette of a human left shoulder, head, and the right shoulder.
reversal pattern
Like the Double Top, strong volume push prices upwards forming the “left shoulder”. The pullback is on lesser volume, then another strong rally on good volume, forming the “head” … but this time, the volume causing this rally although forming higher prices, is now on relatively lower volume as compared to the vol. in the rally causing the left shoulder … as the stock pulls back to the neckline and starts rallying again to form the right shoulder, now volume is very noticeably lighter the break of the neckline confirms the H & S pattern (Neckline is the line connecting the two troughs on either side of the head).
Volume expansion is noticed as the pattern confirmation takes place … and the stock or index is now in a downtrend. (Reverse happens now … vol. expands on the downfall and decreases on a return move up)
Trading-Wise -> ENTRY

The first down day below the neckline confirms the pattern…….short as the neckline breaks or enter short on a weak rally back to the area of the neckline.This line that was formerly strong support now acts as a stiff resistance.Short half on that return move, and the other half below the low of the confirmatory bar.

TARGET
The first target would be … calculate the difference from the head to the neckline.Add that to the low of the bar that confirmed the pattern.
STOP
The high of the right shoulder.
One Important Condition
Once the neckline gets broken, expect a return move … but at all costs the price should not re-break the neckline upwards. If this happens, it is called a FAILED H&S PATTERN. Like a failed breakdown, this acts as a bear trap and is bullish. So get out if that neckline gets broken back upwards.

II) Inverse Head and Shoulders Pattern

– Reverse of the above
– Reversal pattern that ends a downtrend
– Trade-wise, all reverse of above
reversal pattern

Volume and H & S

Volume plays an important role in us calling a particular pattern a H&S. Let us go through the Volume bit.

When the left shoulder is made, in both the h&s and inverted h&s, expect strong volumes. When the head is made, it is on (usually) decreased volumes as compared to the left shoulder. But as Rahul pointed out a key difference, the rt shoulder on a h&s is on usually lower volumes. Volumes increase when necklines break, and patterns get confirmed. And as all breakdown patterns, a break below support is accompanied by strong volumes and then the return rally to what is now resistance is on low volumes, followed by strong volumes again, bringing the stock to newer lows.
But, in the Inverted H & S, once again, we have strong volumes in the forming of the lt shoulder. Again, we have decreased volumes in the forming of the Head. But, here, we have increased volumes taking prices back to the neckline, then a dip in volume as the stk tries to make the right shoulder, and then a burst in volume taking it through the neckline.

Summarizing H&S

Left shoulder   : Strong volumes
Head               : Lighter volumes
Right shoulder : Same as or lighter than the head.
*** Increase in volumes as neckline breaks to the downside.

Summarizing Inverted H&S

Left shoulder   : Strong volumes
Head               : Lighter volumes
*** Increase in volumes, sometimes higher than before the formation of left shoulder
Right shoulder             : Dip in volumes from the rally
Once again, an increase in volumes breaking the stk out over the neckline.
An important thing to remember is that markets or stocks do not need strong volumes for the breakdown from the h&s as it basically falls with its own weight, but you need strong volumes for a breakout from an Inverted h&s.
NOTE : For head & shoulders to occur , we need a prior trend needed for reversal pattern which is uptrend, h&s is incomplete till neckline is broken, neckline break with large volumes confirm it.The support break indicates a new willingness to sell at lower prices. Lower prices combined with an increase in volume indicate an increase in supply. The combination can be lethal, and sometimes, there is no second chance return to the support break.