First, I needed to find a stock that has been trading sideways for the most part on a one-year weekly chart. The Jutia Portfolio provided me with one such candidate: Google (GOOG). Let’s take a closer look.

For this particular graph I used the “Slow Stochastic” indicator that Bigcharts has proved as an option. I was quite surprised to find that this chart of Google fits well in regards to the discussion points I brought up in my previous post on stochastics.

For example, I circled in red all the sell signals that were given when the stochastic crossed below the 80 mark. Also, I circled in green the exact point at which a buy signal was given when the stochastic crossed above 20.

In Part I of my analysis and use of this indicator I also stated that divergences might appear once in a while and can be valuable when spotting the end of a recent trend. The chart above did not disappoint. You’ll notice that I drew a line connecting two descending points on the price of the stock. The mirror image of this occurs when at the same point in time I could connect two ascending points on the stochastic indicator. The rule of thumb in this case would be that when price goes down and the indicator trends up, there is a positive (bullish) divergence and you should be prepared to buy.

This indicator could have helped you buy in near $340 and sold out around $430 in approximately one month’s time.

Seeing that this is a fresh graph of Google, we will look towards the right side of the graph and determine the current status of this stock play. You will notice that the stochastics are indeed above the 80 mark. No bearish divergences have been given yet and the stochastics have not fallen below 80. As long as this scenario holds Google has a fighting chance to break above $500 in the short-term. If Google decides to trend upwards it may render this indicator irrelevant.

Although Stochastics are preferred by some, it is not my indicator of choice. So why would I even discuss it? The reason is for educational purposes and to help you find a strategy that works for you. Who knows, maybe this indicator could be the missing piece in your investment strategy. There are countless strategies that work, but they have to fit your investment style.

Okay…Okay…time to share what I do know about Stochastics.

It is believed that some of the better signals are present when this particular oscillator moves from overbought levels back below 80 (signaling sell) and from oversold levels back above 20 (signaling buy).

Another use is to look for divergences in the similar fashion that we would do with the RSI indicator. By utilizing two key points that trend in the opposite manner as price, we might be able to conclude that the previous trend may soon end.

Note: Stochastics work well in stocks that are drifting sideways in strong trading channels. If the stock you are looking at is in an uptrend or downtrend you may find it difficult to rely on this indicator.

For more information on this topic you can visit StockCharts

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis.

ADX combines +DI with -DI and then smoothes the data with a moving average to provide a measurement of trend strength. Because it uses both +DI and -DI, ADX does not offer any indication of trend direction, just strength. Generally, readings above 40 indicate a strong trend and readings below 20 a weak trend. To catch a trend in its early stages, you might look for stocks with ADX advances above 20. Conversely, an ADX decline from above 40 might signal that the current trend is weakening and a trading range may develop.

In the figure below you can see an example of both the MACD and DMI indicators. There is a direct correlation between both indicators telling us that there is a buying point for stock XYZ around $27. A divergence occurs in both indicators as we can see the positive blue line cross above the negative red line. This would be our buy point. A sell point would occur with the positive blue line crossing back underneath the red line.

There are two ways to use the Momentum indicator:

You can use the Momentum indicator as a trend-following oscillator similar to the MACD (this is the method I prefer). Buy when the indicator bottoms and turns up and sell when the indicator peaks and turns down. You may want to plot a short-term (e.g., 9-period) moving average of the indicator to determine when it is bottoming or peaking.

If the Momentum indicator reaches extremely high or low values (relative to its historical values), you should assume a continuation of the current trend. For example, if the Momentum indicator reaches extremely high values and then turns down, you should assume prices will probably go still higher. In either case, only trade after prices confirm the signal generated by the indicator (e.g., if prices peak and turn down, wait for prices to begin to fall before selling).
You can also use the Momentum indicator as a leading indicator. This method assumes that market tops are typically identified by a rapid price increase (when everyone expects prices to go higher) and that market bottoms typically end with rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization.

As a market peaks, the Momentum indicator will climb sharply and then fall off–diverging from the continued upward or sideways movement of the price. Similarly, at a market bottom, Momentum will drop sharply and then begin to climb well ahead of prices. Both of these situations result in divergences between the indicator and prices.

The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the MACD: crossovers, overbought/oversold, and divergences.

Crossovers: The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.

Overbought/Oversold Conditions: The MACD is also useful as an overbought/oversold indicator. When the shorter moving average pulls away dramatically from the longer moving average (i.e., the MACD rises), it is likely that the security price is overextending and will soon return to more realistic levels. MACD overbought and oversold conditions exist vary from security to security.

Divergence: This occurrence indicates that an end to the current trend may be near occurs when the MACD diverges from the security. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.

Bollinger Bands were created by John Bollinger and are similar to moving average envelopes. The difference between Bollinger Bands and envelopes is that envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods.

Bollinger Bands are usually displayed on top of security prices, but they can be displayed on an indicator. These comments refer to bands displayed on prices.

As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper- and lower-band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices.

Mr. Bollinger notes the following characteristics of Bollinger Bands:

• Sharp price changes tend to occur after the bands tighten, as volatility lessens
• When prices move outside the bands, a continuation of the current trend is implied
• Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend

A move that originates at one band tends to goal the way to the other band. This observation is useful when projecting price targets.

1. Find the highest prince on the chart. Once this price high has been found, mark it with the letter A.
2. Now move to the momentum indicator for about the same date and mark it accordingly with the letter B. This point can vary by a few days left or right of point A.
3. From this point move to the left on the momentum to find the highest momentum and mark it with the letter C.
4. Now move up to the price that corresponds with C.
5. Mark this point with the letter D. You should now have the configuration as seen in the graph below.
6. Now we can chose the lowest momentum move between letter B and C and mark it with the letter E. This point will become our selling point.

The steps used in finding a divergence are as follows:

1. Find the lowest price low on the chart and mark it with the letter A.
2. Now mark the momentum indicator with the letter B for the same time and date as point A.
3. Mark the previous momentum low with a C.
4. Find the price that corresponds to C and mark it with a D. You should now have a configuration which looks like the following illustration below
5. Now locate the highest point between your point B and C and mark it with an E. This point is our buying point. After the stock trades further past point B do not buy until the momentum breaks past this point E.

9:30 a.m. eastern time – market opens
9:50-10:10 – first reversal period
10:25 – milder reversal
11:20 – market tends to retreat, investors head out to lunch
1:30 p.m. – post-lunchtime market begins to improve and some stocks start to move
2:30 – stocks break out (or down) with more conviction
3:00 – Treasury bonds stop trading, possible market reversal
3:30 – mild reversal possible
4:00 p.m. eastern time – market closes

The picture is self-explanatory

Here, we see an “M” pattern forming on a double top which is a major bearish sign. In a double bottom a “W” type pattern is formed in which we see a bullish rally to follow. If the stock is to form more humps and continue to test the resistance or support areas there will be a major move in the direction indicated. This goes along with a major move if a stock moves sideways in a basing pattern for a long time. The longer the wait, the stronger the breakout whether it is up or down.

Major moving averages can act as great supports for a stock. It can be like a magnet in the way a stock will bounce off it only to return to the moving average and bounce off it again.

On the other side of acting as a support, moving averages can also form a resistance. Once a stock has traded under a major moving, that average becomes a ceiling. This fact is especially true once the stock has fallen under its 200-day moving average. Some of the major moving averages include the 20-day, 40-day, 50-day, and 200-day moving averages. Other averages used that could be beneficial are a stock’s 10-day, 30-day, 40-day, and 100-day moving average.

This graph shows a typical setup when a stock is in good shape in an upward trend.

Another tip to consider are huge volume spikes, whether in a downtrend or uptrend, can prove to slow down or completely halt the current trend.

In this graph we notice that when the stock started to top off and begin to pull back, the volume stayed relatively low. This means that the dip was weak and would not last long. If the pullback volume is low this means that many previous buyers are holding their positions. On the other hand, if the pullback in volume is high, buyers are selling just as fast as they bought in. When in a position long and you notice selling on high volume, it might be wise to take profits and get out. There are always better stocks out there to choose from.

For you swing and position traders, look at the volume spikes and locate a stock going through an increase in volume while the stock continues to trade in the same, tight range. This indicates a string possibility that institutional buyers are quietly accumulating the stock and hoping that no one will notice.

Trend lines help us to get a general overview of how healthy the stock is technically. These lines help buyers find dips and excellent buying opportunities. On the flip side, once a downtrend begins to emerge, shorting (selling first, then buying to cover position) may be the best strategy for short term traders.

Do not base your trades on trend lines only. Trend lines are simply a tool to help you become a smarter and more intelligent investor. Information is a bonus if you know how to apply it. Try finding stocks that have up or down trends. Remember to spot higher highs and higher lows in an uptrend and lower highs and lower lows in a downtrend. Practice drawing and applying these lines correctly so that you will be able to make making solid investment decisions.

An upward trend line can be drawn when three or more pivot lows can connect in an orderly fashion. An upward trend should continue if the stock has higher highs and higher lows. Another point to add here is that the best uptrends are formed when the stocks climbs at a 45 degree angle.

Remember that once the stock pivots its way to a lower price the trend has been broken. You should try to draw a trend line as soon as the stock has established two “higher” lows. Try extending the line to view a probable future movement in price of the stock.

On the other hand, when a stock seems to trade in a sideways and orderly fashion, it is said that the stock is consolidating. The longer a stock trades in this pattern, the more powerful the breakout in which ever direction it goes. In this chart you will be able to see an example of when a stock trades in either pattern.

High wave candlesticks show very long upper and/or lower shadows. A group of high wave candlesticks may tell of a trend change.

The gravestone is another profit taking pattern for the bulls when the stock is in an uptrend. Usually following this symbol one will probably see a mob of sellers waiting anxiously to drive the stock price back down. One can see by the illustration that the stock will open and close near the lows of the day.

The “harami cross” forms when the second candlestick is a doji. Since we have a doji forming, there will be a powerful move. This move depends on what body is formed and will be an indication of what direction will follow. If the body is dark, the move will be bearish. If the body is clear, the move will be bullish. Examples of harami and harami cross patterns are shown below.

In the next graph we will take a look at “bullish engulfing” and “bearish engulfing” patterns. These patterns can also predict a trend change. This pattern consists of two candlestick bodies of opposing color in which the second body is larger and “engulfs” the previous body. Remember that these reversal patterns do not always promise a trend change. Instead, they should be viewed upon as a “look out” for price changes in the future.

This figure shows another type of reversal pattern, the “dark cloud,” in which appears at the height of an uptrend or near the top of a sideways move. Here, the first real body is clear and long while the second real body opens above the close of the first, but closes near the low of the trading range. This second move should penetrate deep into the territory that the first real body was trading in. The deeper the pullback, the more bearish of an indicator the signal becomes. On the other hand, the “bullish piercing” pattern, shows us a bullish trend reversal in which a long dark real body precedes a long white real body. This powerful reversal pattern will take place at the bottom of a downtrend.

Candlestick charting techniques were introduced by a world renowned seventeenth-century Japanese rice broker, Munehisa Homma. This man was among the first of his kind to look at price history and then use this information to predict future prices. It is said that Homma made 100 consecutive profitable trades. Since the invasion of this powerful trading tool, many investors have turned to candlestick charting to begin to understand a stock’s past and future movements a little better. Here are some examples of how a candlestick stem might look.

Candlesticks can symbolize minutes, days, and weeks, etc. This depends on the time frame you wish your overall chart to display. In this graph we notice three displays. In the first, a clear, white, body is shown. The white means that in the given time period, the stock traded higher. The straight lines or “shadows” represent the trading range for that same time period as well. In the second display, a black body has formed indicating that the stock traded lower. Again, the lines extending from this body represent the overall range that the stock has traded. In the third display, one can see that the stock opened and closed on or around the same price. This type of symbol is called a “doji” and indicates that a change in trend or a reversal is about to happen. This symbol is very important and should be easily recognized.

Resistance is a term people associate with “holding back,” because that is the basic principle of what is happening to the stock. It is being held back from making more gains. Now, if you can imagine a ball that bounces off the ground and propels itself higher. The ground acts as a support for the ball. The same idea applies to stocks when they are declining and then suddenly hit an imaginary ground, or support. A very important point to remember is that when a stock breaks through its support or resistance, In order to continue the trend, the breakthrough has to be on strong volume. Volume is the measure of how strong the push is behind the movement of a stock. Note that when a stock either returns to a support or resistance three or more times, we would refer to that as a “major support” or “major resistance.” These levels tend to be a little tougher to break through.

Once a stock breaks through support or resistance on high volume it will trade in a new range. If the stocks breaks through support and begins to fall. The old support level now becomes the resistance, or ceiling, and the stock now makes its way to a new support.
On the other hand, say a stock breaks through its resistance on high volume and now looks to begin an upward climb. The stock’s old resistance now becomes a price support as the stock looks higher for a new resistance.

It is during the stage two that a short term trader will take the “sweet spot” of profits out of the stock. Buyers, driven by greed and indecision, begin to purchase the stock at low prices. Position traders will ride the stock all the way to the end of a stock’s stage two. This process may take anywhere from weeks to years.

During stage three, step aside, and look for better opportunities. This is the part of the chart where the stock seems to base sideways, just like in stage one, and begins to fall aimlessly to the ground. Stage three is the point where buyers refuse to pay higher prices and fear begins to set in. Stocks fall about three times faster than they rise. As one can see, fear can be a very powerful ingredient in the steep decline of a stock. Just remember, there are thousands of stocks with numerous opportunities out there waiting to be played.

Stage four is the final stages of a stock’s decline. Here, you should again stay out of the way. Step aside and watch as others pour their money into a stock that they think they are getting a bargain for. Days later they run for the exits as their cheap stocks runs even cheaper, extinguishing those buyers that are left. Finally, the decline starts to wear off and more buyers come back into the picture. This begins a sideways basing pattern that will develop into a new business cycle.

Many people use candlestick charting when viewing stock charts. For example, if you go to Bigcharts and click on interactive charting, you will be taken to a page where you can alter how you view your stock, what time frame you would like, and compare it to other stocks or indicators. Click here to learn more about candlesticks and how to read them.

When individual candlesticks are placed after each other in their respective time frames we can sometimes begin to see the patterns discussed previously and attempt to time investment decisions based on their confirmations. Some patterns are indicative of consolidation and may take a long time to fully develop, depending again on what time frame you are viewing.

If you are new to Technical Analysis and would like to better understand some of the concepts I discuss in this blog, then it is recommended that you take the following steps:

1. Research Technical Analysis to better understand what it is and how it can be applied
2. Learn how to read basic candlesticks and work with them on different time frames (hourly, daily, weekly, monthly, etc.)
3. Study patterns and be able to pick them out in any stock chart
4. Know how to play breakouts from patterns and be prepared to utilize stop losses in case of a “false breakout”

I will explain TA more in detail as we go forward. I also appreciate comments, so let me know if you would like me to address a question or explain something in a different way. My purpose here is to share my knowledge of TA and ramp you up to speed. Like a foreign language or programming code, technical analysis can be difficult to pick up at first, but it will certaintly assist you in becoming a better investor.