Hi Everyone,
Today we are going to study how price action creates support levels and why moving averages are no longer the ideal way to determine support levels.
The chart below is INTU and it is in one of the sectors poised to outperform this year and next. It has been moving up steadily and had a minor retracement during the recent market short term correction. As you can see, the moving averages are not a good way to determine support. The stock tends to move into the moving average area before rebounding and continuing upward. This is a common situation for stocks building platforms. A better way to determine support is to use a different method of chart tools and analysis. MetaStock has easy to use tools that can be employed rather than moving averages that will make the analysis of this chart far easier, more reliable, and faster.
Chart 1
We can see from the indicators that this stock has quiet accumulation by large and giant funds moving in incrementally and that the buy side dominates with plenty of institutional activity. However there is also intermittent pro trader and high frequency traders buying and selling for short term profits.
As retail traders, you must have a quick and simple way to see what is going on.
Below I have used the MetaStock Drawing tools rectangle box to expose the actual sideways action of this stock. From this view with the rectangles around the sideways action suddenly the view becomes clearer as to what is actually going on. This stock spends quite a lot of time moving in a tight range called a 'platform'. A platform is a few points wide and moves up and down between a high and a low price but remains within that range. Platforms are common patterns during a value-oriented market condition which is the most common market condition you will find after a financial debacle and recovery. Institutions are more cautious and are buying with more care. This creates an ideal environment for the platform. Fortunately platforms are one of the easiest sideways patterns to trade short term.
Chart 2
A platform however is NOT a Trading Range. Therefore trading range strategies such as SAR, pivot points, etc do not work for platforms as there is insufficient points gain on either side of the price action.
Knowing whether you are dealing with a true Trading Range or if it is actually a platform makes a huge difference in your profitability.
Also, being aware that although this stock is steadily trending upward, it is doing so at a very slow pace because it is actually moving sideways for about 3 months before it moves up with brief momentum. 3 months corresponds to earnings which is how most platforms are built.
If earnings are going to be strong, the platform bottom will tend to angle slight upward prior to the upside breakout.
Summary: instead of using moving averages to determine support levels, use your MetaStock drawing tools to outline the platform, trading range, consolidation, or other sideways action. By doing so you can quickly determine the proper support lows for your stop losses.
Reminder: never use percentage stop losses. That theory and strategy no longer works in our automated market place. Percentage stop losses were designed before technical analysis was available to the average trader. Technical support is a far better stop loss technique.
As always:
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
(c)2011 Decisions Unlimited, Inc.
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