The Stock Market Basics Approach to Buying Stocks

Buying stocks
After having qualified a stock as a suitable candidate for trading, the primary entry signals used in the stock market basics approach to trading is to look for a confirmed breakout of the stock price from an existing confining stock trading pattern. For an example, as illustrated in the chart below, a confining pattern on the upside is often a level of resistance established by a previous high or an all-time high. For a downside break the opposite applies, a breakout below a previous low or an all-time low. Breakouts also occur from other recognizable trading pattern formations such as the variously called pennants, flags, triangles, consolidation ranges, cup and handle, measured moves, and so on.

While those are the stock markets basic’s guidelines, there are some patterns that have been shown to warrant buying stocks before a breakout occurs, meaning a larger gain can possibly be captured with little extra risk. One type of stock pattern that would fit that approach is one in which the stock appears to trade within a channel, fluctuating up and down between resistance and support and doing so for several repeated cycles. There are some other patterns that also provide similar opportunities. I will look for examples and post a stock chart or two if I can find them.

Await confirmation if possible
Before buying stocks, when the breakout is relatively minor in its price movement, it is my own inclination to wait for two or three days as a way to confirm that the breakout is real and can be seen to continue on its new trend, and sometimes it doesn’t. But if it does, I don’t think it matters that a few points of gain have been lost. A famous trader once told me that sometimes a stock can be a better buy at a higher price.

Increased volume
An additional positive factor is when a breakout is accompanied by a good increase in the volume of trading transactions, meaning that there is significant increase in demand for the particular stock.

A failed move to the upside
A good example of a recent breakout that did not follow through is that of the much awaited S&P 500 index at 1344 a little more than a week ago on April 26, 2011. After a few days of closing above that level, the S&P reversed and traded lower until it found a new support at about 1335 – which you will notice is the same level as the previous high on April 8, (that is how support and resistance levels can be established, from near their previous resistance and support values). Now today, May 9, we are again waiting for a confirmation of a breakout of the earlier 1344 level, followed by another follow through the more recent level reached on May 2^nd around 1370. So from the chart below it can be seen how those resistance and support levels are established.

Click on the chart below for slight enlargement and greater clarity

Like sheep?
When other traders are similarly watching for a signal of that type and are waiting to buy stocks, perhaps it becomes a self fulfilling activity, however, experience shows that it does frequently work.

Caution on earnings announcements
The stock market basic guidelines also suggest to NOT buy stocks when earnings announcements are due to be released soon, within the next two or three weeks or perhaps more. On the days when earnings and forecasts for the future have been released, the stock prices can fluctuate considerably and even the best stocks can take a hit if they should miss the analyst’s forecasts by a penny or two. Sometimes it doesn’t make sense but better to be aware of what can happen. For more on the topic of earnings announcements see Earnings Season Starts Now!

Next post – getting out
In our next post we will address an approach to exiting a stock position, preferably with a profit but sometimes with a loss where the objective is to minimize the losses.

Related posts:

1. Buying Stocks or Buying an ETF (Exchange Traded Fund)
2. Finding Stocks for Stock Market Basics Paper Trading
3. Stock Market 101 Basics – The Paper Trading Approach to Learning About the Stock Market
4. Paper Trading Portfolio No. 3 — An Explanation of the Stock Market Basics Approach to Short-term Trading
5. A Case for Buying Options Instead of Buying Stocks
6. At Last, Charts Signal Time for Buying Stocks? Maybe!
7. Buying stocks — But First, Before We Start

Filed under: Stock Market Basics

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