Stock prices move up and down within what’s called a trading range. Most of the time, they move sideways.
Market prices move in cycles. The name of the game is recognizing these cycles. Extended stock cycles sometimes take years to complete. Within a given cycle, smaller cycles take place over the course of months, weeks, and days. Within a single day, miniature cycles evolve. It’s like a fractal blacklight poster you can make money staring at.
The high points are called peaks and the low points are called valleys (or troughs).Stocks have a tendency to fluctuate between higher and lower price areas in a somewhat predictable, “horizontal” channel, what we’ve been referring to as a sideways pattern. What’s happening is that sellers who are shorting the stock when the price is near the top of the range “cover” their short positions (we’ll go into detail later, but for now understand this means they buy the stock back to close the trade) when it nears the bottom, knowing that buyers will be ready to step in the expectation that the price will reverse to higher prices.
There’s plenty of money to be made in playing stocks trading inside an orderly range, buying the dips and selling the rallies. We recommend this be one of the first techniques you develop a skill at.
A breakout is the exact point where a stock rises over the valley. To qualify as a legitimate uptrend, the stock price must make a series of higher highs and higher lows.
Uptrends are fueled by greed and euphoria. We say a stock is overbought at the height of a cycle. At this point, the overbought stock starts to sputter, the volume usually increasing, and the bears gain control and drive the price back down.
An uptrend continues so long as the price doesn’t decisively break through the previous low of the trend. When the barrier of the trend low is broken and the uptrend has officially concluded, it often “rolls over” into a sideways pattern.
Sometimes buyers get tired of watching a stock trade sideways and get out of a stock, and if enough traders do this, eventually there aren’t enough of them to support the price, and that’s when short sellers move in. A downtrend is characterized by lower and lower lows being reached. They are broken when the price once again closes above a prior high.
Disinterest manifests itself as low volume, and this can often be at the root of a downtrend. But if the volume is strong and the price is still dropping, look out. The stock in trouble. Panic has set in and everyone is trying to get rid of the stock. What your eyes see will be a long black candle, but what your mind should see is panic. Short sellers and long-term investors will be the only ones sticking around.
A bull trap is a false signal of a reversal in a downward trend. That’s all. They happen, and they’re frustrating. Heads up.
When stock dutifully moves sideways in a compact, linear fashion, we call this consolidation. The price range indicated by each candlestick should be short, tight, and orderly. There is a tension here caused by buyers and sellers who are at a relative dead heat. The effect is a compression within the price range that is likely ready to explode in one direction or the other.
Whether you find it on your daily or intraday charts, this is a great pattern to come across. We recommend you focus some attention on finding this pattern in the early stages of your development.
During congestion, no upward or downward trend emerges, but neither does the price fall into an orderly consolidation. Buyers and sellers are being indecisive about the whether the price should be higher or lower, so the stock appears to behave erratically. Symptoms of the market illness known as congestion, other than indecisiveness, are unpredictable daily price ranges and gaps opening upside one day and downside the next.
Congestion is bad news. You don’t want any piece of it. When you recognize it, stay on the sidelines and wait for a better moment to enter.