How’s that for a confusing, convoluted title… hopefully this post will make more sense!

Much of the discussion here has revolved around price and volume action on a daily or weekly basis, but what about when it comes to actually pulling the trigger on a buy or sell.  In other words, what are some of the things to look for on an intraday chart (I use the 5 minute) that will help us to achieve the greatest probability of success.  I say "probability of success" because nothing is certain right?  First of all, there are certain pit falls to absolutely avoid which over time will improve your results dramatically.  It’s actually quite simple.  AVOID TRADING in the first 30 minutes to an hour of the market open (of course there are exceptions which I’ll get into in  a bit – it wouldn’t be a rule without an exception!).  Why?  The first moments of the trading day are the most volatile and ruled by news events, amateur and/or retail trading, overnight orders and market maker manipulation.  With few shares traded at the open, it’s easy for a stock to swing wildly up or down at the open resulting in a gap up or down. 

Rule to trade by: Don’t buy or cover a gap up and don’t sell or short a gap down at the open (first 30 – 60 minutes of trading).  An exception to this rule would be a major news event announced.  If a company announces a formal SEC investigation is taking place, it is probably not in your best interest to ride it out for the first half hour.  You’ll most likely want to cut losses or lock in gains as quickly as possible… then go find the Tums and the aspirin.  Now, it’s important to point out that the opposite of the rule above can be applied to lock in profits or to initiate a new position.  For example, let’s say you’ve purchased a stock and the technicals are telling you it might be a good time to lock in profits.  Maybe the stock has reached an upper trend line and you’re already sitting on a 30% gain.  If the stock gaps up at the the open with a significant move, I’ll lock in profits in the first minutes of trading.  Conversely, if holding a short position and the stock gaps down to a major support area, it might offer a great chance to get out with nice profit at the open.  Using the opposite of the above rule to initiate a new position (ie. shorting on a gap up and/or buying on a gap down) should be used sparingly and with much caution.  A scenario where shorting on a gap up might be useful is if a stock has been hit with institutional selling and has plummeted below major support.  The selling subsides momentarily and the stock works its way back to that support area (which now acts as resistance).  One day the stock gaps up following some good news from a competitor, but hits resistance and retreats immediately.  It may offer a good chance at a short.  Very rarely, if ever, is it a good idea to make a long purchase on a gap down even if the stock bounces off support.  It’s much more of a gamble.

If you’re new to this stuff, reading it might make little sense.  This kind of discussion is best illustrated through the use of annotated charts (thankyou StockCharts.com for great charts!).  I’ll begin posting more intraday charts and lessons here at the blog to better illustrate these points.  For now let’s take a look at OMI Corp (OMM) which illustrates the bolded rule above well.  Below is the daily chart which represents trading up to the end of the trading day on February 14th.  This is a great looking base with nice price and volume action in the right side and declining sell volume in the handle.  It was a bit quick to form in the right side, but hey, no base is perfect.  This is certainly a stock that should have been on many watchlists for a possible breakout.

The following morning, the company announced earnings and beat Wall St. estimates.  The stock gapped up at the open on the news quickly rising to $20  a share.  Yes, the stock soared past the pivot and NO, you should not have jumped in at the point.  (Remember: don’t buy the gap up at the open even if the stock blows past its pivot point.)  Almost immediately, the stock reversed course on heavy volume and closed below the low point of the gap up within minutes.  Taking a look at the first half hour on the intraday chart of OMM below, you see that the stock peaked at 20.09 and reached a low of 19.50 in the first half hour.  These are the support and resistance areas you are concerned with on an intraday chart.  If the stock clearly finds support at the low point of the first half hour with declining sell volume, there is a good chance the breakout will hold (of course you’d want to confirm that by waiting for price and volume to begin to spike higher – i’ll have an example of this later).  In the case of OMM below, the breakout clearly failed at 11AM EST as the stock plummeted below the low of the first half hour with heavy volume, confirming that the gap up has failed.  This is not a breakout that should have been purchased. (click for larger image)

Let’s assume you had purchased the stock at the the open and held throughout the day.  Your hope has turned to frustration, but you’re still in the stock with less than an 8% loss.  What to do?  First of all, you want to remember the first half hour rule of no selling on a gap down in the first 30 minutes (unless of course the company has come out with catostrophic news and/or you’ve hit your max loss allowed level – I use 10% as an absolute max on the loss i’m willing to take, but my average loss is around 6%).  Next, you’d want to map out your exit strategy if the stock continues to slide.  You’ll want to look at the daily chart and ask yourself these questions:  Where on the chart is a 10% loss on my purchase? Where is the next possible support area? Take another look at the daily chart of OMM below. 

Clearly, the stock has massive downward momentum at its back (based on the magnitude of the reversal in terms of price and volume).  It should come as no surpise that the stock would most likely continue that downward momentum (at least according to Sir Isaac Newton..) in the first moments of trading the next day.  So, looking at the daily chart, how much room would you give the stock to run?  I have highlighted the area around 18 as an area I would be willing to let the stock run to if I were holding the position.  Why?  For one, whole numbers often serve as support and resistance .. and two, because the 20 day moving average is near by at 17.80 (the 20, 35, 50 and 200 day moving average are closely watched by many traders – the 50 and 200 being the most important).  Not to mention, that is where my max loss of 10% might kick in.  OK, so we’ve taken a look at the daily chart and we now have a game plan for the next day.  A plan keeps emotions of fear and greed from affecting your trading decisions.  Stick to it.  So let’s take a look at the intraday chart once again and see how the trade played out the following day. (click for larger image)

As expected, the stock continued its downward momentum the next morning right at the open.  It would have been difficult to watch the stock continue its slide at the open.  Fear may have set in at this point, but you’re holding firm and watching the support level you laid out yesterday.  You’re going to avoid selling in the first half hour as long as you haven’t accrued a 10% loss… The stock hits 18 and the selling subsides, giving way to a bounce.  On the intraday chart, notice that the second 5 min price bar is a reversal.  Reversals often indicate bottoms.. whether that be on a monthly, weekly, daily or intraday chart.  In fact all rules apply no matter what time frame you’re looking at (ie. support/resistance and price/volume movement).  Ok, so the bottom of that reversal is 18 and that does end up being the low point of the first half hour.  So, that is your support line.  If the stock drops below 18, that is your cue to exit the position.  However, the stock showed some resiliency by bouncing and never looking back.  Notice the high point of the first half hour is 18.50, which would be your intraday resistance level.  The stock manages to get above this area indicating decent strength (although buy volume is lacking) and you’re still holding the stock awaiting the next breakout attempt!  Which brings up another important tip: don’t ever give up on a stock if it fails the first breakout attempt.  If you had bought this stock at the top the morning of the 15th and then sold for a loss, it’s natural to be disgusted with the stock and forever erase the memory from mind.  But this is a mistake.  Some of the most powerful rallies fail once or twice before exploding to nice gains.  The daily chart below shows OMM as of the close today (Friday, the 18th).  With the failed breakout comes a new pivot point to watch.  Look for a break above 20.09 with heavy volume as a buying opportunity. .. and remember, no trading in the first half hour!

The previous discussion of OMM details an example of a gap up failing.  Let’s take a look at an example of a successful gap up breakout.  The stock highlighed below is Metal Management Inc. (MTLM) which was purchased for the SelfInvestors.com Model Portfolio yesterday.

You can see the gap up breakout with very heavy volume as institutions continue to clamor for the stock and steel stocks in general.  Let’s turn to an intraday 5 minute chart to get a closer look at the gap up breakout. (click for larger image)

Notice how the stock quickly gaps up past the pivot point (highlighted in orange).  But you’re not buying because you know better… right?  In this particular chart, you needed to give the stock an hour to give you a firm intraday support area.  In this case, it was the bottom of the gap up at 28.75.  After the wild volatility of the first 30 – 60 minutes, the trading quiets.  You’ll notice the selling volume begins to decrease and the price hovers around 29 for an hour or so.  Given the strength in steel stocks of late and the magnitude of buy volume over the past few weeks I can be reasonably assured that the breakout will be successful.  What I’m looking for at this point is a break out of this quiet consolidation as an opportunity to pull the trigger on a buy.  Some traders will wait until the stock clears the high of the gap up, the "intraday resistance" before entering a position.  In cases like this, where you have a leading stock in a hot industry, I’ll give the stock the benefit of the doubt and purchase at the first sign the breakout will be successful.  For me, that signal occurred at 29.30 as the stock made another move up with increasing buy volume.  Remember that bullish patterns in daily charts can apply to an intraday chart.  Notice the step pattern of quiet consolidation followed by a small surge in price all the way up through the high of the first hour of trade.  So far the breakout looks great.  The next level of resistance to watch is right around 30.  As mentioned before, major whole numbers such as 20, 25, 30, etc. serve as areas of resistance.  I would expect the stock to consolidate for a bit around the 30 level before resuming its advance.

There are quite a few details here that may be overwhelming, especially if you’re new to investing and/or technical analysis.  I’d be happy to answer any questions you may have.  Just drop me a line at support@selfinvestors.com.

**A stock that sinks less severely during a market correction is outperforming its peers and is a sign of strength. It may be one of the first out of the gate as the market begins to rally.

**An upward price reversal at the bottom of the base with heavy volume indicating major support by institutions (this process may happen over the course of a few days and can be seen in a weekly chart).

**A long base, giving it a greater chance of a sustained breakout

**Volume dry up (decreasing selling volume) at the bottom of the base and in the handle

**Low volatility in the base and handle. An occasional shakeout is fine, but you want to see at least a few weeks of tight, quiet price action indicating a lack of speculators and a load of steady long term shareholders. A stock with a wide and loose base indicates that is in the public eye too much and calls attention to itself. Remember that stocks tend to shoot up to new highs when most people aren’t paying attention.

**A high volume gap up on the right side

**A handle that slopes downward (5-15%) with declining volume and tight price ranges. This handle should form in the upper half of the base (applicable to cup and double bottom bases).

**Volume on the breakout day at least 50% (I like a volume surge of at least 100%) higher than the average and trading volume for that week higher than the previous week. (NOTE: Average volume on the breakout may be OK as long as the volume on days following the breakout begins to increase as institutions begin to build their positions in the stock.

Calculating % Change in Volume at the Breakout
There are 6.5 hours in a trading day. If a stock trades an average of 650,000 shares per day, divide this number by 6.5 to get the hourly average of shares traded. This particular stock trades on average, 100,000 shares an hour. The next day you notice it passes its pivot point at 8:30am and the volume is 350,000. Do you buy? Yes. At 8:30am, you are two hours into the trading day and the average at this time is 200,000 shares. If the volume at the breakout is 350,000 shares, that’s 75% greater than the average. It’s a sign that institutions are starting to accumulate the stock.

**Relative strength is at a 52 week high at the breakout

**Confirmation after the breakout. You should see a few high volume advances within a week or two of the breakout to confirm that institutions are building positions in the stock.

Gauging the feelings of investors about the market is also important in determining the health of the market. The reason for this is fairly simple. If the majority of investors are bullish, there are few buyers left to power the market higher. There is only one place for the market to go… down, as the sellers return. If the majority is bearish, there are few sellers left to send the market down further. Bargain hunters begin to smell an opportunity. As more and more money builds on the sidelines, a positive shift in perceptions will usher in a flood of cash and lead to a new bull market.

In any sustained bull market, it’s necessary to have people concerned about the economy, interest rates or stock valuations. These people sitting on the sidelines and/or shorting stocks provide a lot of capital down the road when they are finally convinced that the bull market is for real. When they do, it’s at this time that you may have the makings of a climax top, tempting the pros to sell. You should be selling too.

The following indicators help to gauge the feelings of investors about the market (however, keep in mind that these indicators are of secondary importance). The price/volume action of the market, the action of leading stocks and interest rates are of primary importance.

Put/Call Ratio
When investors buy calls they are betting that the market will move higher. If they buy puts, they are betting that the market will move lower. If the Put-to-Call Ratio is greater than 1, more investors are betting the market will head lower. Since the majority is usually wrong, a spike up in the ratio may signal a market bottom.

Advisory Newsletters
The newsletters are generally bearish at the bottom and bullish at the top… the majority is usually wrong!

Short-Interest Ratio
Measures the total number of shares being shorted vs. the NYSE’s average daily volume. A value of 3 indicates 3 days of short interest… the larger the number, the more shares are being shorted as investors become bearish. A few spikes in the short interest during a bear market could indicate a bull is just around the corner. The crowd is usually wrong!

Public/NYSE Specialist Short Sales
Another short indicator measuring the ratio of public selling short to NYSE Specialists selling short. A spike in this ratio may indicate the bottom of the market… once again, the crowd is usually wrong!

With each new bull market, new leaders emerge to lead the market. These companies are often found in technology, biotech, leisure and retail. When making your final purchase decision try and focus on stocks breaking out to all time highs. Former leaders will rarely be the biggest winner in the next round of a bull market. There are a few reasons for this. One is due to the impact of overhead resistance. What happens is that people who purchased at a previous high will usually sell once the stock reaches their buy point so they can break even and move on. Purchasing a stock with overhead resistance will constantly encounter resistance points as it moves higher. Another reason, is that too many people are aware of the former leaders. Remember that the largest price moves occur in companies that Wall St. is unaware of. As Wall St. begins to notice, more institutions initiate positions in the stock, driving up the stock price and providing support at major support levels. Soon after, you’ll probably hear the stock mentioned in financial publications and CNBC, driving the price higher. Of course, as a well informed investor, you are selling the stock at this point with nice gains in your pocket. Stay ahead of the herd!

A key ingredient to being a successful investor is knowing at all times where levels of support and resistance are.

Resistance is the area at which price progress has halted due to a decrease in buying and an increase in selling. It often occurs at levels where investors feel the stock is overpriced, but can also occur at previous highs as investors who bought at the previous high look to sell in order to break even.

Support is the area where buyers have begun to outnumber sellers, reversing the downward trend. Support areas indicate where investors have begun to feel the the stock is a good value.

It should be noted that resistance and support levels are not absolute as stocks will often break through resistance and plummet through support. I like to think of these areas as “tests” for the strength of a stock. Stocks that bounce off support and break through resistance are showing great strength and should be considered for purchase, while stocks that retreat at resistance and plummet through support are showing weakness and should probably be sold. Support and resistance become a self fulfilling prophecy as professional traders keep tabs on these important areas and make buy and sell decisions based on the action of the stock as it reaches support and resistance. You should be doing the same!
Common areas of support and resistance are presented below.

Moving Averages
Moving averages are important support and resistance areas to keep an eye on, specifically the 50 Day Moving Average. Many times, institutions and professional traders will add shares to their position at this point. However, a drop below this important line on heavy volume can signal further selling is ahead for the stock. Other important moving averages are the 20DMA, 35DMA and the 200DMA.

Trend Lines
Trend lines are also very important support and resistance areas and can be drawn in order to see where investors may buy or sell shares

To draw trend lines, connect support points to support points and resistance points to resistance points. A positive slope indicates and upward trend (higher highs and lows) while a negative slope would indicate a downward trend (lower highs and lows). Channel trends occur when there is no slope.

Whole Numbers (psychological support and resistance)
Support and resistance can occur at round numbers because traders tend to think in these terms when making buy and sell decisions. If a stock is purchased at 7 and makes its way past 8, then 9… they may say “if it gets to 10 I will sell”. With higher priced stocks multiples of 5 become more important. These become psychological resistance levels.

You see these psychological support and resistance levels mentioned in the news or magazines often. “Dow breaks 10,000!” or “NASDAQ needs to find support at 2000”

Gauging The Strength Of Support and Resistance
 Look at the history of the stock. Has it found support at a trend line or moving average in the past? How many times? If it has a history of showing support at a certain level, you can bet there is a good chance it will be supported there again. If it breaks the habit and is no longer supported there, look out! A deeper correction is most likely ahead.

Role Reversal
When a stock breaks support, that support line becomes resistance. Often times, a stock will break below major support and try and make its way back, only to be turned away by the new source of resistance. Why? Investors who purchased at support, only to have the stock plunge below quickly realize they made a mistake. If the stock makes its way back to the support area, they usually jump at the chance to get out without a loss. The opposite is also true. After a stock powers through resistance, that becomes a support area where traders are often willing to add shares. Investors who missed the initial move will often look to purchase if it makes its way back to the resistance area, creating support there.

Examples of Support & Resistance (click thumbnail for larger image)

The greater the degree of uncertainty, the greater your risk in holding a position in a stock. All stocks are uncertainties, but there is no moment of greater uncertainty than that of an earnings report. It’s the time when the company reports on how well it is doing now and how well it expects to do in the future. Often times, other major announcements are made as well. It can be a time of extreme volatility, especially with small cap, high growth, CANSLIM style stocks. Sure, the upside potential can be great, but there are too many things that can go wrong, which could cause the stock to plummet. Remember, the name of the game is preservation of capital. You can always repurchase the stock once the coast is clear.

A company may report below analyst estimates, or the whisper number (earnings that the company is rumored to report, often leaked by an insider). There are times when a company will beat the analyst estimate, but not the whisper number and sell off.

They may release negative news about the company, the industry, or reveal a less than optimistic outlook for the future.

“Buy the rumor, sell the news”. Often times a stock will rise ahead of expected good earnings, only to sell off once the great earnings are released.

Here are a few recent examples:
AU Optronics (AUO) recently reported blowout earnings on April 27 and has been plummeting ever since. While the weakness in the market is to blame for some of the selling, it’s a classic case of buy on the rumor and sell on the news. Investors sent the stock soaring nearly 100% since the last earnings report, expecting the company to continue to report great earnings.

Tumbleweed Communications (TMWD) is a fast growing provider of spam, virus and fraud protection software that reported less than stellar results on April 27th and promptly sold off. It’s down more than 60%.

The #1 rule of investment success? Keeping losses small (8-10%). When you are wrong about a trade, admit you are wrong and move on. It’s as simple as that. Get over your need to be right, or it will devastate your portfolio. In fact, by keeping losses small, you only need to be right about half of the time to be considered a successful investor. Remember this fact because it’s important.

Think about it.. three consecutive 8% losses can be overcome by one 30% move in a stock. Believe me when I say that buying a successful breakout of a leading stock can yield you a 30% gain in just a couple of weeks if not less. However, hold onto a loser for a 50% loss and the stock would have to bounce back 100% for you to recoup your losses. Many who held onto their losses throughout the bear market of 2000 may never recoup their losses.

In a recent recommendation to my members at SelfInvestors.com, I highlighted a breakout of Aluminum Corp. of China, which had just surged to new highs on heavy volume. Within days, the stock reversed, fell back into its base and ultimately plunged below major support. A sell decision was recommended just as the stock fell below major support of the upper trend in green and the 50 day moving average in red (see the chart below). As you can see, by holding onto the stock you would have suffered a crushing loss as the stock plunged another 25% over the next couple of weeks.

Before getting into my first post, I’d like to say I’m looking forward to what I hope will be an informative and educational running dialogue for investors interested in the CANSLIM (CANSLIM is an acronym describing elements of the investing strategy)approach to investing. While I do run a website for CANSLIM investors, I like the idea of an informal arena for exchanging thoughts with other investors. For more information on this style of investing you can check out the tutorial I have set up on my web site.

When making a decision to buy or sell anything with a high cost what do you do? Well, if you’re a smart shopper, you check out that item thoroughly. For example, buying a house is the largest purchase most people will make. It pays to spend considerable time checking out the merchandise. You’ll probably look at the price of other homes in the area, the quality of schools, location of shopping and recreation, future growth, the quality of the home itself, etc. Making the decision to purchase a stock is no different, however few people take the time necessary to adequately research a stock before spending their hard earned money.

Of course there are many approaches to researching a stock, however an approach that looks at every angle is the most desirable and the CANSLIM method of investing developed by William O’neil does this very well. It’s the reason why it is one of the top investing strategies around. The key to its success is that it uses what I like to call a top – down approach. Looking at the big picture (the economy, interest rates), then the market itself (using volume and price analysis), the industry groups (where in the market the strength lies – there are always pockets of strength) and finally the stock itself (using fundamental and technical analysis). Yes, it can be a labor intensive stock picking strategy, but their are services available (including my own site), that help you invest in the highest quality stocks when the market is strong.