|
|
|
MINOR PRICE SUPPORT - HOW IT WORKS? In our first report, "Why do candlesticks work?" we explored the ways to read individual Japanese candlestick lines to help understand the sentiments of other traders, and how they affect the stock's price. In this report, we will continue to explore the ways to read the sentiments of other traders by observing a very important multiple candlestick line pattern called 'minor price support'. Many of the stock pick recommendations posted in the 'Play of the Day', and the 'Today's Candlesticks' areas of our website are selected based on reversal bars in the area of price support commonly referred to by chart readers as 'minor price support'. But why does minor price support provide such a powerful launching pad for stocks? In this report we will explore some of the theory behind why minor price support works so well in helping to fuel the movement of a stock to higher prices. As with most short term trading techniques, the reasoning behind why it works has a lot to do with what other traders are thinking as they enter and hold a position in a stock. Consider the hypothetical multiple candlestick pattern in Exhibit 1. The stock rallies strong until it hits price resistance at Reversal 1. At this point the Group1 traders realize that the stock is overbought and step up to sell short in anticipation that the stock will pull back.....which it does. The stock pulls back until Reversal 2, at which time selling pressure subsides, and Group 2 buyers step up to begin their buying, pushing the stock to higher prices. After Reversal 2, many of the Group1 short sellers cover their short positions for profit as they anticipate a temporary reversal. However, there are still a large number of die hard traders who delay covering their positions, in hopes that the stock will find another area of resistance, reverse, and then pull back again into profitable territory again. At Reversal 3, the nervous Group1 short sellers find the resistance they are looking for, and sigh for relief as they see their stock begin to fall again. They patiently wait in hope that the stock falls back past the prior area of price resistance, and continues to fall into profitable territory. The pull back also brings in a second group of short sellers (Group 3), who believe that the stock is over bought, and begin selling to help fuel the price fall. As you can see, the area of prior resistance (soon to become minor price support), is a crucial area for the Group1 short sellers. This is where it is very important for the astute trader to temporarily put himself in the shoes of other traders and understand their sentiments regarding the price movements in the stock. Suppose that you are a trader in Group1 who has shorted the stock between Reversal 1 and Reversal 2, and because of your high tolerance for pain, did not cover your position when the stock rallied and broke price resistance between Reversal 2 and Reversal 3. As a result, you still manage to be short at Reversal 3. Even though you are in deep losing territory, you will not immediately cover your position after Reversal 3, because the stock is dropping, and you say to yourself, that if you are lucky it will drop right back down past the point where you first went short (Reversal 1) and into profitable territory again. The question is; however, where will you cover if the stock DOES NOT continue to fall? The answer is, you will probably wait and see how the stock behaves around the area of prior price resistance. If the stock crashes through this area, and continues to fall, you will hold on to the stock and rake in your profits. If the stock reverses before reaching profitable territory, and starts to climb, you will quickly cover your position and cut your losses short. So as you can see, the way the stock behaves at the prior price resistance area, is a very important decision area if you are a Group1 short seller still holding a position. A reversal bar at Reversal 4 will bring in a whole flurry of Group1 traders who will buy the stock to cover their short positions, because they now have finally conceded to the fact that they were wrong when they shorted earlier, and the stock is now going higher, not lower. This explains how an area of prior price resistance can become a new area of price support.
The Group 1 traders; however, are not the only group closely watching the stock at the area of minor price support. As you will remember, Reversal 3 brought in a whole new batch of short sellers (Group 3) who hope to profit from the pull back from the new area of price resistance. The Group 3 traders, all of who are in profitable territory, are primed to cover their short positions at the slightest sign of strength. As soon as they see the green reversal bar (Reversal 4), they all pile in to cover their shorts for a profit. This concentrated burst of buying activity helps fuel the stock to rally to higher prices. The Group 2 traders are also watching to see what happens to the stock at the area of minor price support. If the stock breaks through the support, the Group 2 traders will recognize the weakness and exit the position for a small profit or loss. If the stock reverses at the area of minor price support; however, the Group 2 traders will see this as a bullish signal, recognize that they were correct in entering the first time, and buy even more stock to add to their profitable positions to rack in even more profits. Again, this concentrated burst of buying activity helps fuel the stock to rally to higher prices. The Group 4 players consist of the astute traders (like you and me) who recognize the power within a reversal candlestick forming in the area of minor price support. As soon as the stock shows signs of strength, the Group 4 players enter for a short term ride upward. Again, this concentrated burst of buying activity helps fuel the stock to rally to higher prices. So why does Minor Price Support provide such a powerful buy setup for short term traders? The answer is, because buying interest becomes more concentrated around the area of minor price support, as there are multiple groups (both short sellers and long buyers) looking to buy/cover the stock at any sign of strength. At minor price support, you find not one, not two, not three, but four different groups of buyers taking an interest in buying the stock. As we explored in our first report "Why do Candlesticks Work?", the more buying interest in a stock, the more fuel to help push the stock to higher prices. It is this strong buying pressure that you always want on your side, whenever you enter a stock as a short term trader. The more strong, supporting attributes that a stock possesses, the more buyers will be attracted to the stock, and the greater odds that the stock will follow through to higher prices to reap big profits. Alan Williams
If you have any questions regarding this report or the CANDLESTICKSHOP.COM website in general, please do not hesitate to contact the author at staff@candlestickshop.com
|
|
