How to Use Support On Daily Charts To Pinpoint Intraday Patterns
When
dealing with technical analysis, two terms you hear a lot about are support
and resistance. What they represent are
points on a chart where the probabilities favor a temporary halt in the
prevailing trend. One example would be if prices were declining and reach a
support level. You could probably expect a bounce to the upside when a security
hits its support line on a downtrend. The rally may be temporary, but if you can
get in on the move using skill and good money management, this strategy can be
advantageous.
The objective of
this lesson is to cover the characteristics of the support level of a security
and how one can take advantage of a potential bounce, using an intraday chart.
After the initial bounce, you can look for a certain price pattern on an
intraday chart or use one of several technical indicators that you feel
comfortable with. For this lesson we will be using bar charts, trendlines and
moving averages to tip us off for potential plays and protect our downside.
Rules
About Support
I am often asked
this question: “How do I know how important each support level is likely to
be?” I only wish I knew. I will, however, offer up some of these rules that
have helped me in my trading:
-
The more a
security trades at a certain price point, the more likely that point will
become a support or resistance level. Certain
prices stick in individuals’ minds, and the larger the number of people that
buy or sell at a specific price, the larger the number of individuals that
will remember their own experience in that area. That’s probably why support
levels are at round numbers. It’s easier to remember 28 than 28.34. -
The more times a
support line has been able to halt and reverse a price trend in the past,
the greater its significance will be this time around, meaning that if a
stock can bounce on support, wonderful! But if it breaks through support, I
would let it go and not take chances on it bouncing, because more often than
not, if a stock breaks below support, it will continue down. Remember, we
are looking for bounces to the upside. -
The longer the
time frame that has transpired between the time a support line was last
challenged, the less impact it is likely to have. This means that support
five months ago is more relevant than support
five years ago. -
As I mentioned
earlier, support areas will often occur at round numbers. If you look at our
first example, EMC
(
EMC |
Quote |
Chart |
News |
PowerRating), you can
see several key areas of support at the $17, $16, $15, $14, $13 (the support
area we will focus on), and $12 price ranges. If you look at these price
ranges, you can see how the stock will hover around this area, then
eventually move above or below the trendline. For the strategy that we are
talking about, we want to focus on the stock staying above the support line
long enough to take some money out of the stock.
Chart
1
In Chart 1, EMC is
pulling back from recent highs to test its support level at 13.44 on Dec. 31,
2001. It has been trading in a tight range at this point. A break below this
support level will void this strategy. However, a bounce to the upside is what
we are looking for.
Here is where we want to be careful and not try to jump the gun. Many traders
jump the gun on a trade, and those who do often live to regret it. When looking
at a daily chart in which the stock has pulled back to support, wait to make
sure it hits support and closes above the support line. You then want to draw
your overhead resistance line.
In the EMC example,
we have a tight trading range. The resistance point is 14.00. You can see from
the chart that the overhead resistance has been hit once before, but not
penetrated. We want to see the stock break out above the 14.00
resistance level. When this level looks like it could be penetrated,
that’s when we want to switch to a 10-minute intraday chart. Some people will
argue for use of a 5- or 15-minute chart. That’s fine. Just follow the rules.
They apply to other time intervals.
Chart
2
Chart 2 is a
10-minute intraday chart of EMC on Jan. 2, 2002. The stock has been hitting
its head on the $14 resistance level, but has not broken out. As the trading
session progresses, an ascending triangle has
formed and has now wedged EMC into a possible breakout position. EMC eventually
breaks out to the upside with increasing volume and rallies to close at 14.65.
Chart
3
Now this is where
good money management comes into play. If I have entered an intraday trade, I
will use a 20-period EMA to help me decide where to exit the trade. As soon as
one of the 10-minute bars penetrates the 20-period EMA and
closes below it, I will exit the trade.
In Chart 3 above,
the trading day continues on Jan. 3. As the trading day nears its end, there are
some situations that would cause you to perhaps take some
of your position off the table to lock in a profit. Some of EMC’s
10-minute bars are getting close to closing below the 20-period EMA. At the end
of the session, EMC is right on the 20-period EMA. At this point, I would exit
the rest of my position, which would be at 16.72. You never know what may happen
overnight, and you have now locked up a solid gain from the breakout.
The next trading day
(Jan. 4, 2002), EMC gapped open higher, but quickly retreated below its
20-period EMA. If you had not exited before, this is your final warning to get
out and be happy with your profit. I cannot emphasize enough how important good money
management is. If proper money management is not put into place, you will
find that your success level will falter. So, be sure follow the rules and not
your gut.
Our next example
looks at Cisco
Systems
(
CSCO |
Quote |
Chart |
News |
PowerRating) in
December 2001, when the stock was pulling back from its highs.
Chart
4
On this daily chart,
we see that CSCO is in a narrow sideways channel. It has established strong
support at 18.00. We now want to see if it will break out above 19, its overhead
resistance. Let’s switch to a 10-minute intraday chart.
Chart
5
On the 10-minute
chart, we see CSCO trading in a very tight trading range
for the better half of Jan. 2, 2002. Then volume begins to pick up, and we see
the stock begin to rally and form an ascending triangle.
CSCO then gets close to 19.00, its overhead resistance. It breaks out with
strong volume before the close. Traders who don’t want to hold a position
overnight probably would not want to trade this position. They would wait until
the next day.
Chart
6
On Jan. 3, 2002,
CSCO gaps up and continues to move higher. Again, I use a 20-period EMA as a
trendline to help me decide where to take my profit. If the 10-minute bar does
not close below the 20-period EMA, then I stay in the position.
Chart
7
Here we see CSCO gap
open on Jan. 4, 2002, and trend higher. It then pulls back and falls
below its 20-period EMA. This is the exit signal. Remember, good money
management is key. It’s not a bad idea to take money off the table when you are
profitable on a trade.
How
to Find Good Candidates For This Strategy
Because there are
thousands of stocks out there, you can’t scan all of them to see if they are
hitting their support line. And if they are, will they be stocks that have the
potential to move higher? I narrow my search down by using several of
TradingMarkets.com’s lists from the TradingMarkets.com
Stock Scanner.
They are:
From these lists I
will only choose stocks that are trading above $20, trade at least 300,000
shares or more a day, and have a 3-month Relative Strength of 88 or higher.
These criteria will help narrow down your search for potential winners.
Summary
Remember these
important points and you will enjoy much success trading:
-
Know
the rules of support -
Follow
key entry and exit points -
Employ
sound money management
Happy Educated
Trading!