Reading the charts: technical analysis

To draw a trendline for an uptrend, find the lowest low near the bottom of the trend. Next, look for the major low prior to the highest high. Connect the pivots, as in Figure 6-29.

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gravestone doji,

A variation of the shooting star forms the gravestone doji, another power- long upper shadow, but the candle opens and closes at the low of the day-an ful topping candle. As Figure 5-15(b) displays, the gravestone doji also has a ominous sign. negative pattern only when the next day's candle opens lower and moves lower, Remember, both the shooting star and gravestone doji patterns act on the confirming the weakness in the prior move up.

Figure 5-16 chart explained

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Figure 5-17 explained

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The Evening Star Venus

signals the arrival of darkness. In candlestick chart- ing, the appearance of an evening star denotes a bearish reversal in an uptrend. Three candlesticks create the evening star pattern: The first two are composed of a long, white real body, followed by a star with small body, which can be white or black. The star suggests the top of the uptrend. The third candlestick is a black real body that drops low into the range of the first, white candlestick. Now the bears are in control, and the uptrend is weakened

Ways a stock corrects itself

stock corrects itself in one of two ways: (1) by or (2) by pulling moving sideways, or consolidating, back. In the case of a downtrend, we call the pull- back a "rebound" or "rally." Either way, if the stock pulls back without fall-n ing through support at the breakout point, then turns to back up, this is an excellent time to add to yourthe position. If, however, when the stock pulls back it drops below support, all bets are off. This signals you toSi exit-fast.

An evening doji star

warns of a potential top in an uptrend. It gaps open above the white real body prior to it. > The next candlestick is a black real body that descends into the white real body of the candlestick formed prior to the evening dog star. This confirms the bears gained control, and the uptrend is broken If the next candlestick after the evening doji star is a white real body, the doj warning is negated.

How to identify breakouts and breakdowns

Breakout Steps The leading breakout: the moment the stock moves above key resistance (when the ball shoots through the hole in the first-story ceiling). If the resistance is at $60, you buy when the stock trades-not when it's shown at the ask on a Level II screen, but when an actual trade takes place-say at $60.05 or $60.10. The first strong move above resistance-some traders wait for an actual close-is the breakout point. The best leading breakouts are fueled by strong volume 2. The pullback: As profit-taking sets in, the stock hits resistance (second-story ceiling) and reverses, pulling back toward the breakout price. When the selling recedes and buyers jump back in, the price pivots (reverses) heads north (up) again. The moment the price recovers from the pullback and moves up again, it initiates the second entry, or buying point. This is the safest place to because the leading breakout established the stock has buyers. 3. The secondary breakout: Now the stock shoots up again, past its former pivot point (second-story ceiling). It accelerates through a hole in the sec ond-story ceiling and flies into the third story. dally For day traders trading on intraday charts, this point may come late in the afternoon, and price daily charts can buy the third leg or swing up in a momentum may be slowing. Swing traders using trend, although momentum may slow, as well.

Bullish Engulfing pattern

Engulfing patterns use two candlesticks to prophesy a major trend reversal. bearish engulfing pattern reverses an uptrend. In Japanese Candlestick Charting Techniques, Steve Nison writes, "The bearish engulfing pattern can be viewed as total solar eclipse blocking out the entire sun.'"

Bearish Engulfing patterrm

Engulfing patterns use two candlesticks to prophesy a major trend reversal. bearish enguling pattern reverses an uptrend. In Japanese Candlestick ChartingX Techniques, Steve Nison writes, "The bearish engulfing pattern be viewed total solar eclipse blocking out the entire sun."

Characteristics of Dark Cloud Cover

First candlestick is a strong, white real body any. its Second shadow, if candlestick's price gaps open above the top of the white body and By the end of the move, though, the second body closes well into the white body and near its own low. The more the second, black body moves into the lower part of the first, white body, the higher the probability that the bears are taking control and the uptrend is weakened. If a long, white real body closes above the highs of either the dark cloud cover or the bearish engulfing pattern, it suggests the start of another rally The reverse of the dark cloud cover is the bulish piercing pattern shown in Figure 5-12. This pattern forecasts the reversal, or change, in a downtrend.

When a stock is trading in Range

If a stock '"trades in a range," it fluctuates between higher and lower price areas in a somewhat predictable, horizontal When it dips to the bottom of the range, or channel, buyers step in and support the price from slipping into a downtrend. When it reaches the top of the sellers step in and push the price down once again. Sellers who short at the top of the range "cover" their short positions (buy the stock back to close the trade) when it nears the bottom of the range, knowing buyers will surely step in and reverse the stock to higher prices

Dark cloud cover

is a bearish reversal pat- tern illustrated in Figure 5-11. It appears when an uptrend has run out of steam, or at the conclusion of a congestion move. Again, the pattern consists of two candlesticks.

shooting star.

It derives its name from the shooting star blazing across the night sky, which the Japa- nese say suggests trouble overhead. You can see the analogy in Figure 5-15(a). The shooting star appears at the top of moves up, warning that the bull's buying er is deteriorating. Think of it this way: the long upper shadow shows sell- ers are gaining power.

15.30 16:00 FIGURE 6-23 In this 5-minute chart of Barrick Gold Corp.(ABX), you can seea momentum trade on a smll ime frame (each candle represents five minutes), using a textbook 1, 2,3 breakout pattern. 1. The gold mining and refining stock moved in asteep intraday downtrend,to stop and create a quick base. ABX then started rising at 12.30P.M., and broke out of its base at 29,28 t iped through the prior high at 29,50 and stopped to consolidate right at 29.55. 2. At 2:25 P.M. ABX started up again, and traders could have added to their position. 3. Soon after the breakout of the pullback, the gold stock broke above the consolidation highs at 29.58. Additional shares could have been added. By 2:30PM., ABX hit 29.75 (the prior day's closing price),and created a doj folowed by a dark dloud cover. Savwy momentum traders took profits.

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6-20 I On this daily chart of Pacific Ethanol Inc (PEI),you can see a perfect 1,2,3 breakout in the month of although the producer of renewable fuels had broken out of itsearlier base in January,The nearly perfect breakout par- tern that's good to recognize is the spectacular April pattenm. 1. PEK broke above its consolidation- -a buy signal at $20. As youllearn in later chapters, the immensely strong volume would have told traders to buy a few cents before. 2 The stock flew to 23,thten neatly pulled backto 2. When PEX started to ise out of that pulback,it itiatd nother by signal 3. When PEx penetrated resistance created at the top of the first leg up (23), the position could be added to,if condition warranted There are other breakouts on this chart that initiated nice moves up (hint January). Notice the support and resistance levels and decide where you might enter and exit trades

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FIGURE 6-21 1 On this 15-minute chart of Psychiatric Solutions, Inc. (PSYS), the breakout pattern emerged halfway into the trading day on 4/06. 1. After lunch, the operator of psychiatric inpatient hospitals stock broke out of its intraday base and gave a buy signal at about 30.60. 2. The stock stopped to rest and consolidate at 30.90 3. PSYS broke out again in the last half-hour of the day to close on the high of the day (31.20) on high volume. if you hold stocks overnight you'd be glad you held thisone.On an intradaytrade,if you bought at 30.60 and sold at 31.20,you would have earned about 80 per share.While that's a tidy profit,traders who held the stock overnight (the dotted line marks the dose of one day, and the open of the next) and rode the opening leg up would have made about 50 more per share. Clue: When a stock doses at the high of the day on strong volume, many times they will move higher at the next morning's open This is especially true if the stock market is in a bullih mode and the industry group where your stock resides is moving in an uptrend on a daily and/or weekly chart.

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FIGURE 6-25 | This daily chart of Vertex Pharmaceuticals,Inc. (VRTX) shows the stock in a dandy uptrend from October until March-in fact, it doubled in price. Then the drug manufacturer weakened and started to tumble. L. tfellthrough support (and gave a sell sgnal) on March 23,at 3695(ong, black candle. In the next threedays, VRT.X ell to 34.68. 2. The pharma (current nickname for pharmaceutical companies) stock allied back to prior support zone at 37, which hacd now become resistance. After six days of consolidating,it headed south again,issuing another sell $hort) signal. 3. On the same day (4/06),it quickly sid below its prior low of 3468,jisuing yet another sell short sinal In the nextwo days, the stock plunged to 31. know,pleasethat pharma and biotech stocks can be highly volatile so holding a short position more than 2-3 days can ause being conducted on their products. That's why you'll otice that many times their prcepatterns diverge from theirown indus- heartburn. Manage these positions carefuly. Biotechs, especially, end to hop up or all down according to the clinical tials try group as well as broader market action.

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FIGURE 6-26 This 15-minute chart of Amgen,Inc (AMGN) shows many opportunities for day trades to the short side If you studied a daily chart of this global biotech company-which you would do before you entered a trade on any time frame -youd see that AMGN is currently falling in a downtrend 1. Afer skidding dramaticallythe day before,the biotech managed to gap open higher on this day (4/07) at 72.28 and fly to a high of 72.49. But sellers quickly came in and pounded the stock back to the prior day's close at 71.85, and even lower to 71.25. 2. AMGN rebounded to the prior day's cdose but t was a dlassicbull tap,and the bears once again pounded the bulls In thits ase,youd ad to our position to short AMGN below the low of the high candle (the black one). 3. AMGN plummeted below the first low of the day (71.25) that represented the only support. But buyers put their hands behind their backs as the bears took control and continued to push lower.Smart traders covered their short positions when the biotech stock hesitated at 70.60, then headed higher

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FIGURE 6-27 1 This 15-minute chart of Pfizer, Inc. (PFE) shows the stock in a well-defined downtrend. If you looked at a daily chart of this manufacturer of pharmaceutical and consumer healthcare products, you'd see that it's in a downtrend in that larger time frame, as well. On 4/07, PFE etched a nearly perfect 1,2,3 breakdown pattern on its intraday chart. An aside on pharmaceutical stocks: Pharms are defensive'stocks.During economic downturns, many investors will run to the Consumer Staples sector, which includes health care (pharmaceuticals, biotechs, and medical equipment),food, household goods, per- sonal care, and cosmetic companies

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FIGURE 6-28 1 This 5-minute chart ofthe mini-sized Dow, which is the small version of the standard Dow Jones industrial Index futures contract traded on the Chicago Board of Trade. We'l talk more about the 'mini Dow" as traders all t i ipcaomingchapters,Fornow, et's ook t the breakdown that ocurred during the course of this trding day 1. The mini Dow rose to its intraday high of 11.242, then it chopped sideways into the lunch period. At 12:30,it began its breakdown,fallig through the support zone established by the consolidation top, and sliding to prior support fonm earlier that moming. 2. Note how quickly the mini Dowsurrendered and slipped ffthis consolidation dlif" at 11 215, then held again for anothe 5-minute candle at 11,210 3. When the min ndex approached the prior support area, t fll ast t till with upcoming support perched just below wisetraders wouldn't have added many more contracts to this short position. As you can see, by 2:30AM, buying came back into the futures contract.

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The upside of drawing trend lines

They act as uptrend support lines, or downtrend resistance lines. They dem- onstrate where a stock's current trend is expected to go if it continues, and give you a boundary of trend breaks, or rising, or falling angles. ndlines can make excellent, if somewhat tight, stop-loss points. Channel lines are parallel lines drawn along the tops of uptrend price pat terns, and along the bottom of downtrend price patterns. Traders also use channel lines (if they can be applied to an established trend with an orderly price pattern) as profit-taking points, when the price touches it. (You'll see examples of this in upcoming charts.)

FIGURE 6-31 On this daily chart of the Centex Corp. (CT), you can see an example of an entire price cyde that took place from October through April, and sint over yet. We drew an uptrend line from near the lows of the uptrend (I don't always count single candle shadows as lows, when many lows line up in a row (dotted line). The homebuilder fll hough its uptrend line in late November,and drifted down into the end of the year. In January, CTX again started a euphoric rise, shooting neaty straight up to its high of $79.40. But euphoria has its price, and poor CTX has fallen ever since. To avoid confusion,I've drawn only a single uptrend line, and single downtrend line. Many more support and resistane lines can be drawn on this chart. Since it's your book, you can draw all over it.

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FIGURE 6-32 1 On this daily chart of Amerisourceßergen Corp.(ABC, the pharmaceutical distibutor moved in a near perfect uptrend from November to Apri.Then the neighbors called the cops on the merymakers, and the party was over at leas forthe time being. This chart shows you how uptrends can hesitate (lanuary) and consolidate sideways for a perñiod of ime without actully breaking the trend.(ABC did not make a lower low at this point) Some swing traders use thetop chan- ne line as a sell signal: when the price touches it, and doesn't go through it, they sell their position.

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FIGURE 6-33 I This daily chart of Moody' Corp. (MCO) shows how the provider of cedit ratings stepped neatly up an uptrend for six months, and is still going to date. Note how uptrends can shift si ightly, due to pulbacks Whilethe uptrend itself, wasn't broken dramatially,in the January/ February pullback t aused new trendlines and channel linsto be drawn.

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FIGURE 6-34 On this 60-minute (each bar represents one-hour) chart of Amylin Pharmaceuticals, Inc. (AMLN),you n see how the temperamental biopharma company chopped sideways for a few days, then rose in a missle-like uptrend from 44.50 to 49, where i topped out and fellto 44.t formed ashor-term base, then popped back up from support at 44-back to 49 once again (and who knows where,from here). Note how you can use trendlines for entry signals: When AMLN broke its downtrend line (arrow) and began to move above resistance, short-term traders could have bought and held, keeping profits intact witha railing top. We'll lk boutalling stop orders in upcoming chapters.) Reallick graphics used with permission of Townsend Analytics, Ltd. O 1986- 2007 Townsend Analytics, Ltd.4

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FIGURE 6-35 I This 15-minute chart of Sation Casinas, Inc (STN) shows the wolatile stock moving down ina nasty four- point downtrend (4/09-4/10), You can draw the trendline on this one.Then, the next day (4/1), the wild and woly hotel casino operator gapped open nearly two points,scaring the daylights out of the bears But on the second cande nto the day,STN its short-term trendine. The bears lumbered off for good, this time, as the energetic bulls grabbed the reigns and took STN back once again started aling and slid back to 76.25. 0n 4/12, the stock rattled around all morning, then reversed direction, breaking to 79. Note: Observing the break of the downtrend line on 4/12 would have warned you to close any short positions, and possibly enter a long one

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FIGURE 6-36 I This 5-minute chart of the mini-sized Dow futures contractshows it moving into an uptrend shortly after the equities market opened at 9:30 A, ET. (This futures contract trades nearly around the clock.) The"Yummy'as we some- timescall t the contracts root symbolisYM), moved up smartly and we could connect two lows (lowest and next higher low) by 10:45 AJM.The contract moved up until about 1:15, created a shooting star, and then started down. Important: Trendlines act as support while price is in an uptrend, but if price falls below that trendline, the trendline then acts as resistance. Notice how the uptrend line-extended-acted as resistance after the mini Dow contract moved below it Just remember to check with trend positioning and support and resistancelevels on a daily chart before you jump into any stock on an intraday level The longer the timeframe, the stronger the signal

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FIGURE 6-37 This 5-minute chart of Abercrombie&Fitch Co. (ANF) shows the stock gapping down a few cents at the open on 4/13, then turning to fly up in a strong uptrend for the first half-hour of the trading day (momentum traders would have closed positions, here, with a profit of .70per share). From that high, the clothing manufacturer consolidated until 1130; then it took off again, until noon.If you'd drawn an uptrend line from the opening low to the lows of the consolidation, and then extended it, you could have used it as a 'sell signal"for a day trade, when ANF finally violated it at about 12:30 P.M. From thisillustration and those previous to it, you can see how trendlines are extremely valuable trading tools, both on long-term timeframes, such as daily and weekly charts, and short-term timeframes or intraday charts.

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Figure 6-13

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Figure 6-14

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Figure 6-15

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Figure 6-16

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Figure 6-17

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Figure 6-19 show the three steps in a breakout. When the breakout steps complete the pattern shown in Figure 6-19, the stock has moved out of a trading range and into an uptrend.

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Figure 6-3

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Figure 6-4

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Figure 6-5

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Figure 6-6

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Figure 6-7

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Figure 6-8

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If you think a stock is going to head lower and decrease in If you price value, you can "short" a position. You sell shares on the open market and then buy them back at (hopefully) the lower price. Your profit is the difference sold the shares, and the price at which you bought them between the price you back (covered the position). When the price drops below the last support, or pivot point (basement floor), it may be too late to enter for a day trade, but swing traders can still sell short here.

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To draw a trendline on a stock in a downtrend, find the highest peak, or pivot point above the lowest low, Next, locate the highest peak at the top of the trend. Connect the dots as in Figure 6-30.

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games broke of its prior day's lethargy during the first half-hour of 4/06. FIGURE 6-22 1 On this 15-minute chartofElectronic Arts,Inc (ERTS,you can see how this maker ofinteracive software 1. The break above resistance was the buy signal, at 54.68 ERTS rose to 5, hen pulled back to 54.67 on low volume ers nervous who held their shares as a day trade. ERTS held on the top of prior support, though (see dotted line). And, as 2 Although the pulback was orderly and on low volume (we'lleam more about volume signals, later), it surely made trad- the lunchtime doldrums came to an end, ERTS woke up and resumed its move higher. 3. At about 1:45 a., RTS brokeabove its 55intaday high,to ie to 5,63at 25 a. With a point profit (per share) firmly in hand, wise day traders would take profits. l extended the chartso you couldsee how volatile stocks can become when they diverge, or move in the opposite direction, from their"home" index. On 4/07, the NASDAQ fell hard. Notice how ERTS managed to climb all morning, then gave into the tech index's bad mood in the afternoon. Many times a stock that is trading against the intraday market trend will have the energy to buck that tend in morning hours, but will hen succumb to the largertrend in the afternoon session

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Figure 6-9

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Figure 6-10

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Figure 6-11

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As you can see in Figure 5-9, either real body can be white or black, but it is slightly more bullish if the hammer is white and slightly more bearish if the hanging man is black.

Real bodies can be white or black Hammer on hanging man

Hammer

Real body must be short, but can be clear or dark. The real bodies are at the top of the day's trading range, the lower shadow should be twice the height of the real body, and it should have a shavěn head. A " hanging man 95 " appears at the top of an uptrend.А " hammer " 95 appears at the bottom of a downtrend.

Characteristics of the Bullish Piercing Pattern

The first real body is a black body in the context of a falling price move. The second is a white real body, in which the stock gaps open lower than the previous candlestick's low Then the price rises higher, and the real body closes more than midway into the prior black real body. Now the bulls have wrested control from the bears, and the downtrend is broken. >If the real body doesn't close at least halfway or more into the black body, it negates the signal and indicates the downtrend may continue Note: If the white real body opens lower than the previous day's low and closes higher than the previous day's high, Western technical analysis defines it as a "key reversal day."

Shaven head Hanging Man

The real bodies are at the top of the day's trading range, the lower shadow should be twice the height of the real body, and it should have a shaven head. A "hanging man" appears at the top of an uptrend. Their appearance during a downtrend or uptrend signals the prior move may be broken.

Congestion

The second horizontal pattern-or lack of it-we call "congestion. Say you have a cold, and your head feels miserable and congested. You can't breathe because your nose is all stuffed up. Stocks trading in a congestion pa tern feel the same way. No uptrend or downtrend emerges (stock can't breathe because buyers and sellers won't make up their minds which way this stock hould go. Daily price ranges fluctuate from wide to narrow as the stock floun ders unpredictably. It gaps open to the upside one day, then gaps to the downside. the next. Tactic: Stay away. You don't kiss your friends who have colds, and you and you don't trade stocks that trade and congestion patterns, unless you want your trading account to get sick

Characteristics of Bullish or Bearish Engulfing Patterns

The stock has to be in a definite uptrend or downtrend, even if short term. The second real body should be the opposite color of the prior real body. The second real body has to engulf the first real body although it need not engulf the shadows. This pattern becomes even more accurate when the first real body is quite petite, and the second very long. If the second real body engulfs an additional body the signal grows stronger

Downtrends

When a stock tires of trading sideways, buyers jump ship. Short sellers attack like hungry sharks, and the stock tumbles into downtrend. A stock in a downtrend makes lower highs and lower lows. The trend remains lower until price closes above a prior high in the downtrend. Stocks can slide into downtrends on lack of interest alone (low volume). But if volume picks up as the stock falls, that stock has problems. High volume on a falling stock means fear just escalated to panic. Everybody's dumping and heading for the door During the downtrend, and particularly near the bottom, we called the stock "oversold"

Doji

are created when a candlestick opens and closes at, or very near, the same price; only a lateral line forms the real body. As you can see in Figure 5- 14, doji resemble crosses. Doji stars are doji that gap open either above or below the previous real body in an uptrend or downtrend. They represent powerful reversal indicators and should be respected when they appear in a strong trend move. It means, once again, that the bulls and bears are at a stalemate, and the next move is up for grabs. The candlestick following the doji should confirm the trend reversal and the winner of the power struggle

The morning star

derives its name from Mercury, which appears just befone the sun rises. It foretells a bullish reversal in a downtrend. The pattern is the opposite of the evening star and shows three candlesticks in a complete pattern. > The first two are composed of one, long black body, followed by a star with a small body, which can be white or black. The star gaps open lower than the previous real body's close, then the price rises. This move indicates buying pressure has begun. The third star is a white real body that moves into the price range of the first, black real body. Now the bulls have taken control, and the downtrend is weakened.

A morning doji star

indicates a possible bottom in a downtrend It gaps open below the black real body prior to it. The next white real body opens higher, and the price rises into the area of the black body prior to the morning doji star. Now the bulls are definitely in control, and the move down is broken. If the next candlestick after a morning doji star is black real body, the doji downtrend reversal is negated