Technical analysis is the study of past market action to try to gauge what the market might do in the future. At its most basic, it is the study of price. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes an entirely different approach; it doesn't care about the "value" of a company. Technical analysis is only interested in the price movements in the market.
Technical analysis philosophy: 3 basic tenets
Market action discounts everything
- All known information related to the security is reflected in the price of the stock; this includes fundamental factors
- As soon as new information comes to light it's immediately reflected in the stock's price
Prices move in trends
- In technical analysis, prices of securities tend to move in observable trends with a tendency to stay in the trend
- The trend is considered to be intact until the trend line is broken
- After a trend has been established, the future price movement is more likely to go in the same direction as the trend rather than against it
- The old adage "the trend is your friend" means you should trade in the same direction as the trend
History repeats itself
- Technical analysis is the study of what has happened to the price of a security in the past with the expectation that history tends to repeat itself
- Many of the chart patterns in technical analysis have been used for more than 100 years, and they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves
- The repetitive nature of price movements is attributed to market psychology
Conclusion
When you take away all the bells and whistles, technical analysis is basically a study of supply and demand. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will help enable you to be a better trader or investor. Keep in mind that technical analysis is performed by humans; it’s not an exact science and, as such, is not perfect.
What are charts?
A stock chart is simply a visual representation of a security’s price or index over a set period of time. Any security with price data over a period of time can be used to form a chart for analysis.
On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale. Prices are plotted from left to right across the x-axis with the most recent plot being the furthest right.
Types of charts
Technical analysts use a variety of charts to analyze price movements. The three main types are:
- Line charts
- Bar charts
- Candlestick charts
Line chart
This type of chart is usually used to get a “big picture” view of price movements. The line chart is formed by connecting the closing prices over a specified time frame. Some investors and traders consider the closing level to be more important than the open, high, or low. By paying attention to only the close, intraday swings can be ignored. Today, this type of chart is most commonly seen with mutual fund charts, since they have only closing prices and no intraday movement.
Bar chart
Perhaps the most popular charting method is the bar chart. This type of chart can show the opening, high, low, and closing price of a particular security on a particular day. This can give traders a better idea of how the stock traded throughout the day, or its daily volatility.
The open, high, low, and close are required to form the price plot for each period of a bar chart. The high and low are represented by the top and bottom of the vertical bar. The open and close are represented on the vertical line by a horizontal dash. The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right. One of the main differences between a line chart and an OHLC (open, high, low, and close) chart is that the OHLC chart can show volatility.
Candlestick charts
The third common chart type is the candlestick chart. Many traders like this type of chart because it is similar to an OHLC chart but it can present the information on one particular day’s trading in a quicker, easier-to-read format.
Candlestick charts are very similar to OHLC charts in that they provide the same information, just in a different format. The candlestick is constructed using a horizontal line to indicate the open and close, and a vertical box is made connecting these two lines to form the “body” of the candlestick. A single vertical line is drawn in the middle above the box to show the high and a single vertical line is drawn in the middle below the box to show the low. These are called the “wicks” or “shadows.” The next difference is the color of the body or whether it is filled or not. In traditional candlesticks, if the close is higher than the open, then the body is left hollow (white or green) to indicate an up day in that day’s price action. If the close is lower than the open then the body is closed (black or red) to indicate a down day.
Conclusion
There are many different types of charts available, and one is not necessarily better than the next. The data may be the same to create the chart but the way it is presented and interpreted will vary. Each will have its own benefits and as well as drawbacks. You can choose any type or use multiple types of charts for analysis; it depends on your personal preferences and investing styles.
Trade planning
Planning your Trades.
If you have a written trading or investment plan, congratulations! You are in the minority. While it is still no absolute guarantee of success, you have eliminated one major roadblock. If your plan uses flawed techniques or lacks preparation, your success won't come immediately, but at least you are in a position to chart and modify your course. By documenting the process, you learn what works and how to avoid repeating costly mistakes.
Whether or not you have a plan now, here are some ideas to help with the process.
Disaster Avoidance 101
Trading is a business, so you have to treat it as such if you want to succeed. Reading some books, buying a charting program, opening a brokerage account and starting to trade is not a business plan - it is a recipe for disaster.
Once a trader knows where the market has the potential to pause or reverse, they must then determine which one it will be and act accordingly. A plan should be written in stone while you are trading, but subject to re-evaluation once the market has closed. It changes with market conditions and adjusts as the trader's skill level improves. Each trader should write their own plan, taking into account personal trading styles and goals. Using someone else's plan does not reflect your trading characteristics.
Building the Perfect Master Plan
What are the components of a good trading plan? Here are 10 essentials that every plan should include:
1. Skill Assessment
Are you ready to trade? Have you tested your system by paper trading it, and do you have confidence that it works? Can you follow your signals without hesitation? Trading in the markets is a battle of give and take. The real pros are prepared and they take their profits from the rest of the crowd who, lacking a plan, give their money away through costly mistakes.
2. Mental Preparation
How do you feel? Did you get a good night's sleep? Do you feel up to the challenge ahead? If you are not emotionally and psychologically ready to do battle in the markets, it is better to take the day off – otherwise, you risk losing your shirt. This is guaranteed to happen if you are angry, preoccupied or otherwise distracted from the task at hand. Many traders have a market mantra they repeat before the day begins to get them ready. Create one that puts you in the trading zone. Additionally, your trading area should be free of distractions. Remember, this is a business, and distractions can be costly.
3. Set Risk Level
How much of your portfolio should you risk on any one trade? This will depend on your trading style and risk tolerance. It can range anywhere from around 1% to as much as 5% of your portfolio on a given trading day. That means if you lose that amount at any point in the day, you get out and stay out. It's better to keep powder dry to fight another day if things aren't going your way.
4. Set Goals
Before you enter a trade, set realistic profit targets and risk/reward ratios. What is the minimum risk/reward you will accept? Many traders will not take a trade unless the potential profit is at least three times greater than the risk. For example, if your stop loss is a dollar loss per share, your goal should be a $3 profit. Set weekly, monthly and annual profit goals in dollars or as a percentage of your portfolio, and re-assess them regularly.
5. Do Your Homework
Before the market opens, check what is going on around your Planned Plays. have you done Proper DD on the Plays? Is there a mob of bashers talking about it? do all your planned elements line up for your plays? have you checked the latest news for those plays? besides anyone else telling you something, do you feel this is worth investing in? Plan your Risk according to your found results. going in light is never bad. setting your proper homework. Is the is quick flip? or a long term hold as the markets should reflect a higher value on your best judgment. we all value a dollar differently. Use Common sense.
6. Trade Preparation
Whatever trading system and program you use, label major and minor support and resistance levels, set alerts for entry and exit signals and make sure all signals can be easily seen or detected with a clear visual or auditory signal.
7. Set Exit Rules
Most traders make the mistake of concentrating 90% or more of their efforts in looking for buy signals, but pay very little attention to when and where to exit. Many traders cannot sell if they are down because they don't want to take a loss. Get over it or you will not make it as a trader. If your Mental stop gets hit from your emotional panic, it means you were wrong in your mind. Don't take it personally. Professional traders lose more trades than they win, but by managing money and limiting losses, they still end up making profits. your panic Loss can be another buyers dip. so please judge respectfully as we all can be wrong on a trade not going our way.
factors are Dilution, insiders dumping early entry trades. profit taking, or someone knows bad news, and people as a group follow the action. be prepared mentally for anything. always think of your exit plan, taking profits is to early is much better then panic selling into the bid. as a rule i never reenter the same play, unless its much cheaper then my last profit taking exit. There is endless other plays that cross our path.
Before you enter a trade, you should know where your exits are. There are at least two for every trade. First, what is your stop loss if the trade goes against you? It must be written down. Second, each trade should have a profit target. Once you get there, sell a portion of your position and you can move your mental stop loss on the rest of your position to break even if you wish. As discussed above, never risk more than a set percentage of your portfolio on any trade. After a play has made a big run, sell your initial investment. let free shares ride as that's your profit doing its thing, manage it accordingly, but at least you got your money back, while your remaining shares are working for free.
8. Set Entry Rules
This comes after the tips for exit rules for a reason: Exits are far more important than entries. A typical entry rule could be worded like this: "If signal A fires and there is a minimum target at least three times as great as my stop loss and we are at support, then buy X contracts or shares here."
Your system should be complicated enough to be effective, but simple enough to facilitate snap decisions. If you have 20 conditions that must be met and many are subjective, you will find it difficult if not impossible to actually make trades. Computers often make better traders than people, which may explain why nearly 50% of all trades that now occur on the New York Stock Exchange are computer-program generated.
Computers don't have to think or feel good to make a trade. If conditions are met, they enter. When the trade goes the wrong way or hits a profit target, they exit. They don't get angry at the market or feel invincible after making a few good trades. Each decision is based on probabilities.
Never chase, be careful of Market manipulations on morning Gap ups. always look for the best possible entry on a support line, buy when people are dumping a good play, and you think its based at the bottom, I enter, then sell when a bunch of people start really noticing it and its taking off, let free shares ride. outsmart the basic trader.
9. Keep Excellent Records
All good traders are also good record keepers. If they win a trade, they want to know exactly why and how. More importantly, they want to know the same when they lose, so they don't repeat unnecessary mistakes. Write down details such as targets, the entry and exit of each trade, the time, support and resistance levels, daily opening range, market open and close for the day, and record comments about why you made the trade and lessons learned.
Also, you should save your trading records so that you can go back and analyze the profit or loss for a particular system, draw downs (which are amounts lost per trade using a trading system), average time per trade (which is necessary to calculate trade efficiency) and other important factors, and also compare them to a buy-and-hold strategy. Remember, this is a business and you are the accountant.
10. Perform a Post-Mortem
After each trading day, adding up the profit or loss is secondary to knowing the why and how. Write down your conclusions in your trading journal so you can reference them later.
The Bottom Line
Successful paper trading does not guarantee you will have success when you begin trading real money and emotions come into play. But successful paper trading does give the trader confidence the system they are going to use actually works. Deciding on a system is less important than gaining enough skill to make trades without second guessing or doubting the decision.
There is no way to guarantee a trade will make money. The trader's chances are based on their skill and system of winning and losing. There is no such thing as winning without losing. Professional traders know before they enter a trade that the odds are in their favor or they wouldn't be there. By letting their profits ride and cutting losses short, a trader may lose some battles, but they will win the war. Most traders and investors do the opposite, which is why they never make money.
Traders who win consistently treat trading as a business. While it's not a guarantee that you will make money, having a plan is crucial if you want to be consistently successful and survive in the trading game.
