IRAinvestor.com	02/18/01
IRA Investing > Covered Calls by Mark Wnetrzak	In association with
Trading the Trend: A Beginners Approach

By Mark Wnetrzak

There is one easy way to consistently profit from trading; form the correct outlook for the future movement of the market and position yourself to benefit from that activity. In fact, that is the premise of the technical trader; that past price behavior can be used to forecast future trends, thus providing a means to profit from a successful forecast.

There are a number of advantages to this type of approach but most importantly, it eliminates the need to understand the infinite components of fundamental valuation that market analysts find so intriguing. In addition, trading strategies based on historical price analysis provide precise entry and exit signals, a benefit to investors who participate in short-term strategies. Technical analysis makes three basic assumptions. First, simple market data such as price and volume can indicate the true value of a specific security or financial instrument. Second, prices historically exhibit trends or patterns and third, history eventually repeats itself. These assumptions can be combined with the study of price and volume to provide traders the basic information they need to initiate profitable trading strategies. The technical indicators that identify buy or sell signals are contained in various chart formations and patterns. Of course, the goal of any trader is to profit from their predictions and most experts suggest that the best place to begin is with proven practices such as evaluating an issue's price history or trend.

The most common technical patterns are the trend and trading range. Trends are categorized as "uptrends" or "downtrends" while trading ranges are defined by support and resistance levels. It is important for an investor to be able to identify these trends or trading ranges and recognize the historical chart patterns that signal major turning points or reversals. Since two points define a line, the basic requirement for all trend-lines is that there be at least two points connected, but most analysts require a minimum of three points to confirm and justify a primary trend. After the trend-line is established, its character can be determined and the boundaries of the recent price activity can be used to establish the simplest form of buy and sell signals.

The second general classification of prices is the trading range. It is defined as a series of prices that move between a clearly established high and low value. The upper boundary is known as "resistance" while the lower is termed "support." A resistance level is established when there are more investors who are willing to sell (supply) rather than buy (demand) at a specific price, because they believe the security is overvalued at that level. A support level will occur when investors feel the stock is cheap or undervalued at a given price and they can't afford not to own it. Trading ranges can also occur as part of an uptrend or downtrend. These patterns are often called "continuations" since the general direction of the prices is not changed. Another type of trading range can exist as part of a transition, or "reversal" from an uptrend to a downtrend. A daily price range with a high that is above the previous day's high and a low that is below the previous day's low is a good example of this type of indication. It would be nice if all of the changing trends were illustrated by sharp, well-defined signals but stocks rarely behave in such a benevolent manner.

Next week, we will discuss some of the most common patterns used to forecast changes in the trend (or character) of an issue.

Good Luck!