- Map the Trends
Study
long-term charts. Begin a chart analysis with monthly and weekly charts
spanning several years. A larger scale map of the market provides more
visibility and a better long-term perspective on a market. Once the long-term
has been established, then consult daily and intra-day charts. A
short-term market view alone can often be deceptive. Even if you only trade the
very short term, you will do better if you're trading in the same direction as
the intermediate and longer term trends.
- Spot the Trend
and Go With It
Determine
the trend and follow it. Market trends come in many sizes – long-term,
intermediate-term and short-term. First, determine which one you're going to
trade and use the appropriate chart. Make sure you trade in the direction of
that trend. Buy dips if the trend is up. Sell rallies if the
trend is down. If you're trading the intermediate trend, use daily and
weekly charts. If you're day trading, use daily and intra-day charts. But in
each case, let the longer range chart determine the trend, and then use the
shorter term chart for timing.
- Find the Low and
High of It
Find
support and resistance levels. The best place to buy a market is near
support levels. That support is usually a previous reaction low.
The best place to sell a market is near resistance levels. Resistance
is usually a previous peak. After a resistance peak has been
broken, it will usually provide support on subsequent pullbacks. In other
words, the old "high" becomes the new low. In the same way, when a
support level has been broken, it will usually produce selling on subsequent
rallies – the old "low" can become the new "high."
- Know How Far to
Backtrack
Measure
percentage retracements. Market corrections up or down usually retrace a
significant portion of the previous trend. You can measure the corrections in
an existing trend in simple percentages. A fifty percent retracement of a prior
trend is most common. A minimum retracement is usually one-third of the prior
trend. The maximum retracement is usually two-thirds. Fibonacci retracements of
38% and 62% are also worth watching. During a pullback in an uptrend,
therefore, initial buy points are in the 33-38% retracement area.
5.
Draw the Line
Draw
trend lines. Trend lines are one of the simplest and most effective
charting tools. All you need is a straight edge and two points on
the chart. Up trend lines are drawn along two successive lows. Down trend lines
are drawn along two successive peaks. Prices will often pull back
to trend lines before resuming their trend. The breaking of trend
lines usually signals a change in trend. A valid trend line should be
touched at least three times. The longer a trend line has been in
effect, and the more times it has been tested, the more important it becomes.
6.
Follow that Average
Follow
moving averages. Moving averages provide objective buy and sell signals. They
tell you if existing trend is still in motion and help confirm a trend change.
Moving averages do not tell you in advance, however, that a trend change is
imminent. A combination chart of two moving averages is the most popular way of
finding trading signals. Some popular futures combinations are 4- and 9-day
moving averages, 9- and 18-day, 5- and 20-day. Signals are given when the
shorter average line crosses the longer. Price crossings above and below a
40-day moving average also provide good trading signals. Since moving
average chart lines are trend-following indicators, they work
best in a trending market.
7.
Learn the Turns
Track
oscillators. Oscillators help identify overbought and oversold markets. While
moving averages offer confirmation of a market trend change, oscillators often
help warn us in advance that a market has rallied or fallen too far and will
soon turn. Two of the most popular are the Relative Strength Index (RSI)
and Stochastics. They both work on a scale of 0 to 100. With the RSI,
readings over 70 are overbought while readings below 30 are oversold. The
overbought and oversold values for Stochastics are 80 and 20. Most traders use
14-days or weeks for stochastics and either 9 or 14 days or weeks for RSI.
Oscillator divergences often warn of market turns. These tools work best
in a trading market range. Weekly signals can be used as filters on
daily signals. Daily signals can be used as filters for intra-day charts.
8.
Know the Warning Signs
Trade
MACD. The Moving Average Convergence Divergence (MACD) indicator (developed by
Gerald Appel) combines a moving average crossover system with the
overbought/oversold elements of an oscillator. A buy signal occurs when the
faster line crosses above the slower and both lines are below zero. A sell
signal takes place when the faster line crosses below the slower from above the
zero line. Weekly signals take precedence over daily signals. An MACD histogram
plots the difference between the two lines and gives even earlier warnings of
trend changes. It's called a "histogram" because vertical bars are
used to show the difference between the two lines on the chart.
9.
Trend or Not a Trend
Use
ADX. The Average Directional Movement Index (ADX) line helps
determine whether a market is in a trending or a trading phase.
It measures the degree of trend or direction in the market. A rising ADX line
suggests the presence of a strong trend. A falling ADX line suggests the
presence of a trading market and the absence of a trend. A rising ADX line
favors moving averages; a falling ADX favors oscillators. By plotting the
direction of the ADX line, the trader is able to determine which trading style
and which set of indicators are most suitable for the current market environment.
10.
Know the Confirming Signs
Include
volume and open interest. Volume and open interest are important confirming
indicators in futures markets. Volume precedes price. It's
important to ensure that heavier volume is taking place in the direction of the
prevailing trend. In an uptrend, heavier volume should be seen on up days.
Rising open interest confirms that new money is supporting the prevailing
trend. Declining open interest is often a warning that the trend is near
completion. A solid price uptrend should be accompanied by rising volume and
rising open interest.
"11."
Technical
analysis is a skill that improves with experience and study. Always be a student
and keep learning.
-
John Murphy
