How Can Using Technical Analysis Lead to Consistent Profits in the Stock Market Even in a Down Market?

The two most essential concepts to being profitable in the stock market are using a systematic approach and practicing risk management. Using technical analysis is crucial to choosing the right systematic approach. A down market does not mean that every company is performing poorly. It just means that there are fewer companies that are performing well. A systematic approach will help you, the investor, locate these stocks.

 

A systematic approach will help the investor answer the following questions:

 

1)    What stock to buy?

2)    When to buy the stock?

3)    When to sell the stock?

 

While fundamental analysis helps answer the first question, at the heart of this systematic approach lays technical analysis, in layman’s terms, charts. Technical analysis helps answer the second and third questions. Timing is critical to being profitable in the stock market. Just because a stock has great fundamentals does not mean that the optimal time to buy the stock is today. If you plan to be invested in the company for decades, then fundamental analysis may be enough. Investors who have a long term strategy of being in a stock for several years will likely have a year where the stock is essentially stagnant. If, however, you want to make profits on a stock that is stagnant over a period of time, regardless of whether it pays dividends, you need technical analysis, because it is essential to maximizing your profit in both the short and long terms.

 

Many stocks have chart patterns, which can lead to consistent profits once you understand how to interpret these patterns. In time, with dedicated practice, you will develop the eye to see profit opportunities where everyone else sees stagnation. When everyone else is complaining that their stock barely moved in the past year, you will be beaming knowing that your approach to this stagnant stock resulted in double-digit profits. How?

 

Combine the Channel Price Roll template using technical analysis with the Writing Covered Calls strategy.

 

The Channel Price Roll template involves drawing two trend lines. The first trend line identifies support. Support is established when the stock price drops to a bottom level and then begins to rise off of that level. Support is like the floor. The second trend line identifies resistance. Resistance is established when the stock price rises to a high level and then begins to drop from that level. Resistance is like the ceiling. These two trend lines create a channel. If the stock is stagnant, then the channel is horizontal.

 

The Writing Covered Calls strategy involves two steps.

 

1)    Buy at least 100 shares of a stock. The stock must be optionable. If you are unsure, check the Chicago Board Options Exchange (www.cboe.com). The optimal timing involves buying the stock once the stock price has bounced off of the support trend line (Channel Price Roll).

 

2)    Sell a call option on the stock that you now own. Options are sold in contracts. One contract allows you to control 100 shares of stock. That is why you must own at least 100 shares of the stock on which you want to sell the call option. The optimal timing involves selling the call option once the stock price has approached the resistance trend line (Channel Price Roll).

 

 

The profit is made once you have sold the call option on the stock that you already own. When you sell the call option, the buyer of the call option pays you a premium, which you will see in your account the following day. Unlike stocks, options have expiration dates. When I use this strategy, I typically sell a call option with an expiration date of less than 30 days out. For example, on December 22, 2010 I sold a January 2011 call option. Because options expire on the 3^rd Friday of their expiration month, this call option expired on January 21, 2011, right at 30 days.

 

So, I locked in 6% profit in 30 days. Banks do not pay that kind of interest in a year, let alone one month.

 

The next critical day is the expiration date on the option. In my case, on January 21, 2011, one of the two following scenarios occurred:

 

1)    The call option expired worthless.

 

2)    The buyer of the call option chose to exercise the option.

 

The good news is that I was profitable with either scenario. I have already locked in 6% profit in 30 days. Regardless of what happens on the expiration date, I still keep my 6% profit.

 

For a stagnant stock in a horizontal channel, the first scenario is most likely because of the timing of when I sold the call option (stock price at the resistance trend line). This is a great scenario to have, because I still own the stock. So now, I can turn around and sell another call option that expires the following month, locking in another profit in less than 30 days.

 

This technique is one of many ways how you can use technical analysis to profit consistently in the stock market, even in a down market.

 

Comments

[nifty option]

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[Aneshia]

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