Charting III
In Charting I we considered the three most basic chart patterns - the uptrend, the downtrend and the trading range.
In Charting III we will look in more detail at how we could trade a range profitably.
Support and Resistance
The key concepts in trading a range are support and resistance.
If two local mimima appear one after the other, this is evidence of support for a falling stock at that price. We can draw a support line on the chart - as shown in green in the chart on the right.
Chartists demand three points of contact before an uptrend or downtrend is confirmed. Likewise, we require a third point of contact before support or resitance can be confirmed.
The trading strategy in the case shown above would be to buy just after point 3 on the support line. The sell strategy would be to sell at a price close to the resistance line. The stop loss would be set at a price just below the support line. If the price closes below the support line, your trade has failed. You must accept this and sell at a loss. Some traders will allow a little room for the trade to breathe and will set a stop loss not one tick but several ticks below the support line. This is a perfectly valid strategy but again, if your predetermined stop loss is reached, you must sell.