CHAPTER 13 PRICE RULES

Transcription

1 CHAPTER 13 PRICE RULES The essence of timing is knowing when to buy or sell a stock or when to sell one short. This chapter describes price patterns or rules that call for action when other indicators confirm their buy or sell signal. It is easy to look at a chart and get a general idea that you might like to own it. But should you buy it now or wait? Or should you have done it last week? All too often you can be overtaken by emotions. You want to see whether anything is going to happen before you make a move. But once the stock does move, is it then too late to buy? If you do buy, what is the risk of doing so just as a significant retracement begins? In the worst case, you may buy, into a buying climax just as a major bull move comes to an end. Alternatively, you may buy a stock, expecting it to go up, but it never moves. On the other hand, you may own a stock that appears to be falling out of bed. Should you sell it today, or should you have sold it last week? Or should you hold it? It is all too easy to be driven by fear of losing a profit or of taking a bad loss and to sell out at the worst possible time. Perfection in timing is unachievable. Nonetheless, the eight price rules described in this chapter come as close as possible to achieving timely entries and exits. They apply to chart for all time periods monthly, weekly, daily, and for the very short-term trader, intraday. Although developed independently, they follow the same general principles as the ancient Japanese candlestick price bar patterns. Neither price rules nor candlesticks should be used as stand-alone indicators, although some people try to use candlesticks on their own. Both these approaches help in deciding when to buy or sell, provided they are related to the bigger picture. Before presenting the price rules, the principles and conditions that govern them are described. Both buy and sell signals are illustrated, since it is just as important to know when to sell a stock, or when to sell short, as when to buy. The rules themselves are not cast in bronze, and they occasionally can be stretched if other indicators suggest that would be a reasonable course of action. (Occasionally, when the major trend is very strong, you might intentionally buy low or sell high before a price rule develops.) The most important thing is to understand what they are about. Price Rule Principles 1. When random buying or selling occurs in the ordinary course of business, price charts show random patterns. When there is a persistent weighing of pressure toward either buying or selling, price charts also

2 reflect this fact. One footprint in the sand says nothing. When a pattern of footprints starts to point the way, another way, you want to buy strength and to sell weakness, but only when the probabilities favor continuation of either the strength or the weakness. 2. A close at the extremity of a bar s range suggests that the stock is likely to continue in the direction or the strong close. This is particularly so when there are several consecutive strong closes in the same direction. 3. Ideally, a price rule signal should be in fore on the monthly and the weekly chart before buying or selling a stock. 4. A price rule signal must occur on the daily chart to buy or sell a stock. Completion of a price rule on the monthly or weekly chart delivers a signal in its own right, but this signal must be confirmed by a price rule signal on the daily chart. 5. It is important to act on a price rule signal as soon as it occurs. The bust signals lead to price immediately following through. If you wait for more confirmation, it is almost certain that you will end up trading at a worse price. The risk of a retracement usually increases as the stock moves away from a price rule signal. Confirmations can sometimes be too much of a good thing once a stock starts moving. After completion a buy signal, you can often buy at a lower price. However, the signals that let you do so are often the ones that fail. The best signals often lead to a profit right away. In the long run, it pays to act as soon as a strong price rule occurs. Conditions for all price rules 1. To complete a price rule, the final bar has a close in the top 25 percent of the bar s range for a buy signal or the bottom 25 percent for a sell signal. 2. A price rule may take longer to complete than the minimum specified time. Thus it could take four or five bars, rather than three, to complete a three-bar close rule (Rule 1). It could also take until the fourth or fifth bar to obtain a close in the top or bottom 25 percent of the bar s range, thereby completing the signal. 3. When price closes in the middle of the range, the result is neutral. Assume the same closing designation as for the previous bar. 4. When an emerging pattern is violated, start counting again at the beginning of the formation with a new bar When a price signal is completed (and other indicators confirm taking action), buy or sell right away. Do not chase entries unless there is a new signal.

3 Price Rules 1. The Three-Bar Closes Rule A buy signal occurs on completion of two consecutive bars in which price closes in the upper half of the range and the next bar closes in the top 25 percent of its range. A sell signal is the reverse. Figure The Three-Bar Closes Rule. 2. The Reversal Rule Shorten the proving time from three bars to two when either of the two bars is a reversal closing price, key, or high / low reversal. 3. The Gap Rule Shorten the proving time from three bars to two when a gap occurs. 4. The Island Rule Shorten the proving time to one bar when an island occurs. It is not necessary for closing price(s) within an island to be in the top or bottom of the range. An island may consist of one bar or may. However, the more time taken to form an island and the more symmetrical

4 the gapping, the more likely it is that price has reached an important turning point and will continue in the direction of the new gapping. Islands often indicate absolute exhaustion of the previous trends. 5. A. The Lindahl Buy Rule Within nine bars from the bar of the low for the formation: 1. Price must exceed the high of the bottom bar for the formation: (b) must take out the high of (a). 2. Price must then take out the low of the preceding bar: (d) must take out the low of (c). 3. To buy, price must take out the high of the preceding bar and close above the preceding bar s close and the current bar s opening (e). This formation may be completed in as few as three bars or as many as nine, depending on the number of intervening bars that do not contribute to development of the formation. Put another way, it is not significant when price exceeds previous highs and lows. There may be several neutral bars in between. B. The Lindahl Sell Rule Within eight bars from the bar of the high for the formation: 1. Price must exceed the low of the top bar for the formation: (b) must take out the low of (a). 2. Price must then take out the high of the preceding bar: (d) must take out the high of (c). 3. To sell, price must take out the low of the preceding bar and close below the preceding bar s close and the current bar s opening (e). This formation may be completed in as few as three bars or as many as eight, depending on the number of intervening bars that do not contribute to development of the formation. The commodity futures researcher Walter Bressert, our source for Lindahl signals, found that valid buy signals may require one more bar than is required to complete a valid sell signal. Some people find it

5 difficult to grasp the detail of Lindahl signals. It may take time, but it is worth the effort. Lindahl signals are very reliable when other indicators indicate a turn in price. They also occur very frequently on stock charts of all durations. If you have difficulty learning to recognize Lindahl signals, think of them as looking like a miniature M or W formed by just a few bars. 6. The Trend Continuation Rule Shorten the proving time to one bar when there a single reversal bar in the direction of an established and unmistakable trend. A clear and unmistakable trend requires the 25 and 40 bar moving averages to confirm the direction on the monthly, weekly, and daily charts. It is psychologically difficult to chase a rapidly moving stock. This price rule provides the mechanism for buying with both a manageable stop loss and a high probability of making a profit right away. This price rule may also be used when other indicators suggest that a consolidation within a clearly established trend is ending. 7. The Trend Reversal Rule Trade with the direction of a single, very big reversal bar, even though the trend appears to be in the opposite direction. Hence the name, trend reversal. This rule is useful for selling an existing position after a buying climax. The probabilities seldom favor using it to buy against the direction of an established trend. 8. The Double Reversal Rule Trade on completion of a second reversal bar in the same direction within a period of six bars or fewer, whether closing price reversals, high/low reversals, or a combination. Both reversal bars should close in the top or bottom 25 percent, as appropriate, of the bars ranges.

6 As suggested by the name double reversal, this rule is a double trend continuation (Rule 6). Double reversals occur often and are very reliable. They also occur frequently in Lindahl formations (Rule 5). When buying, the signal is much stronger if the second low is higher, and when selling, if the second high is lower unless the second reversal is exceptionally powerful. The same goes for closes. The second one should ideally be higher when buying and lower when selling. Occasionally, this rule can be completed in as few as two bars. It is very powerful when the second bar completes a double reversal and is also a key reversal bar.