Apple Charts Teach Two Key Lessons

09/21/2011 9:00 am EST

Focus: STOCKS

Corey Rosenbloom

Founder and President, Afraid to Trade

Recent price action in Apple, Inc. (AAPL) teaches some valuable lessons about trend trading and the importance of using multiple time frames to get important confirmation signals.

If you were paying attention to the deteriorating economic news, you might not have noticed a bright spot among all the doom and gloom and bearish headlines.

Apple, Inc. (AAPL) shares broke this week to new lifetime highs after giving a “triangle” breakout buy signal on the daily chart with a supportive structure from the higher time frames.

Let’s take a look at the three time frames in AAPL and learn a few strategies along the way:

chart
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When looking to trade a stock on a chart basis, it’s often best to start with the “bigger picture” monthly chart, mainly to assess the dominant trend and any obvious prior support/resistance (price) levels.

Most traders don’t trade off the monthly chart, but it serves as a backdrop to guide strategies they’ll employ on the lower time frames.

Without getting too technical (yet), Apple remains in a powerful, month-over-month uptrend and each minor pullback (down months) sets up a buying opportunity on the break above price resistance.

Price is overextended from its rising 20-month exponential moving average (EMA), but this structure is common in powerful stocks and should not be a reason to fade (short) an overextended stock. Stocks become overextended for a reason and it’s usually best not to fight that reason.

With the monthly structure above, let’s now fine tune the chart by viewing the current weekly chart (below) and observe some new lessons:

chart
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The first principle of price behavior is that trends, once established, have greater odds of continuity than of reversal. Apple is one of the many examples that demonstrate this foundational principle.

Simple Strategy #1:  Do Not Fight (Fade) Trends

New and developing traders do best using pro-trend strategies, such as buying retracements to rising support (EMAs or trend lines).

Other developing traders (and professionals) like to buy breakouts from prior resistance or consolidation patterns (like rectangles or triangles).

We can see in the weekly chart how this works. Retracement strategies generally trigger a buy signal as price pulls back (retraces) either to a rising moving average or hand-drawn trend line.

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Traders place and trail a stop under the EMA or trend line and hold firm until price forms a sell signal at a higher price, such as a break of a rising trend line or reversal candle that “pokes” through the upper Bollinger band.

See related: John Bollinger on Trading with Bollinger Bands

Breakout strategies require a bit more confidence, as a trader seeks to buy shares (or add to positions) on a price breakthrough above a prior resistance area.

Traders place stops under the breakout price (not too close) and similarly hold for a sell signal above.

You can see the entries/triggers of both strategies best on the weekly chart (this works for swing traders).

Let’s now step into the daily chart for a clearer picture of what just happened and how we got there:

chart
Click to Enlarge

I added “Buy” labels for both of the recent daily chart breakouts:

The first triggered in early July on a break from a “falling rectangle” or “bull flag” pattern (weekly) and the second triggered recently in September on a breakthrough above the triangle pattern. For late-comers, Apple also triggered a breakout buy signal above $400.

Notice how the recent triangle on the daily chart corresponded with a simple retracement to the rising 20-week EMA on the weekly chart. Thus, the recent retracement to the $360 level was a retracement buy signal on the weekly chart that was confirmed as a breakout buy signal on the daily chart (triangle).

By combining time frames like this, you can spot a potential signal on a higher frame and then confirm it—or fine tune entry—with a lower frame. It takes a bit more work to find these opportunities, but they’re often worth it (allowing for a better entry and tighter stop).

See related: More Time Frames, More Confidence

While there’s more you can learn as educational examples from the charts above, I wanted to focus on the lessons for breakout and retracement strategies in a powerfully trending stock, along with the importance of combining time frames to fine tune the chart picture.

By Corey Rosenbloom, trader and blogger, AfraidToTrade.com

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