|Rarely is such a simple concept as the study of price action so misunderstood while, at the same time, made to be so complicated. Worse, the biggest offenders are the technical analysts themselves, especially when they are trying to teach and/or impart their knowledge to beginning traders.|
Rather than wax philosophical intricacies on chart patterns, behavioral psychology, mass crowd psychology, and other such minutiae that only serves to entertain or educate trading geeks, let's get down to pragmatic applications of technical analysis, of what makes money. As Arnold Schwarzenegger's character said in the movie The Predator, "If it bleeds, then we can kill it." For traders, this statement could be rewritten as "If it moves, then we can profit by it."
In trading, a skilled trader can use little more than a trendline and the ability to understand what is going on in the market. The skilled trader strives to understand more than chasing or applying the latest and greatest trading method. Understanding what is actually occurring in real time will do more to keep you out of bad trades and in more good trades than any other factor or tool in your arsenal.
Take a look at a stock and break down the process of what is happening in the price action.
|FIGURE 1: MTD. MTD offered numerous opportunities to profit if you understand how to exploit its price action.|
|Graphic provided by: www.freestockcharts.com.|
|Mettler Toledo International (MTD) bottomed out with the rest of the market in March 2009 and began the ascent to higher price levels. Price continued higher above the previous high set in February before trading lower. The low achieved after the new high was made was a higher low; bullish trends can be identified by a consecutive series of high highs and higher lows. This is the natural ebb and flow of back-and-forth trading in bullish price action. See Figure 1.|
As a result, a bullish price channel formed from May 2009 to the end of that year. Within this chart pattern, numerous buy opportunities present themselves as price traded to the lower support line of the channel, signaling an entry when the downtrend line was broken. Legendary trader Richard Donchian listed as one of his rules that when minor countertrends were broken within the dominant trend, this provided a low-risk entry that skilled traders should capitalize on.
At the end of December 2009, MTD traded downward, revealing a correction under way as the stock traded lower than the previous higher low in its price action. Six weeks later, the stock bottomed before working its way higher, where in March 2010 another entry was signaled as the stock traded to new highs.
|However, at the end of April 2010, price exploded higher in what could have been interpreted as an exhaustion gap where price makes an explosive move in the primary trend's direction before exhausting all buying and trading downward, which is what had happened. The short-term trend changed from bullish to bearish even as the dominant trend stayed, making a lower high and lower low, the sign of a bearish trend. |
From May to September 2010, price contracted within a trading range, oscillating back and forth, with neither bulls nor bears able to muster enough trading volume to take control of the stock and drive it higher or lower.
|In mid-September 2010, MTD traded through the upper-resistance point of the trading range signaling the first entry. A second entry presented itself as MTD, trading within a tight price channel when in October 2010, price traded up through the upper end of the channel's resistance point. From this second entry level point alone, the stock accelerated almost 30 points in seven weeks.|
By spending time studying charts, you will develop an understanding of what price is doing and how to capitalize on it by training yourself to spot clues within a stock's charts to reveal what is happening in the present as well placing it within the context of what it has done in the past. Keep studying and soon you will have both the skill and will to be successful.
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