As with all strategies it is how you manage it that counts. A strategy that works in upward trending markets is buying on the dips at the bottoms.
What I mean by this is that nothing goes straight up, often times you will see a stock or position go up and then start to recycle, with a reverse or profit taking.
If the position is going up nicely and you are looking at a price chart you will see the bars (up-ticks) continue to move upwards. If you see the price chart all of a sudden start to move in the downward range you have a change in direction. Look at Figure 6-3. If we say that this is a daily price chart then each one of the bars black or white represent a day’s worth of trading activity.
So in this case you will see that the position has an long-term trend of moving up. Along the way a few road bumps. In this example you really do not see any trend reversals, this is when the price chart will actually show the position heading as much down if not more than upward.
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FIGURE 6-2GBP/USD 180-Minute Chart 2003
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If you look at Figure 6-3 you will see from left to right that the position is consolidating or moving sideways. Often times when you see a position moving sideways and it is at the bottom of the screen the position is look- ing for direction. Usually the position will go up from here. Consolidation of moving sideways is just that. The overall direction of the bars or daily price is really not going up or down but just kind of sitting there in a range.
A range is when the position is say going up to 12 dollars and down to 10 dollars but no further away up or down from those prices.
When you see the consolidation happening at the top of the chart it is usually looking for direction and is often times overbought and will move in a downward direction. Overbought is when you have to many buyers and no sellers. Now there is no more room for it to go up and no one is selling. A shift will usually take place in the direction as profit taking will kick in.
Profit taking is just that investors start taking their profits because the position has gone up nicely over a period of time say daily, weekly, monthly, or yearly. Let’s look at figure 6-3 again and follow along form left to right again. You will see the consolidation period (sideways) movement and then the position finds direction; the buyers start to buy more than the sellers are willing to sell and you have the supply and demand game. That drives the price up until it hits resistance. Often times investors miss the first opportu- nity to get in on the position when it takes off from its consolidation period.
So you have the first run up and profit taking kicks in. The buyers start selling and the sellers start to outweigh the buyers and the position starts to go down. If it is just normal profit taking the position will go down looking for some support. The support is simply where the buyers think there is a good deal and start buying again. We will cover support in more detail. All of a sudden you have more buying than selling and the position starts to go up again; at this point you will see the chart start to move back in a positive direction. It is at this time a dip has occurred and you have an additional opportunity to buy back in.
Now looking in Figure 6-3 you will see a long run-up period were the position just looks like it is going straight up. There really are no opportu- nities to get back in as there are no definable dips in the price. And if you look at the top just to the left you will see that as the position seems to have hit some resistance it starts to consolidate a bit. The price moves sideways.
Some investors will see this as a small dip in price and an opportunity to get in the position. What usually happens is that the position will move up slightly and then correct a bit before going back up.
The difference between profit taking and correction is that profit tak- ing is usually only for a brief period and the position will move down
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toward its near term support (not very far from its last high). A correction is where the position has run up pretty strong and then turned around sig- nificantly not enough to change the overall direction of the trend but enough to give back a large portion of your profits. This is one reason that I really talk about money management. Good money management will pro- tect your downside when the position goes into a correction. A correction can be classified as a percentage of the last move up to what it can be expected to go down. So if the position goes up say 10 dollars and then goes back down 5 dollars before going back up again you would have had a 50 percent retracement.
So buying on dips gives an investor numerous opportunities to add to their positions or get in on the trade.
Figure 6-3 illustrates this concept.