When to buy

Let's clarify something: No one can predict the future. We can't predict tomorrow's news or how people will feel next week or next month. Technical analysis isn't about making predictions. It's a tool that helps us determine what is more likely to happen in the short run. Are prices more likely to rise, or are they more probable to go down?

As investors, we don't have to be right 100% of the time. If we're right more often than we're wrong and our average wins exceed our average losses, we'll make a steady profit on our investment journey. Technical analysis helps us identify high probability outcomes. If we consistently enter the market during times when prices have a higher chance of rising rather than falling, we'll outperform investors who only buy based on fundamentals and don't consider technical analysis.

The first step is understanding how to read a chart. Picture a typical trading day. The market opens at 9:30 AM Eastern Standard Time (New York Time) and closes at 4 PM. During this time, price movement can fluctuate. For example, let's use Apple as an example. The market opens, and the price starts at $140.70 — that's the day's opening price. As the day goes on, the price fluctuates. When the market closes, the last transacted price, known as the daily closing price, happens to be $143.99.

This pattern of opening at $140.70 and closing at $143.99, means the price closed higher than it opened, making it a bullish day. However, during that day, the price went as high as $145.30 (the day high) and as low as $139.45 (the day low).

There are several types of charts brokers offer, including line charts and candlestick charts. Line charts are constructed by connecting the daily closing prices of each day. It gives you a snapshot of the closing prices over a certain period.

But to better understand the market, you'd want to know the opening price, closing price, day high, and day low. For this, we use candlestick charts, invented by the Japanese over 400 years ago. Top investors and traders still use these today to read the market.

Candlestick charts can be read using the "bodies" and "shadows" or "tails" of the candlesticks. There are two types of candlesticks: bullish (white or green) and bearish (red or black). A bullish candle represents a day when the price closed higher than it opened, and a bearish candle represents a day when the price closed lower than it opened.

The body of the candle represents the opening and closing price, while the shadows represent the day high and the day low. For a bullish candle, the base of the body is the opening price, and the top is the closing price. For a bearish candle, the opening price is the top of the candle, and the closing price is at the base.

A crucial aspect to consider when looking at a chart is the trend. An old adage on Wall Street states, "The trend is your friend." Once you can identify the trend and invest with it, half the battle is won.

There are three types of trends: uptrend, downtrend, and sideways trend. An uptrend is defined as a series of higher highs and higher lows. The impulsive wave is the wave in the direction of the trend, and the corrective wave is the slight correction due to profit-taking. Recognizing these trends and understanding how to read them can help you better time your entries and exits in the stock market.

Imagine this: after conducting a solid fundamental analysis, you've identified a great business. You observe an uptrend, which is an increasing trend in the stock's price. The choice to buy or sell seems obvious. We want to buy, of course! Why? Because on an uptrend, it is more probable that prices will continue to rise, thanks to the optimism and positive sentiment driving the stock up.

But here's the crucial question: when is the best time to buy during this uptrend? Is it at point A, the current peak, or point B, a likely future dip?

It should be instinctual to choose point B. As a buyer, we always aim to get a good deal, and that often means buying at a lower price. So, we aim to buy during a dip on an uptrend. Whenever the price drops temporarily, it's an opportunity to buy. We refer to this phenomenon as a 'correction' on the uptrend.

So, how can we identify the lowest point in a dip to make our purchase? While there's no way to predict this with absolute certainty, we can make educated guesses using a tool called 'moving averages'.

In the world of investing, three key moving averages you should pay attention to are the 50-day moving average, the 150-day moving average, and the 200-day moving average. You'll observe that on an uptrend, the smaller moving average (50-day) tends to be above the larger ones (150-day and 200-day).

Here's another interesting observation: on a clear uptrend, when prices dip, they often find support at one of these moving averages. For instance, if a stock's price hits the 50-day moving average and then rebounds, that’s a good indicator of where the low of the dip might be.

Remember, these aren't guarantees. Instead, they are tools that can help us make more informed decisions and potentially minimize our investment risk.

Let's flip the script now. We've talked about buying during an uptrend, but what about selling? Stocks don't perpetually rise; they can also experience downtrends where prices make lower highs and lower lows.

In a downtrend, prices may rise momentarily, but each subsequent peak is lower than the last. This pattern indicates that market sentiment for this stock is bearish – that is, investors are pessimistic, and prices are likely to continue falling. So, even if the business is fundamentally solid and undervalued, you may want to avoid buying during a downtrend. Instead, you might want to sell and hopefully buy back at a lower price once a new uptrend begins.

When it comes to selling during a downtrend, you want to sell at the peak, which we call a 'rally'. How can we identify this peak? Just as we used moving averages to identify buying opportunities during an uptrend, we use them to spot selling opportunities during a downtrend.

On a downtrend, the moving averages appear in reverse order: the 50-day moving average is below the 150-day and 200-day averages. Additionally, moving averages can act as 'dynamic resistance levels'. Every time the price rises during a downtrend, it often hits resistance at one of the moving averages before falling again. This resistance point could be a good opportunity to sell before the next price drop.

Beyond uptrends and downtrends, stocks can also enter consolidation periods where they move sideways. This typically occurs when the market is uncertain about where to go next.

During a consolidation period, the stock's price is confined within a specific range, bouncing between a resistance level (the upper limit) and a support level (the lower limit). You can define a consolidation by observing that the price reaches similar highs at least three times.

If you see a stock in consolidation and you've done your fundamental analysis, you might consider buying – but only at the strong support levels. If the stock reaches the resistance level and can't seem to break through, you could sell. If it breaks above the resistance and begins a new uptrend, you could buy again.

In conclusion, remember that both fundamental and technical analyses are essential tools in your investment arsenal. While the former helps identify potentially lucrative businesses to invest in, the latter can guide you on when to buy or sell for optimal returns. As with all investments, there's always an element of risk, but understanding these basic principles of stock market trends can help you make more informed decisions.

When analyzing stock trends, it's hard to overlook certain price levels at which a stock's price appears to reverse course. Instead of a random rollercoaster, the price has patterns and pauses - which we call support and resistance levels.

Take the stock Boeing, for example. Each time the price climbs up to $95, it starts to descend. The stock attempts this multiple times, but every occasion ends with the same downward swing. What can we infer from this? That $95 is a resistance level for this stock.

You may ask, "Where exactly do I draw the line to mark this resistance?" Good question!

Identifying a resistance level isn't about pinpointing an exact price point. It's about observing a general area where the price tends to reverse course. When the price goes up and comes down, forming a pattern, this can be used to draw a resistance line.

To visualize this, imagine two lines - line A and line B. If you draw line A, it might touch only one point, whereas line B touches multiple points - let's say four. Line B would be the correct place to draw your resistance line because it represents the best fit and gives a more significant view of the stock's resistance level.

When you can connect three points with a line, that's when you can confidently say that you've identified a strong resistance level. Remember, it's not an exact science; prices can hit a resistance level and move slightly beyond it, or fall short of it. Think of it as a resistance zone rather than a strict line.

The creation of resistance levels is influenced heavily by market psychology. As the price reaches a certain level, investors tend to sell, creating an excess of supply over demand, which drives the price down.

When a stock hits a resistance level and fails to break through, it often leads to bearish momentum. As investors, it's important to consider the resistance level before buying a stock. If there's a resistance level close by, it might be better to wait until the price can clear the resistance before buying.

Now, if we look at a stock's performance over time, we observe that it goes through various trend cycles. A stock might be on an uptrend, followed by a period of consolidation where the price moves sideways.

When in consolidation, two things can happen: either the price breaks out of the resistance level and continues the uptrend, or it breaks below the support level and begins a downtrend. We don't know which will happen until it does, reinforcing the idea of waiting for a breakout or buying at a support level.

Like resistance zones, support zones are price levels where the price goes down, pauses, and then reverses back up. Consider a stock where the price falls to $66, then bounces back up, repeatedly. Once you can identify at least three points where this occurs, you can draw a strong support line.

Support levels occur because a large number of buyers are ready to purchase at this price level. Demand exceeds supply at this point, and as buyers rush in, the price is driven back up.

Before delving deeper, it's pivotal to demystify what precisely we mean by support and resistance. Ever noticed how the movement of prices on a stock chart seems to have a rhyme or rhythm to it? It's seldom random, right? Certain price levels appear to exert a magnet-like pull. Prices move towards these levels, pause for a moment, then alter their course. We refer to these magnetic points as resistance and support levels, or zones.

Take, for instance, the stock of aerospace giant Boeing. It showcases a pattern where the stock price, upon hitting the ninety-five dollar mark, reverses direction to head downward. This reversal is not an isolated incident but rather, it's a pattern that repeats each time the price nears the ninety-five dollar point. Spotting this pattern prompts a crucial question – how can we harness this information? The answer lies in drawing a line connecting these points to form what we refer to as a resistance level.

You might be wondering, "Where should I draw the line?" Coupled with the fact that stock prices do not always pause at a precise level - often going beyond or falling short - this task might seem daunting. Let's simplify it with a scenario.

Visualize a pattern where the stock price ascends, descends, and repeats this process. In such a scenario, where should the resistance line be drawn? Should it be at line A or line B?

Choose line B, and here's why - we aim to draw a line of best fit. This line should touch as many points as possible, thereby enhancing its significance. If you were to draw it at line A, it only brushes past one point, while line B touches the pattern four times.

Armed with the knowledge to draw a resistance line, let's progress to the concept of a probationary resistance level. Whenever you can connect two points, we refer to this as a probationary resistance level. But when three points can be connected, that's when it solidifies into a strong resistance.

Strong resistance is delineated as a line with three points or more in alignment. Remember, in real-world scenarios, a resistance level is not akin to an impenetrable wall where the price will hit and reverse instantly. Sometimes, the price may slightly breach the level or fall short of it. It's more accurate to view it as a zone rather than a rigid boundary.

A pressing question may be, "What causes these resistance levels to manifest in the first place?" The answer is deeply rooted in market psychology. When prices climb to a specific level, a psychological trigger prompts people to start selling because a multitude of sellers are lined up at that price. When the supply at the ninety-five dollar mark overshadows the demand, it fabricates a resistance level.

Timing Your Entries with Technical Analysis

Understanding technical analysis helps investors time their entries and exits in the stock market to maximize profits. It is not about making predictions, but rather identifying high probability outcomes.

Candlestick Charts

A chart used to better understand the market, showing opening, closing, day high and day low prices. White or green candles represent a bullish day when the price closes higher than it opened. Red candles represent a bearish day when the price closes lower than it opened.

Reading Price Candles

Understanding the opening and closing prices of candles, as well as the day high and low. Red/black signify bearish candles, while green/white signify bullish candles.

Uptrends

When prices go down, they make higher highs and higher lows than the previous. This is known as an uptrend, and is statistically more likely to continue than to reverse.

Uptrends and Buying Opportunities

A series of higher highs and higher lows indicates an uptrend, meaning investors are bullish. Prices move in a wave pattern of impulses and retracements, with buying opportunities on dips.

Uptrends and Downtrends

Using moving averages to identify uptrends and downtrends, and how investors can use them to buy stocks.

Selling During a Downtrend

When selling during a downtrend, it is best to sell at the top of a rally, which can be identified by resistance at one of the moving averages. This will allow the seller to get the highest price before the next wave down.

Consolidation: Price stuck in a range, reverses up and down at certain levels, creating resistance and support.

Buying in Consolidation

Buying at strong support levels or when price breaks out of consolidation are optimal points of entry. Avoid buying when price is at center of consolidation.

Support and Resistance Levels

Identifying price levels where prices pause and reverse, drawing a line of best fit connecting points, and giving a buffer for support and resistance levels.

Resistance Levels

When a price hits a resistance level and can't break it, bearish momentum is created. Avoid buying just below a resistance level. Wait for a breakout to enter the stock.

Support and Resistance Zones

Price levels where the price pauses and reverses, either up or down, creating support or resistance zones. Drawing a line between two points creates a support or resistance level, but three points creates a strong one.

Support and Resistance

The price of a stock can be affected by the number of people queuing to buy it. When a stock bounces off a support level, it creates bullish momentum. Resistance levels when broken become support levels and vice versa.

Trending Support and Resistance

Drawing support and resistance levels to time entries and take profits. Trending support and resistance appear as diagonal lines, connecting at least three swing lows in an uptrend. Price respects the line, allowing investors to maximize profits.

Analyzing Trends

Identifying trends by connecting swing highs and looking at multiple time frames (1-10 years) to get different perspectives.

Identifying Support and Resistance Levels

Identifying areas of support and resistance on a chart to determine optimal buy and sell points. Price can pause and reverse at resistance levels, and breakouts can turn resistance into support.

Support and Resistance Levels

Identifying support and resistance levels on a chart to determine best entry points for stocks or ETFs. Resistance can become support when price breaks it and dips, then reverses back up.

Support Becomes Resistance

Analysis of support and resistance in Alibaba stock, showing how a support level can become a resistance level.