Reading Price Action to learn important concepts
Volatility matters
Trader/Investor thrive on volatility. In simple words, they look for price moves. We like to buy a stock that makes a move and hence gives some price appreciation but then there are stocks that just don’t budge. Here’s one chart Ecolab ECL.
ECL for 7 months has been trading in a band between 205 and 227 with support at 200 dma. The chart looks good but there is no volatility. And when you invest in such stocks, it just frustrates you as other stocks keep moving. The lesson we need to learn: How important it is to pay attention to what the stock is doing so that you can make the right capital allocation decisions. You don’t want to get stuck with a stock that’s going nowhere.
It’s very hard to trade random moves
The stocks make two types of move: 1. Textbook move or 2. Random move. Textbook moves happen when there is a clean chart. But there are lots of stocks that don’t make clean moves. So, if you look from distance like Year to Date YTD, you will find stocks making big moves but they were just not tradeable. Reading Price Action is all about finding stocks with clean charts and compelling opportunities.
Edward Lifescience EW stock has trended higher this year but the move has not been clean, and hence this kind of stock never pops up on the trading radar And even if you try to trade them, you will end up with a bad outcome.
This is how Clean Charts look
Every stock has a behavior of its own and 7/10 times, they tend to repeat the behavior. Trading is all about trading the behavior. Take an example of Intercontinental Exchange ICE stock
ICE stock made a big move from 200 dma in Nov 2020. It then rallied from $95 to near $120. Since making that move, the stock has been quietly building a base at 110. What’s encouraging this base building now coincides with 200 dma. Can the stock rally again the way it did last time? The price action says highly likely. The stock has the potential to rally to $140 from current levels. Am I recommending ICE here? Nope. All I am saying – ICE has a clean chart and if one likes the business, then this is how one should for low-risk opportunities.
Why the best opportunity comes when a stock makes a new high?
Do you know what the stock signals when it makes a new high..that there’s more demand for the stock? The demand attracts more demand, as the buzz circulates. That’s why when a stock makes a new high above a well-defined resistance, then it does run some distance. As you can see in the chart below, Moody’s Corp MCO stock made a new high above 302 in early April and the stock never looked back.
One Price Action Choreography that delivers returns
When a stock takes support at an important moving average and then retests that moving average multiple times, then it becomes a launchpad for the rally. Take this chart of Illumina ILMN as an example.
ILMN stock made a big move between Nov 2020 and early Feb 2021 when it rallied from 300 to 500 levels. It then pulled back along with the market but its decline got arrested at 200 dma, a very encouraging sign. The stock then a month later pulled back and retested 200 dma multiple times before surging higher. A buy trade at 200 dma in early May would have resulted in gains of 21%.
Take another example: The Southern Company SO
It took support at 200 dma in October and rallied. So when it pulled back to 200 dma in March, it rallied again.
What’s the purpose of the above Case Studies?
One of the main objectives of the blog is to teach its subscribers’ price action concepts and how to read charts to make well-informed trading decisions. I hope these case studies will help you grasp some important concepts.
Disclaimer – The state of the market notes is Deepak’s perspective on the market. The column is purely for educational purposes. Nothing contained herein is a solicitation to trade or a recommendation of a specific trade. By reading this publication you agree to make no trade relying in whole or in part on the comments of the writers
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