A Share Trading Method That Works
- Charting The Basic Patterns
A chart is a graph of a share prices against time. Charts have become the preferred tool of many successful share traders.
The most straightforward use of charts is trend-following.
Fortunately, the fact that trend following is strightforward does not stop it being profitable.
Traders using trend-following methods buy stocks whose price is, on average, moving upwards over time. They sell stocks whose price has stopped moving upwards or is moving downwards.
An uptrend, shown in the example above, is found when buyers are happy to pay ever higher prices for a share because they believe that the price will continue to rise.
A downtrend - shown on the right - is found when traders, on average, are unhappy about the prospects for a share.
They believe that, if they delay selling, the price will drop even further. They accept whatever price is on offer. The outcome is for the share price to keep sinking.
Clearly, share prices are not perpetually in obvious trends. Often, prices move sideways. When this happens we say the share is in a trading range.
Shares tend to move in trading ranges when the market cannot, on average, make up its mind about a share's prospects.
Once you have identified a trading range, it should be possible to trade it profitably.
Whether we identify a share as trending or trading in a range depends on the timeframe.
The chart on the right aove is trading in a range when we look at all of the data.
If we were to consider only the data between days 2 and 7, there appears to be a strong trend downwards.
Traders often specialise in trading particular timeframes. Daytraders buy and sell on trends developing from minute to minute.
Long term traders may use weekly data in compiling charts and prefer to buy and sell infrequently.
Other traders prefer to deal within timeframes between these extremes.
To summarise so far, we have seen that the three most basic chart patterns are the uptrend, the downtrend and the trading range.
Now we consider how to trade a trend profitably. Later we consider how to profit from a trading range.
It is possible to trade a trending share by simply observing the overall appearance of the chart.
The strategy is to buy shares whose chart is sloping upwards and sell shares if the slope turns downwards. The trend must be observable within your favoured timeframe.
All beginning traders should set hard, objective buy and sell signals before beginning a trade. If you want to trade using charts, the best way to do this is with trendlines.
A trend line is drawn when three peaks or troughs on a chart lie in line.
For uptrends, trendlines are drawn by connecting troughs - as shown on the right. The trendline was first drawn when points 1, 2 and 3 could be connected with a straight line. The share price graph has has gone on to respect the trendline by touching it but not falling below it at points 4 and 5.
Most charts do not permit us to draw perfect trendlines. Beginning traders are advised to restrict themselves to trading shares for which they can draw near-perfect trendlines.
If you buy a share in an uptrend, the sell signal is obvious. You sell when the trend breaks - in other words when the share price closes below the trendline.
Earlier we considered the three fundamental chart patterns - the uptrend, the downtrend and the trading range. We went on to consider how a trend should be traded for profit. We shall now consider how to trade a range.
The key concepts in trading a range are support and resistance.
If two local mimima appear one after the other, this is evidence of support for a falling shareprice at that level of the local minimum. We can draw a support line on the chart - as shown on the chart on the right.
Chartists demand three points of contact before an uptrend or downtrend is confirmed. Likewise, we demand a third point of contact before support or resitance can be confirmed.
The trading strategy in this case would be to buy just after point 3 on the support line. You would sell at a price close to the resistance line.
The stop loss would be set just below the support line. If the price closes below the support line you must accept your trade has failed and sell, taking your loss on the chin. Some traders will allow a little room for the trade to develop and will set a stop loss not one point but several points below the support line. This is a perfectly valid strategy but again, if your predetermined stop loss is reached, you must sell. Sometimes, the only difference between a successful trader and an unsuccessful trader is the discipline to stick to their trading plan.