Which way the market will go? How far up or down? And when he changes direction? Here are the basic questions for a technical analyst. Besides charts, graphs and mathematical formulas, used in the analysis of market trends, there are some basic concepts, applicable to most theories, used by today's technical analysts.
John Murphy, leader in technical analysis of futures markets, based on his thirty years of experience, he developed ten basic laws of technical trading: regulations, which are intended, to help explain the general idea of technical trading to a beginner and simplify the trading methodology to a more experienced practitioner. These prescriptions define the key technical analysis tools., and also then, how to use them, to identify selling and buying opportunities.
Mr. Murphy was a technical analyst for CNBC, hosted a popular show for seven years “Tech Talk” and is the author of three bestsellers in the subject. – Technical Analysis of the Financial Markets, Intermarket Technical Analysis и The Visual Investor.
His latest book demonstrates essential “visual” elements of technical analysis. The basic principles of Mr. Murphy's approach to technical analysis illustrate how, more importantly, to define, where is the market going (up or down), than why it happens.
Here are Mr. Murphy's ten most important technical trading rules:
1. Trend Map
Examine long-term charts. Start analyzing charts with monthly and weekly charts, spanning several years. Larger scale “market maps” provides better visibility of the long-term perspective in the market. Once the long term trend is established, analyze daily and intraday charts. Short-term performance alone can often be misleading. Even if you only trade on the smallest time frame, You will do better, if you trade in the same direction, as an intermediate and longer-term trend.
2. Identify a trend and follow it
Market trends come in different sizes – long-term, intermediate and short term. First define, what are you going to trade and use the appropriate chart. Make sure, that you are trading in the direction of this trend. Buy below, if the trend is up. Sell at the top, if trend – way down. If you are trading an intermediate trend, use daily and weekly charts. If you – DayTrader, use daily and intraday charts. But anyway, let the longer term chart determine the trend, and then use a shorter-term chart to select when to enter the trade.
3. Find its highs and lows.
Find support and resistance levels. Best place to buy – near support levels. Best place to sell – near the resistance level.. After that, how the resistance line was broken, it will usually be a support on subsequent pullbacks. In other words, old “high” becomes new “low”. In the same way, when the support level was broken, it will usually denote a sell on subsequent rallies – old “low”, may become new “high”.
4. Calculate pullbacks
Measure corrections by percentage. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the correction of an existing trend in simple percentages. Fifty percent retracement of the previous trend is most common. Minimal recovery – usually a third of the previous trend. Maximum recovery – usually two thirds. Fibonacci levels 38 % And 62 % also worth watching. During a pullback in an uptrend, hence, the point of purchase is at the level 33-38 %.
5. Draw the lines
Draw trend lines. Trend Lines – one of the simplest and most effective tools. Everything, What do you want – straight line and two points on the chart. Uptrend lines are drawn at two consecutive lows. Downtrend lines are drawn along two consecutive peaks. Prices will often retrace to the trendline before resuming their trending move. Breaking a trend line usually signals a trend change. A reliable trend line must touch the price at least three times. The longer the trend line is the stronger, and the more she was tested, the more important it becomes.
6. Follow the averages
Follow Moving Averages. Moving averages provide objective buy and sell signals. They will inform you, that the current trend is still valid, and help to confirm its change. However, moving averages will not tell you in advance, that a trend change is inevitable. Chart of a combination of two moving averages – the most popular way to detect trading signals. Here are some popular combinations – 4- and 9-day moving averages, 9- and 18 day, 5- and 20 day. Signals are given, when the shorter centerline is crossed by the longer. Price crossovers above and below the 40-day moving average also provide good trading signals.. Since the moving average lines – trend following indicators, they perform best in emerging markets.
7. Examine reversals
Watch out for oscillators. They help to determine whether the market is overbought and oversold.. While moving averages confirm trend reversal, oscillators will often warn us in advance, that the market has risen or fallen too much and will turn around soon. Two of the most popular – Relative Strength Index (RSI) и Stochastics. They both operate on a scale from 0 to 100. For RSI, values over 70 mean overbought, while the values are below 30 – Oversold. Overbought and oversold for Stochastics – 80 And 20. Most traders use 14 day or weekly stochastics and 9 or 14 daily or weekly RSI. Oscillator divergences often warn of market reversals. These instruments work best in a trading range.. Weekly signals can be used as filters on daily signals. Daily signals can be used as filters for daily charts.
8. Remember warning signs
Trade on MACD. Indicator (MACD) Convergence / Moving Average Divergence (founded by Gerald Appel) combines moving average crossovers into a system with overbought / oversold oscillator elements. Buy signal arrives, when the faster line crosses the slower from the bottom up and both lines – Below Zero. Sell signal takes place, when the faster line crosses the slower from top to bottom above the zero mark. Weekly alarms take priority over daily alarms. The MACD histogram is plotted on the difference between these two lines and gives even earlier warnings about a trend change. She is named “histogram”, because vertical stripes are used, to show the difference between these two lines in the diagram.
9. Trend or not?
Use ADX. Average Directional Movement Index (ADX) will help determine, whether the market is trending or in a corridor. ADX measures the degree of the trend or direction of the market. A rise in the ADX line suggests the presence of a strong trend. The fall of the ADX line suggests the presence of a corridor and the absence of a trend. A rise in the ADX line suggests using moving averages; fall of ADX – oscillators. By plotting ADX lines, trader able to identify, which trading style and which set of indicators is most appropriate for the current market situation.
10. Remember the confirmations
Includes volume and open interest. Volume and open interest – important confirmation indicators in the markets. Volume precedes price. It is important to guarantee, that more volume takes place in the direction of the prevailing trend. In an uptrend, more volume should be seen on growth days. Increased open interest confirms, that the new money supports the prevailing trend. Decreased open interest – often warns, that the trend is near its end. An uptrend should be accompanied by rising volume and rising open interest.
Technical analysis – skill, improving with experience and study. Always be a student and keep learning.
