STOCK MARKET KNOWLEDGE

30 DAYS KNOWLEDGE SESSION BY MONK OF STOCKS

WHAT IS STOCK MARKET?

STOCK MARKET, EQUITY MARKET OR SHARE MARKET IS THE AGGREGATION OF
BUYERS AND SELLERS OF STOCKS, WHICH REPRESENTS OWNERSHIP CLAIMS ON
BUSINESSES.

THESE MAY INCLUDE SECURITIES LISTED ON A PUBLIC STOCK EXCHANGE AS WELL

AS STOCK THAT IS ONLY TRADED PRIVATELY SUCH AS SHARES OF PRIVATE
COMPANIES THAT ARE SOLD TO INVESTORS THROUGH EQUITY CROWDFUNDING
PLATFORMS.
INVESTMENTS ARE USUALLY MADE WITH AN INVESTMENT STRATEGY IN MIND.

IN SIMPLE WORDS STOCK MARKET IS A PLATFORM WHERE INVESTORS BUY AND

SELL SHARES OF COMPANIES.

IT IS A SET OF EXCHANGES WHERE COMPANIES ISSUE SHARES AND OTHER

SECURITIES FOR TRADING.

IT ALSO INCLUDES OVER-THE-COUNTER (OTC) MARKETPLACES WHERE INVESTORS

TRADE SECURITIES DIRECTLY WITH EACH OTHER RATHER THAN THROUGH AN
EXCHANGE.

MAIN EXCHANGES IN INDIA

BSE - BOMBAY STOCK EXCHANGE

NSE - NATIONAL STOCK EXCHANGE

BOMBAY STOCK EXCHANGE IS THE OLDEST STOCK EXCHANGE FORMED IN 1875.

IT'S THE FIRST STOCK EXCHANGE IN ASIA AND IS RECOGNISED AMONG THE
WORLD'S LEADING STOCK EXCHANGES.

IN 1986 IT INTRODUCED THE S&P BSE SENSEX WHICH CONSISTS OF THE STOCK OF
THE TOP 30 COMPANIES LISTED ON THE BSE.

NATIONAL STOCK EXCHANGE WAS FOUNDED IN 1992.

IT INTRODUCED ELECTRONIC MODE OF TRADING IN STOCKS OR SHARES OF

COMPANIES.
NATIONAL STOCK EXCHANGE IS THE LARGEST STOCK EXCHANGE IN INDIA BASED
ON MARKET CAPITALISATION.

NSE USES THE NIFTY 50 INDEX AS ITS BENCHMARK WHICH HAS THE TOP 50
STOCKS OF THE SHARE MARKET ACROSS DIFFERENT SECTORS.

SIMILARITIES AMONG BSE AND NSE

1. BOTH EXCHANGES ARE POPULAR AMONG INVESTORS

2. BOTH ALLOW STOCK TRADING

3. BESIDES EQUITY YOU CAN TRADE IN BONDS MUTUAL FUNDS COMMODITIES,

DERIVATIVES, FUTURES AND OPTIONS AND CURRENCIES ON THESE EXCHANGES.

4 BOTH THE EXCHANGES ARE REGULATED BY SEBI

SECURITIES AND EXCHANGE BOARD OF INDIA

5. BOTH HAVE ELECTRONIC TRADING FACILITIES.

6. BOTH HAVE HEADQUARTERS IN MUMBAI.

DIFFERENCES AMONG BSE AND NSE

POINTS NSE BSE

1. FULL FORM NATIONAL STOCK EXCHANGE BOMBAY STOCK EXCHANGE

2. FORMED 1992 1875

3. RANKING 11TH 10TH

4. BENCHMARK NIFTY SENSEX

5. AS ON 13 JAN23 2200 COMPANIES 5300 COMPANIES

6. LIQUIDITY HIGHER THAN BSE LOWER THAN NSE

OK TELL ME CAN WE BUY IN BSE AND SELL IN NSE?

THE ANSWER IS VERY SIMPLE

"YES," WE CAN.

TRADERS PREFER TRADING IN NSE AS IT HAS HIGH LIQUIDITY.

IMPORTANT TERMS IN THE STOCK MARKET

1. STOCK MARKET 30. OPTIONS

2. DEMAT 31. CALL OPTION

3. TRADING 32. PUT OPTION

4. SENSEX 33. LOT SIZE

5. NIFTY 34. CANDLESTICKS

6. STOCKS 35. CHART PATTERN

7. PORTFOLIO 36. STRIKE PRICE

8. BULL RUN 37. SPOT CHART

9. BEAR MARKET 38. PREMIUM

10. IPO 39. OPTION CHAIN

11. ANNUAL REPORT 40. ATM

12. DIVIDEND 41. OTM

13. BLUE CHIP STOCKS 42. ITM

14. BID 43. VOLUME

16. ASK 44. SUPPORT

17. MARKET CAP 45. RESISTANCE

18. LARGE CAP 46. RETRACEMENT

19. MID CAP 47. BREAK OUT

20. SMALL CAP 48. BREAK DOWN

21. LIMIT ORDER 49. REVERSAL

20. MARKET ORDER 50. VOLATILITY

22. STOP LOSS 51. OPTION CHAIN

23. TRAILING STOP LOSS 52. OPTION GREEKS

24. TARGET PRICE 53. INDICATORS

25. EXECUTION 54. PRICE ACTION

26. AGENTS 55. RISK REWARD RATIO

27. PORTFOLIO MANAGEMENT 56. TECHNICAL ANALYSIS

28. RALLY 57. FUNDAMENTAL ANALYSIS

29. CRASH 58. TRADING PSYCHOLOGY

HOW TO BUILD A PORTFOLIO IN THE EQUITY MARKET

KEYS POINTS ARE BELOW

1. DETERMINE YOUR FINANCIAL GOALS.

SHORT TERM GOALS

MID-TERM GOALS

LONG TERM GOALS

2. IDENTIFY YOUR RISK APPETITE

RISK SHOULD BE EVALUATED BEFORE SETTING YOUR REWARD.

NEVER PUT ALL YOUR EGGS IN ONE BASKET SIR WARREN BUFFET

3. INVEST IN COMPANIES WHOSE BUSINESS YOU UNDERSTAND

JUST DON'T INVEST IN A STOCK AS IT IS BUZZING IN THE MARKET.

YOU CAN GET TRAPPED AT HIGHER VALUATIONS.

UNDERSTAND THE BUSINESS, ITS FUTURE DEMAND AND POTENTIAL GROWTH.

4. UNDERSTAND THE FUNDAMENTALS

PROFIT LOSS STATEMENT

BALANCE SHEET

DIVIDEND YIELD

CASH FLOW (RESERVE AND SURPLUS)

 HISTORICAL GROWTH (NET INCOME)

EPS (EARNING PRICE PER SHARE)

P/E RATIO (PRICE TO EQUITY RATIO)

DEBT TO EQUITY RATIO

ROE (RETURN ON EARNINGS)

FII HOLDING AND DII HOLDING TOTAL IS 25% OR MORE

PROFIT LOSS STATEMENT

IT'S A DOCUMENT THAT COMPARES THE TOTAL INCOME OF A BUSINESS AGAINST

ITS DEBT AND EXPENSES.

IT'S AN INDICATOR OF THE FINANCIAL HEALTH OF A COMPANY BASED ON ITS

ABILITY TO GENERATE INCOME THROUGH SALES, MANAGE EXPENSES AND
SUSTAIN A HEALTHY PROFIT MARGIN.

BALANCE SHEET

THE BALANCE SHEET DISPLAYS THE COMPANY'S TOTAL ASSETS AND HOW THE
ASSETS ARE FINANCED, EITHER THROUGH DEBITS OR EQUITY.

IT CAN ALSO BE REFERRED TO AS A STATEMENT OF NET WORTH OR A

STATEMENT OF THE FINANCIAL POSITION OF A COMPANY.

THE BALANCE SHEET IS BASED ON THE FUNDAMENTAL EQUATION.

ASSETS = LIABILITIES + EQUITY

DIVIDEND YIELD
DIVIDEND YIELD IS A STOCK'S ANNUAL DIVIDEND PAYMENTS MADE TO
SHAREHOLDERS EXPRESSED AS A PERCENTAGE OF THE STOCK'S CURRENT PRICE.

FOR EXAMPLE

IF A STOCK TRADES AT RS 100 PER SHARE TODAY AND THE COMPANY'S

ANNUALIZED DIVEDEND IS RS 5 PER SHARE, THE DIVEDEND YIELD IS 5%.

FORMULA

DIVIDEND YIELD = ANNUALIZED DIVIDEND / SHARE PRICE

CASH FLOW

CASH FLOW, IN GENERAL, REFERS TO PAYMENTS MADE IN OR OUT OF BUSINESS.

THE MOVEMENT OF MONEY KNOWN AS CASH FLOW.

IT REFLECTS THE LIQUIDITY IN A COMPANY.

IN A NARROW SENSE ESPECIALLY FROM ONE BANK ACCOUNT TO ANOTHER.

HISTORICAL GROWTH

AN ANALYSIS OF HISTORICAL GROWTH SUPPORTS THE POSSIBILITY OF RADICAL

INCREASES IN GROWTH RATE. NAIVE EXTRAPOLATION OF LONG-TERM TRENDS
WOULD SUGGEST MASSIVE INCREASES IN GROWTH RATE OVER THE COMING
CENTURY, ALTHOUGH GROWTH OVER THE LAST HALF-CENTURY HAS LAGGED
VERY SIGNIFICANTLY BEHIND THESE LONG-TERM TRENDS.

EPS

HIGER THE EARNING PRICE PER SHARE THE MORE PROFITABLE THE COMPANY IS.

COMPARING THE EPS OF COMPANIES OF THE SAME SECTOR CAN CLEAR THE
PICTURE OF OUTPERFORMING COMPANIES OVER A PERIOD OF TIME.

EPS = NET INCOME / TOTAL NO OF SHARES

P/E RATIO

THE P/E RATIO IS THE RATIO FOR VALUING A COMPANY THAT MEASURES ITS
CURRENT SHARE PRICE RELATIVE TO ITS EARNING PER SHARE

P/E RATIO = MARKET PRICE PER SHARE / EPS

DEBT-EQUITY RATIO

DEBT-EQUITY RATIO = TOTAL DEBTS / TOTAL SHAREHOLDERS

R0E
IT IS KNOWN AS RETURN ON EQUITY, IT'S THE NETWORTH THAT WILL BE GIVEN
TO THE SHAREHOLDERS OF A COMPANY ON LIQUADATION.

ROE = NET INCOME / SAHRE HODERS EQUITY

5. WATCH OUT FOR VALUE TRAPS DON'T BUY A STOCK AS IT IS CHEAP

6. COMPETITIVE ADVANTAGE

THE COMPANY'S PROFITABILITY SHOULD BE MORE THAN THE RIVAL COMPANIES

AND IT SHOULD HAVE A COMPETITIVE ADVANTAGE OVER ITS RIVAL COMPANIES.

7. FII AND DII HOLDIND

SHOULD BE MORE THAN 25% ON ADDING BOTH FII AND DII HOLDING %

HOW TO DEVELOP TRADING SKILLS ?

CANDLESTICK KNOWLEDGE

WHAT IS CANDLE STICK?

A CANDLE STICK IS A WAY OF DISPLAYING INFORMATION ABOUT AN ASSET'S

PRICE MOVEMENT.

CANDLE STICK CHARTS ARE ONE OF THE MOST POPULAR COMPONENTS OF

TECHNICAL ANALYSIS ENABLING TRADERS TO INTERPRET PRICE INFORMATION
QUICKLY AND FROM JUST A FEW PRICE BARS.

IT WAS DEVELOPED IN THE 18TH CENTURY BY MUNEHISA HOMMA A JAPANESE

RICE TRADER.

THEY WERE INTRODUCED TO THE WESTERN WORLD BY STEVE NISION IN HIS

BOOK JAPANESE CANDLESTICK CHARTING TECHNIQUES FIRST PUBLISHED IN 1991.

THEY ARE OFTEN USED TODAY IN STOCK ANALYSIS.

THE CANDLE STICKS HAVE THREE BASIC FEATURES UNDER

THE BODY - WHICH REPRESENTS THE OPEN TO CLOSE-RANGE

THE WICK - THAT INDICATES THE INTRA-DAY HIGH AND LOW

THE COLOR - INDICATES THE DIRECTION OF MARKET MOVEMENT.

GREEN BODY INDICATES A PRICE INCREASE

RED BODY INDICATES A PRICE DECREASE

A TRADER CAN RECOGNISE MAJOR SUPPORT AND RESISTANCE LEVELS BY THESE
CANDLE STICK PATTERNS.

BEFORE YOU START TRADING.

ITS IMPORTANT TO BE FAMILIAR WITH THE BASICS OF CANDLESTICK PATTERNS.

TEN BULLISH CANDLESTICK PATTERNS

BULLISH PATTERNS MAY FORM AFTER A MARKET DOWNTREND AND SIGNAL A

REVERSAL OF PRICE MOVEMENT.

THEY ARE AN INDICATOR FOR TRADERS TO CONSIDER OPENING A LONG POSITION

TO PROFIT FROM ANY UPWARD TRAJECTORY.
1. HAMMER

THE HAMMER CANDLE STICK PATTERN IS FORMED OF A SHORT BODY WITH A

LONG LOWER WICK AND IS FOUND AT THE BOTTOM OF A DOWN TREND.

A HAMMER SHOWS THAT ALTHOUGH THERE WAS SELLING PRESSURE DURING

THE DAY, ULTIMATELY A STRONG BUYING PRESSURE DROVE THE PRICE BACK UP.

THE COLOUR OF THE BODY CAN VARY, BUT THE GREEN HAMMER INDICATE A
STRONGER BULL MARKET THAN THE RED HAMMER.
2. INVERSE HAMMER

A SIMILARLY BULLISH PATTERN IS THE INVERTED HAMMER.

THE ONLY DIFFERENCE IS THAT THE UPPER WICK IS LONG, WHILE THE LOWER
WICK IS SHORT.

IT INDICATES A BUYING PRESSURE, FOLLOWED BY A SELLING PRESSURE THAT

WAS NOT GOOD ENOUGH TO DRIVE THE MARKET PRICE DOWN.

THE INVERSE HAMMER SUGGESTS THAT BUYERS THAT BUYERS WILL SOON HAVE
CONTROL OF THE MARKET
7900671908 9528787996

3. BULLISH ENGULFING
THE BULLISH ENGULFING PATTERN IS FORMED OF TWO CANDLESTICKS.
THE FIRST CANDLE IS A SHORT RED BODY THAT IS COMPLETELY ENGULFED BY A
LARGER GREEN CANDLE.

THROUGH THE SECOND GREEN CANDLE OPENS LOWER THAN THE FIRST, THE
BULLISH MARKET PUSHES THE PRICE UP, CULMINATING IN AN OBVIOUS WIN FOR
BUYERS.
4. PIERCING LINE
PIERCING LINE IS ALSO A TWO-STICK PATTERN MADE UP OF A LONG RED CANDLE
FOLLOWED BY A LONG GREEN CANDLE.
THERE IS USUALLY A SIGNIFICANT GAP DOWN BETWEEN THE FIRST CANDLESTICK
CLOSING PRICE AND THE GREEN CANDLESTICK OPENING.
IT INDICATES A STRONG BUYING PRESSURE AS THE PRICE IS PUSHED UP TO OR
ABOVE THE MID-PRICE OF THE PREVIOUS CANDLE.
5. MORNING STAR
THE MORNING STAR CANDLESTICK PATTERN IS CONSIDERED A SIGN OF HOPE IN A
BLEAK MARKET DOWNTREND.
IT IS A THREE- STICK PATTERN
ONE SHOERT-BODIED CANDLE IN BETWEEN A LONG RED CANDLE AND A LONG
GREEN CANDLE.
THE SMALL PLUS SIGN IN BETWEEN REPRESENTS A SMALL STAR
IT SIGNALS THAT THE SELLING PRESSURE OF THE READ-LONG CANDLE IS
SUBSIDING AND A UP MOVE IS ON THE HARIZON.
6. THREE WHITE SOLDIERS
THE THREE WHITE SOLDIERS PATTERN OCCURS OVER THREE DAYS.
IT CONSISTS OF CONSECUTIVE LONG GREEN CANDLES WITH SMALL WICKS THAT
OPEN AND CLOSE PROGRESSIVELY HIGHER THAN THE PREVIOUS GREEN CANDLE
IT IS A VERY STRONG BULLISH SIGNAL THAT OCCURS AFTER A DOWN TREND AND
SHOWS A STEADY ADVANCE OF BUYING PRESSURE.
7. BULLISH PIN BAR
Bullish Pin Bars form when sellers start the session in control but price reaches a
level that’s rejected and buyers take over and dominate the remainder of the
session closing out near or at highs.

8. TWEEZER BOTTOM
A TWEEZER BOTTOM IS A BULLISH REVERSAL PATTERN SEEN AT THE BOTTOM OF
DOWNTRENS AND CONSISTS OF TWO JAPANESE CANDLE STICKS WITH MATCHING
BOTTOMS.
THE MATCHING BOTTOMS ARE USUALLY COMPOSED OF SHADOWS OR WICKS
BUT CAN BE THE CANDLE BODIES AS WELL.
A TWEEZER BOTTOM OCCURS DURING A DOWNTREND WHEN SELLERS PUSH
PRICE LOWER OFTEN ENDING THE SESSION NEAR LOWS, BUT NOT ABLE TO PUSH
THE BOTTOM ANY FURTHER.
TWEEZER BOTTOM ARE CONSIDERED TO BE SHORT-TERM BULLISH REVERSAL
PATTERNS THAT SIGNAL A MARKET BOTTOM.
9. DRAGONFLY DOJI
A DRAGONFLY DOJI CANDLE IS A T-SHAPED CANDLESTICK CREATED WHEN THE
CLOSE, HIGH AND OPEN PRICES ARE NEARLY EQUAL.
THE MOST IMPORTANT PART OF A DRAGONFLY DOJI IS THE LONGER LOWER
SHADOW.
IT INDICATES A BULLISH REVERSAL WHEN IT OCCURS ON A DOWNTREND.
10. BULLISH HARAMMI

A bullish harami candlestick pattern is a two-candlestick pattern that signals a

potential bullish reversal in an ongoing bear market. It consists of a long bearish
candlestick and a small bullish candlestick, whose entire body lies within the
body of the prior bearish candlestick.01 The confirmation of trend reversal in a
bullish harami pattern occurs in the third or fourth candlestick that follows the
harami pattern.1 The pattern should not be traded in isolation but should be
considered along with other factors to achieve confirmation.0 Other technical
analysis tools should be used alongside observation of the bullish harami
pattern for better confirmation. The pattern is useful when analyzing assets
other than stocks, for example, cryptocurrency.
TEN BEARISH CANDLESTICK PATTERNS

BEARISH CANDLESTICK PATTERNS USUALLY FORM AFTER AN UPTREND, AND

SIGNAL A POINT OF RESISTANCE.
HEAVY PESSIMISM ABOUT THE MARKET PRICE OFTEN CAUSES TRADERS TO CLOSE
THEIR LONG POSITIONS AND OPEN A SHORT POSITION TO TAKE ADVANTAGE OF
THE FALLING PRICE.

1. HANGING MAN
THE HANGING MAN IS THE BEARISH EQUIVALENT OF A HAMMER, IT HAS THE
SAME SHAPE BUT FORMS AT THE END OF AN UPTREND.
IT INDICATES THAT THERE WAS A SIGNIFICANT SELL-OFF BUT THE BUYERS WERE
ABLE TO PUSH THE PRICE UP AGAIN.
THE LARGE SELL-OFF IS OFTEN SEEN AS AN INDICATION THAT THE BULLS ARE
LOSING CONTROL OF THE MARKET AS THE LATER CANDLE CLOSES LOWER FROM
THE HANGING MAN CANDLE.

2. SHOOTING STAR
THE SHOOTING STAR IS THE SAME SHAPE AS THE INVERTED HAMMER BUT IS
FORMED IN AN UPTREND.
IT HAS A SMALL LOWER BODY AND A LONG UPPER WICK.
USUALLY, THE CANDLE WILL GAP SLIGHTLY HIGHER AN OPENING AND RALLY TO
AN INTRA-DAY HIGH BEFORE CLOSING AT A PRICE JUST ABOVE THE OPEN LIKE A
STAR FALLING ON THE GROUND.
3. BEARISH ENGULFING

A BEARISH ENGULFING PATTERN OCCURS AT THE END OF AN UPTREND.

THE FIRST CANDLE HAS A SMALL GREEN BODY THAT IS ENGULFED BY A

SUBSEQUENT LONG RED CANDLE.

IT SIGNIFIES A PEAK OR SLOWDOWN OF PRICE MOVEMENT AND IS A SIGN OF

IMPENDING MARKET DOWNTURN.

THE LOWER THE SECOND CANDLE GOES THE MORE SIGNIFICANT THE TREND IS
LIKELY TO BE.
4. EVENING STAR

THE EVENING STAR IS A THREE-CANDLESTICK PATTERN THAT IS THE EQUIVALENT

OF THE BULLISH MORNING STAR.

IT IS FORMED OF A SHORT CANDLE SANDWITCHED BETWEEN A LONG GREEN

CANDLE AND A LARGE RED CANDLESTICK.

IT INDICATES THE REVERSAL OF AN UPTREND AND IS PARTICULARLY STRONG

WHEN THE THIRD CANDLESTICK ERASES THE GAINS OF THE FIRST CANDLE.
5. THREE BLACK CROWS
THE THREE BLACK CROWS CANDLESTICK PATTERN COMPRISES OF THREE
CONSECUTIVE LONG RED CANDLES WITH SHORT OR NON-EXISTENT WICKS.
EACH SESSION OPENS AT A SIMILAR PRICE TO THE PREVIOUS DAY, BUT SELLING
PRESSURE PUSH THE PRICE LOWER AND LOWER WITH EACH CANDLE CLOSE.
TRADERS INTERPRET THIS PATTERN AS THE START OF A BEARISH TREND AS THE
SELLERS HAVE OVERTAKEN THE BUYERS DURING THREE SUCCESSIVE CANDLES.
6. DARK CLOUD COVER

THE DARK CLOUD COVER CANDLESTICK PATTERN INDICATES A BEARISH

REVERSAL- A BLACK CLOUD OVER THE PREVIOUS CANDLE OPTIMISE. IT
COMPRISES TWO CANDLESTICKS A RED CANDLESTICK WHICH OPENS THE
PREVIOUS GREEN BODY AND CLOSES BELOW ITS MIDPOINT.

IT SIGNALS THAT THE BEARS HAVE TAKEN OVER THE SESSION, PUSSING THE PRICE
LOWER, IF THE WICK OF CANDLES ARE SHORT IT SUGGESTS THAT THE
DOWNTREND WAS EXTREMELY DECISIVE.
7. BEARISH PIN BAR
Bearish Pin Bars form when buyers start the session in control but price reaches a
level that’s rejected and sellers take over and dominate the remainder of the
session closing out near or at lows.
8. TWEEZER TOP

A TWEEZER TOP IS A BEARISH REVERSAL PATTERN SEEN AT THE TOP OF THE

UPTREND AND CONSISTS OF TWO JAPANESE CANDLE STICKS WITH MATCHING
TOPS.
THE MATCHING TOPS ARE USUALLY COMPOSED OF SHADOWS OR WICKS BUT
CAN BE THE CANDLE BODIES AS WELL.
A TWEEZER BOTTOM OCCURS DURING AN UPTREND WHEN BUYERS PUSH PRICES
HIGHER OFTEN ENDING THE SESSION NEAR HIGHS, BUT NOT ABLE TO PUSH THE
TOP ANY FURTHER.
TWEEZER TOP ARE CONSIDERED TO BE SHORT-TERM BEARISH REVERSAL
PATTERNS THAT SIGNAL A MARKET TOP.

9. GRAVESTONE DOJI
A GRAVESTONE CANDLE IS AN INVERTED T-SHAPED CANDLESTICK CREATED
WHEN THE OPEN, HIGH AND CLOSING PRICES ARE NEARLY EQUAL.
THE MOST IMPORTANT PART OF A GRAVESTONE DOJI IS THE LONGER HIGER
SHADOW.
IT INDICATES A BEARISH REVERSAL WHEN IT OCCURS ON AN UPTREND.
10. BEARISH HARAMMI

A bearish harami is a two-bar Japanese candlestick pattern that indicates a

potential trend reversal from bullish to bearish.03 It consists of a long-bodied
green candle and a short red candle.0 The first candle is a larger bullish one,
followed by a smaller bearish candle that fits inside the bullish candle, setting up a
reversal to the downside. Look for the price to fail the second candle and hold to
confirm bearish continuation.3 The bearish harami should not be traded in
isolation but should be considered along with other factors to achieve
confirmation.2 Many traders rely on this pattern to predict potential reversals to
the downtrend.
Four continuation candlestick patterns

If a candlestick pattern doesn’t indicate a change in market direction, it is what is

known as a continuation pattern. These can help traders to identify a period of
rest in the market, when there is market indecision or neutral price movement.

1. Doji
When a market’s open and close are almost at the same price point, the
candlestick resembles a cross or plus sign – traders should look out for a short to
non-existent body, with wicks of varying length.

This doji’s pattern conveys a struggle between buyers and sellers that results in no
net gain for either side. Alone a doji is neutral signal, but it can be found in
reversal patterns such as the bullish morning star and bearish evening star.
2. Spinning top
The spinning top candlestick pattern has a short body centred between wicks of
equal length. The pattern indicates indecision in the market, resulting in no
meaningful change in price: the bulls sent the price higher, while the bears
pushed it low again. Spinning tops are often interpreted as a period of
consolidation, or rest, following a significant uptrend or downtrend.

On its own the spinning top is a relatively benign signal, but they can be
interpreted as a sign of things to come as it signifies that the current market
pressure is losing control.
3. FALLING THREE METHOD
A FALLING THREE-METHOD FORMATION PATTERN IS USED TO PREDICT THE
CONTINUATION OF A BEARISH TREND.

THE BEARISH PATTERN IS CALLED THE FALLING THREE METHOD, IT IS FORMED

WITH THE FIRST LONG RED-BODIED CANDLE FOLLOWED BY THREE SMALL GREEN-
BODIED CANDLES AND THE FOURTH CANDLE IS AGAIN A LONG RED-BODIED
CANDLE.

THE THREE SMALL GREEN CANDLES ARE CONTAINED IN THE RANGE OF BEARISH
RED CANDLES.

IT SHOWS THAT THE BULLS DO NOT HAVE ENOUGH STRENGTH TO REVERSE THE
TREND.
4. RISING THREE METHOD
A RISING THREE METHOD FORMS WITH THREE SHORT RED CANDLES SANWICHED
WITHIN THE RANGE OF TWO LONG GREEN CANDLES.
THE PATTERN SHOWS THAT THE BEARS CREATE SELLING PRESSURE AND THE
BULLS HAVE CONTROL.
CHART PATTERNS

A CHART PATTERN IS A SHAPE WITHIN A PRICE CHART THAT HELPS TO SUGGEST

WHAT PRICES MIGHT DO NEXT BASED ON WHAT THEY HAVE DONE IN THE PAST.
CHART PATTERNS ARE BASIS OF TECHNICAL ANALYSIS AND REQUIRE A TRADER TO
KNOW EXACTLTY WHAT THEY ARE LOOKING AT, AS WELL AS WHAT THEY ARE
LOOKING FOR.

LETS SEE SOME IMPORTANT CHART PATTERNS

1. DOUBLE TOP

A DOUBLE TOP IS ANOTHER PATTERN THAT TRADERS USE TO HIGHLIGHT TREND

REVERSALS. TYPICALLY, AN ASSET’S PRICE WILL EXPERIENCE A PEAK, BEFORE
RETRACING BACK TO A LEVEL OF SUPPORT. IT WILL THEN CLIMB UP ONCE MORE
BEFORE REVERSING BACK MORE PERMANENTLY AGAINST THE PREVAILING
TREND.
2. DOUBLE BOTTOM

A DOUBLE BOTTOM CHART PATTERN INDICATES A PERIOD OF SELLING, CAUSING

AN ASSET’S PRICE TO DROP BELOW A LEVEL OF SUPPORT. IT WILL THEN RISE TO A
LEVEL OF RESISTANCE, BEFORE DROPPING AGAIN. FINALLY, THE TREND WILL
REVERSE AND BEGIN AN UPWARD MOTION AS THE MARKET BECOMES MORE
BULLISH.

A DOUBLE BOTTOM IS A BULLISH REVERSAL PATTERN, BECAUSE IT SIGNIFIES THE

END OF A DOWNTREND AND A SHIFT TOWARDS AN UPTREND.
3. TRIPLE TOP

A TRIPLE TOP PATTERN, ALSO CALLED A TRIPLE TOP REVERSAL, IT IS A PATTERN

USED IN TECNICAL ANALYSIS THAT SIGNALS A POTENTIAL REVERSAL.
THE TRIPLE TOP PATTERN CONSISTS OF THREE SIMILAR PRICE HIGHS WITH PRICE
PULLBACKS BETWEEN THE PEAKS.
WHILE A SIMILAR LOOKING FORMATION CAN OCCUR AT VARIOUS TIMES, A TRUE
TRIPLE TOP PATTERN MUST FOLLOW A RALLY.
4. TRIPLE BOTTOM

A TRIPLE BOTTOM PATTERN, ALSO CALLED A TRIPLE BOTTOM REVERSAL, IS A

PATTERN USED IN TECNICAL ANALYSIS THAT SIGNALS A POTENTIAL REVERSAL.
THE TRIPLE BOTTOM PATTERN CONSISTS OF THREE SIMILAR PRICE LOWS WITH
PRICE PULLBACKS BETWEEN THE LOWS.
WHILE A SIMILAR LOOKING FORMATION CAN OCCUR AT VARIOUS TIMES, A TRUE
TRIPLE BOTTOM PATTERN MUST FOLLOW A RALLY.
5. HEAD AND SHOULDER

HEAD AND SHOULDERS IS A CHART PATTERN IN WHICH A LARGE PEAK HAS A

SLIGHTLY SMALLER PEAK ON EITHER SIDE OF IT. TRADERS LOOK AT HEAD AND
SHOULDERS PATTERNS TO PREDICT A BULLISH-TO-BEARISH REVERSAL.

TYPICALLY, THE FIRST AND THIRD PEAK WILL BE SMALLER THAN THE SECOND,
BUT THEY WILL ALL FALL BACK TO THE SAME LEVEL OF SUPPORT, OTHERWISE
KNOWN AS THE ‘NECKLINE’. ONCE THE THIRD PEAK HAS FALLEN BACK TO THE
LEVEL OF SUPPORT, IT IS LIKELY THAT IT WILL BREAKOUT INTO A BEARISH
DOWNTREND.
6. INVERTED HEAD AND SHOULDER
6. ROUNDING BOTTOM

A ROUNDING BOTTOM CHART PATTERN CAN SIGNIFY A CONTINUATION OR A

REVERSAL. FOR INSTANCE, DURING AN UPTREND AN ASSET’S PRICE MAY FALL
BACK SLIGHTLY BEFORE RISING ONCE MORE. THIS WOULD BE A BULLISH
CONTINUATION.

AN EXAMPLE OF A BULLISH REVERSAL ROUNDING BOTTOM – SHOWN BELOW –

WOULD BE IF AN ASSET’S PRICE WAS IN A DOWNWARD TREND AND A ROUNDING
BOTTOM FORMED BEFORE THE TREND REVERSED AND ENTERED A BULLISH
UPTREND.
TRADERS WILL SEEK TO CAPITALIZE ON THIS PATTERN BY BUYING HALFWAY
AROUND THE BOTTOM, AT THE LOW POINT, AND CAPITALIZING ON THE
CONTINUATION ONCE IT BREAKS ABOVE A LEVEL OF RESISTANCE.
7. CUP AND HANDLE
THE CUP AND HANDLE PATTERN IS A BULLISH CONTINUATION PATTERN THAT IS
USED TO SHOW A PERIOD OF BEARISH MARKET SENTIMENT BEFORE THE
OVERALL TREND FINALLY CONTINUES IN A BULLISH MOTION. THE CUP APPEARS
SIMILAR TO A ROUNDING BOTTOM CHART PATTERN, AND THE HANDLE IS
SIMILAR TO A WEDGE PATTERN – WHICH IS EXPLAINED IN THE NEXT SECTION.

FOLLOWING THE ROUNDING BOTTOM, THE PRICE OF AN ASSET WILL LIKELY

ENTER A TEMPORARY RETRACEMENT, WHICH IS KNOWN AS THE HANDLE
BECAUSE THIS RETRACEMENT IS CONFINED TO TWO PARALLEL LINES ON THE
PRICE GRAPH. THE ASSET WILL EVENTUALLY REVERSE OUT OF THE HANDLE AND
CONTINUE WITH THE OVERALL BULLISH TREND.
8. RISING WEDGE
A RISING WEDGE IS REPRESENTED BY A TREND LINE CAUGHT BETWEEN TWO
UPWARDLY SLANTED LINES OF SUPPORT AND RESISTANCE. IN THIS CASE THE LINE
OF SUPPORT IS STEEPER THAN THE RESISTANCE LINE. THIS PATTERN GENERALLY
SIGNALS THAT AN ASSET’S PRICE WILL EVENTUALLY DECLINE MORE
PERMANENTLY – WHICH IS DEMONSTRATED WHEN IT BREAKS THROUGH THE
SUPPORT LEVEL.
9. FALLING WEDGE PATTERN
A FALLING WEDGE OCCURS BETWEEN TWO DOWNWARDLY SLOPING LEVELS. IN
THIS CASE THE LINE OF RESISTANCE IS STEEPER THAN THE SUPPORT. A FALLING
WEDGE IS USUALLY INDICATIVE THAT AN ASSET’S PRICE WILL RISE AND BREAK
THROUGH THE LEVEL OF RESISTANCE, AS SHOWN IN THE EXAMPLE BELOW.
10. PENNANT PATTERN
PENNANTS CAN BE EITHER BULLISH OR BEARISH, AND THEY CAN REPRESENT A
CONTINUATION OR A REVERSAL.
IT IS IMPORTANT TO LOOK AT THE VOLUMES IN A PENNANT, THE PERIOD OF
CONSOLIDATION SHOULD HAVE LOWER VOLUMES AND THE BREAKOUTS SHOULD
HAVE HIGHER VOLUMES.
BELOW WE CAN SEE THE CHARTS AS AN EXAMPLE OF A BULLISH CONTINUATION
AND BEARISH CONTINUATION PENNANT PATTERNS .
BULLISH PENNANT PATTERN
BEARISH PENNANT PATTERN

11. ASCENDING TRIANGLE

THE ASCENDING TRIANGLE IS A BULLISH CONTINUATION PATTERN WHICH
SIGNIFIES THE CONTINUATION OF AN UPTREND. ASCENDING TRIANGLES CAN BE
DRAWN ONTO CHARTS BY PLACING A HORIZONTAL LINE ALONG THE SWING
HIGHS – THE RESISTANCE – AND THEN DRAWING AN ASCENDING TREND LINE
ALONG THE SWING LOWS – THE SUPPORT.

ASCENDING TRIANGLE PATTERN

ASCENDING TRIANGLES OFTEN HAVE TWO OR MORE IDENTICAL PEAK HIGHS
WHICH ALLOW FOR THE HORIZONTAL LINE TO BE DRAWN. THE TREND LINE
SIGNIFIES THE OVERALL UPTREND OF THE PATTERN, WHILE THE HORIZONTAL
LINE INDICATES THE HISTORIC LEVEL OF RESISTANCE FOR THAT PARTICULAR
ASSET.

12. DESCENDING TRIANGLE

IN CONTRAST, A DESCENDING TRIANGLE SIGNIFIES A BEARISH CONTINUATION OF
A DOWNTREND. TYPICALLY, A TRADER WILL ENTER A SHORT POSITION DURING A
DESCENDING TRIANGLE IN AN ATTEMPT TO PROFIT FROM A FALLING MARKET.

DESCENDING TRIANGLE PATTERN

DESCENDING TRIANGLES GENERALLY SHIFT LOWER AND BREAK THROUGH THE
SUPPORT BECAUSE THEY ARE INDICATIVE OF A MARKET DOMINATED BY SELLERS,
MEANING THAT SUCCESSIVELY LOWER PEAKS ARE LIKELY TO BE PREVALENT AND
UNLIKELY TO REVERSE.

DESCENDING TRIANGLES CAN BE IDENTIFIED FROM A HORIZONTAL LINE OF

SUPPORT AND A DOWNWARD-SLOPING LINE OF RESISTANCE. EVENTUALLY, THE
TREND WILL BREAK THROUGH THE SUPPORT AND THE DOWNTREND WILL
CONTINUE.

13. SYMMETRICAL TRIANGLE

THE SYMMETRICAL TRIANGLE PATTERN CAN BE EITHER BULLISH OR BEARISH,
DEPENDING ON THE MARKET. IN EITHER CASE, IT IS NORMALLY A CONTINUATION
PATTERN, WHICH MEANS THE MARKET WILL USUALLY CONTINUE IN THE SAME
DIRECTION AS THE OVERALL TREND ONCE THE PATTERN HAS FORMED.

SYMMETRICAL TRIANGLES FORM WHEN THE PRICE CONVERGES WITH A SERIES

OF LOWER PEAKS AND HIGHER TROUGHS. IN THE EXAMPLE BELOW, THE OVERALL
TREND IS BEARISH, BUT THE SYMMETRICAL TRIANGLE SHOWS US THAT THERE
HAS BEEN A BRIEF PERIOD OF UPWARD REVERSALS.

SYMMETRICAL TRIANGLE PATTERN ON UPWARD REVERSAL

HOWEVER, IF THERE IS NO CLEAR TREND BEFORE THE TRIANGLE PATTERN
FORMS, THE MARKET COULD BREAK OUT IN EITHER DIRECTION. THIS MAKES
SYMMETRICAL TRIANGLES A BILATERAL PATTERN – MEANING THEY ARE BEST
USED IN VOLATILE MARKETS WHERE THERE IS NO CLEAR INDICATION OF WHICH
WAY AN ASSET’S PRICE MIGHT MOVE. AN EXAMPLE OF A BILATERAL
SYMMETRICAL TRIANGLE CAN BE SEEN BELOW.
14. BULLISH FLAG
A BULLISH FLAG IS A CONTINUATION PATTERN THAT FORMS WHEN A STOCK IS IN
UPTREND AND EXPERIENCE A BRIEF CONSOLIDATION BEFORE CONTINUING ITS
UPWARD JOURNEY.
15. BEARISH FLAG
A BEARISH FLAG IS A CONTINUATION PATTERN THAT FORMS WHEN A STOCK IS IN
DOWNTREND AND EXPERIENCE A BRIEF CONSOLIDATION BEFORE CONTINUING
ITS DOWNWARD JOURNEY.
CHART PATTERNS SUMMED UP
ALL OF THE PATTERNS EXPLAINED IN THIS SESSION ARE USEFUL TECHNICAL
INDICATORS WHICH CAN HELP YOU TO UNDERSTAND HOW OR WHY AN ASSET’S
PRICE MOVED IN A CERTAIN WAY – AND WHICH WAY IT MIGHT MOVE IN THE
FUTURE. THIS IS BECAUSE CHART PATTERNS ARE
 CAPA
BLE OF HIGHLIGHTING AREAS OF SUPPORT AND RESISTANCE, WHICH CAN HELP A
TRADER DECIDE WHETHER THEY SHOULD OPEN A LONG OR SHORT POSITION; OR
WHETHER THEY SHOULD CLOSE OUT THEIR OPEN POSITIONS IN THE EVENT OF A
POSSIBLE TREND REVERSAL.

SUPPORT AND RESISTANCE BASICS

SUPPORT AND RESISTANCE ARE TWO FOUNDATIONAL CONCEPTS IN TECHNICAL

ANALYSIS. UNDERSTANDING WHAT THESE TERMS MEAN AND THEIR PRACTICAL
APPLICATION IS ESSENTIAL TO CORRECTLY READING PRICE CHARTS.
PRICES MOVE BECAUSE OF SUPPLY AND DEMAND. WHEN DEMAND IS GREATER
THAN SUPPLY, PRICES RISE. WHEN SUPPLY IS GREATER THAN DEMAND, PRICES
FALL. SOMETIMES, PRICES WILL MOVE SIDEWAYS AS BOTH SUPPLY AND DEMAND
ARE IN EQUILIBRIUM.

LIKE MANY CONCEPTS IN TECHNICAL ANALYSIS, THE EXPLANATION BEHIND

TECHNICAL CONCEPTS ARE RELATIVELY EASY, BUT MASTERY IN THEIR
APPLICATION OFTEN TAKES YEARS OF PRACTICE.

KEY TAKEAWAYS....
TECHNICAL ANALYSTS USE SUPPORT AND RESISTANCE LEVELS TO IDENTIFY PRICE
POINTS ON A CHART WHERE THE PROBABILITIES FAVOR A PAUSE OR REVERSAL
OF A PREVAILING TREND.
SUPPORT OCCURS WHERE A DOWNTREND IS EXPECTED TO PAUSE DUE TO A
CONCENTRATION OF DEMAND.
RESISTANCE OCCURS WHERE AN UPTREND IS EXPECTED TO PAUSE TEMPORARILY,
DUE TO A CONCENTRATION OF SUPPLY.
MARKET PSYCHOLOGY PLAYS A MAJOR ROLE AS TRADERS AND INVESTORS
REMEMBER THE PAST AND REACT TO CHANGING CONDITIONS TO ANTICIPATE
FUTURE MARKET MOVEMENT.
SUPPORT AND RESISTANCE AREAS CAN BE IDENTIFIED ON CHARTS USING
TRENDLINES AND MOVING AVERAGES.

WHAT IS SUPPORT?
IN A DOWNTREND, PRICES FALL BECAUSE THERE IS AN EXCESS OF SUPPLY OVER
DEMAND. THE LOWER PRICES GO, THE MORE ATTRACTIVE PRICES BECOME TO
THOSE WAITING ON THE SIDELINES TO BUY THE SHARES. AT SOME LEVEL,
DEMAND THAT WOULD HAVE BEEN SLOWLY INCREASING WILL RISE TO THE LEVEL
WHERE IT MATCHES SUPPLY. AT THIS POINT, PRICES WILL STOP FALLING. THIS IS
SUPPORT.

SUPPORT CAN BE A PRICE LEVEL ON THE CHART OR A PRICE ZONE. IN ANY EVENT,
SUPPORT IS AN AREA ON A PRICE CHART THAT SHOWS BUYERS’ WILLINGNESS TO
BUY. IT IS AT THIS LEVEL THAT DEMAND WILL USUALLY OVERWHELM SUPPLY,
CAUSING THE PRICE DECLINE TO HALT AND REVERSE.

WHAT IS RESISTANCE?

RESISTANCE IS THE OPPOSITE OF SUPPORT. PRICES MOVE UP BECAUSE THERE IS

MORE DEMAND THAN SUPPLY. AS THE PRICES MOVE HIGHER, THERE WILL COME
A POINT WHEN SELLING WILL OVERWHELM THE DESIRE TO BUY. THIS HAPPENS
FOR A VARIETY OF REASONS. IT COULD BE THAT TRADERS HAVE DETERMINED
THAT PRICES ARE TOO HIGH OR HAVE MET THEIR TARGET. IT COULD BE THE
RELUCTANCE OF BUYERS TO INITIATE NEW POSITIONS AT SUCH RICH
VALUATIONS. IT COULD BE FOR ANY OTHER NUMBER OF REASONS. BUT A
TECHNICIAN WILL CLEARLY SEE ON A PRICE CHART A LEVEL AT WHICH SUPPLY
BEGINS TO OVERWHELM DEMAND. THIS IS RESISTANCE. LIKE SUPPORT, IT CAN BE
A LEVEL OR A ZONE.

ONCE AN AREA OR “ZONE” OF SUPPORT OR RESISTANCE HAS BEEN IDENTIFIED,

THOSE PRICE LEVELS CAN SERVE AS POTENTIAL ENTRY OR EXIT POINTS BECAUSE,
AS THE PRICE REACHES A POINT OF PREVIOUS SUPPORT OR RESISTANCE, IT WILL
DO ONE OF TWO THINGS: BOUNCE BACK AWAY FROM THE SUPPORT OR
RESISTANCE LEVEL, OR VIOLATE THE PRICE LEVEL AND CONTINUE IN ITS PRIOR
DIRECTION—UNTIL IT HITS THE NEXT SUPPORT OR RESISTANCE LEVEL.

THE TIMING OF SOME TRADES IS BASED ON THE BELIEF THAT SUPPORT AND
RESISTANCE ZONES WILL NOT BE BROKEN. WHETHER THE PRICE IS HALTED BY OR
BREAKS THROUGH THE SUPPORT OR RESISTANCE LEVEL, TRADERS CAN “BET” ON
THE DIRECTION OF PRICE AND CAN QUICKLY DETERMINE IF THEY ARE CORRECT. IF
THE PRICE MOVES IN THE WRONG DIRECTION (BREAKS THROUGH PRIOR
SUPPORT OR RESISTANCE LEVELS), THE POSITION CAN BE CLOSED AT A SMALL
LOSS. IF THE PRICE MOVES IN THE RIGHT DIRECTION (RESPECTS PRIOR SUPPORT
OR RESISTANCE LEVELS), HOWEVER, THE MOVE MAY BE SUBSTANTIAL.

SUPPORT AND RESISTANCE CAN BE FOUND IN ALL CHARTING TIME PERIODS;

DAILY, WEEKLY, AND MONTHLY. TRADERS ALSO FIND SUPPORT AND RESISTANCE
IN SMALLER TIME FRAMES LIKE ONE-MINUTE AND FIVE-MINUTE CHARTS. BUT
THE LONGER THE TIME PERIOD, THE MORE SIGNIFICANT THE SUPPORT OR
RESISTANCE. TO IDENTIFY SUPPORT OR RESISTANCE, YOU HAVE TO LOOK BACK
AT THE CHART TO FIND A SIGNIFICANT PAUSE IN A PRICE DECLINE OR RISE. THEN
LOOK FORWARD TO SEE WHETHER A PRICE HALTS AND/OR REVERSES AS IT
APPROACHES THAT LEVEL. AS HAS BEEN NOTED ABOVE, MANY EXPERIENCED
TRADERS WILL PAY ATTENTION TO PAST SUPPORT OR RESISTANCE LEVELS AND
PLACE TRADERS IN ANTICIPATION OF A FUTURE SIMILAR REACTION AT THESE
LEVELS.

TECHNICAL ANALYSIS IS NOT AN EXACT SCIENCE, AND SOMETIMES THE PRICE

WILL DIP BELOW SUPPORT LEVELS OR REVERSE BEFORE IT GETS TO THE PRIOR
SUPPORT LEVEL. THE SAME IS TRUE FOR RESISTANCE: PRICE MAY REVERSE
BEFORE IT GETS TO THE PRIOR RESISTANCE LEVEL OR BREAK ABOVE IT. IN EACH
CASE, FLEXIBILITY IS REQUIRED IN INTERPRETING THESE CHART PATTERNS. THIS IS
WHY SUPPORT AND RESISTANCE LEVELS ARE SOMETIMES REFERRED TO AS
ZONES.

LET’S IMAGINE THAT JIM NOTICES THAT THE PRICE FAILS TO GET ABOVE $39
SEVERAL TIMES OVER SEVERAL MONTHS, EVEN THOUGH IT HAS GOTTEN VERY
CLOSE TO MOVING ABOVE THAT LEVEL. IN THIS CASE, TRADERS WOULD CALL THE
PRICE LEVEL NEAR $39 A LEVEL OF RESISTANCE. AS YOU CAN SEE FROM THE
CHART BELOW, RESISTANCE LEVELS ARE ALSO REGARDED AS A CEILING BECAUSE
THESE PRICE LEVELS REPRESENT AREAS WHERE A RALLY RUNS OUT OF GAS.
SUPPORT level

SUPPORT LEVELS ARE ON THE FLIP SIDE OF THE COIN. SUPPORT REFERS TO THE
PRICE LEVEL ON A CHART WHERE EQUILIBRIUM IS REACHED. THIS MEANS THAT
DEMAND HAS INCREASED TO MATCH SUPPLY. THIS CAUSES THE DECLINE IN THE
PRICE OF THE ASSET TO HALT; THEREFORE, THE PRICE HAS REACHED A FLOOR. AS
YOU CAN SEE FROM THE CHART BELOW, THE HORIZONTAL LINE BELOW THE
PRICE REPRESENTS THE PRICE FLOOR. YOU CAN SEE BY THE BLUE ARROWS
UNDERNEATH THE VERTICAL LINE THAT THE PRICE HAS TOUCHED THIS LEVEL
FOUR TIMES IN THE PAST. THIS IS THE LEVEL WHERE DEMAND COMES IN,
PREVENTING FURTHER DECLINES. THIS IS SUPPORT.
TRENDLINES

THE EXAMPLES ABOVE SHOW THAT A CONSTANT LEVEL PREVENTS AN ASSET’S

PRICE FROM MOVING HIGHER OR LOWER. THIS STATIC BARRIER IS ONE OF THE
MOST POPULAR FORMS OF SUPPORT/RESISTANCE, BUT THE PRICE OF FINANCIAL
ASSETS GENERALLY TRENDS UPWARD OR DOWNWARD, SO IT IS NOT
UNCOMMON TO SEE THESE PRICE BARRIERS CHANGE OVER TIME. THIS IS WHY
THE CONCEPTS OF TRENDING AND TRENDLINES ARE IMPORTANT WHEN
LEARNING ABOUT SUPPORT AND RESISTANCE.

WHEN THE MARKET IS TRENDING TO THE UPSIDE, RESISTANCE LEVELS ARE

FORMED AS THE PRICE ACTION SLOWS AND STARTS TO MOVE BACK TOWARD
THE TRENDLINE. WHEN THE IS MOVING AGAINST THE PREVAILING TREND, IT IS
CALLED A REACTION. REACTIONS CAN OCCUR FOR A LARGE VARIETY OF REASONS,
INCLUDING PROFIT TAKING OR NEAR-TERM UNCERTAINTY FOR A PARTICULAR
ISSUE OR SECTOR. THE RESULTING PRICE ACTION UNDERGOES A “PLATEAU”
EFFECT, OR A SLIGHT DROP-OFF IN STOCK PRICE, CREATING A SHORT-TERM TOP.

MANY TRADERS WILL PAY CLOSE ATTENTION TO THE PRICE OF A SECURITY AS IT

FALLS TOWARD THE BROADER SUPPORT OF THE TRENDLINE BECAUSE,
HISTORICALLY, THIS HAS BEEN AN AREA THAT HAS PREVENTED THE PRICE OF THE
ASSET FROM MOVING SUBSTANTIALLY LOWER. FOR EXAMPLE, AS YOU CAN SEE
FROM THE NEWMONT CORP. (NEM) CHART BELOW, A TRENDLINE CAN PROVIDE
SUPPORT FOR AN ASSET FOR SEVERAL YEARS. IN THIS CASE, NOTICE HOW THE
TRENDLINE PROPPED UP THE PRICE OF NEWMONT’S SHARES FOR AN EXTENDED
PERIOD OF TIME.
ON THE OTHER HAND, WHEN THE MARKET IS TRENDING TO THE DOWNSIDE,
TRADERS WILL WATCH FOR A SERIES OF DECLINING PEAKS AND WILL ATTEMPT
TO CONNECT THESE PEAKS TOGETHER WITH A TRENDLINE. WHEN THE PRICE
APPROACHES THE TRENDLINE, MOST TRADERS WILL WATCH FOR THE ASSET TO
ENCOUNTER SELLING PRESSURE AND MAY CONSIDER ENTERING A SHORT
POSITION BECAUSE THIS IS AN AREA THAT HAS PUSHED THE PRICE DOWNWARD
IN THE PAST. TO BE A VALID TRENDLINE, THE PRICE NEEDS TO TOUCH THE
TRENDLINES AT LEAST THREE TIMES. SOMETIMES WITH STRONGER TRENDLINES,
THE PRICE WILL TOUCH THE TRENDLINE SEVERAL TIMES OVER LONGER TIME
PERIODS. ALSO, IN AN UPTREND, THE TRENDLINE IS DRAWN BELOW THE PRICE,
WHILE IN A DOWNTREND, THE TRENDLINE IS DRAWN ABOVE PRICE.
THE SUPPORT/RESISTANCE OF AN IDENTIFIED LEVEL, WHETHER DISCOVERED
WITH A TRENDLINE OR THROUGH ANY OTHER METHOD, IS DEEMED TO BE
STRONGER THE MORE TIMES THAT THE PRICE HAS HISTORICALLY BEEN UNABLE
TO MOVE BEYOND IT. MANY TECHNICAL TRADERS WILL USE THEIR IDENTIFIED
SUPPORT AND RESISTANCE LEVELS TO CHOOSE STRATEGIC ENTRY/EXIT POINTS
BECAUSE THESE AREAS OFTEN REPRESENT THE PRICES THAT ARE THE MOST
INFLUENTIAL TO AN ASSET’S DIRECTION. MOST TRADERS ARE CONFIDENT AT
THESE LEVELS IN THE UNDERLYING VALUE OF THE ASSET, SO THE VOLUME
GENERALLY INCREASES MORE THAN USUAL, MAKING IT MUCH MORE DIFFICULT
FOR TRADERS TO CONTINUE DRIVING THE PRICE HIGHER OR LOWER.

UNLIKE THE RATIONAL ECONOMIC ACTORS PORTRAYED BY FINANCIAL MODELS,

REAL HUMAN TRADERS AND INVESTORS ARE EMOTIONAL, MAKE COGNITIVE
ERRORS, AND FALL BACK ON HEURISTICS OR SHORTCUTS. IF PEOPLE WERE
RATIONAL, THEN SUPPORT AND RESISTANCE LEVELS WOULDN’T WORK IN
PRACTICE!

ROUND NUMBERS

ANOTHER COMMON CHARACTERISTIC OF SUPPORT/RESISTANCE IS THAT AN

ASSET’S PRICE MAY HAVE A DIFFICULT TIME MOVING BEYOND A ROUND
NUMBER, SUCH AS $50 OR $100 PER SHARE. MANY PEOPLE THINK IN TERMS OF A
ROUND NUMBER, AND THIS CARRIES OVER INTO THE STOCK MARKET. BECAUSE
PEOPLE HAVE EASIER TIME VISUALIZING IN ROUND NUMBERS, MANY
INEXPERIENCED TRADERS TEND TO BUY OR SELL ASSETS WHEN THE PRICE IS AT A
ROUND NUMBER.

ALSO, MANY TARGET PRICES OR STOP ORDERS SET BY EITHER RETAIL INVESTORS
OR LARGE INVESTMENT BANKS ARE PLACED AT ROUND PRICE LEVELS RATHER
THAN AT PRICES SUCH AS $50.06. BECAUSE SO MANY ORDERS ARE PLACED AT
THE SAME LEVEL, THESE ROUND NUMBERS TEND TO ACT AS STRONG PRICE
BARRIERS. FOR EXAMPLE, IF ALL THE CLIENTS OF AN INVESTMENT BANK PUT IN
SELL ORDERS AT A SUGGESTED TARGET OF $55, IT WOULD TAKE AN EXTREME
NUMBER OF PURCHASES TO ABSORB THESE SALES AND, THEREFORE, A LEVEL OF
RESISTANCE WOULD HAVE BEEN CREATED.

MOVING AVERAGES

MOST TECHNICAL TRADERS INCORPORATE THE POWER OF VARIOUS TECHNICAL

INDICATORS, SUCH AS MOVING AVERAGES, TO AID IN PREDICTING FUTURE
SHORT-TERM MOMENTUM. IN FACT, PEOPLE WHO FIND IT DIFFICULT TO DRAW
TRENDLINES OFTEN WILL SUBSTITUTE THEM FOR MOVING AVERAGES. AS YOU
CAN SEE FROM THE CHART BELOW, A MOVING AVERAGE IS A CONSTANTLY
CHANGING LINE THAT SMOOTHS OUT PAST PRICE DATA, ALLOWING FOR AN
EASIER IDENTIFICATION OF SUPPORT AND RESISTANCE. NOTICE HOW THE PRICE
OF THE ASSET IN THE CHART BELOW FINDS SUPPORT AT THE MOVING AVERAGE
WHEN THE TREND IS UP, AND HOW IT ACTS AS RESISTANCE WHEN THE TREND IS
DOWN.
TRADERS CAN USE MOVING AVERAGES IN A VARIETY OF WAYS, SUCH AS TO
ANTICIPATE MOVES TO THE UPSIDE WHEN PRICE LINES CROSS ABOVE A KEY
MOVING AVERAGE, OR TO EXIT TRADES WHEN THE PRICE DROPS BELOW A
MOVING AVERAGE. REGARDLESS OF HOW THE MOVING AVERAGE IS USED, IT
OFTEN CREATES “AUTOMATIC” SUPPORT AND RESISTANCE LEVELS. MOST
TRADERS WILL EXPERIMENT WITH DIFFERENT TIME PERIODS IN THEIR MOVING
AVERAGES SO THAT THEY CAN FIND THE ONE THAT WORKS BEST FOR THEIR
TRADING TIME FRAME.

OTHER INDICATORS

IN TECHNICAL ANALYSIS, MANY INDICATORS HAVE BEEN DEVELOPED AND ARE

STILL BEING DEVELOPED TO IDENTIFY BARRIERS TO FUTURE PRICE ACTION. SOME
INDICATORS ARE PLOTTED ON PRICE CHARTS, WHILE OTHERS ARE PLOTTED
ABOVE OR BELOW THE PRICE. THESE INDICATORS CAN OFTEN SEEM
COMPLICATED AT FIRST, AND IT TAKES PRACTICE AND EXPERIENCE TO LEARN TO
USE THEM EFFECTIVELY. BUT REGARDLESS OF HOW COMPLEX AN INDICATOR
APPEARS, ITS USE AND INTERPRETATION ARE OFTEN NO DIFFERENT FROM THAT
OF OTHER INDICATORS CREATED THROUGH SIMPLER METHODS LIKE
CALCULATING MOVING AVERAGES AND DRAWING TRENDLINES.

THE “GOLDEN RATIO” USED IN THE FIBONACCI SEQUENCE, IS ALSO OBSERVED

REPEATEDLY IN NATURE AND SOCIAL STRUCTURE.

FOR EXAMPLE, THE FIBONACCI RETRACEMENT IS A FAVORITE TOOL AMONG

MANY SHORT-TERM TRADERS BECAUSE IT CLEARLY IDENTIFIES LEVELS OF
POTENTIAL SUPPORT/RESISTANCE. THE REASONING BEHIND HOW THIS
INDICATOR CALCULATES THE VARIOUS LEVELS OF SUPPORT AND RESISTANCE IS
BEYOND THE SCOPE OF THIS ARTICLE, BUT NOTICE IN THE CHART BELOW HOW
THE IDENTIFIED LEVELS (DOTTED LINES) ARE BARRIERS TO THE SHORT-TERM
DIRECTION OF THE PRICE.
TRADING RANGES

TRADING RANGES CAN SOMETIMES OCCUR. THESE ARE AREAS WHERE SUPPORT
AND RESISTANCE LEVELS ARE RELATIVELY CLOSE AND THE PRICE BOUNCES
BETWEEN TWO LEVELS FOR A PERIOD OF TIME. EXPERIENCED TRADERS WILL
SOMETIMES TRADE WITHIN THESE TRADING RANGES, WHICH ARE ALSO KNOWN
AS SIDEWAYS TRENDS. ONE STRATEGY THAT THEY USE IS TO PLACE SHORT
TRADES AS THE PRICE TOUCHES THE UPPER TRENDLINE AND LONG TRADES AS
THE PRICE REVERSES TO TOUCH THE LOWER TRENDLINE. THIS STRATEGY IS
EXTREMELY DANGEROUS, AND IT IS MUCH BETTER TO WAIT TO SEE IN WHICH
DIRECTION THE PRICE WILL BREAK OUT OF THE RANGE AND THEN PLACE YOUR
TRADES IN THAT DIRECTION.
SUPPORT AND RESISTANCE REVERSALS

A PREVIOUS SUPPORT LEVEL WILL SOMETIMES BECOME A RESISTANCE LEVEL

WHEN THE PRICE ATTEMPTS TO MOVE BACK UP, AND CONVERSELY, A
RESISTANCE LEVEL WILL BECOME A SUPPORT LEVEL AS THE PRICE TEMPORARILY
FALLS BACK.

PRICE CHARTS ALLOW TRADERS AND INVESTORS TO VISUALLY IDENTIFY AREAS OF

SUPPORT AND RESISTANCE, AND THEY GIVE CLUES REGARDING THE
SIGNIFICANCE OF THESE PRICE LEVELS. MORE SPECIFICALLY, THEY LOOK AT:

NUMBER OF TOUCHES

THE MORE TIMES THAT THE PRICE TESTS A SUPPORT OR RESISTANCE AREA, THE
MORE SIGNIFICANT THE LEVEL BECOMES. WHEN PRICES KEEP BOUNCING OFF A
SUPPORT OR RESISTANCE LEVEL, MORE BUYERS AND SELLERS NOTICE AND WILL
BASE TRADING DECISIONS ON THESE LEVELS.

PRECEDING PRICE MOVE

SUPPORT AND RESISTANCE ZONES ARE LIKELY TO BE MORE SIGNIFICANT WHEN

THEY ARE PRECEDED BY STEEP ADVANCES OR DECLINES. FOR EXAMPLE, A FAST,
STEEP ADVANCE OR UPTREND WILL BE MET WITH MORE COMPETITION AND
ENTHUSIASM AND MAY BE HALTED BY A MORE SIGNIFICANT RESISTANCE LEVEL
THAN A SLOW, STEADY ADVANCE. A SLOW ADVANCE MAY NOT ATTRACT AS
MUCH ATTENTION. THIS IS A GOOD EXAMPLE OF HOW MARKET PSYCHOLOGY
DRIVES TECHNICAL INDICATORS.
VOLUME AT CERTAIN PRICE LEVELS

THE MORE BUYING AND SELLING THAT HAS OCCURRED AT A PARTICULAR PRICE
LEVEL, THE STRONGER THE SUPPORT OR RESISTANCE LEVEL IS LIKELY TO BE. THIS
IS BECAUSE TRADERS AND INVESTORS REMEMBER THESE PRICE LEVELS AND ARE
APT TO USE THEM AGAIN. WHEN STRONG ACTIVITY OCCURS ON HIGH VOLUME
AND THE PRICE DROPS, A LOT OF SELLING WILL LIKELY OCCUR WHEN THE PRICE
RETURNS TO THAT LEVEL, SINCE PEOPLE ARE FAR MORE COMFORTABLE CLOSING
OUT A TRADE AT THE BREAKEVEN POINT THAN AT A LOSS.

TIME

SUPPORT AND RESISTANCE ZONES SEEN IN LONGER TIME FRAME CHARTS SUCH
AS WEEKLY OR MONTHLY CHARTS ARE OFTEN MORE SIGNIFICANT THAN THOSE
SEEN IN SHORTER TIME FRAME CHARTS SUCH AS THE ONE-MINUTE OR FIVE-
MINUTE CHART.

SOME INVESTORS DISMISS SUPPORT AND RESISTANCE LEVELS ENTIRELY BECAUSE

THEY SAY THAT THE LEVELS ARE BASED ON PAST PRICE MOVES, OFFERING NO
REAL INFORMATION ABOUT WHAT WILL HAPPEN IN THE FUTURE. BUT ALL OF
TECHNICAL ANALYSIS IS BASED ON USING PAST PRICE ACTION TO ANTICIPATE
FUTURE PRICE MOVES; THEREFORE, THIS IS AN ARGUMENT FOR DISMISSING
TECHNICAL ANALYSIS ENTIRELY.

HOW CAN IDENTIFYING SUPPORT AND RESISTANCE LEVELS HELP TRADERS ?

DETERMINING FUTURE LEVELS OF SUPPORT CAN DRASTICALLY IMPROVE THE

RETURNS OF A TRADING OR SHORT-TERM INVESTING STRATEGY BECAUSE IT
GIVES TRADERS AN INDICATION OF WHERE PRICE DECLINES ARE LIKELY TO HALT.
CONVERSELY, FORESEEING A LEVEL OF RESISTANCE CAN BE ADVANTAGEOUS
BECAUSE IT WILL ALERT TRADERS TO BE VIGILANT AS THE PRICE APPROACHES
THIS AREA FOR A LIKELY REACTION IN PRICE. AS MENTIONED ABOVE, THERE ARE
SEVERAL DIFFERENT METHODS TO CHOOSE WHEN LOOKING TO IDENTIFY
SUPPORT/RESISTANCE, BUT REGARDLESS OF THE METHOD, THE INTERPRETATION
REMAINS THE SAME: THE TRADER IS LOOKING FOR AN INDICATION THAT THE
PRICE OF A SECURITY WILL LIKELY REACT IN A CERTAIN MANNER AS IT
APPROACHES AND TOUCHES A RECOGNIZED PRICE LEVEL.

HOW CAN MARKET PSYCHOLOGY INFLUENCE SUPPORT AND RESISTANCE

LEVELS?
MARKET PSYCHOLOGY AND BEHAVIORAL FINANCE CAN INFLUENCE WHERE
SUPPORT AND RESISTANCE LEVELS OCCUR. ANCHORING, FOR INSTANCE, IS WHEN
PEOPLE ASSIGN MEANING OR SIGNIFICANCE TO OTHERWISE ARBITRARY
NUMBERS. A PREVIOUSLY ESTABLISHED LEVEL OF SUPPORT OR RESISTANCE MAY
THEREFORE BECOME AN ANCHOR AT WHICH POINTS FUTURE RESISTANCE OR
SUPPORT WILL BE OBSERVED - EVEN THOUGH THESE POINTS MAY NOT REFLECT
ANY FUNDAMENTALS. LIKEWISE, ROUND NUMBERS SUCH AS $1,000 OR $25,000
MAY SERVE AS SUPPORT OR RESISTANCE LEVELS, NOT BECAUSE THEY ARE
FUNDAMENTALLY-DRIVEN, BUT ARE SYMBOLICALLY MEANINGFUL AS
PSYCHOLOGICAL ANCHORS. AS THESE LEVELS ARE BREACHED, TRADERS MAY
ADJUST THEIR ANCHORS ACCORDINGLY.

WHAT HAPPENS IF A PRICE BREAKS THROUGH ITS SUPPORT OR REISTANCE?

A BREAKOUT FROM A SUPPORT OR REVERSAL CAN INDICATE A TREND REVERSAL.
IF SUPPORT IS BROKEN, THAT WILL LIKELY BECOME THE NEW LEVEL OF
RESISTANCE. ALTERNATIVELY, IF RESISTANCE IS BROKEN TO THE UPSIDE, IT CAN
FORM THE BASIS FOR SUPPORT IN THE SHORT TERM.

THE BOTTOM LINE

SUPPORT AND RESISTANCE LEVELS ARE KEY CONCEPTS USED BY TECHNICAL
ANALYSTS AND FORM THE BASIS OF A WIDE VARIETY OF TECHNICAL ANALYSIS
TOOLS. THE BASICS OF SUPPORT AND RESISTANCE CONSIST OF A SUPPORT LEVEL,
WHICH CAN BE THOUGHT OF AS THE FLOOR UNDER PRICE, AND A RESISTANCE
LEVEL, WHICH CAN BE THOUGHT OF AS THE CEILING ABOVE PRICE. PRICES FALL
AND TEST THE SUPPORT LEVEL, WHICH WILL EITHER HOLD, AND THE PRICE WILL
REVERSE TO THE UPSIDE, OR BE VIOLATED, AND THE PRICE WILL DROP THROUGH
THE SUPPORT AND LIKELY CONTINUE LOWER TO THE NEXT SUPPORT LEVEL.

PRICE ACTION

Key points to take in note to trade Price action

1. Trend
2. Support resistance
3. Candle sticks
4. Chart patterns
5. Fibonacci retracement
6. Option chain
7. PCR
8. INDIA VIX
9. Elliott wave
10. Dow theory

What is Price Action? – Price Action Trading Explained

Price action trading is a methodology for financial market which consists of the
analysis of basic price movement across time. It’s used by many retail traders and
often by institutional traders and hedge fund managers to make predictions on
the future direction of the price of a security or financial market

Put simply, price action is how price changes, i.e., the ‘action’ of price. It’s most
easily observed in markets with high liquidity and volatility, but really anything
that is bought or sold in a free market will generate price action.

Price action trading ignores the fundamental factors that influence a market’s
movement, and instead it looks primarily at the market’s price history, that is to
say its price movement across a period of time. Thus, price action is a form a
technical analysis, but what differentiates it from most forms of technical analysis
is that its main focus is on the relationship of a market’s current price to its past
or recent prices, as opposed to ‘second-hand’ values that are derived from that
price history.
In other words, price action trading is a ‘pure’ form of technical analysis since it
includes no second-hand, price-derived indicators. Price action traders are solely
concerned with the first-hand data a market generates about itself; it’s price
movement over time.

Price action analysis allows a trader to make sense of a market’s price movement
and provides him or her with explanations that serve as way for the trader to
build a mental scenario to describe the current market structure. Experienced
price action traders often attribute their unique mental understanding and ‘Gut
feel’ of a market as the main reason for their profitable trading.
Price action traders make use of the past history of a market’s price movement,
most typically focus on the recent price action of the last 3 to 6 months, with a
lighter focus on more distant price history. This price history includes swing highs
and swing lows in a market, as well as support and resistance levels.

A trader can use a market’s price action to try and describe the human thought
process behind a market’s movement. Every participant in a market will leave
price action ‘clues’ on a market’s price chart as they trade their markets, these
clues can then be interpreted and used to try and predict the next move in a
market.

What is price action trading?

Price action refers to the characteristics of an asset’s price movements over time.
These price movements are often plotted on a chart and displayed without
supplemental technical indicators (except maybe volume). Although such bare
charts may, at first, seem a little too minimal to provide much information,
focusing on price alone can help uncover nuanced movements that might be
difficult to detect via an indicator.
Price action trading is a method of financial analysis and speculation that
generates its insights and actions solely from the interpretation of price
movements.

William Blake suggested we can “see a world in a grain of sand.” In this case, it’s
about observing the movement of price—from small grains to large gaps—to see
what it might indicate in terms of future shape and direction.

Trading with price action analysis

In the financial markets, technical indicators are like maps. They can give shape to
a dynamic market environment, making price movements clearer to see and
easier to interpret. But on the flip side, indicators can also oversimplify or even
blot out the very thing they’re trying to analyze: the price action itself.

Price action trading focuses almost solely on the movement of price over time.
Traders who follow price action may use minimal technical indicators or avoid
them altogether.
Price action analysis focuses on trends, chart patterns, and significant historical
price events and movements.
And that’s why some traders prefer to ditch the proverbial map by chucking most
or all indicators, opting for a more minimalist approach. This is what price action
trading is all about: working directly with an asset’s price and price history to
analyze and anticipate its potential direction.
Price Action Trading is about Keeping it Simple

Price action traders often use the phrase “Keep It Simple Stupid” in reference to
the fact that trading is something many people over-complicate by clouding their
charts with numerous technical indicators and generally over-analyzing a market.

Price action trading is also sometimes referred to as ‘clean chart trading, raw or
natural trading, in reference to trading from a simple price action only price
chart.
The simple stripped-down approach of price action trading, means there are no
indicators on a trader’s charts and no economic events or news is used in making
one’s trading decisions. The sole focus is on a market’s price action, and the belief
amongst price action traders is that this price action reflects all the variables
(news events, eco. data etc.) that influence a market and cause it to move.
Therefore, the implication is that it’s much simpler to just analyze a market and
trade from its price action, rather than trying to decipher and sort the many
different variables affecting a market each day.

What Does Price Action Tell You?

Price action can be seen and interpreted using charts that plot prices over time.
Traders use different chart compositions to improve their ability to spot and
interpret trends, breakouts and reversals. Many traders use candlestick charts
since they help better visualize price movements by displaying the open, high, low
and close values in the context of up or down sessions.

Candlestick patterns such as the Harami cross, engulfing pattern and three white
soldiers are all examples of visually interpreted price action. There are many more
candlestick formations that are generated off price action to set up an
expectation of what will come next. These same formations can apply to other
types of charts, including point and figure charts, box charts, box plots and so on.
In addition to the visual formations on the chart, many technical analysts use
price action data when calculating technical indicators. The goal is to find order in
the sometimes seemingly random movement of a price. For example, an
ascending triangle pattern formed by applying trend lines to a price action chart
may be used to predict a potential breakout since the price action indicates that
bulls have attempted a breakout on several occasions and have gained
momentum each time.

How to Use Price Action

Price action is not generally seen as a trading tool like an indicator, but rather the
data source off which all the tools are built. Swing traders and trend traders tend
to work most closely with price action, eschewing any fundamental analysis in
favor of focusing solely on support and resistance levels to predict breakouts and
consolidation.
Even these traders must pay some attention to additional factors beyond the
current price, as the volume of trading and the periods being used to establish
levels all have an impact on the likelihood of their interpretations being accurate.
Many institutions have begun leveraging algorithms to analyze prior price action
and execute trades in certain circumstances. In a 2020 report to Congress, the
Securities and Exchange Commission (SEC) noted that the "use of algorithms in
trading is pervasive."

These automated systems are fed price action data and can deduce outcomes
and determine potential future price action.

Limitations of Price Action

Interpreting price action is very subjective. It's common for two traders to arrive
at different conclusions when analyzing the same price action. One trader may
see a bearish downtrend and another might believe that the price action shows a
potential near-term turnaround. Of course, the time period being used also has a
huge influence on what traders see as a stock can have many intraday
downtrends while maintaining a month-over-month uptrend.

The important thing to remember is that trading predictions made using price
action on any time scale are speculative. The more tools you can apply to your
trading prediction to confirm it, the better.

In the end, however, the past price action of a security is no guarantee of future
price action. High probability trades are still speculative trades, which means
traders take on the risks to get access to the potential rewards. Price action does
not explicitly incorporate macroeconomic or non-financial matters impacting a
security.
How Can I Use Price Action in Trading?
Price action is used to analyze trends and identify entry and exit points when
trading. Many traders use candlestick charts to plot prior price action, then plot
potential breakout and revering patterns. Although prior price action does not
guarantee future results, traders often analyze a security's historical patterns to
better understand where the price may move to next.

How Do I Read Price Action?

Price action is often depicted graphically in the form of a bar chart or line chart.
There are two general factors to consider when analyzing price action. The first is
to identify the direction of the price, and the second is to identify the direction of
the volume.

Should a security's price be moving upward while the volume increases, this
means there is strong conviction in the market as many investors are buying at
the increasing price. Alternatively, should there have been low volume, the price
action may not be as convincing as not many investors are choosing to invest at
the current pricing levels.

What Is Bullish Price Action?

Bullish price action is an indicator giving positive signals that a security's price is
due for future increases. For exactly, one bullish trend is often defined by "higher
highs" and "higher lows" forming an ascending triangle pattern. This means the
price action of a security recently surpassed a high price but remained higher than
a recent low price.

Is Price Action Good for Swing Trading?

Swing traders rely on price movement; if a security's price remains unchanged, it
is harder to seek opportunities to profit. In general, price action is good for swing
traders because traders can identify the oscillations up and down and trade
accordingly.

Price Action Trading Strategies (Patterns)

Price action patterns, also called price action ‘triggers’, ‘setups’ or ‘signals’, are
really the most important aspect of price action trading, because it’s these
patterns that provide a trader with strong clues as to what price might do next.

The following diagrams show examples of some simple price action trading
strategies that you can use to trade the market.

Inside bar pattern

An inside bar pattern is a two-bar pattern, consisting of the inside bar and the
prior bar which is usually referred to as the “mother bar”. The inside bar is
contained completely within the high to low range of the mother bar. This price
action strategy is commonly used as a breakout pattern in trending markets, but it
can also be traded as a reversal signal if it forms at a key chart level.
Pin bar pattern
A pin bar pattern consists of a single candlestick and it shows rejection of price
and a reversal in the market. The pin bar signal works great in a trending market,
range bound market and can also be traded counter-trend from a key support or
resistance level. The pin bar implies that price might move opposite from the
direction the tail is pointing; as it’s the tail of the pin bar that shows rejection of
price and a reversal.
Fakey pattern
The fakey pattern consists of a false breakout of an inside bar pattern. In other
words, if an inside bar pattern breaks out briefly but then reverses and closes
back within the range of the mother bar or inside bar, you have a fakey. It’s called
a “fakey” because it fakes you out, the market looks like its breaking one way but
then comes back in the opposite direction and sets off a price movement in that
direction. Fakey’s are great with trends, against trends from key levels and in
trading ranges.
Trading with Price Action Patterns

Let’s look at some real-world examples of trading with price action patterns.

The first chart we are looking at shows us a bearish fakey sell signal pattern. In
this example, the trend was already down, as we can see the overall downward
track starting at the top left of the chart and falling as price moves toward the left
side of the chart. Thus, this fakey sell signal was in-line with the overall daily chart
downtrend, this is good. Trading with the trend generally gives a price action
setup a better chance of working in your favor.
The chart below shows an example of a bullish fakey pin bar combo setup in the
context of an upward moving market. Typically, when a market has a strong near-
term bias, meaning it’s been moving in one direction recently and aggressively, a
price action trader wants to trade in-line with that near-term momentum.
In this next example, we are looking at the inside bar trading pattern. This chart
shows both a regular inside bar signal as well as an inside pin bar combo setup. An
inside pin bar combo is simply an inside bar with a pin bar for the inside bar.
These setups work very well in trending markets like we see in the chart below.
The last chart we are looking shows examples of the pin bar pattern. Note the
large up moves that followed both of these pin bar buy signals. Also, note how
these pin bars both had long tails in comparison to some of the other bars on this
chart that you might identify as pin bars. Pin bars wit nice long tails like these two,
and that are clearly protruding out from the surrounding price action, often are
very good setups to trade.
Trading Price Action Patterns with Confluence

Trading with price action signals is not only about the signal itself, but it’s also
about where the signal forms on the chart. Every pin bar, inside bar, etc. is not
created equal. Depending on where a particular price action signal forms in a
market, you may not want to trade it or you may want to jump on it without
hesitation.

The best price action signals are those that form at ‘confluent’ points in the
market. Confluence, simply means ‘a coming together’ of people or things. In the
case of price action trading we are looking for an area on the chart where at least
a couple things line up with a price action entry signal. When this happens, we say
the price action signal ‘has confluence’.
In the chart example below, we can see a good example of a pin bar pattern with
confluence. The confluence is that the pin bar has formed in the direction of an
up-trending market and that it has formed at a support level in that uptrend.
Thus, we have the confluence of the trend and the support level, together these
things give the pin bar buy signal more weight than if they weren’t there
supporting the signal. The more confluent factors a price action signal has behind
it, the higher-probability signal it is considered to be.

Final word on the fakey pattern

The fakey pattern is an extremely powerful price action pattern if you know how
to properly spot it and trade it. What a fakey reflects to us, is a reversal in market
sentiment and a ‘fake out’, which obviously has some profound trading
implications. A false breakout is a very big clue in the market, it shows us what
the ‘big boys’ are thinking and doing and gives us an opportunity to take
advantage of that.

Amateur and beginner traders often get caught up in buying breakouts. Indeed,
there are entire trading strategies and systems built around trading breakouts.
Breakouts are one of the oldest and most over-used trading approaches in
existence, and for that reason, they are easily snuffed out and taken advantage of
by the bigger market players, whilst smaller retail traders are usually the ones
getting taken advantage of.

A fakey pattern is essentially the hard evidence of what I said in the above
paragraph, and they give savvy price action traders the ability to truly trade like
the ‘big boys’. I invite you to learn more about this topic and get my price action
trading course, because that is where I coalesce all of my knowledge and
experience on the fakey pattern and exactly how to trade it properly.

I hope you’ve enjoyed this price action trading tutorial. You now have a solid basic
understanding of what price action is and how to trade it.

Going forward, you should look to expand your price action trading understanding
and knowledge as there is much more to it than is covered here.

For a complete education and in-depth insight into simple yet powerful price
action strategies, as well as insight into the world of professional trading from an
experienced trading veteran, checkout my price action trading course for more
information.
Why eliminate or minimize indicators?
Indicators were designed to emphasize certain technical aspects of the markets
(including volume, trend, momentum, and so on). But in doing so, they exclude
other technical aspects. This is why traders often combine indicators—to
compensate for gaps in technical perspective.

For all the insights indicators may provide, they invariably produce blind spots:

Lagging indicators that trail behind current prices (such as moving averages) can
sometimes divert attention away from market conditions taking shape in the
present.
Indicators designed for specific functions can obscure other important details.
Multiple indicators can overcomplicate market scenarios, sometimes yielding
conflicting readings that can lead to the dreaded “analysis paralysis.”
The quantity of indicators doesn’t always correlate to the quality or adequacy of
market information.
Analyzing price action
If you plan to analyze or trade markets based solely on current and historical
prices, you’re likely to focus on three things: trends, chart patterns, and significant
technical events.

Trends. In general, an uptrend is defined by higher highs and higher lows (see
figure 1), while a downtrend consists of lower lows and lower highs. So, is a stock
trending up, down, or sideways? Some traders draw simple trendlines to identify
these movements. Other traders might use a formula to detect trends.

Chart patterns. The chart pattern universe is extensive. There are classic chart
patterns, such as the symmetrical triangle (see figure 1). You can also study a
smaller range of sessions by analyzing groups of bars, such as the bullish engulfing
candlestick pattern (figure 1).
KEY TAKEAWAYS
Price action generally refers to the changes of a security's price over time.
Different looks can be applied to a chart to make trends in price action more
obvious for traders. This is especially true when analyzing data covering different
time periods.
Technical analysis formations and chart patterns are derived from price action.
Technical analysis tools like moving averages are also calculated from price action
and projected into the future to inform trades.
Though many use price action to forecast future prices, prior price action does not
guarantee future results.

Elliott Wave Theory

What Is the Elliott Wave Theory?

The Elliott Wave Theory in technical analysis describes price

movements in the financial market. Developed by Ralph Nelson Elliott,
it observes recurring fractal wave patterns identified in stock price
movements and consumer behavior. Investors who profit from a
market trend are described as riding a wave.
The Elliott Wave theory is a technical analysis of price patterns related to changes
in investor sentiment and psychology.
The theory identifies impulse waves that establish a pattern and corrective waves
that oppose the larger trend.
Each set of waves is within another set of waves that adhere to the same impulse
or corrective pattern, described as a fractal approach to investing.

Understanding the Elliott Wave Theory

The Elliott Wave theory was developed by Ralph Nelson Elliott in the 1930s. He
studied 75 years' worth of yearly, monthly, weekly, daily, and self-made hourly
and 30-minute charts across various indexes. His theory gained notoriety in 1935
when Elliott made an uncanny prediction of a stock market bottom and has
become a staple for thousands of portfolio managers, traders, and private
investors.

How Elliott Waves Work

Some technical analysts profit from wave patterns in the stock market using the
Elliott Wave Theory. The theory assumes that stock price movements can be
predicted because they move in repeating up-and-down patterns called waves
created by investor psychology or sentiment.

The theory is subjective and identifies two different types of waves: motive or
impulse waves, and corrective waves. Wave analysis does not equate to a
template to follow instructions. Wave analysis offers insights into trend dynamics
and helps investors understand price movements.

Impulse and corrective waves are nested in a self-similar fractal to create larger
patterns. For example, a one-year chart may be in the midst of a corrective wave,
but a 30-day chart may show a developing impulse wave. A trader with this Elliott
wave interpretation may have a long-term bearish outlook with a short-term
bullish outlook.

Impulse Waves

Impulse waves consist of five sub-waves that make net movement in the same
direction as the trend of the next-largest degree. This pattern is the most
common motive wave and the easiest to spot in a market. It consists of five sub-
waves, three of which are motive waves. Two are corrective waves.
Wave 2 can’t retrace more than the beginning of Wave 1
Wave 3 can not be the shortest wave of the three impulse waves, 1, 3, and 5
Wave 4 does not overlap with the price territory of Wave 1
Wave 5 needs to end with momentum divergence
2
If one rule is violated, the structure is not an impulse wave. The trader would
need to re-label the suspected impulse wave.

Corrective Waves
Corrective waves, called diagonal waves, consist of three, or a combination of
three sub-waves that make net movement in the direction opposite to the trend
of the next-largest degree. Its goal is to move the market in the direction of the
trend.

The corrective wave consists of 5 sub-waves.

The diagonal looks like either an expanding or contracting wedge.
The sub-waves of the diagonal may not have a count of five, depending on what
type of diagonal is being observed.
Each sub-wave of the diagonal never fully retraces the previous sub-wave, and
sub-wave 3 of the diagonal may not be the shortest wave.

Elliot Wave Theory vs. Other Indicators

Elliott recognized that the Fibonacci sequence denotes the number of waves in
impulses and corrections. Wave relationships in price and time also commonly
exhibit Fibonacci ratios, such as 38% and 62%. For example, a corrective wave
may have a retrace of 38% of the preceding impulse.
Other analysts have developed indicators inspired by the Elliott Wave principle,
including the Elliott Wave Oscillator Chart. The oscillator provides a computerized
method of predicting future price direction based on the difference between a
five-period and a 34-period moving average. Elliott Wave International’s artificial
intelligence system, EWAVES, applies all Elliott wave rules and guidelines to data
to generate automated Elliott wave analysis.

What Is the Elliott Wave Theory?

In technical analysis, the Elliott Wave theory looks at long-term trends in price
patterns and how they correspond with investor psychology. These price patterns
or ‘waves’ depend on rules developed by Ralph Nelson Elliott in the 1930s. They
identify and predict wave patterns within stock markets and help predict future
movement.

How Do Elliott Waves Work?

Based on Elliott's Wave Theory, market prices will alternate between an impulsive
phase and a corrective phase. Impulses are always subdivided into a set of 5
lower-degree waves, alternating again between motive and corrective character,
so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller retraces of
waves 1 and 3.

How Do You Trade Using Elliott Wave Theory?

If a trader sees a stock moving upward on an impulse wave, they may go long
until it completes its fifth wave. Anticipating a reversal, the trader may then go
short on the stock. Underlying this trading theory is the idea that fractal patterns
recur in financial markets. In mathematics, fractal patterns repeat themselves on
an infinite scale.

The Bottom Line

The Elliott Wave Theory was developed by Ralph Nelson Elliott. It provides a
technical analysis of price patterns related to investor sentiment and psychology.
The theory identifies impulse waves that establish a pattern and corrective waves
that oppose the larger trend. It assumes that stock price movements can be
predicted because they move in repeating up-and-down patterns.

Correction—July 27, 2023: This article has been amended to state that the third
impulse wave can never be the shortest of Waves 1, 3, and 5. This article also
previously misstated that Wave 4 cannot go beyond the third wave at any time.
The content has been revised to state that Wave 4 does not overlap with the
price territory of Wave 1 per Elliott Wave Theory.

SMART MONEY CONCEPT

What Is the Dow Theory?
The Dow Theory is a financial theory that says the market is in an upward trend if
one of its averages (e.g., industrials or transportation) advances above a previous
important high and is accompanied or followed by a similar advance in another
average. For example, if the Dow Jones Industrial Average (DJIA) climbs to an
intermediate high, an investor might watch the Dow Jones Transportation
Average (DJTA) climb to confirm an upward trend.

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KEY TAKEAWAYS
The Dow Theory is a technical framework that predicts the market is in an upward
trend if one of its averages advances above a previous important high,
accompanied or followed by a similar advance in another corresponding average.

The theory is predicated on the notion that the market discounts everything,
consistent with the efficient market hypothesis.

In such a paradigm, different market indices must confirm each other in terms of
price action and volume patterns until trends reverse.

Dow Theory

Understanding the Dow Theory

The Dow Theory is an approach to trading developed by Charles H. Dow, who,
with Edward Jones and Charles Bergstresser, founded Dow Jones & Company, Inc.
and developed the Dow Jones Industrial Average in 1896. Dow fleshed out the
theory in a series of editorials in the Wall Street Journal, which he co-founded.

Charles Dow died in 1902, and due to his death, never published his complete
theory on the markets, but several followers and associates have published works
that have expanded on the editorials. Some of the most important contributions
to Dow Theory include the following:

William P. Hamilton's The Stock Market Barometer (1922)

Robert Rhea's The Dow Theory (1932)

E. George Schaefer's How I Helped More Than 10,000 Investors to Profit in Stocks
(1960)

Richard Russell's The Dow Theory Today (1961)

Dow believed that the stock market as a whole was a reliable measure of overall
business conditions within the economy and that by analyzing the overall market,
one could accurately gauge those conditions and identify the direction of
significant market trends and the likely direction individual stocks would take.

Aspects of the theory have lost ground—for example, its emphasis on the
transportation sector and railroads—but Dow's approach forms the core of
modern technical analysis.

How the Dow Theory Works

There are six main components to the Dow Theory.
1. The Market Discounts Everything

The Dow Theory operates on the efficient market hypothesis (EMH), which states
that asset prices incorporate all available information.

Earnings potential, competitive advantage, management competence—all these

factors and more are priced into the market, even if not everyone knows all or
any of these details. In more strict readings of this theory, even future events are
discounted in the form of risk.

2. There Are Three Primary Kinds of Market Trends

Markets experience primary trends which can last a year or more, such as a bull
or bear market. Within the broader trends, secondary trends make smaller
movements, such as a pullback within a bull market or a rally within a bear
market; these secondary trends can last a few weeks to a few months. Finally,
minor trends can last a few days to a few weeks. These small fluctuations are
considered market noise.

3. Primary Trends Have 3 Phases

According to the Dow Theory, the primary bull and bear trends pass through
three phases.

A bull market's phases are the:

Accumulation phase: Prices rise alongside an increase in volume.

Public participation (or big move) phase: Retail and average investors begin to
notice the upward trend and join in—generally, this is the longest phase.

Excess phase: The market reaches a point where experienced investors and
traders begin exiting their positions while the larger average investing population
continues to add to their positions.

A bear market's phases are the:

Distribution phase, where news of a decline begins to be distributed throughout

the investing community via various channels.

Public participation phase: Opposes that of a bull market participation phase—

average and retail investors are selling stocks and exiting positions to reduce
losses. Again, this is generally the longest phase.

Panic (or despair) phase: Investors have lost all hopes of a correction or full
reversal and continue selling at scale.

4. Indices Must Confirm Each Other

For a trend to be established, Dow postulated indices or market averages must
confirm each other. This means that the signals that occur on one index must
match or correspond with the signals on the other. If one index, such as the Dow
Jones Industrial Average, shows a new primary uptrend, but another remains in a
primary downward trend, traders should not assume that a new trend has begun.

Dow used the two indices that he and his partners invented, the Dow Jones
Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA), on
the assumption that if business conditions were healthy—as a rise in the DJIA
might suggest—the railroads would be profiting from moving the freight this
business activity required; thus, the DJTA would also be rising.
5. Volume Must Confirm the Trend

Trading volume generally increases if the price moves in the direction of the
primary trend and decreases if it moves against it. Low volume signals a weakness
in the trend. For example, in a bull market, buying volume should increase as the
price rises and falls during secondary pullbacks because traders still believe in the
primary bullish trend. If selling volume picks up during a pullback, it could be a
sign that more market participants are turning bearish.

6. Trends Persist Until a Clear Reversal Occurs

Reversals in primary trends can be confused with secondary trends. It is difficult

to determine whether an upswing in a bear market is a reversal or a short-lived
rally followed by still lower lows. The Dow Theory advocates caution, insisting
that a possible reversal be confirmed by comparing indexes.

Special Considerations

Here are some additional points to consider about the Dow Theory.

Closing Prices and Line Ranges

Charles Dow relied solely on closing prices and was not concerned about the
intraday movements of the index.

Another feature in Dow Theory is the idea of line ranges, also referred to as
trading ranges in other areas of technical analysis. These periods of sideways (or
horizontal) price movements are seen as a period of consolidation. Therefore,
traders should wait for the price movement to break the trend line before coming
to a conclusion on which way the market is headed. For example, if the price were
to move above the line, it's likely that the market would trend up.

Signals and Identification of Trends

One challenging aspect of implementing Dow Theory is accurately identifying

trend reversals. Remember, a follower of Dow Theory trades with the overall
direction of the market, so it is vital that they recognize the points at which this
direction shifts.

One of the main techniques used to identify trend reversals in Dow Theory is
peak-and-trough analysis. A peak is defined as the highest price of a market
movement in a period, while a trough is seen as the lowest price of a market
movement in a period. Note that Dow Theory assumes that the market doesn't
move in a straight line but from highs (peaks) to lows (troughs), with the overall
moves of the market trending in a direction.

An upward trend in Dow Theory is a series of successively higher peaks and

troughs. A downward trend is a series of successively lower peaks and troughs.

The sixth tenet of Dow Theory contends that a trend remains in effect until there
is a clear sign that the trend has reversed. Similarly, the market will continue to
move in a primary direction until a force, such as a change in business conditions,
is strong enough to change the direction of this primary move.

Reversals

A reversal in the primary trend is signaled when the market cannot create
successive peaks and troughs in the direction of the primary trend.
During an uptrend, a reversal occurs when the index consecutively fails to reach
higher highs and higher lows over a long period. Instead, the index moves in a
series of lower highs followed by lower lows.

The reversal of a downward primary trend occurs when the market no longer falls
to lower lows and highs. Consecutively higher highs and higher lows in a
downward-trending market demonstrate a possible reversal to an upward trend.

It's vital to remember that primary trend reversals can take months to present
themselves—a change in price direction over a one-month, two-month, or even
three-month period might only be a market correction.

What Are the 3 Trends of the Dow Theory?

The three trends are primary, secondary, and minor. The primary trend is the
long-term trend, called a bull or bear. Secondary trends are smaller trends, such
as a market correction. Finally, minor trends are day-to-day price fluctuations in
the market.

What Is the Goal of Dow Theory?

The overall goal of the Dow Theory is to identify the market's primary trend
through proof and confirmation.

What Factors Affect Dow?

The Dow Jones Industrial Average, known as the Dow, is affected by the prices of
the stocks that make up the index. Stock prices are affected by many factors.

The Bottom Line

The Dow Theory attempts to identify the primary trend a market is in. It is
comprised of three primary trends, each made up of secondary and minor trends.
The theory assumes that the market already has knowledge of every possible
factor and that prices reflect current information. This implies that there is no
need to investigate further why assets are priced the way they are but to act on
price movements and volume and depend on signals and confirmation for trend
reversals.

7 Mistakes to avoid when trading options

1. Not having a trading strategy

Trading options has its benefits, but diving in without any sort of
trading strategy is not a recipe for success. For example, how will you
identify potential trading opportunities? What criteria will you use to
determine whether a potential trade is worth pursuing? How much are
you willing to lose on a trade that doesn’t go according to plan? These
are important questions to answer.
If you don’t have a clearly defined options trading plan, you might end
up making random decisions based on emotion or what you heard in
the news. When you have a trading plan, your decisions are based
simply on whether an opportunity fits within the framework you have
created.

In addition, inexperienced traders sometimes don’t have an exit

strategy, which can be a problem. Options can make big moves in
either direction. You should know not only how large of a move should
trigger action on your part, but also how long you’ll wait before taking
action.

2. Lack of diversification

One of the most common problems when trading options is a lack of

diversification. When buying equities, diversification usually means
purchasing stock in many different companies and industries. When
thinking about options, it means something a little different.

With options, you have more possibilities than buying promising stocks
and selling the losers. You’ll have both calls and puts, and many trading
strategies and tactics to use them, such as covered calls, married puts,
and bear put spreads. So you can match the options strategy with a
variety of situations.
Using multiple options strategies can also help you succeed even if one
particular strategy is unsuccessful, and this diversification can be
especially helpful since options can be an all-or-nothing wager. If you
put all your cash into one options position and it doesn’t work out, you
don’t have any more cash to trade with.

3. Lack of discipline

Options trading requires an acute sense of discipline and self-control.

While it can provide wins more quickly than investing in index funds,
that isn’t to say it will always produce immediate results. If you want to
do well, you must be willing to stick to your strategy.

For example, options traders can be too quick to sell a winner while
holding onto a loser for too long. Or perhaps they wait too long to buy
back short options. Options require you to be smart with how you trade
if you want to be successful in the long run.

4. Using margin to buy options

Using a margin loan can be tempting when trading options since it

might allow you to make a nice profit without putting up much capital.
The problem is that while a margin loan can amplify the wins, it does
the same with losses. Buying on margin is risky, whether or not you use
it to trade options. Margin calls are also a concern when trading with
leverage.
It’s important that you don’t trade with money you can’t afford to lose,
but trading options increase the likelihood of that happening. Because
of the heavy risk associated with buying on margin, it’s like you’re
doubling your risk when you use margin to buy options.

5. Focusing on illiquid options

Liquidity is the ease with which something can be converted into cash.
Shares of stock are often quite liquid since they can easily be sold for
cash whenever the market is open. But trading options isn’t as simple
as selling shares at a given market price.

Options traders are at the mercy of the bid-ask spread, the difference
between what sellers are asking for an asset and what buyers are
willing to pay (bid). If there is a big difference between those two
prices, you have an illiquid option. That means you might have trouble
finding a buyer for your option when needed, which can be a problem,
given the sometimes rapid price swings with options.

6. Failing to understand technical indicators

When trading options, traders must understand the dynamics of option

pricing and how they work. For instance, indicators such as the delta,
gamma, vega and theta of an option should be second nature to you. If
you aren’t familiar with the “Greeks” of options trading, it’s best to
understand them before getting started.

For example, delta represents how much the option price is likely to
move based on a $1 change in the underlying security. In other words,
it tells you the price sensitivity of the option. Similarly, theta explains
the effect of time on the option. An effective options trading strategy
requires that you understand these various indicators so that you know
how options prices will move in response to time, the price movement
of the underlying stock and the overall market’s volatility, among other
factors.

7. Not accounting for volatility

As noted earlier, the options market can be volatile. However, savvy

options traders can use this to their advantage. The expected volatility
of a stock influences the option’s premium, or the price the options
trader pays for the contract. So understanding volatility will help you
determine whether an option is cheap.

Your trading strategy should account for volatility so you know

whether a contract is worth buying. And if it isn’t worth buying, then

maybe it’s worth selling instead. Options can help you play the situation
either way.
Bottom line

Options allow traders to magnify their gains, but they can be risky if you
don’t have the necessary knowledge beforehand. Like most things, the
learning curve options trading requires learning by doing. But keeping
these common mistakes in mind can help make your learning
experience a less costly one.

Stop-Loss Orders: One Way To Limit Losses and Reduce Risk

How Stop-Loss Orders Work

Traders or investors may choose to use a stop-loss order to limit their losses and
protect their profits. By placing a stop-loss order, they can manage risk by exiting
a position if the price for their security starts moving in the direction opposite to
the position that they've taken.

A stop-loss order to sell is a customer order that instructs a broker to sell a

security if the market price for it drops to or below a specified stop price. A stop-
loss order to buy sets the stop price above the current market price.

Advantage Over a Stop-Limit Order

A stop-loss order becomes a market order to be executed at the best available
price if the price of a security reaches the stop price. A stop-limit order also
triggers at the stop price. However, the limit order might not be executed
because it is an order to execute at a specific (limit) price. Thus, the stop-loss
order removes the risk that a position won't be closed out as the stock price
continues to fall.

Potential Disadvantages

One disadvantage of the stop-loss order concerns price gaps. If a stock price
suddenly gaps below (or above) the stop price, the order would trigger. The stock
would be sold (or bought) at the next available price even if the stock is trading
sharply away from your stop loss level.

Another disadvantage concerns getting stopped out in a choppy market that

quickly reverses itself and resumes in the direction that was beneficial to your
position.

Investors can create a more flexible stop-loss order by combining it with a trailing
stop. A trailing stop is an order whose stop price, rather than being a fixed price,
is instead set at a certain percentage or dollar amount below (or above) the
current market price. So, for instance, as the price of a security that you own
moves up, the stop price moves up with it, allowing you to lock in some profit as
you continue to be protected from downside risk.

Some traders and investors may also use option contracts in place of stop orders
to allow them to control their exit price points better.

Benefits of Stop-Loss Orders

Stop-loss orders are a smart and easy way to manage the risk of loss on a trade.

They can help traders lock in profit.

Every investor can make them a part of their investment strategy.

They add discipline to an investor's short-term trading efforts.

They take emotions out of trading.

They eliminate the need to monitor investments on a daily (or hourly) basis.

Examples of Stop-Loss Orders

A trader buys 100 shares of XYZ Company for $100 and sets a stop-loss order at
$90. The stock declines over the next few weeks and falls below $90. The trader's
stop-loss order gets triggered and the position is sold at $89.95 for a minor loss.
The market continues trending downward.

A trader buys 500 shares of ABC Corporation for $100 and sets a stop-loss order
for $90. After the market closes, the business reports unfavorable earnings
results. When the market opens the next day, ABC's stock price gaps down. The
trader's stop-loss order is triggered. The order gets executed at a price of $70.00
for a substantial loss. However, the market continues dropping and closes at
49.50. While the stop-loss order couldn't protect the trader as originally intended,
it still limited the loss to much less than it could have been.

What's a Stop-Loss Order?

It's an order placed once you've taken a position in a security (on the buy side or
sell side) with instructions to close out your position by selling (or buying) the
security at the market if the price of the security reaches a specific level.
How Does a Stop-Loss Order Limit Loss?

A stop-loss order limits your exposure to less of a loss than you might otherwise
experience by automatically closing out your position if your stock trades to an
unfavorable market price level that you designate. If you use a trailing stop with
your stop-loss order, that protection can move with your position even as it
increases in value. So, a loss could translate to less profit rather than a complete
loss.

Do Long-Term Investors Need Stop-Loss Orders?

Probably not. Long-term investors shouldn't be overly concerned with market

fluctuations because they're in the market for the long haul and can wait for it to
recover from downturns. However, they can and should evaluate market drops to
determine if some action is called for. For example, a downturn could provide the
opportunity to add to their positions, rather than to exit them.

OPTION GREEKS

1. THETA

What Is Theta?

Theta, the Greek letter θ, is used to name an options risk factor concerning how
fast there is a decline in the value of an option over time. This is also known as an
option's time decay. As an option gets closer to maturity or the contract's end, it
loses value as long as everything is the same.

Theta is generally expressed as a negative number for long positions and a

positive number for short positions. It can be thought of as the amount by which
an option's value declines daily. For instance, a theta of -0.05 indicates that the
option's price will decrease by five cents per day.
Theta refers to the rate of decline in the value of an option over time.

If all other variables are constant, an option will lose value as it passes time
toward its expiration date.

Theta, usually expressed as a negative number for long positions, indicates how
much of the option's value is being lost.

2. DELTA

There are various risk measures for options such as delta, gamma, theta, and
vega. In this article, we'll take a closer look at delta as it relates to actual and
combined positions—known as position delta, which is a very important concept
for option sellers. Delta is a ratio that compares the change in the price of an
underlying asset with the change in the price of a derivative or option.

Below is a review of the risk measure delta and an explanation of position delta,
including an example of what it means to be position-delta neutral.

Delta is a ratio—sometimes referred to as a hedge ratio—that compares the

change in the price of an underlying asset with the change in the price of a
derivative or option.

Delta is one of the four measures options traders use for analyzing risk; the other
three are gamma, theta, and vega.

For options traders, delta indicates how many options contracts are needed to
hedge a long or short position in the underlying asset.
3. GAMMA

Gamma (Γ) is an options risk metric that describes the rate of change in an
option's delta per one-point move in the underlying asset's price. Delta is how
much an option's premium (price) will change given a one-point move in the
underlying asset's price. Therefore, gamma is a measure of how the rate of
change of an option's price will change with fluctuations in the underlying price.
The higher the gamma, the more volatile the price of the option is.

Gamma is an important measure of the convexity of a derivative's value in

relation to the underlying asset. It is one of the "options Greeks" along with delta,
rho, theta, and vega. These are used to assess the different types of risk in options
portfolios.

Gamma is the rate of change for an option's delta based on a single-point move in
the delta's price.

It is a second-order risk factor, sometimes known as the delta of the delta.

Gamma is at its highest when an option is at the money and is at its lowest when
it is further away from the money.

Gamma is also highest for options closer to expiration than farther-dated ones, all
else equal.

Gamma is used when trying to gauge how movements in the underlying asset will
affect an option's moneyness.

Delta-gamma hedging immunizes an options position against moves in the

underlying asset.
[Link]

What is Vega

Vega is the measurement of an option's price sensitivity to changes in the

volatility of the underlying asset. Vega represents the amount that an option
contract's price changes in reaction to a 1% change in the implied volatility of the
underlying asset.

Vega measures an option price's value relative to changes in the implied volatility
of an underlying asset.

Options that are long have positive Vega, while options that are short have
negative Vega.

5. RHO

Rho is the rate at which the price of a derivative changes relative to a change in
the risk-free rate of interest. Rho measures the sensitivity of an option or options
portfolio to a change in interest rate. Rho may also refer to the aggregated risk
exposure to interest rate changes that exist for a book of several options
positions.

For example, if an option or options portfolio has a rho of 1.0, then for every 1
percentage-point increase in interest rates, the value of the option (or portfolio)
increases 1 percent. Options that are most sensitive to changes in interest rates
are those that are at-the-money and with the longest time to expiration.
In mathematical finance, quantities that measure the price sensitivity of a
derivative to a change in an underlying parameter are known as the "Greeks." The
Greeks are important tools in risk management because they allow a manager,
trader, or investor to measure the change in value of an investment or portfolio
to a small change in a parameter. More important, this measurement allows the
risk to be isolated, thus allowing a manager, trader, or investor to rebalance the
portfolio to achieve a desired level of risk relative to that parameter. The most
common Greeks are delta, gamma, vega, theta, and rho.

Rho measures the price change for a derivative relative to a change in the risk-
free rate of interest.

Rho is usually considered to be the least important of all option Greeks.

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