technical analyst-some basic...
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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.