cheat sheet john murphy

7/30/2019 Cheat Sheet John Murphy

http://slidepdf.com/reader/full/cheat-sheet-john-murphy 1/23

Rapping up John Murphy

1. Dow Theory

a. Averages discount everything – price reflect past, present & future

b. 3 Trends- Primary , Secondary, Minor

c. Major Trend 3 phases =Accumulation, Public Participation , Distribution d. Averages Confirm each other-

i. Both averages must exceed a previous peak

ii. Moving average serve as confirmation of a trend

iii. Covered in Continuation pattern

e. Volume must confirm the trend

f. Law of Physics- Trend in effect, until definite signal shows a reversal

g. Closing Price & Lines-

i. Averages > Previous High = Significance

ii. Intraday omit

2. Criticism

a. Miss 20-25% of a move

b. Self fulfilling prophecy

3. Trend has 3 direction

a. Up, down, ranging

b. Indicators work poorly during ranging times

c. Dow Theory definition of trend –last 1 year

4. S/R

a. longer prices trade @ S/R, more significant

b. Volumec. More recent, more potent

d. Determine how many percent penetration rate of S/R

e. Importance of Round Number =psychological

5. TL

a. 3 point TL- 3rd confirms it

b. Significance- test frequency, time frame

c. Closing beyond TL

d. Price Filter- 3% penetration for Long Term, 1% for short term

e. Time Filter- Close beyond TL for 2 days

f. 3 TL broken = Strong Trendg. 3 is a Magic Number

h. 45 degree TL are the best = prices and time are advancing in a balancing

manner

6. Channel

a. Unexpected reversal within channel = weakening trend, channel might be

broken



b. Broken channel = Prices will travel an equal amount to the width of broken

channel

7. Retracement

a. Gann – 38, 52, 60

8. Speedline

a. Gap of a trend- divide by 3 parts

b. Fibo line

9. Gaps = Areas where no trading happened. Opening above or below the

closing price

a. Common Gap

i. Uneventful

ii. can be caused by a stock going ex-dividend when the trading

volume is low

iii. Price will close the gap

iv. Worsen by low trading volume b. Breakaway Gap = Major Breakout, heavy volume

i. Happens at the completion of an important price patterns

ii. Signal of a beginning of an IMPORTANT market move

iii. After TOPPING OR BASING pattern, happens very often with

breaking of S/R

iv. Heavy volume, less likely to fill the gap. (too bullish or bearish)

v. also act as S/R

vi. Close below upward gap = Weak, vice versa

c. Runaway Gap/ Measuring = Occurred @ midway point.

i. move effortlessly with moderate volumeii. Show of strength. Act as S/R. Gap X2 as projection

iii. Close below upward gap = Weak, vice versa

d. Exhaustion Gap

i. Very likely to appear after Breakaway and Runaway

ii. Leap and reverse

iii. high volume and large price difference

e. Island Reversal Pattern

i. Exhaustion +Breakaway

ii. Reversal

10. Price Patterns

a. Criteria

i. Prerequisite- Existence of a prior trend

ii. First Signal- Breaking of an important TL

iii. Larger the pattern, greater subsequent move

iv. Topping patterns shorter in duration, more volatile than bottom



v. Bottoms have smaller price range and longer to build

vi. Volume important on upside

b. H&S

i. Left shoulder heavier volume

ii. Rally new high with lighter volume

iii. Right shoulder with lower volume

iv. Shoulders have lighter volume than the head

v. Return move = a retest @ the broken neckline

c. The importance of Volume

d. Inverse H&S

i. Requires more volume to break neckline to launch a bull rally

ii. Volume: left shoulder heavier, Head lower, Right lighter

iii. Return move happens on light volume

iv. Uptrend happens on heavier volume

e. Necklinei. slope is sign of market weakness

ii. rising neckline is market strength

iii. tilting neckline is

f. Complex H&S

i. Single left shoulder indicates Single right shoulder

ii. Tactics: Buying usually starts @ Right shoulder

iii. Failed H&S = Neckline re-cross again

**Lessons: Keep Trading losses small, exit losing trade ASAP**

11. 3X TOP & BOTTOMa. Heavy UPSIDE volume on the completion of a bottom

b. Each subsequent peaks should have lighter volume than before

c. Volume more important on the upside breakout

d. Price Objective = Height of the Pattern

12. 2X TOP & Bottom

a. height measured from middle trough



b. volume lighter on second peak

c. return back to lower line not unusual

d. Ideal Top/ Bottom always have same height

e. Filters: Close beyond previous peak, close two days above the resistance

as valid penetration, Friday close above the peak, VOLUME

f. Sign of False breakout from previous peak: breakout with false volume,

subsequent decline on large volume

g. Size of pattern. Longer time period btw two peaks, greater height of the

pattern, greater the impending reversal

13. Saucers and Spikes

a. Marks major turn

b. V reversal – high volume, hard to spot in advance

c.

14. Continuation Patterns

Reversal Pattern takes longer to build Continuation has a shorter term

a. Triangles

Intermediate terms

Usually a continuation pattern

Can be reversal pattern as wel

Ascending ∆: Bull

Descending ∆: Bear

b. Symmetrical ∆:

Each Line must be touched twice

Trend should break out between 2/3 or 3/4 of the triangle

Penetration of Upper TL = Bull

If remain within ∆ beyond 3/4 = losing potency= drift out apex or beyond

o Assume width 20 weeks long, breakout should be between 13 th to

15th

week

o Apex act as an important S/R

o Minimum penetration = closing price outside S/R

o Volume : Volume should decline within the ∆

Should increase during penetration of TL

Volume more important on upside than downside

Uptrend bounce should have heavier volume

Measuring:

o Widest Height, measured from breakout point



o Draw parallel TL to the lower TL of the triangle

c. Ascending/ Descending ∆:

More bullish than symmetrical Same measuring technique

Continuation & Bottoming pattern

15. Broadening Formation

Rare

Volume expand along with the formation

16. Flags & Pennants

Represent dynamic market move

Preceded by a sharp straight line move

Market pause briefly to catch brief

Flags= sharp line with channel

Pennant= sharp line with symmetrical ∆

Volume= dry up

Timeframe= short term= within 1-3 weeks

Bearish= faster to develop =1-2 weeks

17. Wedge

Similar to ∆ but with noticeable slant upside or downside

Up slant= bear, Down slant= bull

Continuation pattern

18. Rectangle Formation Channel/ ranging

Market consolidation

Can be continuation and consolidation pattern

Oscillators are useful for ranging

Project distance from the measuring height



19. Continuation H&S pattern

Broken neckline= continuation

20. Confirmation & Divergence

All indicators agree on the direction

Divergence is the opposite. Eg: Price breaks previous high with low volume

FUTURES INDICATORS

21. Volume & Open Interest

Volume not used on monthly chart Open Interest= total outstanding long & short

Open Interest

if both buyers are sellers are initiating new positions, open interest

increases.

If both are liquidating, open interest decreases

One liquidate , one initiate = stays the same

22. Volume

= intensity & pressure

Volume should increase or expand in the direction of the price trend (as

confirmation)



23. Volume Indicators

OBV (On Balance Volume): Confirm the quality of the current trend

o Volume is assigned +/- depending on the closing is higher or lower

o Higher price= plus vice versa

o The trend > numbers

o By right should have the same direction as the price trend

o Cons: poor representation of the price by only using closing price

o Sophisticated OBV: greater weightage to days with bigger movements,

less for smaller movements, Money Flow Indicator = sophisticated OBV

o Futures volume one day lag

o Futures can reach limit up on light volume, bad indication of a rally

24. Open Interest

Prices increase + total open interest increasing= bullish

Price increase + open interest decline = short coverings (bear) Price decrease + total open interest increasing = bearish

Price decrease + open interest decline = bull

25. Commitment Reports

Twice a month= mid month & month’s end

Breaks down open interest into: hedge fund, speculators, small traders

Blowoffs & Selling Climax

Blowoff: occur at market top, with lower open interest. Rally after long advance Selling climaxes: Prices drop sharply on heavy trading activities

Trader’s commitment

Divides open interests into 3 categories= large hedgers, large speculators, and

small traders

Watch the commercials

Watch what the big boys are doing

Open Interest in Options

Put/Call ratio

Put/Call open interest, volume

o Higher Call Volume = Bullish

o Higher Put Volume= Bearish

o



Long term Charts

Weekly & monthly chart

Charts for Contracts with expiry are linked together, known as continuation chart

o Problems:

Contracts trading premium or discount, causing big jumps duringrollover

Extreme volatility before expiration

o Solutions:

Stop plotting the nearest contract month a month or two before it

expires

Avoid using the nearest contract, chart second or third contract

instead

Chart the contract with the highest open interest, spot month is

supposed to be the truest representation of value

Linking specific calendar month: eg. Nov 2011-Nov2012

Perpetual Contract: taking a weighted average of two other prices

Long term Trends disputes Randomness

Should Long term Charts adjust for inflation? NO

o Reason : market has already made the necessary adjustment

o Price action discounts everything

Long term charts are not meant for trading purposes

MOVING AVERAGES

Variation: MA of closing, of daily average & (high+vwap+low)/3

Simple MA:

o Arithmetic mean

o Criticism: only cover days specified, equal weightage on all days

Linearly Weighted MA:

o (First day closing X 1 + 2nd

Day Closing X2….)/(1+2+3….)

o More recent the closing, higher the weight

o Problem: Lagging, only include Price action covered by the length of the

calculation Exponential Smoothed MA

o Greater weight to most recent data

o Less weightage for last day, Higher weightage for recent days

Shorter MA:

o Pro: Faster Entry

o Cons: Many False signal



Longer MA:

o Longer MA is stronger if the trend supports it

o Shorter MA good for detecting reversals

Popular Combinations

o 5-20, 10-50 (Futures Trading)

o 4-9-18 (Futures Trading)

MA Envelope

o Used to measure how far apart the Price Action strayed away from the MA

o Longer MA> Higher % of envelop. Eg. 21 days >3% Envelope

Boilinger Band

o Developed from Envelope

o Common: 20 days, 2 Std Dev

o Measures how dispersed is the price away from the Average Value

o Measures Volatility for the last 20 days (everchanging). Envelopes are

constant 3%) Rising Volatility = Widening Band

Band is wide apart= end of the trend

o Works best with Overbought / Oversold Oscillators

Centering the average

o Placing it in the middle of the period covered. Eg 10 day average plotted

five days back

o Cons: Producing much later trend change signal



o Cyclic analyst uses it to isolate underlying market cycle

Moving Averages tied to cycles

o There is relationship between trading cycles of stock and MA

o Certain prices will return to the MA at a particular pattern. Eg. 20 days MA

= trading days for 1 month

o Cycles are related to each other harmonically, the next longer cycle is

double the MA & vice versa

o Explains the preference of: 5, 10, 20 MA

MA in Long term Charts

o Popular: 10-13 SMA, 30-40 SMA

o Fibo related MA: 21 days SMA, 13 week SMA

o 10-40 week SMA tracks the primary trend on futures

Pros & Cons of MA

o Pros: Trend following, signals that are easy to follow, Works best during

trending periodo Cons: Not applicable during ranging

The 4 week rule

o Weekly Price Channel or The Weekly Rule

Oscillators & contrary options

good for ranging period

can be useful for trending period given combined with other indicators

warn of trend losing momentum

Overbought / Oversold position Crossing of midpoint can give important signals

Momentum

o rate of change of price @ X number of days

o latest closing price > 10 days ago, positive value would be assigned above

0, vice versa

o Crossing 0 line- trading signals

o Leading indicator- ahead of price action. Breakout on Momentum occurs

earlier actual chart

o Used along with Long term MA to confirm trend

o Resistance line from the past can be drawn to identify overbought position

Rate of Change (ROC)

o 100(V/Vx). 100 is index point = no change

Constructing Oscillators with 2 MA

o Short MA x Long MA

o The distance between both MAs are registered as histogram bars with +

or -



o Function

Spot divergence

Spot overbought/ oversold positions

Crossing of MA will be reflected in the Histogram. Eg. Short cross

above Long = +

o Previous resistance will indicate overbought or oversold position

Commodity Channel Index (CCI)

o Measures difference between Price Action and MA

o Then divided by divisor

o Above +100= buy, Below -100= sell. 20days MA (Recommended by

founder)

o Chartist prefer to use it as Overbought & Oversold positions

RSI

o 70 Overbought, 30 Oversold

o 100- 100/(1+RS)o RS= Average of x up days/ average of x down days

Stochastic

o %K=100 [(C-L14)/(H14-L14)]

o Measures % basis of 0 to 100 where the closing price is in relation to the

total price range

o >80 = overbought, <20 = Oversold

o %D line = 3 period MA = fast stochastic. Smoother slow, reliable signal

o %K line- faster

o Best combined with RSI

o Sell = K (faster) below D (slower) @ Overbought >80. Vice versa

o Can be used on weekly chart

Larry Williams %R

o Measuring latest close in relation to its price range over number of days

o (High- Today’s Close)/ Total range of the same period

Usefulness of Oscillators

o Good during ranging

o Bad during trending/ early stage of trending. Oscillators stay at overbought

position very long

MACDo Oscillators plus MA convergence/ divergence

o Can be used with TL

o MACD line (faster) = diff btw 12 day & 26 day MA

o Signal (slow) = 9 day MA

o Histogram = diff between signal line & MACD = momentum.



Contrarian opinion on Futures

Some form of psychological analysis

Determining the degree of bearishness and bullishness

When majority agree on something, they are generally wrong

Market letters poll is taken to gauge market sentiment

Bullish consensus 75% & above = overbought, 25% and below= oversold

Contrary opinion measures remaining buying and selling power

Full commitment on bullish= overbought = no more fund to commit

Assumed to already taken their position

Question: who is left to push the market higher?

If market sentiment is too one sided, no more buying pressure left

Assume 20% are short, Shorts must be very well financed to handle the long (

variable margins)

Shorts are well capitalized = strong hands The other 80% are small traders with small position = weaker hands

55 % equilibrium, 90% 20% are extreme

Open Interest SIGNIFICANT- contrarian opinion should not be taken when

OPEN INTEREST increase

o Study Trader’s commitment report

o Contrary opinions works best when most open interest are held by weaker

hands

o Contrary Opinion works best when Large Hedgers is on the minority side

Watch the news

o Failure to react to bullish news = overbought

o Vice versa

Contrarian opinion can be combined with other indicators

Point & Figure

X rising, 0 declining

Indicates the range prices were frequently trading

Can be used for trading

Buy signal when X rises above previous high

Advantage

o Precision and ease recognizing trend signals

o Flexibility – customize for shorter trend trading

Larger the boxes needed to be overcome, less sensitive for PF

chart

Customized box size



Elliott Wave

5 waves up, 3 waves down (uptrend) or 5 waves down, 3 waves up (down trend)

Depending on degree, each wave can be part of a bigger wave (5 wave up=

Wave 1, 3 wave down= Wave 2)

Corrective Waves

o Zig Zag

Against major trend: 5 trend, 3 correction, 5 trend (5-3-5)

o Flats

Follows 3-3-5

Normal flat: top Wave of B exceeds top of Wave A, wave C breach

bottom Wave A

Wave B reaches Wave A, Wave C fails to breach Wave A

o Triangles

Happen during 4th wave

Precede final move before major trend

Triangles are bullish and bearish indicators:

Bullish due to signal of resumption of trading

Bearish due to indication of peak by Elliott Wave

Elliott has 4 diff triangles

Ascending

Descending

Symmetrical

Expanding

Minimum requirement= 4 points. 2 points for each converging TL

Triangle fails sometimes because the Triangle breakout is usually

the 5th

wave

The Rule of Alternation

o Market doesn’t act the same way two times in a row

o If Wave 2 is a simple pattern (a-b-c), Wave 4 will be a complex pattern

o Vice versa

Channeling

o Draw Support channel from the bottom of Wave 1 & 2, parallel it as a

Resistance

o If Wave 3 exceeds channel, channel needs to be redrawn Wave 4 as significant support

o After 5 wave up, the bear market (a-b-c) won’t move below Wave 4(bull 1-

2-3-4-5)



Fibonacci Numbers

Market moves according to Nature’s Law – golden ratio 1.618

62%, 38%, 50%

Fibonacci Time Target

Fibo and time relationship exists

13th, 21th, 34th, 55th, 89th trading days are usually important turning points

Elliott in Stocks & Commodity

Wave 3 EXTEND in stocks, Wave 5 EXTEND in Commodities

RULE: Wave 4 can never breach Wave 1

o Applicable in stocks

o Not applicable in Commodities

Time Cycles

Philosophy: Summation, Harmonicity, Synchronicity & Proportionality

Summation

o Addition of all active cycles

o All price patterns are formed by interaction of two or more cycles

o Length of a cycle A + Length of Cycle B = Cycle C

o Just a theory

Harmonicity

o Neighboring waves are related by a small whole number

o Eg. 20 day cycle, neighboring short cycle =10, long =40o 4 week rule: 2 week short, 4 week long

Principle of Synchronicity

o Wave of different lengths to bottom at about the same time

o Correlation in action

Principle of Variation

o Variation does occur

Principle of Nominality

o There seems to be a structure in the cycles move

Cycles + TA

Explains the turns in Double Top, H&S

Synchronizing MA with cycles

Dominant Cycles

o Easy to identify

o Of real value for forecasting



o Analysis should always start from higher timeframe to lower

Kondratieff Wave

o 54 year wave

Combining cycles lengths

o Weekly 3 to 6 months is most useful = intermediate trend

o 4 week – short trend,

o 10 day alpha beta cycles

Importance of Trend

o Trend of each cycle is determined by the direction of the next longer cycle

28 days trading cycle

o Important: 28 day trading cycle-tendency to form a trading cycle low every 4

weeks

o 28 days= 4 weeks

Left & Right Translation

o Shifting cycle peaks at either left or right of the ideal mid cycle point

o 20 day cycle, by right the peak should happened in the middle, 10 day cycle

o Most variation happen at peak not at trough

o If trend us up, crest shifts to right of ideal midpoint, vice versa



Isolating Cycles

Isolate cycles to study cause and effect on different market

The point is seasonal cycle exists Soybean, seasonal tops between April & June. Seasonal bottom @

August & October

February Break – grain and soybean usually drop from late

December or early Jan into Feb

Copper: shows strong uptrend from Jan/ Feb with tendency to top

in March or April

Silver has a low in Jan with high prices into March

Gold bottoms in August

Petroleum peaks during October

USD bottoms @ Jan Treasury Bond hit high @ Jan

Stock: strongest Nov through Jan

January Barometer

o Jan will determine what kind of year the market will have

Presidential Cycle

o 4 years



o 1st

election year is normally strong

o Post election and mid years (2& 3) weak

o Pre-election is normally strong

TA + Cycles (2)

MA & Oscillators

For Oscillators, use half of the cycle

Maximum Entropy Spectral Analysis (MESA)

Cycles aren’t static, but ever changing

MESA optimizes MA & oscillator type indicators

Distinguishes Market in Cycle mode or Trending mode

Cycle then use oscillators, Trend use MA

Computer & Trading System

Welle’s Wilder popular system

o Directional Movement Indicator, Parabolic System

Parabolic SAR

o SAR= Stop and Reverse

o Position is reversed when protective stop is hit

o Trend -friendly

o Works like a trailing stop

o As trend grows stronger, dots grow stronger as well, vice versa

o Backed by acceleration factor

DMI & ADX

o ADX

Rising ADX = trending

Measures degree of directional movement

Scale 0-100. 40 confirms weakening of trend, crossing above 20

confirms the resumption of trending phase

Trend trader’s fav, trade stocks with high ADX rating

o DMI

Used on its own or filter for Parabolic Trending friendly

Pros and Cons of System Trading

No emotion

Discipline

Consistency is possible



Trend traders

Participation is guaranteed in the direction of every trend

Hold on profits

Minimize loss

Disadvantage

Rely highly on major trends

Not profitable when market is not trending

Only exits if the trend is confirmed reverse (lagging exit strategy)

Trading Successfully

Price forecast

Timing

Money management = survival

o Max 50 % for total investment (eg bonds)

o Crucial for Futures since it is leveraged

o Max 10-15% for commitment in one market for margin. Shouldn’t place

too much capital in one trae

o 5% cut loss if the idea did not work. 100,000 should not risk more than5000 on a single trade

o 20-25% total commitment in one market

Diversification vs Concentration

Diversification might dilute profits

Diversify in negatively correlated markets

Protective Stop/ Stoploss

Must be placed consideringo Money management

o Volatility of the market

o Characteristic of the chart

Risk & Reward

At least 3 to 1



Averaging

Average down or average up?

Trading breakouts

Trading breakouts increases the odds of making bad trade

Waiting for actual break increases the chance of winning

o Waiting can make u miss the market as well

Trendline Breakout

Most useful entry and exit strategy

S& R Breakout

Set stop loss under support, vice versa

Fibo Retracement

40%-60% are good for long position or averaging

Price Gaps

Use as S/R



Bonds vs Stocks

Influenced by interest rate

Move opposite of interest rates due to falling yield

Stock will follow suit

Bonds vs Commodities

Commodities are leading indicator of inflation & USD

Commodity trend opposite of bond

Commodities vs USD

USD up, commodity down

USD depreciate= inflation, commodity up

Stock Sectors

Bonds up, interest rates down, commodities weako Financial, consumer, utilities will be up

Dollars vs Big Cap

Dollar up, too expensive for foreign buyers

Small cap might do better than big cap



Relative Strength Analysis

Plot two markets in terms of ratio

Top Down Market Approach

Study overall market, then determine the stock to enter

Select sectors that have the highest relative strength

cheat sheet john murphy

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