Price action and chart patterns are very helpful in trading and understanding market dynamics. I use charts to see if a market is in an uptrend (higher highs, higher lows), in a downtrend (lower highs, lower lows), or consolidating (range, flag, triangle…).
Price action refers to the reaction of the price to certain situations. Simply put, is the market showing signs of strength or weakness. For example, if a breakout takes place, is there a sudden follow-through or a quick reversal?
Chart courtesy of StockCharts.com
Abbreviations: BO = breakout, LH = lower high, LL = lower low, HL = higher low, HH = higher high, SOS = sign of strength
The chart above shows how to apply those concepts to the silver market; descriptions correspond to the numbers within the chart.
1. Silver consolidated for a couple months. A longer consolidation means often a higher chance of a bigger trend move in either direction. Be open-minded to adjust your view and positions.
2. Downward breakout of the range with less follow-through. However, the price was unable to recapture the range (sign of weakness). Afterwards, a nice move down started over two months with a clear structure of lower highs and lower lows. Note that the price was unable to rise above the daily bands (sign of weakness).
3. New lows at the beginning of September were reversed by the month’s end (first sign of waning downside pressure). Price rose slightly above the daily bands for the first time since couple months (first sign of strength). Traders with short positions want to reduce their exposure.
4. Market slightly undershot the September low and reversed strongly within a day (confirms the market is not able to push lower and some traders are now trapped in short positions). Short positions should be closed, and aggressive traders already try to establish a first long positions with a stop below the November low.
5. Silver makes a slightly higher high, which indicates the first possibility to increase the long position.
6. After consolidating two weeks below the upper boundary of a multi-month sideways period, the market breaks out, which is another opportunity to increase the long position. Breakout shows good momentum without a pullback (sign of strength).
7. First bigger pullback into the daily bands can be seen as a possibility to add to your long position., but it needs to stay above 14.9-15 USD to hold the breakout and remain highly bullish (falling below a clear breakout means a lot of traders will sell their established long positions = negative).
8. Market makes a clear higher high with good momentum, but reverses within two days (limited short-term upside?). Taking some profits is a wise decision. However, I would still hold at least half of the long position.
9. Next pullback again bounced of the daily bands, possibility to increase the positions size slightly.
As the example shows, there is plenty of information all the time. Collecting those information may help to make better trading/investing decisions.
✓ Former hedge fund portfolio manager/trader
✓ 15 years of experience in financial markets
✓ Master of Science (MSc) in Business and Economics from the University of Basel
✓ Developed quantitative tools for an asset management