Today’s Trading Lesson From TradingMarkets

  • September 29, 2004
  • TradingMarkets Editors

Editor’s Note:

Each night we feature a different lesson from

TM University. I hope you enjoy and profit from these.
E-mail me if you have any
questions.

Brice

Are we experiencing a
bear market, or are we still in a bull market? The other day, I had a
chance to talk to a friend who works at a local brokerage house as a mutual fund
sales person. I asked him how he was surviving in this brutal market condition.
As expected, his response was somewhat pessimistic at first, but he quickly
changed his tune to a salesman’s pitch/ “This bull market is still alive. It’s
just resting now,” he said, telling me to look at the Dow Jones Industrial
Average chart in three different time frames — monthly, weekly, and daily. The
monthly chart confirms the market is still in a long-term uptrend. Formation of
a trading range in both the weekly and the daily chart may suggest the market is
in a resting phase before resuming the uptrend. (See charts below.)


 

By the
way, my friend and I
completely agree the Nasdaq is, without doubt, in a bear market. All three time
frames of the Nasdaq Composite Index charts show a clear downtrend.  

As daytraders or short-term traders, how can we take advantage of
different time-frame charts? How should we trade a stock when it displays
contradicting trends in different time frames? If your friend has multiple
personalities like Sybil, which person do you listen to? In other words, can you
trust daily chart patterns more than five-minute chart patterns? Are long-term
charts more reliable than short-term charts? In this lesson, I would like to
discuss briefly how to benefit from multiple time-frame charts — especially the
effective use of longer-term charts for short-term trading. 

In an interview by Active Trader magazine,

Linda Bradford Raschke said, ” To watch the market intraday, I have 30-,
60-, and 120-minute charts for each market I’m watching. That gives a pretty
good road map. If you can’t see something with that, then there’s really nothing
going on. On one of those time frames you’ll always see either a retracement
pattern, like a bear flag or a bull flag, or you’ll see a test of a key support
or resistance level. The market’s either retracing or testing — that’s about
all there is to it.”  

Robert Krausz, featured in “New
Market Wizards,” puts it this way: “Use the higher time frame price activity
to define the tradable trend as well as the potential support and resistance
level. For example, if you are trading the Treasury bond futures and you follow
the market using 50-minute bars, then look to the daily bar’s activity to
indicate the trend and support and resistance levels”

I believe those two great traders are stating the same facts about how important
it is for traders to watch multiple or different time frames. If you follow your
stock in only one time frame, you may never discover tradable patterns which may
be obvious in a different time frame. Many of you probably experienced your
stock reversing direction as soon as you entered the market. This could happen
if your stock hit an important support or resistance level in a different time
frame. I must stress again the importance of following your stocks in multiple
time frames. If you are a five-minute chart user, don’t forget to study the
daily chart because it reveals important price levels.

Below is a daily chart of American Eagle Outfitters (AEOS)
as of 2/26/01. The stock is in an uptrend, and it appears to be setting up for a
breakout to a new high. We can also see the stock has established a resistance
level around 40 and a support near 35 in last five weeks. Now, we have vital
information of the stock. The trend of the stock is up, and it has clear
resistance and support levels. 


 

As short-term
traders, the next obvious step is to apply the information above on shorter time
frame charts, such as a five- or 10-minute chart. On Feb. 27, instead of
breaking out to a new high, AEOS made a weak open at 39 3/8, suggesting a
potential test of the support level near 35 from the daily chart. At 9:40 a.m.,
the stock broke down below its ascending trendline. (See five-minute chart
below.) This could be our first short sell entry point. Of course, our target
price was 35,  the support level from the daily chart. At 10:15 a.m., the stock
fell below its minor support level. This was the second short sell entry point.
Eventually, the stock hit the intraday low of 36 5/8 at 11:10 a.m. and began to
reverse. 

 

I would like to show
you another example. The chart below is the daily chart of Qualcomm (QCOM).
As of 2/21/01, the stock indicates a clear resistance level near 90 and a
support level around 68. Let’s see what developed in the five-minute chart the
following day.

On Feb. 22, shortly
after the open at 9:50 a.m., the stock violated its support level of 68 from the
daily chart. Needless to say, this was our short sell entry point. At 10:35
a.m., QCOM hit the intraday low price of 63 1/16. I want you to look at the
chart below again. This trade would not materialize if you did not see the
support level at 68 from the daily chart. Perhaps you might have had a chance to
enter a short sell when the stock gapped down a few bars before the 9:50 am bar.
But the point I want to stress is that nobody can anticipate a gap-down, while
we can anticipate a violation of a support level. 


 

Finally,
If you use daily charts for your
trading, you can get valuable insights from weekly charts. The chart below is
the weekly chart of W.R. Berkley (BKLY)
as of 2/9/01. The stock has successfully tested its rising trendline, and it
appears ready to resume its uptrend. The closing price for the week was 39 1/4,
and the weekly high was 39 7/8. With this information, our plan would be to buy
the stock if it trades above 39 7/8 the following week. 


 

On Feb. 12, BKLY
took out 39 7/8. (See daily chart below.) This event coincided with a breakout
above its 50-day moving average. As we know, the 50-day moving average is widely
watched important indicator, and the stock is still extending its gains as of
March 2. You might argue that you didn”t need a weekly chart for this trade.
You could simply buy as soon as the stock breaks out above the 50-day moving
average. Well, don’t forget the fact that the weekly chart signaled a potential
upswing as of Feb. 9, one trading day before the breakout. 


Let’s review:
If you are a daytrader or a
short-term trader using five- or 10-minute charts, be sure to study the daily
charts carefully because they provide you with the trend and important
resistance and support levels. So often, critical price levels are found in
longer time frame charts such as daily or weekly charts. Simply by studying
several charts from different time frames, you can protect yourself from
unexpected price reversals.