Anatomy of a Trade Following Stock Market Basics Guidelines

On this stock market basics website I often stress the value of reading stock charts and learning how to identify typical patterns that past history has shown them to be indicators that often signal it’s the right time to enter or exit a position. I have also mentioned that chart reading is not foolproof and has no mathematical or scientific basis that I am aware of. But it is accurate to say that the graphical pattern that depicts a series of trading events in the past reoccurs very frequently when a new series of similar trading events take place on later occasions.

In other words, when the past repeats itself, it looks the same on a stock chart and that means that when you know what happened next in the past, you can assume that something similar will happen again, and in this way you hope to be able to forecast the future with some certainty when you take a stock position based on the recognized chart pattern.

Stock Market

Breaking through Resistance
One of my favorite and simple trading strategies is to buy a stock when it breaks out through overhead resistance to a new high. It is well-known that stocks reaching new highs often continue their upward trend and continue to make further gains.

As a chart watcher, when I see a breakout occurring, like the one mentioned above, I would also hope to see some confirming patterns in the shorter-term moving averages, such as those of the 5-day and 10-day, that can be seen on the chart for KOG shown below, where the 5-day is the red line and the 10-day is the blue line. On that same chart for KOG, I also check the RSI (relative strength index), the mini-graph at the top and the MACD (moving average convergence divergence), the mini-graph below the main KOG chart.

For a simple interpretation of those indicators, I will just point out that
1.  the RSI is currently confirming an upward move,
2. the moving averages show that the daily trading range must be above the red line to be positive, and
3. the MACD has currently not confirmed the positive with a cross-over, as in the blue circles, but looks to soon do so — we will await the closing prices for the next few days to see if that takes place.

Of course, that is just an interpretation, there is no way to really be sure of what will happen. KOG Stock Chart

For additional reassurance, I check into Yahoo Finance, enter the stock symbol, in this case KOG, in the “Get Quotes” box and a small chart appears showing the day’s trading. After a glance at that and a check of the trading volume where I prefer to see at least a few million shares daily average volume, I then go to the “Headlines” list below and click on the most recent headline stories that take me to articles that mention or feature the stock in question. For instance, looking at KOG today as I write this on March 10, 2012, I see the top three headline stories are:
  • The Best Oil Stocks Today at Motley Fool [Fri, Mar 9]
  • Today’s Commodity News To Trade On at Seeking Alpha [Fri, Mar 9]
  • 4 Drillers Under Short Attack at Seeking Alpha [Thu, Mar 8]

I read those stories and any others that are relevant and easy to find. The comments in those articles may not be in agreement with each other but from them I gain relevant information of interest in support, or otherwise, of my decision to make a trade based on the previously mentioned stock chart pattern. There is a lot of other useful information and data available from many other such sources and I recommend it as a good way to gain an insight into the stock market basics as seen by other traders and financial commentators.

But not every trade becomes a winner — and that should be no surprise!

And here is what happened recently in my KOG trade:
The orange horizontal line on the above chart shows the stock price high reached on January 7 — which then became a level of resistance. After that, in the following days, KOG fell to around the 8.50 mark and then the stock turned around again and resumed its upward trend and this time broke through the January 7 resistance level at about 10.35.

In accordance with the above explanation of how I follow the charts, I took that as a buy signal and bought stock at 10.33 on February 21. As the chart shows, this stock moved up to 10.75 at which point it turned around and fell to around 9.00 in a period of about  seven days. So much for my forecast based on the chart patterns and a good object lesson that keeps you humble.


Sold for a loss
Regarding the exit point, by following another general guideline commonly in use and referred to in the past on this stock market basics site, I exited the stock when it fell by a pre-established percentage of 8% more or less. That should have been at about 9.50 but with a lot of action at that time on a falling stock it was not possible to get the target price, my actual sale price was 9.18, a loss of about 10%.

An 8% loss is the recommended amount of loss to take on a losing trade in order to preserve capital, that’s according to trading experts such as William O’Neil, publisher of Investor’s Business Daily, mentioned elsewhere on this website.

In conclusion
In making this play, I followed the stock market basic guidelines but this time did not get a winner, nevertheless, experience has taught me that this particular strategy often provides a profit within a short period of time usually less than two or three months. The target going in was to achieve a 25 to 35% gain within 3 to 4 months. In that way, that particular amount of working capital would have been available for three or four more speculations of the same type and time duration.

Next question for you to think about:

Since KOG has again reversed and is heading back up . . . when would you place a trade to re-enter? (assuming you believe, as I do, that KOG has a good future and will likely move higher before too long). Maybe I will comment tomorrow or soon, and give my own opinion and maybe make a trade too.