One of the big challenges in stock trading centers around the control of one’s bias – especially when the trader has an existing position in a stock. Often a trader will begin to see what they want to see in a chart to justify their position – and this can lead to plenty of trouble down the road if this becomes a habit.
It takes a lot of discipline, and a level of comfort with being wrong at times to ensure that you minimize this situation as much as possible. One way to do that is to put energy into your chart reading efforts that expand beyond just traditional moving average and trend line review.
One exercise that I like to do is to take a clean chart and create several differing/opposing views of the chart – then ask myself which is the most likely and which represents the highest probable outcome.
For an example, let’s take a look at a few charts in $MCD (McDonald’s Corp). The first is with a simple Trend Line (TL) drawn, Volume at Price (VaP) turned on, and the 65 day simple moving average:
In this Weekly chart, price has made quite a move in the past 12 months, but so far has avoided testing the slightly rising Trend Line below. It has taken 2 stabs near the $86 price level so that is decent support for now. Does it look like it wants to move down to test the TL below?
Now let’s take a look at the same Weekly chart but with the TL removed, and the Fibonacci levels added:
This chart shows that price has made 2 dips under the 50% retracement of the January 2011 lows and the January 2012 highs. You can also see that the largest Volume at Price bar resides at this price level. Can it hold this 50% retracement level ($87.25)?
For some additional perspective, let’s pull out to the Monthly chart:
Know your time-frame, keep a clear perspective, and trade what you see.