|Attempting to follow the jagged fluctuations of a stock's movement can be confusing to even a skilled trader without a proper understanding of a price action. While many traders obsess with the latest trading tactic or system, it is the traders who have the greatest understanding of the market themselves, or to be more specific, a working method of analyzing price action and a set of principles to exploit it for profit.|
In stock trading, the greatest gains are going to be from stocks that are bullish versus bearish. The reason for this is that trading to the upside possesses the potential to yield unlimited gains. Now, the probability is unlikely that you will have a limitless return on a stock's upward trajectory, but the potential is still there, nonetheless, and you only have to go back far enough to study the charts of a Walmart, Dell Computer, Amazon.com, or Microsoft to observe the staggering gains that they have made over their lifetimes to appreciate that core precept. See Figure 1.
|FIGURE 1: PCLN. PCLN broke out to an all-time high on huge volume and expanded in price, offering small contractions along the way THAT could have been low-risk entries. A trendline was established to track the stock's trajectory before it was broken and a base-on-base pattern emerged, revealing that price contraction was taking place and PCLN consolidated in this range while preparing for another possible bull run.|
|Graphic provided by: www.freestockcharts.com.|
|Trading to the short side of the market, or bearish side, limits your potential gains because a stock can only go so far till it reaches zero. For example, if you were to short a stock perfectly from the very peak of the stock's price action and the stock were to plummet to zero, the most you could make would only be 100% compared to the limitless potential of trading to the upside.|
Now, to find a strong candidate in a stock to trade to the upside, it is recommended that you find a stock that is trading at or near its all-time high. There are derivations of this principle, such as a five-year high or 52-week high, that have some merit, but a study by Blackstar Funds indicates that stocks that are trading near their all-time highs, regardless of fundamentals, have a strong tendency to advance from that point to achieve above-average gains even when factoring buying and selling decisions along the way as well as tax liability from selling the stock.
|Once you find a stock trading at an all-time high, you must first identify a trend by drawing a definitive trendline. Price action involves a series of expansion and contraction in the stock's movement where price advances and then pulls back to consolidate before moving forward. As this occurs, by drawing a trendline from the lowest low point in the price action to the highest low point, you can establish a working bullish uptrend.|
This helps you follow the stock's trajectory and spot any price patterns or low-risk pullbacks to the trendline with which you can use to make new entries into the trend or add to an existing position in order to maximize the profit potential of the stock's bull run.
If the trendline is broken, observe if the stock's price has undergone a big runup leading up to it. Such runs are often due to a large expansion if price and traders may be taking profits or hesitant to buy at higher prices until such values can be justified.
|Unless a correction is in place, then it may be worth sitting out as the stock gets ready for another massive price expansion but, as always, use protective stops to lock in your gains and/or protect yourself from the unexpected.|
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