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Wednesday 12 May, 2010

Phil Newton's Break out Strategy



Saturday 8 May, 2010

BANDS AND BANDS AND CHANNELS

Trading bands and trading channel are related. Both chart patterns act as a restraint on price activity, confining it within defined boundaries. The channel defines trend behaviour. The band defines support and resistance behaviour and can be used to set price targets.

The trading channel is constructed with two trend sloping trend lines. These are parallel lines and as with any trend line, their value changes daily. The lines show changing sentiment about value. A trading channel shows the limits of this changing sentiment as price bounces from support and retreats from resistance.

The trading band is defined by support and resistance levels where the value remains constant. These are horizontal parallel lines. Price stops trending and develops a sideways movement. These patterns are more useful because they are used to project upside and downside targets. When price moves above the resistance level then the width of the trading and is used to set the potential upside target.

Both trading bands and trading channels are range-bound chart features. They provide short term trading opportunities as price moves between the support and resistance levels. However the range bound trend continuation of a trading channel is traded differently from the trading band with its potential for trade band breakout opportunities.

By Daryl Guppy

Friday 7 May, 2010

TREND LINE CONSTRUCTION

Look at the chart display. What is the trend for prices? Quite clearly they are going down. If we already have purchased this counter at $7.50, we should be worried. If we are potential buyers of this counter then the price move or break above $6.70 gives us a reason to buy the stock. The trend line gives us a way to decide which price action is significant, but only if it is accurately drawn.


We use a straight edge trend line to tell us which direction prices are moving and to give us a better way to judge the trend. If prices close under the up trend line then it suggests the stock price is falling. Ideally we would want to get out to this stock, selling it to collect our profits and to protect ourselves against loss. We get this exit signal when there is a close, or a series of closes, below the trend line.

In a downtrend, the line is placed along the price highs. A close above this line tells traders the trend may be about to change direction. This is used as an entry signal. Where we draw the trend line is important because it could cost us money.


When we think about buying a stock many traders try to buy a trend breakout. This is when a downtrend turns to an uptrend and prices ‘break out’ above the trend line. Traders try to buy the stock near the bottom just as the stock price starts to move up. They get a buy signal when the price closes above the downtrend line.

Up trend or down trend, the principles of drawing the trend line are the same. An accurate trend line uses the information available from a bar or candlestick chart. Good trend lines need to use the high or the low prices for accuracy. They are not easy to plot accurately to a line chart.

These are the construction rules:


1) The line is placed along the lows of the price bars or candlesticks in a rising trend. An up trend is defined by higher lows each day. This is the price element we want to track, so the line goes underneath. If prices fall below this line then the trend may change into a downtrend.

A falling trend is defined by the failure of prices to make new highs each day. We track this by placing the downtrend line along the highs as shown in the chart.


2) The trend line uses the extremes of the price bars or candle sticks. This is the high or the low price. These extremes are important because a close beyond the extreme tells traders the trend might be changing. This is an entry, or an exit, signal.


3)The trend line starts at the very extreme high, or low. This is called a pivot point.


4) The trend line should touch the maximum number of possible price bar or candlestick extremities. This means we do not exclude too many, nor do we go for the maximum number of hits. We want to use the trend line as a trading signal, so we are interested in closes beyond the extremes of the existing trend because these give the best trading signals

5) The more often a trend line is hit by price extremes, but not broken, the more powerful the trend line signal. A trend line that has been hit 5 times, but not broken, is very strong. So when prices do close beyond the trend line it is a very strong signal that the trend is changing.


On the chart trend line 1 is a correctly drawn trend line. It touches the optimum number of price extremes. Trend line 2 shows the general direction of prices. Trend line 2 does not give any useful trading signals and prices move above and below this line all the time. Trend line 1 shows us when the downtrend has finished. The close above t trend line 1 clearly signals the beginning of a new up trend and provides an entry signal.


Straight edge trend lines are a very powerful trading signals, but they must be placed correctly. They are used to show the short term trend - perhaps days or weeks - the intermediate term trend - perhaps weeks or months - and the long term trend - perhaps months or even years. Long term trends are best seen on a weekly bar or candlestick chart.

Not all trends are easily defined with a straight edge trend line.


By Daryl Guppy

THE RELATIVE STRENGTH INDICATOR AND DIVERGENCE

Technical indicators are constructed by manipulating some aspect of price such as a moving average of prices over a 10 day period. The Relative Strength Indicator (RSI) tries to anticipate a change in the trend. This is a leading indicator of a trend change. The results are used to deliver messages about the strength of the market. It is called an oscillator because the indicator readings are converted into percentage results which range from 0% to 100%. The position of each day’s indicator reading gives the trader an indication of the strength, or weakness, of the existing price trend.
The RSI is calculated by monitoring changes in the closing prices of the stock. The number of higher closes is compared to the number of lower closes for the selected period. The RSI compares the internal strength of a stock by looking at the average of the upwards price changes and comparing it with the average of the downward price changes. The results are expressed as a percentage, providing the upper and lower boundaries. The plotted results oscillate between these two levels and give traders information about the speed and acceleration of the changes. Traders use either a 14, 9, or 7 day period in the Relative Strength Calculation.
In this sense the RSI is very similar to a stochastic and uses similar principles. Where the stochastic quantifies the ability of the market to close near the high or the low of the day, the RSI quantifies the strength of the way the market moves higher, or lower. The over-bought and over-sold signals are the same as any oscillator, although with an RSI they are traditionally set at 70% and 30%.
The most significant trading signal delivered by any oscillator style indicator is a divergence signal. This sounds complicated but it just means that the significant valley patterns shown by the RSI trend in the opposite direction to the significant valley patterns as shown by the price line chart. A valley is created by two distinct lows that each precede a rally from a downtrend. This builds a valley in the price chart. The lows of these valleys are joined with a short trend line as shown.
The corresponding lows on the RSI indicator are also joined by a short trend line. When the RSI line slopes differently from the price chart line, a divergence occurs. When these valleys form below the 30% area on the RSI, or form peaks above the 70% level, they are most reliable. Oscillator activity between these levels is not used to find divergence signals. Divergence signals give the trader an advantage by confirming an entry into a downtrend as it weakens and just before it turns into an up trend. It is also used to get out of an up trend as it weakens, and before it collapses into a downtrend. The divergence signal does not occur every time a trend changes, but when it does, it delivers a strong confirmation signal that a trend break is likely.
RSI divergence signals often appear in advance of a trend change, but they are not very good at suggesting the time of a trend change. The divergence signal may appear just as the trend changes, as in the chart extract, or several weeks before. Traders use the RSI divergence as an early warning signal to enable them to prepare for a trend change.
When the RSI and price chart lines move in the same way we get a confirming signal that the existing price trend is unlikely to change. These signals are not very important because we can get the same information from just looking at the chart.
The RSI is one of the very few oscillator style indicators where trend lines and support and resistance lines can be effectively used. These are used as signals to confirm the trend shown on the price chart. When other chart patterns suggest action, then the RSI trend line might also confirm this. When the RSI is used like this it does not give the trader any distinct advantage.

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By Daryl Guppy