Stock Price History and It's Relationship to Overbought and Oversold Conditions
To see why stock price history tells successful traders when securities are oversold or overbought, we must first define the meanings of "oversold" and "overbought". An oversold condition can be defined as the price where sellers will be replaced by more buyers who are hunting for bargains or looking for profit opportunities by buying securities when their prices bottom out. Overbought conditions occur at the price where buyers are replaced by sellers for a position in that stock. This is similar in theory to the economics concept of "supply and demand".
When analyzing chart pattern reversals to better estimate price resistance and price support levels to help you exploit profit opportunities and to handle your trading decisions using stock price history, any stock chart profile can be reviewed. If you are buying and trading options, stripping dividends, writing covered calls, or even writing LEAPs, you can apply this regularly used information to your advantage.
So exactly what happens in the real world and how do the outcomes of stock price history translate to stock chart patterns as they relate to price points or plots?
A price level on a stock chart profile where we can expect an increase in the demand for a security, where the buyers take over as the weak sellers fold, is indicated by support (bottom price support). How do we know this? We know this by identifying the previously documented reaction to a price level in the chart's stock price history. While learning how to read stock charts, we see that for any stock there are certain price levels where the selling pressure slows down or subsides, and the price trend shifts and reverses as stock price increases. We can assume, when this happens, that this price level will retain its significance when the price approaches that level again in the future.
It is important to note that all recorded plots at the end of the day represent the capital buying and selling net results of investors or institutions. Thus, it is very clear and factual. A bottoming price is known as the price support level, because the stock begins its recovery and the security's price is supported at this level. Conversely, the overhead price resistance is the level where the security price has shown an inability to rise anymore, and a reversal to the downside can be expected. The best technical analysis tool to review for that price level is the RSI technical indicator.
Market Direction: Is there any patterns in the markets? Being able to recognize patterns allows an investor to predict the next price move with a high degree of accuracy. Being able to identify candlestick signals in those price patterns provides additional clarification of the next potential price trend. Investor sentiment is incorporated into candlestick signals. That sentiment can be better identified when analyzing which candlestick signals appear in a price trend.
What does the Dow chart reveal? The trend analysis becomes much easier to read when using candlestick signals and stochastics. Analyze the trend of the Dow from mid-July. Candlestick signals appeared in the oversold condition. A Morning Star signal started the rally. Where did the rally come to an end? With a Long-legged Doji in the overbought condition. That would have been a viable reversal signal by itself. However, additional evidence was added by the fact that it occurred at the last peak of the market trend at the beginning of July; that observation indicated, with a high degree of probabilities, that the uptrend was over.
How far might the downtrend move? A simple rule of trend analysis is that once a major moving average is breached, prices will usually come back to test it. The 50 day moving average became an obvious support level. The bullish candle, followed by a Hammer signal, with lows of the day just touching the 50 day moving average started to produce the visual evidence to anticipate a reversal from that level. The Hammer signal, followed by an Inverted Hammer signal provided a strong format for anticipating the uptrend starting.
Where does that uptrend stop? With a Bearish Harami in the overbought condition. What did the candlestick signals tell us in the pullback from that level? The indecisive trading signals revealed that the selling was not very convincing. After a mild pullback, a Bullish Engulfing Signal after a Spinning Top indicated they were trying to take prices back up. Is this 20-20 hindsight? No, if a trend can be analyzed witnessing candlestick signals occurring in overbought or oversold conditions, the trend movement can be anticipated with a fairly high degree of accuracy. Having the ability to analyze what the trend should do with the probabilities in your favor allows for establishing positions that will be participating in the correct direction of a market trend.
DOW
Knowing simple rules, applied to candlestick analysis, produces the investment format for knowing when to be in long positions or in short positions. As witnessed in the Dow over the past few days, the current uptrend seems to be waning as we near the recent highs. Thursday's trading formed a doji. One of the simple rules for doji's is that the trend will usually move in the direction of how they open the price the day following a doji. With stochastics in the overbought condition, and a doji forming at the recent highs, a weaker open on Friday was clearly demonstrate that the uptrend may have fizzled. At this area of the trend, a strong bullish candle is required to demonstrate that the recent high is not acting as resistance.
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Learn how to analyze the patterns in the markets. If you know what should occur in specific patterns, anticipating what should occur at important technical levels, dramatically enhances an investors ability to extract profits from the market. Click here to learn more about the high profit patterns.
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