In order for dividend investing to work, you first need to make sure you select the best stocks, and that you do it at the best moment.

There is no secret recipe to picking successful dividend-paying stocks, but there are a few things that will make the process easier and more reliable, leading to decisions that are more likely to be profitable in the long run.

What Is a “Quality” Company?

This question can be answered in a thousand and one ways. A quality company can be a company that brings value to its customers and to the market. It might be a company that is showing constant growth. Or it might simply be a company that has a proven track record of success in whatever endeavors they engaged in.

It all depends on where you stand and the lens you use to look at this question. If you have to filter this matter through the most important aspect of dividend investing (long-term reliability), a quality company will usually meet a cumulus of characteristics.

In theory, it’s all very easy: you need a company that does pay dividends and then reinvests those dividends over the years so that you increase your net worth.

However, the quality of the company you are investing is can make or break this simple plan. Otherwise, you might have to face severe cuts in dividend payments, the complete elimination of these payments, or simply stock price depreciation.

The most important characteristics of a good company for dividend investing include the following:

1. Consistent profits. If a company records amazing profits one year and drops well below that the next year, it’s a clear sign that it might not be the steadiest business.
2. Growth. As it was mentioned before, the best dividend paying companies are not growing at a staggering rate – but they are

steady in the way they do this. This is quite important because you want to invest in dividend stocks that will appreciate over time. In general, look for businesses that show growth expectations that range between 5% and somewhere around 15%. Anything above that might lead to severe disappointments that will eventually hurt your portfolio’s performance.

• Good cash flow. Earnings are one thing, and cash flow is a completely different matter. The first will show you if a company is doing a good job, but the second will actually tell you whether or not that company will actually pay its dividends.
• History. Generally, you should look for businesses that have increased their dividend payments over the past 5 years (or more). This will make it more likely that your chosen company will increase their dividend payments over the next years as well.
• The ex-dividend dates. This is quite significant because buying shares after this date means that you will not be eligible for the current round of dividend payments.
• Debt. Most companies have some form of debt, but you should definitely stay away from those that show excessive debt. As you will see later on, there is a special ratio that should be calculated to help you determine just how indebted a company is. Most of the times, companies with a debt to equity ratio of more than 2 are to be avoided.
• Industry. This is a characteristic that is frequently overlooked, but you shouldn’t make the same mistake. For instance, investing in an oil company might not be the best option, precisely because the entire industry is hanging by a string. With oil reserves running low and new technologies pushing electric cars further (both in terms of performance and in terms of pricing), oil companies might soon find themselves struggling. It might not happen overnight, but it is more than likely that they will not continue to grow any further.
• At the same time, the healthcare industry is likely to boom over the next years. Not only are more and more discoveries made, but with the very numerous Baby Boomer generation aging, it is very probable that health services will be in higher demand over the next decades.

Low CAPEX (Capital Expenditure). Companies with lower capital expenditure are past the phase where they need to constantly reinvest their profits for further growth. Consequently, this means that they are more probable to pay dividends, rather than reinvest their earnings entirely.

This should be put into perspective a little. Some industries (like tech) need constant improvement and growth, so it should be a generally bad sign that a tech company is investing a very small percentage of their earnings into further research and growth. At the same time, companies like this are unlikely to pay dividends anyway, so you might as well avoid them altogether. A decent CAPEX is OK for dividend investing, but if most of the company’s earnings are going into reinvestments, it is best to just move on to another option.

Fundamental analysis is important, and it plays a central role in the analysis of buy-and-hold and dividend investors. Its also important for swing traders to determine the health of a company you are thinking of investing in. However, the main tools of trade for the swing trader center around technical analysis and reading charts. Over the course of days, you are interested in spotting trends, changes to trends, and price boundaries for stocks. There are several tools used to do this but one of the most important tools in the industry goes by the name “candlesticks”. These are colored markers on stock charts, and they can be displayed for any time frame of interest. For example a day trader may look at 1 minute, 5 minute, 1 hour, or 4 hour candlesticks. As a swing trader you’re probably more interested in looking at daily candlesticks and then following trends as they develop over days and weeks. In either case, candlesticks work the same and the same rules apply. Please note that while we will often refer to “stock” in our discussion, candlesticks are used in any investment context such as with Forex.

Swing traders are going to make money on price swings, as the name implies. Trading strong trends is one way that swing traders can handsomely profit. However, you can also profit when a security is trading in a range of prices, that is bouncing up and down between two price levels and not seeming able to break out. Profits are still to be made as the price fluctuates up and down, although you may be making larger profits when trading trends. In fact most swing traders look to trade trends for this reason. Some traders will do both, trading ranges as a matter of course and trading trends when the opportunities present themselves. In this chapter we are going to look  at some tools that help you spot reversals, which are important for looking at entry and exit points for a trade. We will also discuss more about trends at the end of the chapter.

Price Action

Price action is a simpler, mainly visually oriented approach to technical analysis. Price action indicators include looking for trends, familiar chart patterns, levels of support and resistance, and other chart signals to determine when to enter and exit trades. Basically, you make your trading decisions, when to buy and sell, based on the price movements of the stock that you’re seeing. Many of the indicators that are used in price action trading are visual, and include the use of candlesticks or chart patterns. Other indicators used are checking basic data such as trading volume. Some traders are only price action traders. Others use more technical analysis indicators like moving average and other mathematically based tools that we discuss in the next chapter, and still others use a combination of the two methods.

Price action traders will look for breakouts. A stock might trade within a range for a long time, and then suddenly move up out of the range. For example it might be trading between $100 and $120 a share for 25-40 days. Then when a trader sees the stock price rise to $125, that could be a signal of a coming breakout into an upward trend. The trader may take the price change into consideration with multiple indicators like what the candlesticks are saying along with trading volume. A high trading volume could indicate a lot of excitement building for the stock, which could indicate future price increases.

Price action trading doesn’t require as much time put into research, and many price action traders completely ignore things like fundamental analysis. Once you familiarize  yourself with candlesticks, price bars and chart patterns, that may be all you need to decide when to enter and exit trades.

Part of what price action traders look for are trends, and ranges. Trends and ranges

Trends are long term movements of a stock in one direction or the other. You may see a trend or you may not depending on what kind of time frame you are looking at. As a swing trader, you need to pick out the time frame you are most comfortable with, be it a few days or a few weeks, and then look for trends within those time frames for the securities that you are interested in.

Inside any trend, there are going to be shorter term fluctuations. If investors are bullish on a stock, the trend may be moving up slowly and it may be unstoppable, at least for now. The upward trend may be clear over the course of a week or more, but on any given day you might not see the trend. If the trend is steeper, indicating stronger investor interest, then you may spot the trend on shorter time frames as well.

An upward trend means investors want to get in on the stock, and they believe its undervalued. You can double check their interpretation of the situation by looking at company fundamentals like price to earnings ratio. On the other hand, a trend may be downward if the future prospects of the company are not good, or investors believe the stock is overvalued.

Sometimes you will see sideways moves. A stock may see a peak value, indicated by a “hill” followed by a small drop, and then it remains in a sideways area for a long time. Stocks are moving sideways when they don’t move particularly strongly in one direction or the other. This is often referred to as a range, or we might say the stock is “boxed in”. Of course any range is not a flat line. Instead, you are going to see the stock bouncing around an average price, rising a little bit but not too high, and then dropping back down again, but quickly reversing course. Neither the bears or the bulls have control.

A sideways action can be an opportunity to take advantage of small price moves to make small profits, however it can also be a dangerous zone to be in. Many times if a high price drops a bit and is followed by a sideways movement, then the stock may end up entering a major downturn. When you see sideways movements you always want to check your indicators, including all of the tools we discuss in this chapter.

It’s also possible for the stock to be sideways, but then break to the upside. In the following sections, we will describe candles that can be very helpful in estimating when such a breakout is going to happen, and which direction it might move.

Causes of Price Action

Movements of price in the stock market boil down to basic economics. When there is a larger number of buyers, and people are excited by the stock, sellers can demand higher prices. You can find out what’s going on by examining the bid and ask prices for any financial security, including stocks. The bid is the current price that investors are willing to pay or offering for the stock. The Ask is the asking price. When a stock is rising in price the Ask is going to be higher than the bid and vice versa. When a stock is rising, a seller can ask for a higher price and wait it out, waiting for a buyer to finally agree to the price. More buyers means prices are going to rise.

When there is lower demand, when bad news comes out or people simply think a stock is overvalued, then prices drop. So you have a situation of increased supply and reduced demand, and what that really means is that there is reduced demand at the price that people are asking. Unless there has been a catastrophic event, there is always demand for something – but the question is at what price are people willing to pay in order to own the asset?

Herd mentality often takes over with stock markets, driving trends to ridiculous highs or ridiculous lows. When people are suffering from “irrational exuberance”, the prices of a financial asset can be driven sky high. This happened in the 1600s in the Netherlands when people began trading tulip bulbs, as if this was something of financial value. It led to a mania where the prices of tulip bulbs skyrocketed, and people were getting rich by buying and selling tulip bulbs. But as you might guess, the herd mentality and exuberance eventually wore off and the fake market collapsed. While many people had become rich in the interim, a lot of people ended up losing everything, because they were the ones holding the bag when the entire situation came to a halt.

Of course with stocks, there is real value underlying the financial instruments being traded, the ownership stakes in the companies themselves. That said, there are times when irrational exuberance will inflate stock prices. One signal to look for is unusually high trading volume, and a steep increase in the curve on the stock charts. You can avoid falling prey to this problem by not letting greed dictate your trades. Always have set entry and exit points so that although you might be forgoing certain unrealized profits, you will get out before there is a big crash, if one is coming.

This can work in the opposite direction as well. Its more than possible that panic will set in, and it often does. A professional trader always has stop loss orders in place. That way their trades are not governed by panic, they get out of the trade when its not worth it to be in the trade anymore. This is better than following the herd over the cliff. People who trade emotionally usually stay in their positions too long, clinging to hope that the trade will reverse. By the time they come to the realization that its not going to, at least not anytime soon, the stock is priced well below their original investment.

Later we will show a graph of a counter trend, which is simply a move against the overall trend. Pay attention to the strength of counter trends. If they are growing in strength over time, or there is a particularly strong one in the midst of a long upward or downward trend, the counter trend could indicate a coming reversal. You will want to confirm looking at your candlesticks or indicators, but looking for counter-trends is easy and it’s often the first signal that change is coming. Boxes and ranges can often indicate that a change in direction one way or the other is coming. Tesla provides a nice example of some of the things we have been talking about. On the left side of the chart, we note that there was a hill or bump in price, and then price dropped a bit leading to a long term zone of sideways movement. But, that sideways movement was followed by a break toward a lower stock price.

After we have finished this chapter, you will want to study charts like these and see if you can spot the signals of coming trends, in the middle of the charts. Here is how it would have looked on March 8.

This also shows the importance of keeping up with financial news. Although there is a downward trend toward the right of the graph, do you think it’s a counter trend, just a temporary interruption of a sideways move, or do we see the possibility of a coming reversal or breakout to the upside? Notice the bars along the bottom of the chart. These represent trading volume. Something to notice is the downward trend at the far right of the chart shows a big increase in volume. That indicates a lot of traders were figuring now was the time to get out of Tesla, and the chart we looked at earlier proved them right. Volume is one of the things you should look at when trying to determine the strength of trends.

Price Bars

The first thing you might consider are price bars, which show you how the price of a financial security changed over a given time period. When you add price bars to a chart, the color of the bar will indicate whether prices rose over the trading period indicated by the bar, or whether they fell during the trading period indicated by the bar. Falling prices are indicated by red bars, rising prices are indicated by green bars. The length of the bar is important as well, with the top of a green bar telling you the highest price and the bottom of the bar telling you the lowest price. For red bars, it’s the opposite with the top of the bar representing the opening price, and the bottom of the bar representing the closing price. Horizontal ticks or lines on the bars represent high and low prices for the day. This is an example of a stock chart with price bars.

Most traders actually use candlesticks, which are pretty similar both in the information they provide as well as in ways to use bars to interpret coming changes in trends. Therefore we will introduce candlesticks and then look at important patterns that indicate changing trends in pricing.

Basics of Candlesticks

A candlestick tells you the range of prices and open and closing prices for a given time period – and they also tell you whether or not the trading was bearish or bullish for the given time period. That is, if investors were buying and pushing up prices, or if they were selling off.

Bullish candlesticks are colored green, while bearish candlesticks are colored red. The color designations allow you to see at a glance whether or not traders were buying up or selling off the security over the given time period.

A candlestick has a thick, colored body. Whether or not the color is green or red changes the meanings of the top and bottom of the body. If it’s a green, and therefore bullish candlestick, that means that the stock closed at a higher price than it opened, for the given period. Remember that the period can be different lengths of time, so if the candlestick is a five minute candlestick, the open reflects the price at the beginning of the five minute period, while the close represents the price at the end of the five minute period. If the candlestick is a daily candlestick, then the prices are the true opening and closing prices for that trading day.

For a green, or bullish candlestick, the top of the candlestick is the closing price. The bottom of the candlestick is the opening price. For a red, or bearish candlestick, the top of the candlestick is the opening price, and the bottom of the candlestick is the closing price. That reflects the fact that the price dropped over the trading period.

Each candlestick may have wicks or shadows extending out of the top and bottom of the body. The top wick is the high price for the period of interest. Sometimes the high price is going to go well above the opening and closing prices, but at other times it will only coincide with either the closing price or the opening price. The same applies in the other direction, and the bottom wick represents the low price for the time period.

For example, if a candlestick is red or bearish, it could have a long wick on the top, which indicates that bulls pushed the stock price up during the time period. However, the stock still closed at a lower price, and so the bears won out over the time period. Or put another way, for part of the time period investors were buying up the stock, but in the end there were more sellers than buyers, leading to a lower closing price.

Engulfing Candlesticks

At this point you should already noticed the candlesticks provide a great deal of information when it comes to analyzing the market. The candlestick color indicates overall investor sentiment. You can also get a gauge on the investor sentiment from how the high and low price went and how the closing and opening prices went. However by comparing one candle stick to the previous candlesticks to its left, which therefore represent earlier time periods, we can see what the trend is doing. The most important thing to look for in candlesticks is whether or not the trend is entering a reversal. A reversal can be an indication that it’s time to sell off the stock, or if it’s bottoming out and you see a reversal, it could be a time to enter a trade, in anticipation of coming gains.

Most important candles in this regard is the engulfing candle. What this simply means is that you see a candle that is much larger than the candles to its left. Particular we are interested in a change of color when seeing and engulfing candle. This can indicate that the investor sentiment has changed.

So if you see a small red candle followed by a large green candle, that could indicate that there was been a shift from selling off to buying the stock. Conversely, if you see a green candle followed by a much larger red candle, that could indicate a Cumming downturn. What it tells you is that investors have shifted from buying up the stock to selling it off.

It’s important to realize that while these candlesticks are good indicators, they are not fortunetellers. Therefore you shouldn’t take them as an exact predictions and before entering a trade or exiting a trade, you should look at other indicators besides the candlesticks. That said, knowing the candlesticks and what they mean is a very important part of technical analysis. In the image below we see an engulfing candlestick. This took place at the bottom of a downturn in the stock. It was followed by an upturn as you can see in the image. In short, the engulfing candle indicated a coming change in trend.

Notice the green candle which is circled has a much larger body than the red candle that preceded it a day earlier – indicating that the stock opened relatively low and rose quite a bit during the day. This was followed by an uptrend in the stock price.

This works the other way too, as the image below shows. When you see a red candle that engulfs a previous green candle, or that is a bearish candle that engulfs a bullish candle that happened the day before, that is a strong indicator for a change in trend, to the downside.

In this particular example, there are two large red or bearish candlesticks in a row, indicating a strong downward trend.

Shooting Stars

Another signal that can happen at the top of an uptrend is a shooting star. This is a red or bearish candlestick with a long wick shooting upward. The long wick that shoots upward indicates that the price during the day reached a very high level, but by the end of the trading day investor sentiment had become negative, so much so that the price dropped and ended up lower than the opening price for the day. This can indicate a coming trend reversal toward a lower stock price.

If the body is green (bullish) and the candlestick occurs at the bottom of a downtrend, its known as an inverted hammer. An inverted hammer is a different kind of signal, because it means that while the price reached a high during the day and it closed lower than the high, it still closed at a higher price than it opened for that trading period.

A hammer at the bottom of a downtrend is taken as a signal indicating a coming reversal to an uptrend. This is a bullish or green candlestick, with an extreme low price for the day or time period, but the sell off was temporary and not enough to overwhelm the bulls. So the stock ended up closing at a higher price than it opened at even though there was this sell off at some point.

A hammer by itself is not an indication that you should buy the stock. You need to look for a confirmation from another indicator such as a moving average crossing, or you can wait for the next days trading to see if there is a second bullish candle indicating a genuine uptrend.

Harami Patterns

Sometimes, when you are at the bottom or top of a trend, a simple change in candlestick color without engulfing can be a signal of a changing trend. This is called a Harami pattern. For a Harami bullish trend, you are going to want to look for two bullish candlesticks in a row. The next example shows a nice Harami bullish signal. Although the red or bearish candlestick has a larger body than the succeeding bullish (green) candlestick, the change in investor sentiment at the bottom of the downtrend has to be noted. This was followed by a very large bullish candlestick, which indicates that the closing price went up much higher than the opening price for the day. This was indeed followed by an uptrend.

You can also look for bearish Harami signal at the top of an uptrend. Again, it needs to be confirmed by a follow-on bearish candlestick, but when you see a bullish candlestick followed by a bearish one at the top of an uptrend, that can be taken to be a sign of a trend reversal. A second bearish candlestick will confirm it, or a crossing of the moving averages.

Piercing Lines

First lets take a look at a bullish piercing line, which is something you will be looking for in a downtrend. What you are going to look for is a bearish candle followed by a bullish candle, but the opening price for the bullish candle is lower than the closing price of the previous day. Then, however, the closing price of the bullish candle ends up higher, above the mid line of the previous bearish candle. This is a very strong indicator of changing investor sentiment and a coming upward trend in prices. You can get confirmation but many traders will not require confirmation if they see this signal. In the bullish piercing line below, the opening price in the bullish candlestick was lower than the previous closing price, but the price rallied to close higher. This was followed by a solid uptrend in the price.

A bearish piercing pattern is the opposite, you will see a green candlestick followed by a red candlestick, that is positioned above the mid line of the bullish candlestick, indicating a higher opening price. However, during the day the stock was not able to keep rallying and there was a drop in price, indicating a coming downturn.

Dark Cover

In Bearish Dark Cloud cover, the stock will be trending upward. At some point along the trend you’ll see a bullish candlestick with a long body, indicating that the price rallied and closed a lot higher than the opening. But then the following time period you’ll see a red or bearish candlestick, and it will have an opening price that was higher than the previous time periods closing price, but during the day or time period a selloff begins and it ends up closing lower. This is a strong indicator that the uptrend is coming to an end, and its time to sell your shares.

Doji Stars

Investors also look for Doji star patterns, which occur with a three candlestick formation at the top or bottom of a trend and including a doji. At the bottom of a trend it will be a bearish candlestick followed by a doji, and then a bullish candlestick. The candlestick in the middle will have a very narrow body with long wicks extending above and below, indicating that overall for the day the share price opened and closed at about the same level, but there was a lot of activity during the trading day pushing the stock up high but also down low. A candlestick with long wicks but the same or very close opening and closing prices is called a doji. If this is followed by a bullish/green candlestick at the bottom of a downtrend, its taken as a strong signal of a coming uptrend and is a good point to buy shares.

This pattern can also happen at the top of an uptrend. In this case, you will have a green or bullish candlestick, followed by a doji. That means that again, prices were pushed high and low during the day, but it closed at the opening price or very close to it. Then if this is followed by a bearish candlestick, its taken as a signal that the stock price is about to turn downward.

Three White Soldiers

This is a candlestick pattern where you see three bullish candlesticks in a row, indicating a coming upward trend in price.

Support and Resistance

Now we leave candlesticks aside for awhile, and look toward different things to look for in stock charts themselves. Let’s review support and resistance, which are important in other price action strategies. The first thing to look for is support. This is a low pricing level that the stock doesn’t seem to drop below for an extended period of time. You are going to see the stock bounce off the support price level but never or barely go below it, so the stock might have a zig-zag kind of pattern.

Likewise, the stock will have a level of “resistance” that it cannot cross when increasing in price. So this is a high price level that the stock will flirt with but seemingly be unable to cross.

The stock chart might have a general appearance like this:

Here is a real example, where for a time Netflix was “boxed in” between two share pricing levels:

While profit opportunities may not be as large, support and resistance represent important pieces of information. For example, you might enter a trade just as it comes off the support pricing level, with a goal to sell when the stock approaches the resistance price level. While it may not be the highest profit you could make on the stock, its still a profit opportunity.

The importance of triggers

Support and resistance also offer opportunities to set triggers. What we mean is you are going to want to enter into trades with per-defined entry and exit points that you make real by placing limit orders. If you aren’t familiar with this concept, a limit order is an order to buy or sell shares that only happens if the market price matches the price you specify in the limit order. You can pair orders together in a “one order cancels the other” fashion, so that if one of your limit orders is executed the other one gets canceled. So you will want a limit order to sell the shares if the price drops too low to prevent losses, and you will want a limit order to sell and take profits if the price reaches a certain high point.

Support and resistance can help guide your decisions in where to place these orders. For example, in the Netflix chart above, the bottom line of support is $345.73 a share. We could place a stop-loss order slightly below the level of support, so we would put a limit order to sell our shares after we enter the trade at say $344.50. If the price drops to that level or below that, the trade would automatically execute and that would mean we’d be closing our position. But the purpose of doing this is to prevent ourselves from getting in a situation where we are taking too much risk, and possibly losing a large amount of money.

To ensure that you get profits, you should set a per-defined goal, and place a limit order to sell your shares if and when that point is reached. This helps you avoid getting into a problem of being overwhelmed by greed, a situation that has destroyed many traders. If you start hoping for too much profit in individual trades, you are just as likely to see yourself waiting too long to exit, which means you’ll be in a situation where the stock drops off and you end up not realizing any profits at all. Its better to treat your trading as a business and set specific, realizable goals. If a stock is showing a level of resistance, that is one indicator you can use. In this case, the Netflix stock was topping out at $383 a share. So we could set our limit order a little bit below that, say $382.50. If we had recognized this pattern in the chart as it was forming, we would have realized that when the stock was around $345 a share it was a good time to buy. Entering into the trade, say with 50 shares, it would have cost $17,250 to buy the shares. A limit order to sell at $382.50 would have gotten us $$19,125, and we’d profit $1,875 from the trade less commissions.

This Tesla chart shows the value of placing a stop loss order. The earlier part of the chart could have indicated a situation similar to that with Netflix, where it would have a level of support. However you see there is a break toward the downside with share prices dropping from $273 all the way down to $178. If we are disciplined traders, we would have sold early avoiding the downside. However, if we were emotional traders hoping for a turn around, you might have been stick with your shares when it dropped into the $178 range, and faced big losses.

Watch for Counter Trends

A counter trend is an opposing move that is a part of an overall, larger trend in one direction. For example, a stock of successful and growing tech company is going to spend a lot of time moving upward. As part of that larger upward trend, there will be counter-trends that temporarily move in the opposite direction. Counter trends can represent buying opportunities.

ABCD Patterns

The so-called A-B-C-D chart pattern indicates a breakout to higher price levels. The stock rises to an initial high at point A, which is followed by a counter-trend to point B. The price level A represents the ‘breakout’ price that the trader expects to either represent the high price point or a coming marker for higher prices. The point B is taken as the risk level or new level of support. After reaching point B, the stock will rise a little and show a slower uptrend along C, until it eventually reaches a new high at D. The trader will use point A as the guideline that can determine where to set a limit order to sell and take profits.

Trading Volume

Trading volume is an important indicator, as we mentioned earlier. One of the first things you will need to do when considering volume is to determine what the historical trading volume for a stock is. The word historical should be considered carefully, as historical doesn’t necessarily mean you take the all time average or go back 20 years ago. Historical trading volume that is more relevant is how has it been going recently. If you start to see a large increase in trading volume coupled with a trend reversal, that could be a signal that more trend reversal is coming. Whenever you see other signals, such as candlestick indicators that are coupled with increased volume, that should reinforce your confidence in a trading situation.

Retracements vs. Reversals

One of the most important things that new swing traders need to become conscious of are retracements. These are small counter trends that can look like trend reversals over the short term, but they are not real reversals. Rather, they are small random blips in the midst of a solid trend that is continuing one direction or the other. They key to recognizing a retracement as compared to a genuine reversal, and its not easy, is to look for the share price breaking through previous levels of support if we are looking for a new downward trend, or resistance if we are looking to identify a new upward trend. This chart showing SPY, which tracks the S & P 500, is a good example. For most of 2018 SPY showed a steady upward trend. Retracements are indicated by the dotted arrows. These were short term counter trends that were not interrupting the inexorable upward trend. Toward the end of the year, we see a massive downshift, that broke levels of support. That is indicated by the dotted oval in the chart. This was followed by a genuine downward trend. Note the rise in trading volume indicated by the vertical bars at the bottom of the chart.

You will notice that another signal is present toward the right side of the chart. While SPY seemed to enter a sideways area for a time, there is another red candle with an extremely large body, which of course was followed by plummeting share prices.

Even professional traders have difficulty distinguishing between a retracement and a real change in trend that would qualify as a reversal, but you should spend time studying charts so that you can begin to recognize retracements more often than not.

Pin bars and price rejection

One thing to look for at (what may be) the peak of upward trends or (what may be) the bottom of a downward trend is a pin bar. This is a narrow bodied candlestick with a long wick sticking out in one direction or the other. When a candlestick has a long wick, that means either the low or high price was way out of proportion to the open and closing prices – and so was rejected. A high price that is rejected at the top of an upturn can indicate a coming reversal. In the snapshot below, the green or bullish candle in the middle has a high price that went well above the closing price, and you can see this was followed by two bearish candlesticks (two days of declining prices). This could be taken as a sell signal, or a buy signal if you were shorting the stock.

At the bottom of an uptrend, when you see a low price that was rejected, that is the candle ended up with a much higher closing price, it could be a buy signal for bullish investors. Of course, you should always protect yourself by utilizing a stop loss order. In the event that you are wrong, you can put the stop loss order at slightly below the most recent low, to prevent your trade from being caught up in a renewed downward trend.

Inside Bars

Another price action strategy is to look for inside bars. This is when a long bar is followed by a smaller bar that would completely fit inside the previous bar, but it’s the opposite type. So its kind of like the reverse of an engulfing patter. Forex traders in particular like trading inside bars. They can represent a coming breakout.

In the image above, on the left we have a bullish bar followed by a smaller bearish candlestick, while on the right side we see the opposite situation, a bearish bar followed by a smaller bullish bar. If either of these are seen in part of a trending market, they can be taken as a signal of a coming breakout. When occurring in or near a level of support or resistance, the pattern can indicate a coming trend reversal. You should confirm this type of signal with other indicators.

Time Frames for Swing Traders – Again

It’s important that you not get too deep into the forest for the sake of looking at trees. As a swing trader be careful about over analyzing and looking at time frames that are too small to be relevant to the types of trades that swing traders are going to make. If you are utilizing price bars or candles, going with a 1-day time frame for the candles is the most reasonable way to do your analysis. Look for zones of support and resistance on time frames of days and weeks, but avoid falling into the trap of zooming in to see smaller time scales. These are simply not that relevant to the swing trader in most cases. You will find at times that looking at different time scales can help you “zoom in” on true support levels, but in most cases the added information is not going to be significant enough to matter.

Determining Key Levels

You can eyeball a chart and estimate where the price fails to break above or fall below, that part is easy enough. However, how can you be sure that a certain price level is really support or resistance?

When it comes to trading, you can never be 100% sure of anything and can only play to increase your odds. One principle you can apply here to increase the odds that an apparent level of support or resistance is real is to require that at minimum, the price touches the level at least two times. Three times is better, and it can help to widen your time window to see if the price has been in this area before, and what happened. You’ll also want to look for pin bars near zones of support and resistance. Is the price touching the support or resistance level with the end of a long wick, or are open and close prices near the level? The latter can be a stronger signal.

Use chart styles that work for you

Study candles or price bars, but if a line chart makes it easier for you to spot trends, then go with that type of chart for most of your analysis. This works better for swing traders who are playing on weekly and monthly time scales. In those cases, the high and low of the day is less important than the overall movement in price. Don’t get in late on a trend

Everyone has some common sense about the stock market, after a long rally its probably not the best time to start buying lots of shares, since its more likely than not a “correction” is in the offing. The same holds true for trends. If a strong trend has been continuing for several weeks or even months, that is probably not the best time for a swing trader to load up on shares. While its true the trend may continue, the odds are starting to work against you at that point. Getting on board with a trend when its just forming is the best time, but of course identifying real trends early is something that takes a lot of experience and skill, and no trader is going to be successful at it all the time.

Since its often hard to identify a real trend, trading ranges can be more profitable for the disciplined trader. You can enter and exit multiple trades while trading ranges, and although you make a smaller amount of profit on each individual trade, when you can trade multiple times the profits can add up to be as much as you might get trading with a strong trend. A swing trader is going to have more success trading both ranges and trends, rather than only following big trends.

When trading ranges, there is always the risk of a breakout that occurs and you miss the signals. Suppose that there is a breakout to the upside. If the stock has been trading between $80-$100 for several weeks, you might buy at $80 a share and have a limit order to sell at $79.50. The order could execute and then the stock could rise to $110 or $120 a share, leaving you missing out on huge profits. Of course hindsight is always 20/20.

On the other hand, maybe the stock ends up moving the other direction, and finds a new level of support at $70. That is why its always important to have stop-loss orders in place. You don’t want to be in a situation when you are out golfing or at a doctors appointment and the price suddenly drops and you don’t find out until later. If you had a stop loss order in place, fine. If not then the losses could really take out a chunk and if you are trading on margin, get you in trouble with the broker as well.

One important way to deal with all the ifs, and, and buts when it comes to these issues is to decide what kind of trader you want to be and stick with it. You will have to live with the consequences, but that’s life. So if you are more inclined to look for bigger returns – a 10% or more move in the price of a stock, and the higher the better, you might be better off focusing on trading with the trend rather than trying to be a jack of all trades. The more you focus the more you can become an expert in your little niche, and really learn how to spot true trends, and therefore earn profits from them.

Finding trends can involve the use of sophisticated indicators, so we will discuss this in the following chapter.

Using Retracements to Enter into a Trade

Retracements can actually be used to our advantage. What we want to so is to look for signals in the data that indicate the trend is about to resume.

First you want to take advantage of a drop in share price, and so wait for the stock to have lower and lower highs for three days in a row. This will often be followed by bullish candles that are bullish because they’ve had higher closing than opening prices, but compared to the previous day the opening and closing prices might be continuing the down trend – for the moment. The fact the candles are bullish indicates that an uptrend is probably coming. The buy signal comes when you see the first candle that has a high price for the day that is higher than the previous day. Alternatively, you can wait for the stock to have three days in a row or more with each days low price lower than the previous day. This can be taken as the low point prior to a reversal.

In the candlestick chart below, notice that there are three bearish candles in a row with declining highs. This indicates a decent entry point or buy signal.

Should Candlesticks Guide Your Trades?

It’s important to keep in mind that no single tool should determine whether or not you enter or exit a trade. In the coming chapters, we are going to be learning more tools that you can use in conjunction with candlesticks and other indicators. So when you see a signal looking at the candlesticks, you’ll want to confirm it using other tools before making a move.