Option Trading College

Subject: Basic charting
Instructor: The donFranko
Length: 10 sessions

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Session 1 -- Basic Charting Technique   

One of the most fascinating things about trading in the stock market is trying guess where a stock is going to go next. Well my trading friends, your future is in the Charts!

As we begin this series, you will come to know that charting is an important key to your financial future. Had I learned these simple techniques in my early days of trading, I would not have spent literally thousands of dollars sailing the seas of the financial markets without a rudder. I cannot begin to tell you how much a stock is manipulated and controlled by its historical chart. Let me say that again, a stock is MANIPULATED by the chart and assisted by our good friends the Market Makers (MM), but we will discuss this later.

Ok, here we go. The first thing you need to do in order to make the most of this series is subscribe to what I believe to be the best charting program available. Telechart 2000 by Warden Brothers, Inc. You can log onto www.tc2000.com to get the software for free, but the data has a monthly fee. I use this software myself and will base my teaching on it.

In the beginning, I was tripping (more like falling) over pennies while I missed thousands of dollars because I would not invest the money in the right tools for this trade. Remember! This is a business and not a hobby. If you treat it like a business, you will get rewarded like a business. The monthly investment is approximately $29.75 per month for the annual subscription and its well worth it!

There are some freebie's (see links) out there but they do not offer the tools necessary to do things like: custom searches, large visual display, proprietary technical indicators, and the most important tool is the ability to un-adjust splits. This will be crucial to determine where a stock might end up as you will see in the next sessions.

The next charting service I use is www.quote.com and their software called  Q-Charts. Q-Charts offers the best of both worlds. I use it for both my live streaming quotes and charts. They cover both options and stock. You can also draw trend lines on the charts and this will prove to be invaluable in trading.

 

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Session 2 -- Support and Resistance  

There is a saying I like, "The teacher will appear when the student is ready....Are you ready?"

 

The first thing you will need to do is start to look for patterns in the stocks you choose to play. Each stock has a unique personality and style all its own. The reason for this is people are people, and well, there is one person who controls each stock traded on the NYSE (specialists) and a few large players who control the NASDAQ (market makers). These people buy the stocks in large quantities and then piecemeal them out to you and me. They are investors like us, but with substantially larger money pots to dip into.

 

Each day when the MM starts up his computers, he sees a list of sell orders and buy orders (open order book). He takes a look at the stocks closing price and decides where he will open it for trading...thus the explanation for the gaps up or down. Once the initial opening price has been traded, the general trading public kicks in and drives a stock up and down throughout the day. Now here is the interesting part about this manipulation I was talking about. It happens at the end of the day. There is another system of order routing called Trade Imbalance or Market On Close orders. If there is not enough stock to cover, the MM has to adjust the price to get buyers or sellers motivated. If you take a look at the charts below you will see what I mean:

 

In this first chart, we will take a look at why a stock tends to stop as specific price points on any given day. Here is an old favorite of mine, Yahoo! Inc. (YHOO). Notice how it stops at certain points along the way? (You have to always be in a detective mode to see things.) The first question would be why did it stop there?

 

figure 1

 

Now take a look at the second chart below.

 

figure 2

 

I have drawn a trend line at the point it stopped at. If you follow the line, you will notice Yahoo has support from a few days back but is this enough to make a buying or selling decision? I think not. Lets dig a little deeper shall we?

 

figure 3

 

It appears to have stopped for no reason right? Well here is where TC2000 really makes the difference from those freebie charts. I will un-adjust the split back in Feb ‘99 and lets see what we see.

 

figure 4

 

The support line I drew is actually an old resistance line back in Dec of 1998. Yahoo gaped open over that resistance; then it became support while it made a new high. Notice how quickly it fell below this line and then became resistance again by the time the split kicked in. A picture is worth thousands of dollars!!

 

Session 2 --  

Now we will go forward to see where it is going to end up? Any guesses?

 

figure 5

 

After making another attempt for the high, Yahoo failed and fell below support. The line is currently becoming resistance again and we have a split coming next week. Did you notice where it stopped falling?

 

figure 6

 

Right where it stopped last time. Are you getting the picture here? Is this stuff amazing or what? Now I will finish drawing the lines at key stopping points and we can predict where this stock will climb or fall to in the future. In my experience I have found this to be accurate better than 70% of the time. Even if it spikes up or down from a key support or resistance it returns to it shortly. Notice the top of the next chart and the bottom.

 

Figure 7

 

See where it broke out to a new all time high of $500 but then quickly fell back to old resistance at $450? Now look at the diagonal line, this is where Yahoo is likely to fall after it clears the support from the last dip and notice that the diagonal line intersects the fall before the last split run. Of course it’s not a guarantee but you can sure plan on it being close. Therefore you need to place your orders to buy and or sell accordingly. NEVER try to pick the top or the bottom, just shoot for the fat middle. Also one last note, make sure you buy enough time to ride the dips especially on these Internet stocks.

 

Session 3 -- The future  

 

It's been over 4.5 years (wow does time fly) since I wrote this section and I am now going to post the chart on Yahoo to see how accurate my theories were. [are!]

 

figure 8

 

Now isn't this interesting? Notice that back at the end of 2000, I showed the support and resistance lines (figure 7). If you look into the future you will see that Yahoo came right down to my support line and then violated it with each subsequent stop at previous major support lines. Then at the end of 2001, the stock took on a nice rally and just like clockwork it failed at resistance from early 2001. Notice the lengthy recovery from mid 2002 all the way through the beginning of 2004. Why did it finally take out that resistance? They announced another stock split and it was happy days again. Once the stock split, it quickly rallied right back to old resistance from 1997!

 

Now the stock is sitting at a very pivotal resistance line. It goes all the way back to the first split on 9/2/1997! See how the long-term trend line from its first all time high intersects with the last split? We are at a major crossroad with this stock. Simply amazing stuff!  You really need to subscribe to TC2000 to capture the full benefit of un-adjusting the splits. www.tc2000.com

 

Here is what it looks like if you cannot un-adjust the stock split:

 

figure 9

 

It's pretty hard to predict with a lot of accuracy where the stock is going.

 

Session 4 -- Deciphering Chart Patterns  

There are several types of chart patterns you can use to help you make good trading decisions. First up is my personal favorite. It's called the Cup & Handle.

The Cup & Handle formation is very popular with technical traders. In fact, it's become so popular, it's very hard to get one to fully set up! What you want to look for is stocks that has had a strong move over the past 2 to 4 months. Once you spot that, you want to see it go through a slight correction; typically the stock will sell off into a slight correction for around 30% off its previous high point. If you find a good one, it will have taken 8 to 12 weeks to properly set up. Of course, the overall market conditions play a factor, so do not get married to the pattern.

Now, once a stock moves up to test that old high, it should incur some selling pressure and this causes the stock to drift sideways for a few days to as much as 3 weeks.

 

                                                                                        

 

 

Next, you want to pay attention to the handle. It should be 5% below the previous high point. If the handle should fall more than this, I would use caution. When should you buy? That depends on two things. The stocks volume coming out of the dip, and the overall market/sector conditions. The trigger point is when the stock rises into a new high at the top of the handle. Note: do not use the previous high as your top.

You can find some of the biggest winners in stocks when you start to recognize this pattern...it's VERY powerful! In fact, it has been one of the most reliable of all the chart patterns; and when you find a classic formation, you can just about print money!

There is one caveat that needs to be adhered to: The best time to take advantage is when the best stocks are moving with the market/sector at the beginning of that move or after a good market correction. Do not jump the gun during, or at the end of a major market advance. You want the momentum to carry you...not bury you!

 

Session 5 -- Deciphering Chart Patterns

Next up is the crème de la crème of stock chart patterns. It's called the Head and Shoulders. No it's not related to shampoo, but if you learn to scrub your charts for this pattern you will have all kinds of cash fall out of your account!

Here is a really great explanation of this money maker!

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:chart_patterns:head_and_shoulders_t

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:chart_patterns:head_and_shoulders_b

 

Profits Up!

The donFranko 

 

 

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