Stock trading isn’t difficult; beginners just need to pay attention and be patient enough to wait for the best pattern. Trading that pattern is just as easy as 1, 2, 3.
I continuously come across charts like the ones below during my trading sessions. So yes, you can find similar ones all by yourself. The difficult part is to find them on time!
What patterns should we be looking for?
Support and Resistance, baby
Support and resistance is one very basic pattern of technical analysis. In brief, we are looking for bottoms or tops aligning at the same price. They will provide support and resistance respectively.
Usually we buy at support and sell at resistance.
Each time stock prices bounce off a support or resistance level, that level becomes more important. Like the support level at $16.74 of Digital River’s daily chart.
It was back in August when DRIV’s decline stopped at that support level; still an insignificant level. A month later the level provided support twice. Then once more in October. At that point it was hard to miss the support level at $16.74. Maybe that’s why sellers failed to push DRIV stock price below that level in December.
Buyers stepped in on December 20, and confirmed the support level for a 5th time! Also notice the volume spike on that very day.
Now comes the best part: Although the price penetrated that support level most notably in September, there hasn’t been a single day that closed below that! Check that out at the most detailed chart at TradingView!
This means that if we had placed a limit order to buy at $16.74, every time our order was executed we would never end up losing money at the end of the day. Additionally, in 3 out of 4 times we did that (obviously we wouldn’t trade the first bounce, since we didn’t really know price would find support there), we would make at least $1.80 per share, given the price climbed up to $18.50.
Now, I told you stock trading for beginners is as easy as 1, 2, 3:
- Find the entry point by using the support or resistance level ($16.74);
- Trade 70% of your position at the most recent resistance ($18.50) or support level respectively and move your stop loss to the breakeven point; and
- Close 20% of your remaining position at the next resistance ($20.00) or support level. Use a loose trailing stop order for the rest of your position.
How difficult does that sound? This is probably the easiest trading plan you can ever follow!
There are times also that support and resistance levels can be identified by looking way back. Like at the Ceco Environmental’s daily chart.
In March CECE stock price met resistance at $14.29. In October the breakout momentarily pulled back at that level and converted the resistance level into support. If we didn’t trade that particular pullback, we still had the chance to do it in December!
Again there hasn’t been a day’s close below that level.
Note: Obviously if you had traded short in October, expecting the stock price to respect the resistance level, you would have lost. But the uptrend that followed the support confirmation should win you more money than you lost. That is why we as beginners in stock trading should always trade with risk/reward ratio that exceeds 1:1.
Yet, you shouldn’t have gone short in October. Have you been paying attention to the tips here? Let’s go back and rewrite this:
So, why shouldn’t we trust the resistance level? Price bounced off only once before! Compare that with the December’s bounce and I’m certain you’ll notice the difference.
Support and resistance is just one of the key basic patterns of technical analysis. There is one more.
Trend lines are our guides for trend-following trading
Trend lines are lines drawn by connecting bottoms or tops during a trending stock price. If the stock price is trending upwards, we connect the bottoms. Like in the daily chart of Mesa Laboratories stock.
Again, the more often stock price confirms the trend line, the more significant that trend line becomes.
We begin drawing the trend line by connecting the two bottoms of July and August. Note here that resistance has already become support! That’s just one additional signal that the stock is trending.
MLAB stock price doesn’t fall back to the trend line till November. Although it would have been a profitable trade if we entered long at that point, it was just the third confirmation of the trend line. When the stock price pulled back once again in December, the candlestick’s long wick showed that selling power was simply exhausted. On the other hand, the upper wick was also long, indicating the market’s uncertainty of the direction.
But if we had drawn the trend line, we would have a guide to remind us of the long-term trend.
Let’s see now the three steps when trading using trend lines:
- Find the entry point by using the ascending or descending trend line ($68);
- Trade 70% of your position at the most recent resistance ($74) or support level respectively and move your stop loss to the breakeven point; and
- Close 20% of your remaining position at the next resistance ($82.00) or support level. If the stock is trading into uncharted territory, draw Fibonacci extensions between bottoms and tops like I showed at the Twitter stock chart. Use a loose trailing stop order for the rest of your position.
Stock trading for beginners: can’t get any simpler than that!
Trend lines, support and resistance levels are found in all time frames. Suffice to say, the shorter the time frame, the less important the patterns are. Begin your experiments at the daily chart or even weekly ones, before moving down to hourly or 5-min charts. We’ll talk in the future how we go back and forth between different time frames to pinpoint our entry points.
So, what do you think? Is stock trading really that difficult for you as a beginner? How hard is it to draw simple lines like support and resistance levels on stock charts?