How To Use Support To Trade Trends

04/22/11 08:35:41 AM

by Billy Williams

Trading range-bound stocks has been the cornerstone of many successful traders, but one small tweak in this approach can lead to many home-run trades.

Security: AAPL
Position: Hold

When price undergoes a periods of price contraction, buying and selling begins to slow down and volume begins to decline and, often, forming a trading range. When a stock's price action is in a trading range, support and resistance levels begin to form within certain price points that offer stock traders the opportunity to trade back and forth between support and resistance with high probability of success.

It's an effective trading strategy with many part-time novice and full-time professional traders solely devoting themselves to this one approach to trading stocks. And due to the fact that stocks will always enter a trading range at some point in their business cycle, an active trader will never lack for range-bound stocks to trade.

But there are some disadvantages, such as when a stock breaks out and enters a period of expansion again, trading to new price levels and leaving you behind, missing out on a large potential profit. Minor periods of price contraction occur right before a stock resumes a primary trend, and if you're on the opposite side of the primary trend, you could face a nasty loss that could wipe out a significant portion of your profits.

Plus, the profits could be small compared to the large profits of catching an emerging trend occurring right after a breakout, so you may have to sit it out on the sidelines -- especially when you factor in the awesome power of a bull move just as it begins to move into an expansion phase where its potential is staggering.

Fortunately, there is a way to capitalize on a stock's price expansion to the upside even earlier than the breakout traders who are waiting for price to trade up through its upper price range before first entering the move themselves.

FIGURE 1: AAPL. In early October 2010, AAPL set a new high before trading downward over the next two weeks, setting a signficant low in its price action. From that point over the next two weeks, it traded higher to test its former high and found resistance, turning it downward until November 17, 2010, where it found support. The 100-day SMA's slope was moving upward, setting up a potential long entry, which was triggered on November 19, 2010, gaining almost 18% or 55 points from that entry level.

Graphic provided by: www.freestockcharts.com.

Using a combination of price and the 100-day simple moving average (SMA), you can filter out high-probability stock trades that are range bound while putting yourself on the side of the dominant trend to take advantage of any potential bull run at the same time.

Place a 100-day SMA over price and you'll be able to detect by the slope of the moving average the direction of the trend. When price enters a period of contraction, wait for support to be established on the bullish side of the trading range and enter at that point. By doing it this way, you put yourself on the side of the trend so your trades off of support will have the strength of the primary trend behind it, and if the stock resumes its bull run and breaks higher, you're in a plum position to sit back and ride the momentum higher. See Figure 1.

This is breakout trading, but with much better entries.

To recap, many traders make their living (and a nice one at that) trading range-bound stocks, but using this approach gives you the opportunity to snag a few home runs as well. In addition, having a bag full of tricks gives you the chance to approach the market like any skilled tradesman who uses his various tools to get a job done with a combination of quality and efficient effort in his approach.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

Company:	StockOptionSystem.com

E-mail address:	stockoptionsystem.com@gmail.com
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