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Most of us are familiar with what happens when you pull a rubber band too far.
It has a tendency to snap back. That same idea applies to stocks, too. For example, if a stock sells off too much too fast, it has a tendency to snap back, or revert to mean.
Or, if a stock runs too high, too fast, it’ll often snap back as well.
Great traders will always go where the action is.
Volatility, momentum, new highs, and liquidity are some of the key traits they’ll look for. Other times, there’s a fundamental reason for the break, including news, or event that’ll draw even more traders in.
Just what is a breakout, though?
By now, you’re well aware of how to find trends using simple moving averages, such as the 50- and 200-day moving averages. But you should also know how to potentially spot when a trend could stop dead in its tracks, or birth a new trend.
All we have to do is wait for a crossover to do so.
For example, we can spot a bullish “golden cross” when the short-term moving average, such as the 50-day crosses above the longer-term average, such as the 200-day. When this happens, we’ll typically see a move higher in a stock or an index.
Look at the Dow Jones Industrials for example.
o the average trader, candlestick patterns are a bunch of crosses and oblong shapes with odd names, like the three black crows, or the abandoned baby bottom.
Some traders choose to ignore them. Others understand that it gives a clear illustration of the war between the bulls and the bears. In fact, every time you look at a candle you can see who is ahead, who is falling behind, and whether or not the war has come to a standstill of indecision.
For example, a doji cross is the perfect picture of indecision.
Whether you trade currencies, commodities, or stocks, understanding technical analysis is crucial to your success. Unfortunately, many traders continue to fall into the same trap of ignoring the basics like the head fake.
This can happen when a price temporarily moves higher, for example, giving the impression that a bottom may be in place. But as many of us are well aware, trading on the impression of recovery can be costly.
To many, technical analysis is useless.
But as we’ve proven countless times, such analysis is essential, especially when you’re trying to gauge the strength and weakness of momentum with support and resistance.
One of the best indicators to understand is the channel, defined as two parallel trend lines within a tight trading range. The upper line connects the price peaks in the channel while the lower line connects the price lows.