Referring to Figure 5.2, United Technologies goes through the cup and handle pattern before breaking out to the upside strongly with above average volume. To prevent getting false signals or breakouts, the cup should be as wide and round as possible and not a V shape. And the handle should be small and not drag below 50 percent of the height of the cup.

The longer the time it takes to establish the cup formation, the more powerful the rally. And lastly, the breakout should always accompany big volume, which indicates huge buying interest.

In Figure 5.3, Spyglass breaks below a crucial support level, which happens to be its new yearly low, and prices break down.

The Reversal Roles of Support and Resistance

Once price breaks below a support, that support line becomes its resistance. Referring back to Figure 5.3, Spyglass experienced difficulty rising back above the break down point. That support line has become a resistance line. Hence, one should sell short or avoid buying Spyglass once it rises to that line.

Conversely, once price breaks above a crucial resistance line, the resistance becomes the support line. Referring back to Figure 5.2, UTX found support at the breakout point after it has gone through the cup and handle pattern.

Figure 5.2 Stock chart showing a<5up and handle pattern with a breakout to the upside.

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Once again, one should not apply support and resistance strategies blindly to any markets or stocks. Picking the right stocks that work consistently and combining that with other technical tools is the key.

Trendlines-A Popular Tool

Another popular tool is the trendline method. In Figure 5.4, Eli Lilly bounces off support and resistance at points A, B, arid before breaking though D with a strong uptrend. One can draw an upward sloping line frorji left to right below price during this uptrend to find good entry levels. The best way to play an uptrend stock is when the stock occasionally pulls back to or close to its trendline. That will be your buy entry since the trendline is the support line in an uptrend and therefore offers minimal downside risk. The odds are very good if the uptrend is backed by improving or strong fundamentals.

A sell short entry is initiated when price rises to an established strong downtrend line. In Figure 5.3, Spyglass is going through an obvious downtrend. The downtrend line is drawn form left to right above the prices. See how difficult it is for the stock to break above the trendline? The downtrend line is a strong resistance line for this stock and one would sell short the stock once price hits the line or comes close to that line. If the downtrend is accompanied by deteriorating fundamentals in the stock, the odds are even better for a good entry.

Figure 5.4 Stock chart showing support and resistance lines at breakout to the upside.

mechanical Entry methods Using more Advanced Technical Indicators

The Moving Average and the Moving Average Crossover Method

A moving average curve can be defined as the mathematical average price for the past N days. Nine-day and 14-day moving averages are quite popular and widely used. A popular entry method is the moving average crossover method (see Figure 5.5). Moving averages of two different time periods are used. When the shorter time period moving average (solid line} crosses over the longer time period moving average (dotted line), a buy signal is triggered. And when the shorter time period moving average crosses below the longer time period moving average, a sell short signal is activated.

I do not encourage the use of moving averages or moving average crossovers. The simple reason is different people use different time periods for their averages. Some prefer a 15-day average to a 9-day average. Some prefer a 15,10-day crossover to a 14,7-day crossover. It is highly subjective, and the lack of consensus weakens the self-fulfilling prophecy needed as a catalyst to make a technical indicator effective and profitable.

This is true of any technical indicator. An unknown, unfollowed indicator will not be effective and an overly used indicator used in a widely followed market or stock would not be profitable either. You want an indicator with a good degree of consensus in a stock or market not too widely fallowed.