Bulls on Wall Street. 4 Day Trading Bootcamp

Transcription

2 Contents Chapter 1 Introduction Chapter 2 The Basics Chapter 3 - Technical Analysis Value of Technical Analysis Understanding the Dynamics of an Auction Market How to Follow the Flow of Money Chapter 4 - Charting Basics Chart Setup Price/Volume Relationship Intraday vs. Daily Charts Chapter 5 - Support and Resistance Trading The dynamics of support and resistance Types of support/resistance Box Trading Chapter 6 - Trends Different types of trends How to identify trends Monitoring trends on different time frames Chapter 7 - Breakout Trading Traits of a Breakout Flat Top Breakouts Base Breakouts Flag Breakouts Chapter 8 - Trading Pullbacks PB to moving averages PB to price support Chapter 9 - Risk Management Risk Management Guidelines Tips on Managing Winning Positions to Maximize Profits Types of Stop Losses and Exit Strategies Managing Your Portfolio Risk in Conjunction with Market Cycles Chapter 10 Putting it All Together Scanning 101 Journaling Brokers

3 Chapter 1 Introduction I started trading in my first year of college. After placing my first trade in Exodus Communications, I was hooked. It was all I thought about and wanted to study. As I was learning my craft I had many ups and downs. I had times where I had large amounts of money in the bank and then days later it could all be gone. Such is the life of a 19 year old trader who has no real idea of what he is doing, but knows he loves doing it. After trading on and off successfully, and blowing up numerous accounts, I decided after college to get a real job. While doing this job, all I could think about was the stock market. A couple years later I got into the recruiting business and started to make a very good living for myself. I was vice-president of my company at the age of 25. Even then, I always had the stock market in the back of my mind. That s when I knew that I had to be a full time trader, as no amount of success or money could satisfy that constant urge I had to be involved in the markets. How many people are so lucky to find that type of passion at such a young age? I was truly lucky in that regard and it would have been a disservice to not follow that dream. I believe that all people are meant to do something special and that everyone has a talent or a knack for something where they can be extraordinary. The key is to find it and embrace it. Its a sad thing to see so many people muddle through their lives just living to work, putting in their time and doing just enough to get by and making just enough to survive. So many people go through life and never find that one thing that moves them, that inspires them and gives meaning to their career. Other times I see people that do have a passion for something but are just to afraid to go after it. They are afraid to fail or that they won't be able to support themselves if they follow their dreams. That fear hangs over them for a long time before they finally let their dream be extinguished and then just live a life of regret. Most people never regret the risks they take in life, but they often regret the risks they DIDN'T take. I took that risk and it changed my life forever. I'm not only able to take care of my family and spoil them rotten, but I am able to live my life on my own terms and under my own rules. If you're like me and dream about the markets at night and on Sunday get goosebumps of excitement from the market opening in a few hours...if you sit at your cubicle hating your job and your boss as the only thing you want to be doing is trading, then this class is going to be the tool that gets you where you want to be. I ve been meaning to write something for quite some time. As I've had the Bulls on Wall Street website now for years, I've interacted and spoken with over 1000 traders. From those conversations I started to understand why 99% of traders fail. It became evident that most traders end up going bust and never making it due to the same basic problems. What I found from speaking with so many is that most traders never develop their own METHOD. A system of trading that they can stick to no matter what. A system that gives them a step-by-step process and routine that tells them what to do every single day. Most traders will float from one method to the next constantly, always searching for the holy grail. One day they are momentum traders, the next they are value investors. They follow all these distinct styles simultaneously, trying to pick and choose from each one. This is not methodical--they have no edge. Often they are just seeking riches or excitement, with unrealistic expectations as to what they will need to do to develop expertise. Its been said that it takes 10,000 hours to develop mastery over a subject; if you're jumping from method to method, style to style, how can you get the repetition, the practice, to truly develop any level of expertise? To be a successful trader, you need an exact and clearly-defined method. You need to be able to identify stocks that fit your style of trading. You need to have an exact method of picking entry points, targets, stop losses. You need to be able to 1

4 measure your risk and then size the position accordingly. Once you have all that, to truly be a trader you will need to be able to manage that position and make adjustments according to market conditions. This is what the BULLS METHOD is. I've taken every piece of the trading circle and put it into a comprehensive method that takes a trader through: 1. Stock scanning 2. Vehicle selection 3. Picking precise entries 4. Setting targets 5. Measuring risk This will take you full circle. This coursebook will not guarantee you become a successful trader. It can give you the tools and knowledge to succeed, but it will still be up to you. To be truly great at something, you have to be a bit insane or borderline obsessive about it. That's the only way to master a very complicated subject in a very short amount of time. Doctors go to school for a decade plus and spend over $100k on their training before they ever pick up a scalpel. Imagine the work and suffering they go through before they finally have a chance to make the big bucks. Well you will have to go through the same type of trials and tribulations, but we are going to try to shorten the time frame from 10 years to months! Chapter 2 The Basics What is a stock? How do you buy them? What does it mean to sell short? The Bulls Method of trading will provide a set of guidelines for profitably trading stocks, but first it's important to understand some core concepts and define key terms that will be essential for applying the information presented in the rest of this course. So lets start at the beginning. What's a stock? A stock is a contract granting partial ownership in a company. As the perceived value of a company and its stock goes up and down, so does the price of the stock. As traders, we take advantage of these price movements to make a profit, ideally buying shares the individual unit of a stock at one price and selling at a higher price. For example, you could buy 10 shares of Apple stock at $615 per share (a total investment of $6150) and then sell them at $620 per share for a $5 per share profit $50 total profit. The United States stock market is essentially an auction in which you can buy and sell shares of stocks for any of the 8,000+ companies currently listed. The U.S. stock market is open from 9:30 AM to 4:00 PM, EDT, Monday through Friday, excepting holidays. During that period of time, you can buy, sell and short stocks. With so many different stocks trading on the market, it sometimes helps to have a tool that allows you to quickly and easily gauge market sentiment and tell whether most stocks are going up or going down at a particular point in time. A stock index, which is a grouping of stocks with something in common, provides this function. Two popular indexes are the Dow Jones Industrial Average (the DOW), which comprises 30 of the largest US companies and the S&P 500 index, which is made up of the top 500 publicly traded US companies. To buy and sell shares, you need a broker. A stock broker is a company that executes the buying and selling of stocks on behalf of its clients. Popular examples include Etrade, Scottrade, and Ameritrade, though there are many others. In the past, many brokers would offer investment advice in 2

5 addition to buying and selling shares for their clients, but today most brokers provide an online platform and all the tools needed for their clients to buy and sell stocks on their own, with investment advice offered as a separate service. Some brokers charge a monthly service fee and all brokers charge a commission, which is the fee you pay when you buy or sell a stock. When you setup your brokerage account, you must also fund it by depositing money from an outside source, like a checking account. Each brokerage has a different starting account minimum, which is the amount you must deposit to open an account. Many also have an ongoing minimum balance, which is a minimum value, derived from the current value of all stocks held plus the cash balance of the account. We talk more about how to select a broker in Chapter 10 day 4 of the course. So once you have a brokerage account and have deposited money, how do you actually make a trade? In the past, you would call your broker and he would execute the trade on your behalf. Though still offered, that service is expensive and uncommon and has largely been replaced with web-based tools that allow customers to place their own buy and sell orders. Each brokerage has a slightly different interface for executing trades, but all share a few important components: Ticker or Symbol: the company you want to buy or sell. MSFT for Microsoft, BBY for BestBuy, etc Shares: the number of shares of the stock you wish to buy or sell Buy/Sell/: Do you want to buy or sell shares? Type of Order: the two most commonly used options are limit and market, discussed below Execute button: once the components of your order have been filled out (number of shares, ticker, etc) you will need to tell your broker to execute the trade The two most commonly used types of orders are market orders and limit orders. A market order tells your broker to buy or sell the specified number of shares immediately, at the price the stock is currently trading. It does not specify an exact price. For volatile stocks that fluctuate in price rapidly, a market order is not ideal, as your order could get executed at a price significantly higher or lower than desirable. For less volatile stocks, a market order is fine. A limit order specifies limits on the price at which you want the trade to be executed. A buy limit order for $5.50 tells your broker to buy X stock at $5.50 or less, establishing an upper limit for how much you are willing to pay for that stock. A sell limit order tells your broker to sell X stock for $5.50 or higher, establishing a lower limit for much you are willing to sell the stock. In addition to buying and selling, you can also short or sell short stocks. When you short a stock, you are telling your broker to borrow shares of that stock and then immediately sell them. You then cover the short later, which tells your broker to buy back the same number of shares shorted. The goal is to short a stock you think is going to go down, selling it at one price and then buying it back (covering it) at a lower price, with the difference between the two prices your profit. Finally, what is day trading? When you buy and sell a stock within the normal market hours of one day (9:30 AM - 4:00 PM) that s a day trade. The SEC (Securities Exchange Commission) places limits on day trading, as do most brokers. The most significant of these restrictions is the requirement that you maintain a minimum account balance of at least $25,000 if you plan on making more than three day trades in a rolling 5-day period. Before day trading, it s important you read and understand the restrictions and requirements for day traders. 3

6 Chapter 3 - Technical Analysis Technical analysis catalogs market data and establishes a system for finding trade ideas, picking entries & exits, and managing risk. It encompasses nearly all your trading decisions from steps A to Z. I look at an average of over 1000 charts a day. I've been trading a majority of my adult life. Its safe to say over the course of my trading career I may have looked at and analyzed nearly 1 million charts. During this time, I would be studying numerous methods and styles, always looking for the holy grail. That perfect setup or indicator that would tell me when to buy a stock before it explodes. So far I have found no such pattern or indicator. Positive price action in the form of momentum is really the best way I have found to extract profit from the market on a consistent basis. The best way to do this is by following and trading trends. As trend/momentum traders we enter stocks as they start to show momentum and stay in the stock as long as it is moving in the anticipated direction, and then sell or cash out as that momentum fades. Using charts and timing techniques, we are always involved in stocks that are in constant motion and sit on the sidelines when that ends or there is indecision. We use technical analysis, which allows us to objectively measure the supply and demand at work in the stock market to get ahead and gain an "edge." We then conclude what could be next for the short term trend of the stock. Reading price action via technical analysis is about understanding the motivations of participants so that with high probability we can anticipate the next move based on historical patterns and then use that knowledge to exploit market inefficiencies. This provides us with market clarity, and reveals order amidst what appears to be nothing more than random chaos! Trading is all about timing the markets and the best way to time the markets is with technical analysis. You can't time stocks with fundamental analysis. No amount of research on the numbers of the stock can tell you when to buy the stock. Sure it can tell if a stock is cheap but can never tell when that cheapness becomes an opportunity for momentum to start. My goal as a trader is to enter a stock the minute I see the momo and ride it out till the momo ebbs and then cash out. This is the most efficient way to use your capital as its not tied up in stocks that are waiting. As traders we need our cash to constantly be in movement in stocks that have the potential to trend in the direction of our purchase. T.A. can give us all the tools we need to time any stock/index/market. These clues and hints from technical analysis are written on price charts. The chart is the picture that speaks a thousand words! It allows us to measure the collective market actions of all traders in a graphical format. There is no guessing when looking at a chart, as there is no news or opinions or talking heads. A chart is formed solely on the actions of traders and what they are doing with their money. The stock market is essentially just one giant auction with buyers & sellers. In the end, everything is broken down into the two simplest things: SUPPLY & DEMAND (sellers & buyers). When you're looking at a chart, you're essentially looking at the supply/demand. By the end of this program, you will be able to understand market participants and see where the demand comes in on a chart and where there will be levels of supply that can stop price right in its tracks. Over the years, many aspects of the market have changed: the advent of hedge funds, high frequency traders, government interventions, an increasing globalized world where everyone has access to all markets, etc. All this makes traders think that the market is ever-changing and that it's chaotic and random. Therefore the market can't be beat over the course of time, as small retail traders can't possibly have an advantage. Well I am telling you that 50 years from now we will most likely be trading in a very similar manner. The tools & techniques of technical analysis will still be valid, for this reason: The world may change, the markets may change but the behavior of people will always be the same. Traders will still rule and respond with emotions. Greed & fear will still be prevalent. Supply & 4

7 demand dynamics will always be the same. There will always be buyers & sellers and levels where demand comes in on a stock and levels where supply is offered, as humans throughout history have always guided themselves in the same way. In the years I have been trading, so much about the world and the markets have changed, yet my method still works as its based on reading price action via charts. The charts will always show what is happening with market participants and what they are doing with their money. Chapter 4 - Charting Basics Charting allows us to see the actions of all traders in graphical format. Charting is the tool that takes what looks like random, chaotic data and forms it into a concise picture. We use charts to determine not only where a stock has been but also where it is going. In this chapter we learn what indicators can be used to confirm positive price action and exactly how we use them. We also learn how to read volume and how it relates to price on a chart. In the end, we will show you how to take these pieces of the chart and tie them together using multiple time frames to build a high probability, low-risk trade. Chart Setup The primary component of any chart is price. A chart allows the collective actions of traders to be represented in a picture. We are not only able to see where a stock has been and what it has been doing but through technical analysis we can predict where a stock may potentially go in the future. Is there a discernible price trend or has it been bouncing around aimlessly? How does the stock react around key levels on the chart? Price tends to move in trends and trends are much more likely to continue than reverse. Identifying and then participating in those trends is the basis momentum trading. When setting up your chart, the first consideration is how the price data will be represented. The three most common options are candlestick, line, and bar/ohlc. Like the majority of active traders today, I use and recommend candlestick charts. Candlestick charts provide a concise yet robust representation of price data that can be quickly understood. Each candlestick, regardless of whether it represents one minute or one week of price data has an open and a close. The section of the candle between the open and the close is called the real body. If the close is higher than the open, the real body of the candlestick will be colored white or green, to represent a price increase. If the close is lower than the open, it will be colored black or red to represent a price decrease. Additionally, many candlesticks will have an upper or lower shadow, sometimes referred to as a wick. These shadows represent price action that occurred outside of the opening and closing prices, ie, the highs and lows. 5

8 Volume After price, volume is the most important component of a chart. Volume illustrates the number of shares that were traded in the specified period of time. This provides the trader with several important pieces of information: Is the stock liquid enough to allow for easy entries and exits? Is current volume higher or lower than average? Are more shares being accumulated or distributed? The most common way to display volume is a bar at or near the bottom of the chart. Each candlestick will have a corresponding volume bar that illustrates the number of shares exchanged for that period of time. Many brokers and charting services will display red volume bars and green volume bars. A green volume bar is for a period of time in which the closing price was higher than the previous closing price, and a red volume bar for when the closing price was lower than the previous closing price. This allows you to quickly see if there is more volume when a stock is moving up or moving down. VOLUME is the fuel that can cause stocks to rocket. Any stock that is a big winner--a stock that goes up %--will have large volume behind it. The exact volume number does not matter a stock can have 200,000 shares traded or 200 million. That is not our concern. What we want to see is high relative volume. If a stock usually trades 500k shares a day, but in the first hour of trading has already traded 500k shares, we have an expansion in volume high relative volume. Volume patterns can also signal a potential shift in the velocity of a stock and the formation of a new trend. Often stocks will show accumulation patterns when a new uptrend has commenced. Positive accumulation patterns are common in stocks right before a new trend is starting as the "smart money" and crafty traders are buying up shares in expectation of a large price move. Accumulation in a stock is simple to see: When the volume bars on the up days in the stock are higher than the volume bars on down days, the stock is in an accumulation phase. When a stock shows larger volume bars on down days vs up days, this stock is in a distribution phase and should be watched closely for a potential sell-off (which could be shorted) 6

9 In the example below, Sprint (S) made a significant move upward. The volume was above average, indicating that there was momentum behind the movement. When evaluating a stock for entry, it is important to look at the volume pattern. For a long position, it's good to see high volume on up days and low volume on down days. This indicates that momentum is on the side of the bulls. The reverse is true when considering a short position: the ideal short candidate will have stronger volume on down days. Moving Averages A moving average is the mean of a stock's price for a specified period of time. For example, a 20 point moving average drawn on a daily chart will represent, in the form of a line, the average of the last twenty days' price. On a five minute chart, that same moving average would show the average of the last twenty, five-minute candles. Moving averages come in two basic forms: simple and exponential. An exponential moving average (EMA) averages the specified number of data points, but gives more weight to the recent price data. A simple moving average (SMA) does not weight the data based on recency. We use SMA or simple moving averages. The SMA 20,50,200. Moving averages serve 2 purposes. 1. To help identify trends. 2. As areas of support/resistance. Stocks spend only a small portion of their time in a trending environment. Often they are range bound, consolidating for the next move up or down. Moving averages can help identify trends on different time frames. 20 SMA = short term trend 50 SMA = intermediate trend 200 SMA = long term trend. 7

10 The slope of the moving average will illustrate the direction of the trend for that particular time frame. The following daily chart provides an example of a stock in a clear uptrend, with the stock riding above the rising 20 (blue), 50 (brown), and 200 (green) moving averages. In addition to providing a way to quickly determine the trend, or lack thereof, of a stock, moving averages can provide support and resistance for that stock. We will cover support and resistance in detail in Chapter 4, but for the purpose of this section, simply know that support is an area at which a falling stock will meet significant demand, slowing or reversing its descent. Resistance is an area at which an ascending stock will meet supply, thus slowing or reversing its ascent. Moving averages, particularly the commonly used 20, 50, and 200 SMAs, can provide these areas of support and resistance, because many traders pay attention to them. Moving averages are just imaginary lines. There is no true price action in those areas, as they are just lines drawn by mathematical calculations. But, since they are watched by so many traders they become important as the collective actions of traders tend to repeat around such key levels. This does not give us a signal to buy or sell, but to examine the price action more closely on smaller time frames to see if there is a potential play when a stock nears such a key level. 8

11 The following chart is an example of a stock's 20 SMA serving as support. Note how each time the stock touched the 20 SMA, it bounced, resuming its uptrend. An example of a moving average acting as resistance. Stochastics The stochastic oscillating indicator, often referred to simply as stochastics, is a technical indicator that can help confirm price movements and momentum. The stochastic indicator uses a complex formula to illustrate areas in which a stock is overbought or oversold, and thus potentially due for a reversal. For more information about this formula, visit Investopedia. Stochastics are most useful with the daily chart of a range-bound (non-trending) stock. It is important to note that we use the stochastics overbought and oversold signals as secondary, supporting evidence to help confirm our evaluation of a stock as a long or short candidate. The stochastics signals are not accorded the same level of importance as price, volume, or moving averages, but can be a helpful piece of additional information to have available. 9

12 Below is an example of a range-bound stock that bounces out of its oversold zones. Note that when the blue line of the stochastics indicator dips below 20% it indicates an oversold condition. When the blue line crosses above 80% it indicates an overbought condition. This stock does not react as quickly or strongly to being overbought as it does to oversold. Bollinger Bands The final technical indicator we add to our charts are Bollinger Bands. Bollinger Bands are applied to the price area of a chart and are similar in appearance to moving averages, with the most popular configuration showing an upper band, lower band, and center band. The center band is a moving average, most commonly 20 point SMA, though it can be an EMA or SMA of any value. The upper and lower bands represent a specified standard deviation from the center band, with +2/-2 as the most commonly used values for the upper and lower bands, respectively. As a stock goes through a period of decreased price movement, the bands will narrow, indicating decreased volatility. Momentum stocks often have long periods of very minimal activity, punctuated by brief bursts of significant price increase or decrease, and Bollinger Bands can help identify these movements when they first occur. Finally, Bollinger Bands can act as support and resistance, as most stocks spend the majority of the time within the confines of the upper and lower bands. In the example below, the upper Bollinger Band acts as resistance, with the stock never breaking and holding over it, and the lower Band acting as support in March. 10

13 In this example, a stock breaks out of a long period of low volatility in early February. Price and Volume Relationship The combination of a price and volume on a chart tell a powerful story. With price alone, we can see where a stock has gone and where it might be going next. Add volume and we can also see the strength of moves up and down and thus gauge the depth of market participation in those movements as well as the conviction of the participants. While a stock can increase or decrease in price significantly on low volume, many of the most powerful moves are accompanied by an increase in volume. This is important because, as momentum traders, we are interested in stocks that are making, or about to make, substantial price movements. Higher than average volume on a move up demonstrates that the momentum is, at least temporarily, on the side of the long traders. Though this alone isn't a buy signal, when viewed in conjunction with positive price action and other technical factors, it can help us evaluate the strength of that movement and the likelihood that it will continue. No stock moves in the same direction forever. All stocks either reverse or trade sideways periodically after running up or down and volume can help us tell whether the trend has ended or is likely to continue. A stock that makes a significant upward thrust on high relative volume and then 11

14 reverses on lower volume is more likely to continue upward after a period of rest than a stock that runs up on high volume and reverses on volume that is as high or higher. In the first case, the majority of long participants have held or added to their position on reversal, whereas in the second case a majority have sold or shorted. In this example, the stock twice ran up on strong volume and then pulled back on significantly lower volume. This is a bullish volume and price pattern. Intraday vs. Daily Charts As day and swing traders it's important to use both daily and intraday charts to plan and execute your trades. The Bulls method begins with a daily chart of 3 6 months time. Price, volume, and 20, 50, and 200 SMAs are a must, along with stochastics. The daily chart is used for idea generation. It illustrates the longer term trend of a stock and is the starting point for compiling a watch list of stocks to potentially trade in upcoming sessions. The price data, volume pattern, and moving averages will help you quickly get a general sense of the stock's trend, general areas of support and resistance, and current volatility. The stochastic and Bollinger Band indicators will help determine if the stock is currently overbought or oversold. Once we have identified a potential trade on the daily chart, we then switch to an intraday time frame to identify exact levels of support and resistance and to execute the trade. As daytraders, the intraday chart allows us to zoom in with more precision. Our intraday charts are 3-day, 5 minute charts. We use price, volume, and moving averages. Stochastics and Bollinger Bands are less valuable on the 12

15 intraday time frame Sometimes, we want to look at an intermediate time frame something between the daily and intraday. For this, we use a 10-day 30 minute chart, with volume and moving averages. This time frame is helpful for finding exact levels of support and resistance over the previous several days. For short swingtrades this time frame can be very helpful for finding your reward to risk level in terms of where your target and stop will be. Chapter 5 Support and Resistance Trading There are multiple types of support and resistance on a chart. Prices move in an auction market from high to low levels because the price is constantly looking for its fair value. There is constantly changing supply and demand in a stock due to the many variables and emotions involved in the market. Support and resistance areas are established as buyers and sellers fight for control of the stock. Understanding the dynamics and reasons why support and resistance levels are established will help you see how to position trades around these levels. In this chapter you will learn the types of support and resistance levels and exactly how to use these areas on charts to make actionable and profitable trades. The Dynamics of Support and Resistance Support and resistance are areas on a chart of any time frame where a stock's current trend is likely to be reversed or temporarily halted. Stocks that are increasing in price will encounter areas of resistance that impede their upward movement. Quite simply, these resistance areas are prices at which supply sellers--meet or exceed demand buyers--acting as a ceiling. When the upward-moving stock encounters an area of resistance, it will either reverse the trend, sending the stock lower, or it will cause consolidation. The consolidation period will either end with the stock ending its former uptrend and heading lower (supply has exceeded demand) or the stock resuming its former uptrend (demand has exceeded supply). Support is the inverse of resistance; when a stock is trending lower, it will encounter areas of support where demand will exceed supply, reversing or halting the downtrend. If resistance is a ceiling, slowing or stopping an upward-moving stock, support is the floor, slowing or stopping a downwardmoving stock. When a stock moves through an area of resistance, that area then becomes support. The same is true for support: after price breaks down through the support level, it then becomes resistance, impeding upward price action. In the momentum stocks we often trade, the break of an area of support or resistance will often lead to rapid price movement. For example, a momentum stock that has encountered resistance at $5.25, upon breaking that price, could quickly move up several percentage points in minutes or even seconds, as buyers pour into the stock rapidly and must pay ever-higher prices to acquire shares. Demand in this stock rockets as the supply of shares offered has diminished due to sellers realizing the buyers have gained control of the stock. Directionless price action or congestion in areas is what forms support/resistance zones. The battle between bulls & bears for control of the price in those areas is what forms support/resistance, thus the movement above or below those areas become the basis for the start of new trends. The longer a previous support/resistance level took to form the greater the importance of that level. Price has a memory and if price is stuck at a certain level for a long time, the traders in that stock 13

16 will assign more meaning to that level. Thus a move past that level can cause a frenzy of activity as fresh buyers come in and supply is diminished supply. Many traders will be caught off guard as the level has held strong previously. These areas are where short sellers tend to cover their positions and momentum traders step in with strong purchases. These initial price thrusts tend to bring all types of traders and that initial large pop due to the passing of the supply zone will bring chasers into the stock that get excited and just buy on fear of missing out on a potential new trend. Traders who missed the breakout of this key level will wait on the sideline after the initial big thrust will be there ready to defend the stock if it ever re-traces back to the prior breakout so that they can participate. Broken support will tend to act as heavy resistance. The longer the support held the more significant the new resistance will be as all the longs that held the stock as it broke support will be looking to unload their shares if the stock ever gets back to the key level where it broke down. That s very common for traders and what makes resistance so important as a majority of traders will hold their losing positions until they come back and break even. That's why at key breakout levels it can be so hard for the stock to thrust past, as there are so many bag-holders in the stock. Types of Support/Resistance There are several types of support and resistance. Each meet the definition above--an area at which a stock's trend is temporarily halted or reversed but there are still some important distinctions to be made. Price support/resistance refers to certain prices where a stock will encounter a large number of buyers or sellers. So, for example, if a stock attempts to move higher over a period of time and is unable to continue upward beyond a certain price, that area is acting as price resistance. In the example below, the stock was unable to surpass the $10 mark, which acted as significant longterm price resistance. Moving averages can also provide support and resistance levels. Some stocks react more 14

17 strongly to moving averages than others, but it's important to note that moving averages rarely provide any kind of consistent support or resistance for consolidating stocks, just for trending stocks. Many stocks that are in an uptrend will find support when they pull back to the rising 20 SMA, and to a lesser extent, the 50 SMA. The same is true for stocks in downtrends, with the 20 and 50 SMAs overhead often providing resistance on counter-trend movements. This is an example of an uptrending stock that finds support at its 50 SMA (orange line). This is an example of a downtrending stock that finds resistance at its 20 SMA (green line). 15

18 Trend lines can also provide support and resistance levels. For a stock in a downtrend, the trend line resistance level will be a sloped line that reverses each attempt the stock makes to end the downtrend and move upward. On an up-trending stock, the trend line support is a sloped line that connects the lows of each pullback. In the example below, this up-trending stock consistently pulls back to a trend line support level and 16

19 then resumes its uptrend. Below is an example of trend line resistance Bollinger Bands are a final type of support and resistance. The further a stock deviates from its mean, the stronger the pull to revert to mean. As such, the upper Bollinger Band often acts as resistance and the lower Bollinger Band as support. These levels of support and resistance aren't exact, but stocks generally experience a reversal or consolidation move when touching the upper/lower bands. Bollinger Band Support/Resistance Example 17

20 Box Trading Stocks sometimes bounce between the same levels of support and resistance repeatedly, tapping the resistance level and then retreating down to support before bouncing and moving up to resistance again. This forms a box, with resistance acting as the top of the box and support as the bottom. Box trading takes advantage of the consistency of this support and resistance. You can trade this box pattern by buying the stock at or near the support and riding it up to the resistance level and then selling. If the stock breaks resistance it then becomes a breakout trade and can be traded as such. If it breaks below the support level, the box has been broken and the trade should be stopped out. Of course, it's also possible to trade the box from the short side: opening a short position at or immediately underneath resistance and riding it down to support and then buying to cover. 18

21 The chart below is an example of a box pattern, with defined and consistent levels of support and resistance. Chapter 6 - Trends A trend can be thought of as the path of least resistance in a stock. There are both uptrends and downtrends in stocks. An uptrend occurs when a stock is making higher highs and higher lows while a downtrend is when a stock makes lower highs and lower lows within a specific time frame. The reason that trends are important is because a stock will lay in its primary trend till a force greater than or equal to it is thrust upon it. As traders the lowest risk and highest reward trades come when you trade in the direction of the primary trend. Investors, swing-traders, and day-traders all use different time frames to monitor trends. In this chapter we will learn how to identify forming trends, how to identify the strength of a trend, and how to identify when trends are breaking using volume, price action, and indicators. An object in motion stays in motion till a force equal to or greater is thrust upon it. You guys have heard this right? It's a basic tenet of physics! Isaac Newton's first law of motion. Stocks are the same way: a trend, once its started, is more likely to continue than to reverse. Stocks can stay in trends for much longer than anyone expects and often won't reverse until a force equal to or greater is thrust upon it. This what we call the path of least resistance, as a stock will just keep following its trend until a source of supply that's greater than the demand can challenge it. This is the whole basis of trend trading. How does an uptrend start? Once a stock makes higher highs and higher lows on a particular time frame an uptrend has formed. While a stock making lower highs and lower lows is a downtrend. 19

22 And if the moving averages for the time frame you are looking at are advancing/sloping higher we have confirmation also. 20 SMA=short term trend 50 SMA=intermediate trend 200 SMA=longterm trend Now a key part of trend trading is matching your time frames. If you're a longterm investor, trends on weekly time frames are going to be more important than what is happening on an intraday time frame. Frankly, a longterm investor should not even consider such a short time frame in their analysis. For daytraders, your main focus is going to be on the trend of the last 10 days or less! What is happening on a weekly time frame will be of no concern to you. This is often a big mistake that traders make. Often they are so zoomed in or out on a chart that they feed themselves the wrong information. If you're swing-trading a stock why would you care whats happening on a 1 minute time frame? Yet that s what traders will do; they get so focused on what is happening tick by tick they totally forget the original goal for the trade and will often chop themselves out of a trade by selling too soon. For our Daytrades, we use three timeframes: Daily chart for finding tradeable setups 10-day, 30 minute chart for identifying exact levels of support and resistance 20

23 3-day, 5 minute chart for monitoring the stock intraday, watching for the ideal entry point and then managing the trade once we've entered For Swing-trades (holding for one day several weeks), we use two timeframes: Daily chart for finding tradeable setups 10-day, 30 minute chart for identifying exact levels of support and resistance and managing the trade once we've entered For longer-term investments (holding for months or longer), we use two timeframes: Weekly chart or daily chart for finding tradeable setups Daily chart for identifying exact levels of support and resistance and managing the trade once we've entered The best trades come when there is an alignment of trend across multiple time frames. The longer term time frames are the most powerful as they have the most say in where a stock is going. In the context of a longer term uptrend, on short term time frames intraday setups, such as pullbacks to support and flags, tend to resolve in the direction of the longer time frame. So if a stock is breaking out on the daily for a multiday run you can assume on a 3 day 5 minute chart that flags, base breaks, and shallow pullbacks will result in bounces to the upside. Hence the lowest-risk, highest-probability trades are when you trade in the direction of the trend as its the path of least resistance. This is why when I scan for stocks I only look at daily charts. I get my ideas from there as for my style of trading that is the primary trend. Then after my scanning is done and the market opens, I am picking my entries off the 3 day 5 minute chart. Once stocks start in their new uptrend, often after a break of a large consolidation period, this can create buying opportunities for months at a time. I find that after a big break of consolidation the great momentum stocks can often have ten different trade opportunities in the first 90 days on various time frames, as these stocks will often pullback, bringing in fresh demand. Stocks will correct after the initial start of an uptrend in two ways: one is via pullbacks. and this is a correction via price. The other is for the stock to correct via time. When stocks correct through time its just a low volume/low volatility sideways movement, AKA a flag. This will bring in new breakout buyers. Numerous types of setups on the daily and intraday will form that first few months which is why its so important to always be keeping track of stocks coming out of big bases that start to exhibit new momentum. In our chatroom you will see it everyday: When a stock first starts getting momentum we might trade that stock 3-4 times a week until the momentum fades. Once a stock exhibits movement for sometime, a trader must be on the lookout for potential clues that the trend is weakening. Its during this time when the charts look great still but the trend is slowing down that traders can get chopped around in stocks. You still remember the first initial powerful moves and how you killed it on those trades so you keep going back to the well, but the trading gets much more choppy and difficult when a trend has weakened, so we look for clues that its weakening. One of the clues we will use is volume. If volume is weakening then the mojo of traders is put into question. That volume can signal that the stock is vulnerable to a pullback. Now volume is never a buy or sell signal. All indicators are just used to confirm price action. Indicators like stochastics or volume can just give you a signal that you need to study the price action more closely as the probability. The bounces are another clue. How does the stock act when it pulls back to support? Does fresh demand come into the stock, propelling it higher quickly? Or do you get a much lighter & lower volume bounce than the previous bounces? 21

24 Finally, trend lines and moving averages can be used to see if the trend is weakening. If you keep testing a trend line that can often be a sign of the stock weakening. We often talk about taps. The more times a stock taps a resistance area, the more supply it sucks up and this can lead to a powerful breakout. The opposite is true also: the more times a stock taps a support area or a trend line the more likely and powerful the breakdown will be. Those 4th and 5th taps to support can be the most deadly and are great potential short opportunities. Now just because a stock breaks a trend line doesn t mean that the trend is over and it will turn into a downtrend. Often it can just signal that the velocity of that particular uptrend is over and a new, slower rate of change is in the works. A stock might be going up 5% a week for months then break that uptrend and it could end up in a neutral consolidation for months, or even still continue higher but just at 1% a week. There are many factors that can come in and a majority of the time its not a full-on reversal just because an uptrend is broken, it can just be an initial price correction, then a digestion period where the stock is in a neutral range for some time. Unless, of course, a stock goes parabolic towards the tail end! That can often just crash and wipe everyone out and the trend is dead for a longtime as so many people chased the stock higher and higher in an emotional frenzy only to get hit with a large source of supply as the smart traders unload their shares, catching everyone with their pants down. As the selling onslaught comes, traders become paralyzed in shock and surprise that they once again chased a stock way too high and got caught in a massive pump job. They continue to hold the stock as losses pile up,becoming permanent bagholders as the stock crashes and every attempt at a bounce is met with big selling. Chapter 7 Breakout Trading A breakout is when price moves outside an area of resistance. Whether you trade on a weekly, daily, or intraday time frame, the concepts and strategies are exactly the same. There are many traits that must accompany a breakout for it to be a true breakout. In this chapter you will learn what types of breakouts to look for as well as how to know if a breakout is working or if it is a failed breakout. Traits of a Breakout The term breakout refers to a stock that has broken through a significant level of resistance and consequently experienced a significant price increase, often in a very short period of time. Every breakout or potential breakout has a few traits in common: 1. A stock that actually has a history of breaking out. Some stocks, particularly large caps, never breakout. They may clear levels of significant resistance and thus become more favorable for long positions, but they don't experience the flurry of buying and subsequent price surge of a breakout stock. 2. Resistance. By definition, there must be something for the potential breakout stock to break over resistance. As previously discussed, resistance can come in several forms. Generally, the more substantial the resistance the larger the breakout will be when it occurs, as this indicates that there was enough demand to overwhelm the supply found at the resistance level. 3. Volume. Though the volume can and often is low preceding the breakout, once the resistance level is broken volume usually increases considerably on the actual breakout. 22

25 Flat Top Breakouts A flat top breakout consists of a stock making higher lows, while consistently hitting the same level of resistance. This shows that demand for the stock is increasing, but that it is encountering a level of significant resistance. Once this resistance is broken, the stock will often increase significantly in price. This pattern equally present on both daily and intraday time frames 1. Multiple taps on highs that has failed. The more times tested the stronger the breakout 2. Volume Pattern is key (Accumulation) 3. Align on multiple time frames. (daily and intraday chart) Beware of hidden resistance Sometimes its not an exact trigger.. You have to use your discretion and weigh the other things going on in the market. In the following daily chart example, TAOM tapped the resistance level several times before finally eating through the entire supply and sending the price considerably higher. Flat top breakout example 1 23

26 Flat top breakout example 2a 24

27 Flat top breakout example 2b Base Breakouts The base breakout is one of the most powerful types of breakout patterns. It consists of a stock that has come off a downtrend and entered a period of price consolidation, generally in a narrow range on low volume. The components of a base breakout are as follows: 1. A stock that has been in a neutral range for an extended amount of time (either intraday or daily) 2. Volume diminishes completely as buyers and sellers have struggled for control of the stock. There is finally balance between supply/demand as the stock refreshes. 25

28 3. Volatility diminishes as the range contracts as neither bull nor bear has any push 4. The stock should be bought immediately on break of base 5. When the breakout occurs the stock can often double in week.. It is very powerful. Base breakout example 1a 26

29 Base breakout example 1b Base breakout example 2a Base breakout example 2b 27

30 Base breakout example 2c 28

31 Flag Breakouts This setup consists of two important components: the pole and the flag. The pole is a significant increase in price, on higher than average volume. After this movement, which generally consists of 1 3 candlesticks, the stock needs to consolidate. This consolidation often takes the form of downward price movement. There are three important things to consider when trying to determine whether the pullback is building a flag pattern or is signaling the end of the preceding upward price movement: 1. Volume. The ideal pullback should be on significantly lower volume than that of the run-up period. 2. Price action. The best pullbacks are orderly, with the peaks of the candles forming a clean descending trend line 3. Depth of retracement. If the pullback erases the entirety of the pole, you are most likely looking at a reversal, rather than a true flag. There are two ways to trade flags. The first is to buy the break of the descending trend line established by the highs of the pullback candles. This works best on relatively shallow, orderly pullbacks that have a clearly defined descending trend line The second is to wait for the pullback to complete and the price to move back up, exceeding the previous high of the pole, and then buy on the break of that high. Flag Example 1a 29

32 Flag Example 1b 30

33 Flag Example 2a 31

34 Flag Example 2b 32