Today’s Trading Lesson From TradingMarkets

Many
short-term and position traders ignore some of the most valuable uses
of longer-term charts. I hear many short-term traders saying things like, “What
do I need to look at monthly and weekly charts for, when I’m trading for just a
few days?” What’s interesting is that many of the very best short-term traders
hold just the opposite opinion. In my own trading, most of the very best
short-term trades I’ve ever made, those ten-baggers and higher, have come from
interweaving long-term charts with very short-term opportunities. Let me give
you a brief look at two ways of using longer-term charts to enhance position and
short-term trading. Let’s look at how to use trend channels and long-term
previous support/resistance levels to improve your trading position.

A trend-channel (which is most
commonly base on a weekly chart, but sometimes on a daily, intraday, or monthly
chart) is an extremely valuable tool that is extremely simple to use, and often
hugely profitable. I remember vividly sticking my neck out and risking 50 points
in a sell signal off of a weekly trend-channel resistance level in the Swiss
Franc in the 1980s, and being able to pay for the next year of college off of a
one-contract 1300 point profit. I’ve been using trend-channels to enhance my
trading ever since. Here are a few examples of ways to use this simple but
valuable tool.

Our TradingMarkets.com “Top RS New
High List” is produced on our site every day, and it allows us to view all of
the new highs that also have strong relative strength and strong earnings growth
on a daily basis, so as not to miss any big potential winners. One stock that
appeared with frequency on these lists starting in May-July, then again in
September-December, and again recently, was Audiovox (VOXX)
(actually, the symbol was VOX earlier in 1999). VOXX developed a beautiful daily
chart trend-channel that was validated in September, 1999. Please see
Figure 1.

Figure 1. 

A trend-channel is “validated” when
three points are confirmed as acting as support or resistance. Thus we can draw
a simple up-trendline connecting the points labeled “A” and “B,” and when the
stock gets support and rallies off of point “C,” the trendline is validated. We
can also take the A-B trendline and move a line parralel to it up to the last
significant high. If we get another “new” high that bounces off of this parallel
line, that can also be considered validation. In Audiovox’s case, point “F”
validated the trend-channel, but since “C” had already represented a third point
of validation, we already knew that at least the uptrend-line was valid after
the market bounced off of “C.”

In September, Audiovox made a new
high, breaking out of both a flag-pattern (our favorite buy pattern), and of a
cup-and-handle on good volume and on a thrust pattern. Points 1,  2, and 3,
where Audiovox came down and tested the uptrendline, could then be used as
points to move up ops’s and to add to positions. Simple using a breakout above
the high of the day that tests the trend-channel support and an ops a tick below
that day’s low, yielded two trades that returned over ten times risk in profit
potential. Shorter-term traders could use these “tests” of a valid trend-channel
support as areas to focus on for even shorter-term entry methods (as we’ll show
in the MSFT example below).

Figure 2.

Figure 2
shows another stock that appeared frequently on our new high lists last year,
Microsoft (MSFT).
While we wouldn’t personally have traded Microsoft on a position-trade basis
because its PE in relation to growth and growth potential were not favorable,
Microsoft could be traded on a short-term basis. Microsoft made the more common
weekly trend-channel. Taking the trendline from “A” to “1” and then making a
parallel trendline up to “B,” we can see that point “C” acts to validate this
trend-channel by being a third point of proof. At point “3,” Microsoft comes
down to within a point of its weekly trendline support. Notice that volume
declines during the price decline into weekly trendline support.

Figure 3. 

Figure 3
shows Microsoft on a daily basis as it hits the weekly trendline support. Notice
that volume declines during the price decline into weekly trendline support.
(We’ve also noted how Microsoft had a distinct decline on volume on the rise
into trendline-channel resistance at the 120 level, which led to a decline of 25
points.)

Figure 4. 

Finally, Figure
4 shows a half-hourly bar chart of Microsoft. Notice that as Microsoft
hits 95 weekly trendline support, it quickly thereafter breaks a half-hourly
down trend-channel resistance level, near 98. Here, Microsoft confirms that it
is getting support at the weekly trendline and could be bought with a 94 3/4
ops. Notice also that on a half-hourly basis, Microsoft has since embarked on an
uptrend channel that has been validated. Investors could have taken full or half
profits on longs from 98 at the 107 level, when half hourly trendline support
was broken, for a seven-day 9 point profit on a 3 1/4 point risk. Longer-term
bulls could hang on with an ops below the last trendline support level at the
104 level. This example illustrates how looking for support via a weekly
trend-channel support level and then focusing in on a shorter-term chart, led to
a profitable short-term trading opportunity.

Even shorter-term traders could have
focused in even more closely for a much lower risk-trade via the five-minute
chart. On a five-minute chart, Microsoft made a double bottom, right off of
weekly trendline 95 support. Microsoft could have been bought on a 96 stop with
a 94.75 ops, based on the breakout of this five-minute double-bottom formation.
Taking profits as per above at 107 then delivered a hefty 11 point profit on a 1
1/4 point risk, or nearly a nine-bagger in just seven days. Clearly it pays
short-term traders to look at longer-term trend-channel support levels!

Figure 5. 

Another method I use long-term charts
for is determining potential support for short sales. The simple rule is that
prior support levels that led to monthly rallies, become potential support when
stocks decline to those levels again. Thus, Figures 6 and
7 show that Goodyear (GT)
and Norfolk Southern (NSC)
have broken key support and have a significant number of points to go down
further before they hit past support levels from here.

Figure 6. 

Figure 7. 

Whereas Figures
8, 9, 10, and 11 show that both United Asset Management (UAM)
and Caterpillar (CAT)
are approaching significant past support levels on weekly or monthly charts, and
that investors short these stocks should tighten up trailing stops significantly
or else take at least partial profits until these significant suport levels are
clearly broken. If an investor were contemplating a new short-sale, without the
long-term charts, United Asset Management and Caterpillar would look just as
favorable as a short-sale candidate as Goodyear and Norfolk Southern. However,
as our look at the long-term support levels of these stocks shows, United Asset
and Caterpillar are at levels where investors should consider taking profits,
not putting on new shorts. Clearly, if United Asset and Caterpillar break
strongly below these support levels–and those already short Caterpillar and
United Asset from shorter-term patterns may profit greatly by exiting on any
signal of a rally off of these support levels (à la Microsoft example).
Therefore, looking at prior weekly and monthly support levels is a significant
aid to short-term traders and position traders alike.

Figure 8. 

Figure 9. 

Figure 10. 

Figure 11. 

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