Stop (or stop loss) –Stop (or stop loss) –a means to manage risk. If I buy a stock at $10, and place a stop at $9 (closing price). Then, if at any point my position closes the day below $9, the next day, I sell at the market with no questions asked.
We believe it is better to stop out of a position early and miss a few percentage points on the rally when it resumes (if we were to miss the new momentum by a couple of days). This is a better alternative to being stuck in a stock wishing we could get out.
It is more difficult to make up for losses than to make up gains. For example, if a position is down 50%, then you must go up 100% to make back the loss. If a position is down 80%, you must go up 400% to break even from that loss.
We use this technique on opening positions because we want to manage our potential losses. Substantial losses are difficult to overcome, so we attempt to mitigate this with using stops (as well as other techniques).
- Once a stock is up significantly and our product-first fundamental thesis has proven to be accurate, we will remove the stop.
- We then shift and hedge these “buy-and-hold” positions collectively.
After witnessing first hand many advisors and their clients’ getting wiped out in 2008, it became clear to me that everyone has an entry plan, but most of the PMs I met with neglected an exit plan. Losses most people experienced in 2008 take years to make up, and in some cases cannot be recovered. This is why all great money managers stress the importance of managing risk first and foremost.
No system is perfect. We have found that managing risk by sacrificing some gains is a winning strategy, especially in the tech space.
Uptrend Uptrend – when price makes a series of higher highs and higher lows. Also, the various moving averages will be stacked on top of each other and trending with the shortest time frame on top and the longest time frame on the bottom.
DowntrendDowntrend – When price makes a series of lower highs and lower lows. Also, moving averages reverse to where the longest time frame is on the top and the shortest time frame is on the bottom.
Consolidation Consolidation – This is when an uptrend or downtrend pauses and moves in a sideways pattern. Price tends to be choppy. Also, note how the various moving averages swirl around one another in a disheveled order.
Support Support – A horizontal price level where buyers/demand steps in and halts a decline. Sellers become exhausted and buyers overwhelm the decline in price. Once a support region is broken, it becomes resistance.
Resistance Resistance – A horizontal price level where excess supply stops price from moving up. Buyers get exhausted and sellers step in. Once a region that is resistance is broken, it acts as support.
GapGap – This is literally a gap in price between trading days. For example, if a company reports stellar earnings and the price opens up, say, 20% above the close of the prior day, you’ll literally see a gap on the chart. There is a saying that price does not like gaps. These emotional points in a stock’s price movement can act like magnets, attracting price to “close the gap,” before continuing on a trend. Gaps are important points of support and resistance, as well.
Moving AveragesMoving Averages – a moving average represents the average price over a given time period. For example, a 5-day moving average is simply the closing price of an asset over a 5-day period, divided by 5. The next day, you add a new number to the average on the front end and get rid of the last number on the back end. So, it’s a fluid price, changes each day and provides valuable information about the short, intermediate and long-term trend as well as key support and resistance zones. The most important aspect of these averages is the direction they are pointing and the slope. The sharper the slope, the more powerful the trend.
Simple moving average (SMA) is created by taking the average price over a given period. 50-day, 100-day, and 200-day moving averages are widely followed averages to determine support and resistance points as well as key trends. Each day’s price is given equal weighting in determining the average price of a simple moving average. I use these to determine longer time frames.
Exponential moving averages (EMA) is like the simple moving average, but gives more weight to the most recent days. Past data is not as important as what is happening now. These are more geared towards determining the current trend on shorter time frames.
For the sake of this site, I use the 8-day EMA (green), 20-day EMA (blue), 55-day EMA (red), and the 200-day SMA (black). I will sometimes use the 150-day SMA, as well.
Anchored Volume Weighted Moving Average (AVWAP)Anchored Volume Weighted Moving Average (AVWAP) – A volume weighted moving average is a simple way to determine who is in control of price between the bulls and bears. This method factors in volume as well as price. For example, if one day you have 3 shares trade at $10 and the next day you have 1 share trade for $5, then the average volume weighted price is $8.75 (10+10+10+5 divided by 4).
The “anchored” element of this technique allows you to literally place the beginning of the calculation from any point in time – e.g., a top, bottom or maybe a gap in price.
It’s uncanny how accurate this method is for determining key support/resistance levels.
Trend lineTrend line – a dynamic, sloping line that price uses as support or resistance while trending. A stock’s movement will track this line throughout the trend.
VolumeVolume – The number of shares that have traded for a particular stock. Volume tells an important story in technical analysis. It shows the force of a price move or if a recent move is weak. For example, if price breaks through resistance on heavy volume, that tells us that several new buyers have stepped in at higher prices. We can also use volume to gauge institutional participation with huge volume spikes. Furthermore, if price is increasing while volume is decreasing, it is telling us that not many buyers are stepping in to support the elevated prices.
Cup & Handle PatternCup & Handle Pattern – a bullish pattern where price hits resistance, sellers step in with force, hit a support region, then buyers push price back to the resistance zone. Another sell off then follows, except with less volume. We then see price break through resistance on heavy volume. This is usually a bullish pattern.
Head and Shoulder PatternHead and Shoulder Pattern – A bearish pattern (an inverted head and shoulder pattern is bullish). The visual is 3 peaks, the middle peak being the highest. Volume is key with these patterns. You want to see volume create a cup pattern – decreasing as prices peak and increasing into the selling. When price breaks the neckline (primary support), volume should be high.
Source: Eagle FX
Flag Pattern (continuation pattern)Flag Pattern (continuation pattern) – A pattern that is a period of congestion after a sharp move higher (or lower). Flag patterns are sideways with the upper and lower boundary lines being parallel. “Pennant” or “Wedge” Patterns are also Flag patterns with the upper and lower boundary lines converging rather than being parallel. All of these are known as “continuation patterns” as they result in the prior price trend continuing in the same direction after the pattern completes.
Symmetry Symmetry – Symmetry is an important concept in technical analysis, especially with corrections. Correction tend to unfold in 3 legs (or waves in Elliott Wave Theory) and each leg relates to the others symmetrically. Prices also tend to form symmetries in time between bull/bear markets.
Basing Basing – is a pattern we look for to gauge a potential breakout. It is when a stock pulls back, holds support around a specific price zone multiple times and holds each time. Also, volume should be fading the more attempts price corrects into the support zone. Ideally, you want to see lower volume and smaller pullbacks the closer you get to the upper resistance that makes up the breakout price.
Coiling/Building EnergyCoiling/Building Energy – This is a term used to indicate a momentum pattern that we see prior to a break out. I typically use the MACD to gauge this pattern, but also use the CCI as times (look below for definition of these indicators). In short, this is when the MACD has a sharp 45 degree rise with price, then falls, usually above the 0 line, and holds in a horizontal level. This allows the technicals to reset for another move higher.
Indicators
If price were a person, then indicators read the vital signs. Indicators look under the hood of a trend to see if it is healthy or weak. They also provide crucial information about trend reversals as well as trend continuations.
There are three general classifications of indicators: momentum, which looks at the strength and direction of a trend; oscillators, which lead price and attempt to predict trend changes; volume based, which analyzes participation in a trend (these indicators are typically leading indicators and attempt to predict trend changes). There are hundreds of indicators; however, for the sake of this site, I will reference the ones below going forward.
Before I get into the indicators, there are two very important concepts that should be understood:
Negative DivergenceNegative Divergence – An important concept in technical analysis. When a momentum indicators/oscillator decreases, making lower highs, while price is increasing, making higher highs. This suggests weakness and usually leads to a correction at minimum.
Positive DivergencePositive Divergence – Refers to momentum indicators/oscillators trending up while price is trending down. This signifies that selling pressure is fading while price is hitting lower levels. It usually precedes a bottom.
Negative ReversalNegative Reversal – Not to be confused with divergence. A negative reversal occurs during a downtrend. Prices make lower highs relative to the indicator making higher-highs. This is a very powerful signal.
Positive ReversalPositive Reversal – A Positive Reversal happens in an uptrend. When the indicator (RSI in this example) makes a lower low and price makes a higher low, it usually signals that the uptrend will continue.
Relative Strength Index (RSI)Relative Strength Index (RSI) – is an oscillator that moves between 100-0. It’s used as a leading indicator of a potential trend change. It is designed to measure the internal momentum of a price series by simply measuring the speed and rate of change in a stock’s price.
The RSI measures how likely a stock is to keep heading the direction of its current trend. If it is overbought (above 70), it’s less likely to head lower. And if it’s oversold, (below 30) it’s due for a bounce back. Within uptrends, a reading of 40 tends to hold during corrections, while in downtrends, a reading of 60 tends to hold during corrections.
MACDMACD – A trend following indicator that measures the distance between two moving averages. The MACD is calculated by subtracting the 26-Day EMA from the 12-day EMA (this is the MACD line in blue). Then a 9-day EMA is placed over the MACD line to provide buy and sell signals (in red). When the crossover occurs, these are potential buy or sell signals.
The MACD HistogramThe MACD Histogram – is also an indicator I use, which is part of the MACD indicator. It is the green and red curves that oscillate above or below the 0 line. It was designed to help anticipate a crossover between the MACD line and the signal line. It’s calculated by measuring the distance between MACD (in blue) and its signal line (the 9-day EMA in red).
Like MACD, the MACD-Histogram is also an oscillator that fluctuates above and below the zero line. This indicator is an early warning sign for momentum fading or shifting. It works well with spotting weakness and divergences with a price increase or price decrease.
Accumulation/Distribution Index (A/D)Accumulation/Distribution Index (A/D) – this indicator gauges supply and demand by looking at where the price closed within the period’s range, and then multiplying that by volume. It was designed to be a leading indicator. The unique feature of this indicator is that it tracks the relationship between opening and closing prices intraday. If price closes higher than the open, then the A/D ticks up, and vice versa.
Opening prices tend to track pressure that has built up during the market being closed. Amateurs trading on reports/news will tend to use the opening hours to trade. Professionals trade throughout the day as well; however, the final hours, are mostly dominated by the pros/smart money. So, this gauge is a means of tracking what smart money thinks of a stock.
Chaiken Money Flow (CMF)Chaiken Money Flow (CMF) – Like the A/D indicator above, this is a volume-based indicator that looks to track the flow of money into and out of a security. However, instead of a cumulative total, seen in the A/D, the CMF sums the money flow volume for a specific look-back period, typically 20 or 21 days. The resulting indicator fluctuates above/below the zero line just like an oscillator.
This oscillator is a great leading indicator that helps identify when a range bound stock is likely making a breakout move.
Money Flow Index (MFI)Money Flow Index (MFI) – Like the RSI, this indicator uses price to identify overbought and oversold conditions. However, unlike the RSI, this indicator also factors volume into its equation.
This indicator attempts to be a more meaningful leading indicator based on the idea that volume leads price. Because the MFI factors in volume, there is a sentiment component to it, so it factors in the accumulation at specific price points. In essence, it helps measure enthusiasm for a stock. When it is showing overbought/oversold or negative/positive divergences, it is more meaningful than the RSI, and usually holds more weight than a divergence on the RSI.
Commodity Channel Index (CCI)Commodity Channel Index (CCI) –Is a momentum oscillator that can be used to also show overbought and oversold conditions, as well as divergences. The CCI measures the difference between the current price and the historical average price. When the CCI is above zero it indicates the price is above the historic average. When CCI is below zero, the price is below the historic average. This indicator is also great for spotting new trends developing.
Candlestick Patterns
Candlestick PatternsCandlestick Patterns – Candlesticks are a visual representation of buying and selling within a given time period. On a daily bullish candlestick, the body of the candle opens at the base and closes at the peak of the body. The wicks that extend above and below the body represent the high and low of the day.
Source: Wikipedia
These patterns offer valuable information about the battle between buyers and sellers, which can be used to predict trend changes. There are numerous patterns; some of the ones I use are below.
Kangaroo Tail
Source: Trade Street
Engulfing PatternsEngulfing Patterns – the bigger the engulfing candle the more notable of a signal. Also, the more volume the signal is based on the number of days the candle engulfs.
Source: Trade Street
Hammer and Shooting Star PatternsHammer and Shooting Star Patterns – These indicate a strong rejection of a price advance. A hammer pattern signals that buyers have stepped in with force, and it can signal a bottom in a downtrend. A shooting star is the reversal of this pattern in an uptrend. Sellers step in with force, signaling a strong resistance level. These patterns can precede a trend change.
Source: Medium
Island Top ReversalIsland Top Reversal – This pattern occurs when price gaps up, then trades in a consolidation pattern/sideways. Then price gaps back down on heavy volume. This price usually precedes a reversal in a trend.
Source: All Charts
If you have any questions, you can reach out to us in our Chat Room on the forum, or email us directly at knox@beth.technology and beth@beth.technology. We only work with tech stocks on this site. We are not financial advisors, so we cannot offer personalized advice. We limit our analysis to what we believe and are actively doing with our own funds. We are happy to help with anything tech related.