Last week we talked about support and resistance, This concept allows us to determine where prices might go to and where they might turn. This week we are going to look at a couple of charts and draw some support and resistance lines on those charts at points that make sense and we will get a deeper understanding of why these levels are important. In conjunction with our support and resistance levels, we are going to talk about the concept of confirmation. As important as support and resistance levels are we never really know if they are going to hold and have a price reversal or whether those levels will be broken through but the process of confirmation can keep us on the right side of those breaks or reversals.
This first chart is that of URA. We can see that the red line that I have drawn is important to this stock as it has been rotating around that one price for a significant length of time. This tells us that psychologically the market believes that this price point has meaning. It is either too expensive on the way up or a bargain on the way down. In this chart, one could surmise that the next time the price of URA gets down to the support level that there is a certain likelihood that it could reverse back up. This is how we use support and resistance to identify areas that could lead to a higher probability trade setup. The caveat here is that we don’t know if this is one of those times that the price will bounce or just “keep on truckin!” So the way we ensure that we at least start on the right side of a trade is by letting the market tell us what it is going to do before we make our move. That is the confirmation I was speaking about. We are going to let the price of URA drop down to our support level and only enter the trade when the stock actually reverses to the upside. If it continues down through the support then we can let the trade pass us by or we could look to do a breakout trade on the downside.
Let’s look at one more chart to make sure this is concept is clear. This next chart shows a resistance level just below the 15 price level. This stock has tried to break this price level 3 times and had no luck, this gives us an indication that $15 is too expensive for the buyers to push it up at this moment. Going back to the confirmation concept, if we were going to make a trade on this we would either want the price to start moving back down towards support or break up through the 15 level. We could make either a bullish trade or a bearish trade depending on what the equity does. Now, we must remember that the higher probability trade is to go with the trend so we would want to look at the longer-term trend and take the trade that is moving in that same direction. Now that we are able to visualize support and resistance did you notice anything else by looking at these two charts? Did you notice that certain patterns were emerging in conjunction with support and resistance? That leads us to the discussion about the four basic patterns that we look for when we are looking for trade ideas.
The four basic patterns we look for are the bullish retracement, which you can see starting to form on the URA chart, the bullish breakout, the bearish retracement and the bearish breakdown. Each of these patterns gives us a higher probability of success if we are able to find these patterns and use our confirmation to enter these type of trades.
Below are pictures of the four basic patterns. See if you can find examples of these patterns in your charts. When you learn to identify these patterns in the charts you out yourself on the road to trading success. Over the next few weeks, we will find an example of each type of trade and go through how one could safely enter and exit a trade of that type. First is the bullish retracement. Second is the Bullish Breakout. Third is the Bearish Retracement. Fourth is the Bearish Breakdown.
We will go through each of these patterns and learn how to set ourselves up for trading success in each of them.
Until next week, keep looking at those charts and training your brain to recognize patterns, thats where the opportunties are!