I followed the rule of buying at support. Yet prices went south. How is this possible? Why does this always seem to happen to me?
Know what support and resistance zones are before proceeding.
Trading is a business. In business, there is no 100% guarantee. Probability and chance are the name of the game. However, not all is lost. There is a way to minimize losses.
The use of indicators can help reduce risks. The 2 indicators which I will introduce are the Relative Strength Index (RSI) and C50D. Both indicators will show you the overbought and oversold areas.
When the indicator points to an overbought area, it suggests that it is better to sell and/or not accumulate.
When it points to the oversold area, it suggests that it is better to buy and/or not to divest.
Let’s start off with the RSI first.
RSI
When it points to the oversold area, it suggests that it is better to buy and/or not to divest.
When the RSI is above the 70 mark, the stock is considered to be overbought. On the other extreme is the 30 mark. The stock is considered to be oversold in any value below the 30 mark.
Can I just rely on the RSI to make money? Notice that when RSI is in the overbought area, prices continued rallying, despite the indicator going downwards.
In 2013, prices stayed in the overbought zone for about 4 out of 5 months and yet prices continued climbing higher. The same goes for the other highlighted areas, we can see that prices stayed in the overbought are while prices still continued rising.
This is because RSI is calculated by using the average close price of the number of ‘N’ days (be it closing up or down). Through the manipulation of this, the RSI tends to stay in the overbought zone when prices are moving up with strong momentum. Thus, I would not really consider it overbought when prices are moving upwards and RSI is in the overbought zone.
C50D
Then, how do we minimize losses using an indicator that gives a warning to us that a stock is overbought?
Introducing Swim Trading’s proprietary indicator – C50D!
Taking historical values of C50D as a reference and drawing a line across, we see that once C50D values are near the green line or above the green line, prices tend to retrace. This is how we minimize losses at Swim Trading.
Trading support in conjunction with the C50D indicator helps. If prices are near the green line even though prices are at the support area, I will not take the trade. I will wait as the retracement is not completed.
If you are interested in testing out this indicator for FREE, email Jay at jay@swimtrading.com to find out more!
As with all indicators, you need to pair it with charts to increase your chances of success. It takes a lot of practice and hard work. Find out more here.
Cheers
MH
Swim Trading Resident Columnist