When I’m analyzing charts to find the most attractive trades, I’m looking for a number of different factors. Here are my top three I always pay attention to:
1. VOLUME: I look for equities trading over 1 million shares each day. At lesser volume, support and resistance levels tend to overshoot significantly adding more risk to a trade than I’m typically comfortable with. I look to see if recent trading volume has increased. When it is higher than normal, I expect support and resistance levels to be pierced (typically no more than 1%). If it is significantly higher, i.e. several times its average trading volume, this can signal a turning point in price movement, especially at extreme highs or lows of a chart.
2. TREND: It is important to know if price is trending higher, lower, or sideways. “The trend is your friend, until it ends” which means trades aligning with the trend are lower risk, and if you see the trend change when you’re in a trade, be very cautious with the trade and consider taking profits if you can. The trend on any time frame is easy to identify by using the moving averages. I like to use the 20MA, 50MA, and 200MA. Essentially, if they are sloping up, the trend is up. If they are sloping down, the trend is down. For the best, lowest risk trades, the trend is confirmed by the same trend on larger time frames. For example, if you are using a daily chart to identify a buy level for a swing trade, an uptrend on the chart is preferable, and then, if there is also an uptrend on the weekly chart, even better for the trade, and likewise on the monthly chart.
3. OVERBOUGHT OR OVERSOLD: When an equity is overbought, it essentially means it has had a large move up in price over a very short amount of time and could be due for a pullback. An oversold condition is just the opposite. Be careful with this information. You would never want to enter a trade based solely on an overbought or oversold condition. This is because the degree to which an equity is overbought or oversold is subjective, so it is hard to gauge when a pullback will start. In addition, price can always consolidate making the chance of a pullback much less likely. The pullback may never happen if there’s enough consolidation. When you have an overbought or oversold condition, it is imperative to identify other factors indicating a potential turning point in price.