technical analyst-some basic...

TechnicalAnalyst-SomeBasicRules

q StockCharts.com'sChiefTechnicalAnalyst,JohnMurphy,isaverypopularauthoronthesubjectofTechnicalAnalysis.His“TenLawsofTechnicalTrading”isacollectionofrecommendationsforthosenewtoTechnicalAnalysis.

q Murphy’stenmostimportantrulesoftechnicaltrading:1.  Mapthetrends2.  Spotthetrendandgowithit3.  Findthelowandhighofit4.  Knowhowfartobacktrack5.  Drawtheline6.  FollowthatAverage7.  Learntheturns8.  KnowtheWarningSigns9.  TrendorNotaTrend10.  KnowtheConfirmingSigns

1.MapTheTrends….

Long Term Chart: Corn (Dec 2016) Monthly

Short Term Chart: Corn (Dec 2016) Daily

2.SpottheTrendsandGoWithIt

q  Determinethetrendandfollowit.Markettrendscomeinmanysizes–long-term,intermediate-termandshort-term.

q  First,determinewhichoneyou'regoingtotradeandusetheappropriatechart.Makesureyoutradeinthedirectionofthattrend.

q  Buydipsifthetrendisup.q  Sellralliesifthetrendisdown.q  Ifyou'retradingtheintermediatetrend,usedailyandweeklycharts.q  Ifyou'redaytrading,usedailyandintra-daycharts.Butineachcase,let

thelongerrangechartdeterminethetrend,andthenusetheshortertermchartfortiming.

3.FindtheLowandHighofIt

q Findsupportandresistancelevels.Thebestplacetobuyamarketisnearsupportlevels.

q Thatsupportisusuallyapreviousreactionlow.q Thebestplacetosellamarketisnearresistancelevels.q Resistanceisusuallyapreviouspeak.Afteraresistancepeakhas

beenbroken,itwillusuallyprovidesupportonsubsequentpullbacks.Inotherwords,theold“high”becomesthenewlow.

q  Inthesameway,whenasupportlevelhasbeenbroken,itwillusuallyproducesellingonsubsequentrallies–theold“low”canbecomethenew“high.”.

4.KnowHowFartoBacktrackq Measurepercentageretracements.Marketcorrectionsupor

downusuallyretraceasignificantportionoftheprevioustrend.q Youcanmeasurethecorrectionsinanexistingtrendinsimple

percentages.q Retracementsaretemporarypricereversalsthattakeplacewithin

alargertrend.Thekeyhereisthatthesepricereversalsaretemporary,anddonotindicateachangeinthelargertrend.

q Afiftypercentretracementofapriortrendismostcommon.§  Aminimumretracementisusuallyone-thirdofthepriortrend.§  Themaximumretracementisusuallytwo-thirds.

4.KnowHowFartoBacktrack…q Measurepercentageretracements.Marketcorrectionsupor

downusuallyretraceasignificantportionoftheprevioustrend.

5.DrawtheLineq Drawtrendlines.Trendlinesareoneofthesimplestandmost

effectivechartingtools.Allyouneedisastraightedgeandtwopointsonthechart.

q Uptrendlinesaredrawnalongtwosuccessivelows.q Downtrendlinesaredrawnalongtwosuccessivepeaks.q Priceswilloftenpullbacktotrendlinesbeforeresumingtheir

trend.q Thebreakingoftrendlinesusuallysignalsachangeintrend.q Avalidtrendlineshouldbetouchedatleastthreetimes.The

longeratrendlinehasbeenineffect,andthemoretimesithasbeentested,themoreimportantitbecomes.

5.DrawtheLine…q  Anuptrendlineisastraightline

drawnupandtotheright,connectingsuccessiverisingmarketbottoms.

q  Thelineisdrawninsuchawaythatallofthepriceactionisabovethetrendline.

q  Whileittakestwopointstodrawatrendline,athirdpointisnecessarytoidentifythelineasavalidtrendline.

q  Ifpricesinanuptrenddipbackdowntothetrendlineathirdtimeandbounceoffit,avaliduptrendlineisconfirmed

6.FollowThatAverageq Followmovingaverages(MA).MA’sprovideobjectivebuyandsell

signals.Theytellyouiftheexistingtrendisstillinmotionandtheyhelpconfirmtrendchanges.

q MA’sdonottellyouinadvance,however,thatatrendchangeisimminent.

q AcombinationchartoftwoMAisthemostpopularwayoffindingtradingsignals.q  Popularchoicesare4-and9-dayMA’s,9-and18-day,5-and20-day,15-and50-day.

q Signalsaregivenwhentheshorteraveragelinecrossesthelonger.q Sincemovingaveragechartlinesaretrend-followingindicators,

theyworkbestinatrendingmarket.

6.FollowthatAverage…q  Mostchartpatternsshowalotofvariationin

pricemovement.Thiscanmakeitdifficulttogetanideaofanoveralltrend.

q  Onesimplemethodistoapplyamovingaverage(MA).AMAistheaveragepriceofacommodityoverasetamountoftime.Byplottingtheaverageprice,thepricemovementissmoothedout.

q  Asignalofatrendreversaliswhenonemovingaveragecrossesthroughanother.Forexample,ifthe15-daymovingaveragecrossesabovethe50-daymovingaverage,itisapositivesignthatthepricewillstarttoincrease.

7.LearntheTurnsq Trackoscillators.Oscillatorshelpidentifyoverboughtandoversold

markets.WhileMA’sofferconfirmationofamarkettrendchange,oscillatorsoftenhelpwarnusinadvancethatamarkethasralliedorfallentoofarandwillsoonturn.

q Twoofthemostpopularwhichbothworkonascale0to100:1.  RelativeStrengthIndex(RSI)§  WiththeRSI,readingsover70areoverboughtwhilereadingsbelow30areoversold.

§  Mosttradersuse9or14daysforRSI2.  StochasticOscillator(SO)§  WiththeSO,readingsover80areoverboughtwhilereadingsbelow20are

oversold.§  Mosttradersuse14daysorweeksforSO

q Oscillatordivergencesoftenwarnofmarketturns.

UsingRSI-Overboughtq  Overbought:Atechnical

conditionthatoccurswhenpricesareconsideredtoohighandsusceptibletoadecline.OverboughtconditionscanbeclassifiedbyanalyzingthechartpatternorwithindicatorssuchastheRelativeStrengthIndex(RSI).

q  AcommodityisconsideredoverboughtwhentheRelativeStrengthIndex(RSI)exceeds70.Itisimportanttokeepinmindthatoverboughtisnotnecessarilythesameasbeingbearish.Itmerelyinfersthatthestockhasrisentoofartoofastandmightbedueforapullback

8.KnowtheWarningSignsq TradetheMACDindicator.TheMAConvergenceDivergence

(MACD)combinesamovingaveragecrossoversystemwiththeoverbought/oversoldelementsofanoscillator.

q Abuysignaloccurswhenthefasterlinecrossesabovetheslowerandbothlinesarebelowzero.

q Asellsignaltakesplacewhenthefasterlinecrossesbelowtheslowerfromabovethezeroline.

q Weeklysignalstakeprecedenceoverdailysignals.q AnMACDhistogramplotsthedifferencebetweenthetwolines

andgivesevenearlierwarningsoftrendchanges.It'scalleda“histogram”becauseverticalbarsareusedtoshowthedifferencebetweenthetwolinesonthechart.

UsingMACD-Trends&Momentumq  TheMACDturnstwotrend-following

indicators,MA’s,intoamomentumoscillatorbysubtractingthelongermovingaveragefromtheshortermovingaverage.Asaresult,theMACDoffersthebestofbothworlds:trendfollowingandmomentum.

q  TheMACDfluctuatesaboveandbelowthezerolineasthemovingaveragesconverge,crossanddiverge.

q  Traderscanlookforsignallinecrossovers,centerlinecrossoversanddivergencestogeneratesignals.ThehistogramispositivewhentheMACDLineisaboveitsSignallineandnegativewhentheMACDLineisbelowitsSignalline.

q  PositiveMACDindicatesthattheupsidemomentumisincreasing.

q  NegativeMACDindicatesthatthedownsidemomentumisincreasing.

9.TrendorNotaTrendq UsetheADXindicator.TheAverageDirectionalMovementIndex

(ADX)linehelpsdeterminewhetheramarketisinatrendingoratradingphase.Itmeasuresthedegreeoftrendordirectioninthemarket.

q ArisingADXlinesuggeststhepresenceofastrongtrend.q AfallingADXlinesuggeststhepresenceofatradingmarketand

theabsenceofatrend.q ArisingADXlinefavorsmovingaverages;afallingADXfavors

oscillators.q ByplottingthedirectionoftheADXline,thetraderisableto

determinewhichtradingstyleandwhichsetofindicatorsaremostsuitableforthecurrentmarketenvironment.

UsingADXIndicator-Trending?•  AtitsmostbasictheADXcanbeusedto

determineifacommodityistrendingornot.Thisdeterminationhelpstraderschoosebetweenatrendfollowingsystemoranon-trendfollowingsystem.AstrongtrendispresentwhenADXisabove25andnotrendispresentwhenbelow20.Thereisagrayzonebetween20and25.

•  ThischartshowsNordstrom(JWN)withthe50-daySMAand14-dayAverageDirectionalIndex(ADX).ThestockmovedfromastronguptrendtoastrongdowntrendinApril-May,butADXremainedabove20becausethestronguptrendquicklychangedintoastrongdowntrend.Thereweretwonon-trendingperiodsasthestockformedabottominFebruaryandAugust.AstrongtrendemergedaftertheAugustbottomasADXmovedabove20andremainedabove20.

10.KnowtheConfirmingSigns

q Don'tignorevolume.Volumeisaveryimportantconfirmingindicator.Volumeprecedesprice.

q  It'simportanttoensurethatheaviervolumeistakingplaceinthedirectionoftheprevailingtrend.

q  Inanuptrend,heaviervolumeshouldbeseenonupdays.Risingvolumeconfirmsthatnewmoneyissupportingtheprevailingtrend.

q Decliningvolumeisoftenawarningthatthetrendisnearcompletion.Asolidpriceuptrendshouldalwaysbeaccompaniedbyrisingvolume.

“TradingCharts.com”Legend

FinalThoughtsq  BestofBothWorlds:Thereisnodefinitiveanswerwhethertechnical

analysiscanbeusedasasubstitutionforfundamentalanalysis,thereislittledoubtthatcombiningthestrengthsofbothstrategiescanhelptradersbetterunderstandthemarketsandgaugethedirectioninwhichcommoditiesmightbeheaded.

q  Tradersshouldconsiderbothanalyseswhenformulatingstrategiesintoonemarketoutlook.

q  Markettopsandbottomsareprogressionswhichretrospectivelymaybeobvious,butatthetimeoftheiroccurrenceprovideno“ringingbell”orbuzzertotellyouthatamajorchangeindirectionhasoccurred.Therearenomystical,foolproofindicatorsthatgiveperfectsignals.Theabilitytorecognizeamajormarketchangeindirectionisanevolvingthoughtprocessthatdependsontheevidenceavailable.

q  TechnicalanalysisandJohnMurphy’s10rulesoftradingcanbeutilizedalongwithfundamentalanalysistoprovidemoreinformeddecisionsaboutmarkettrendsandtimingofbuyingandsellingcommodities.