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Technical Analysis
Reference Guide
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04/2015
TECHNICAL ANALYSIS
Welcome
Welcome to the world of technical analysis.
Each topic taught here is designed to build your
confidence in and strengthen your understanding
of the tools available to you. The principles you
will learn are transferable to almost any market
in which there are sufficient buyers and sellers to
create liquidity.
Please download the companion Online Course
slides in PDF format from the Investools
Education Center by clicking on the Adv
Technicals Course icon > click I Agree on the
Disclaimers page > in the left hand menu under
Resources click on Download Slides.
Notes
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TECHNICAL ANALYSIS
1
Technical analysis often involves many different
indicators. The most influential indicator—and
perhaps the most important—is price itself. Many
indicators are derived from price.
Through price, you can recognize candle patterns,
resistance levels, price patterns, support levels and
other helpful insights.
There are three tenets, or principles, of technical
analysis.
1. Market action discounts everything.
2. Prices move in trends.
3. History repeats itself.
Notes
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TECHNICAL ANALYSIS
2
Defining the trend enables you to follow the
prevailing direction of a stock’s price movement. It
is said that “an object in motion stays in motion.”
This principle of motion also applies to stock trends.
Identifying and trading a particular trend is one way
experienced investors put probabilities on their side.
Remember, it is easier to swim with the current than
against it.
Notes
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TECHNICAL ANALYSIS
3
Trend is determined by analyzing a stock’s price on
a chart. Stocks are like waves with regular ebbs and
flows. A stock can rally higher and then pull back,
creating peaks and troughs just like a wave.
Trends occur over various time cycles or time
horizons. Short-term trends are typically days to
weeks. Intermediate-term trends are months to
one year. Long-term trends are more than one
year.
When identifying short-term uptrends, compare
recent and previous highs . When identifying shortterm downtrends, compare recent and previous
lows.
1-2-3 Reversal: When identifying trend reversals,
locate a combination of three higher highs and lows.
Notes
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TECHNICAL ANALYSIS
4
Technicians use relative strength to analyze and
compare stocks to one another or to a benchmark
such as an index or sector. The Relative Strength
indicator default setting compares the chart to the
SPX.
This comparison creates a relative strength line
that can be analyzed as you would analyze any
line on a chart. If the line is rising, the stock has
the strongest relative strength. If the line is falling,
the index has the strongest relative strength.
Notes
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TECHNICAL ANALYSIS
5
It is important to realize that the trend of the relative
strength line is not the same as the trend of the
individual stock or sector. As shown, you can have
rising sectors despite a falling relative strength line.
This simply means the sector is not performing as
well as the SPX that it is being compared to.
Notes
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TECHNICAL ANALYSIS
6
Technicians use many different chart types.
The line chart only plots the closing price for each
period and connects those prices with a single line.
The line chart is used to see trend and support and
resistance levels.
The bar chart tracks the opening, high, low and
closing prices for each period and can be useful
when determining entries and exits.
Candle charts have been used since the 1700s
when they were used in Japanese rice markets. Like
a bar chart, candles show three things: opening
price, trading range and closing price.
As with any investing discipline, it is important to
have a thorough understanding of the basics of
charting and technical analysis to ensure you have a
strong foundation upon which to build. All too often,
investors believe they don’t need to spend as much
time on these basic principles, only to have their
lack of preparation come back to haunt them. Learn
these concepts backward and forward. You’ll be
glad you did.
Notes
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TECHNICAL ANALYSIS
7
BULLISH
Dragonfly Doji: Confirmation not required. May wait
for higher close.
Hammer: Confirmation not required. May wait for
higher close.
Inverted Hammer: Confirmation with higher close.
Bullish Harami: Confirmation with higher close.
Piercing Line: Close above the midpoint.
Confirmation not required. May wait for a higher
close.
Bullish Engulfing: Confirmation not required.
Morning Star (three candles): Confirmation not
required.
BEARISH
Tombstone Doji: Confirmation not required. May
wait for lower close.
Shooting Star: Confirmation not required. May wait
for lower close.
Hanging Man: Confirmation with lower close.
Notes
Bearish Harami: Confirmation with lower close.
Dark Cloud Cover: Close below the midpoint.
Confirmation not required. May wait for a lower
close.
Bearish Engulfing: Confirmation not required.
Evening Star (three candles): Confirmation not
required.
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TECHNICAL ANALYSIS
8
Support and resistance is one of the most important
technical concepts. Support and resistance levels
are price levels that are created by the buying
and selling pressure of investors. Prices tend to
bounce up off support levels and bounce down off
resistance levels. As with all technical principles,
support and resistance levels are not absolute, but
using these levels can help as you try to increase
your probability of a successful trade.
Notes
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TECHNICAL ANALYSIS
9
The concept of support and resistance is relatively
simple. However, identifying appropriate support and
resistance levels is much more involved.
Support is where buying pressure becomes stronger
than selling pressure and is a price level that is
difficult for a stock to penetrate on the downside. It
may be a horizontal or diagonal price level.
In most instances, support levels are important
trading areas. In a downtrend, old support can
become new resistance. Analysts examine past
support levels and, assuming the psychological and
financial conditions that existed in the past still exist,
project where future support levels will be. Investors
then use these projected levels in their future trading
decisions. The more often a stock price bounces off
a support level, the stronger it becomes.
Notes
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TECHNICAL ANALYSIS
10
Resistance is the opposite of support. It is where
selling pressure becomes stronger than buying
pressure and is a price level that is difficult for a
stock to penetrate to the upside.
In an uptrend, old resistance often becomes new
support. It may be either a horizontal or diagonal
price level. Just like support levels, resistance levels
are created by market participants. The more often
a stock price bounces off a resistance level, the
stronger it becomes.
Notes
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TECHNICAL ANALYSIS
11
When support or resistance is established with two
or more touches, high volume should confirm the
breakout. Price typically closes 1% - 3% past the
level.
Price Targets: When price breaks out of a support
and resistance channel, the price difference between
support and resistance can be added to the
resistance price for a bullish price target and can be
subtracted from the support price for a bearish price
target.
Example: A stock trading between support at 45
and resistance at 51 would have a $6 difference. If
the stock breaks out of resistance the bullish price
target is 57. If the stock breaks below support the
bearish price target is 39.
Notes
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TECHNICAL ANALYSIS
12
Another form of support is found in gaps.
BREAKAWAY GAPS
These usually occur after a short-term
consolidation or correction. They generally take
place with above-average volume. These gaps
create a significant level of support or resistance.
RUNAWAY GAPS
These gaps occur while a stock is trending. They
gap in the direction of the trend on average to above
average volume. They signal a very strong trend.
The gap creates a significant level of support. It is
held that these gaps will occur near the middle of a
trend and can be used as a measuring point for a
future target. This is why they are also referred to as
measuring gaps.
EXHAUSTION GAPS
Exhaustion gaps appear at the end of a trend. They
often occur after a runaway gap. Unfortunately,
there is no way to distinguish this gap until the price
closes under it.
Notes
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TECHNICAL ANALYSIS
13
Use gaps as potential areas of support or resistance.
You may find them useful for managing your risk as
areas to adjust stops.
At times it may be beneficial to ignore gaps.
Some potential gaps to ignore are buyouts, ADRs,
commodity gaps and common gaps.
After-hours price action may also create a gap on the
open. A gap may be anticipated if there are tighter
bid/ask spreads in after-hours trading. Gaps created
at the open that are less than 10¢ to 20¢ are often
ignored. Always look for confirmation of the gap with
volume to identify significance.
Notes
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TECHNICAL ANALYSIS
14
Market analysts and technicians have devoted
entire books to Fibonacci retracements and how
they can help identify, and even predict, support
and resistance levels.
Notes
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TECHNICAL ANALYSIS
15
Charles Dow, the first editor of the Wall Street
Journal, made several observations when
developing his theory. One important observation
was that of retracements. He noticed that price
action was likely to retrace to either one-third, onehalf or two-thirds of the previous move.
Today technicians combine Dow’s retracement
observations with Fibonacci’s number sequence.
Notes
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TECHNICAL ANALYSIS
16
Historians credit Italian mathematician Leonardo
Fibonacci with discovering a sequence of numbers
in which each subsequent number in the series is
equal to the sum of the two previous numbers. The
Fibonacci sequence has an interesting relationship
with nature. Sunflower seeds, nautilus shells and
tree branches, for example, all exhibit growth
formations related to the sequence.
Notes
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TECHNICAL ANALYSIS
17
Three important ratios occur between numbers
in the Fibonacci sequence. The first ratio is 38
percent—the ratio between alternating integers
in the sequence. For example, if you divide 21 by
55—the next alternating number in the sequence—
you get 38 percent (21 / 55 = 38 percent). The
second ratio is 62 percent—the ratio between two
sequential integers in the sequence. For example,
if you divide 34 by 55—the next sequential number
in the sequence—you get 62 percent (34 / 55 = 62
percent). The final ratio is 50 percent—a common
retracement level halfway between 38 percent and
62 percent.
Notes
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TECHNICAL ANALYSIS
18
As an investor, you are looking to see where
potential support is. It could be at any of the
Fibonacci levels illustrated on the chart. Watch for
confirmation of a bounce at each level. If the stock
price breaks the 38 percent level, expect to set a
new target at the 50 percent level. If the stock price
breaks the 50 percent level, set a new price target
at the 62 percent level. A support bounce at any of
these levels gives you another chance to decide if
you want to go long.
To see potential support, draw the Fibonacci level
from low to high. To see potential resistance levels,
draw the Fibonacci level from high to low.
Notes
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TECHNICAL ANALYSIS
19
Price patterns are tools for displaying areas of
support and resistance. Price patterns can be
used to project future price direction. Investors
tend to react in predictable ways to various
situations, and price patterns illustrate these
reactions. These formations have been a favorite
tool of technicians for years because they capture
market sentiments and can give specific entry and
exit points.
Notes
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TECHNICAL ANALYSIS
20
To recognize patterns, it is essential to identify
support and resistance levels. Price patterns
are the result of connecting these levels of
consolidation. Once you identify these levels,
the price pattern suggests a specific entry point
and a minimum price target.
When a stock moves above resistance or below
support, it is known as a breakout. It is important
to always trade in the direction of the breakout,
even if it occurs in the direction you didn’t expect.
You will see variations of each pattern as you
learn about trend continuation and trend reversal
signals for each pattern.
As shown, we have organized price patterns into
three groups: flags, triangles and rectangles.
Notes
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TECHNICAL ANALYSIS
21
A flag is a short-term pattern that forms over a few
days or weeks. It can be either bullish or bearish.
Flags often trend in the opposite direction of the
previous trend, which means that bull flags tend to
trend down and bear flags tend to trend up.
Bull flag is a pullback in an uptrend followed by a
support bounce and a trend continuation move.
Bull Flagpole is the price difference from the
previous support low to the recent resistance high
before the flag pullback and is added to the entry
price for the flagpole price target. In this example the
flagpole is about $6.
Bear flag is a bounce in a downtrend that rallies to a
lower high followed by a trend continuation move.
Bear flagpole is the price difference from the
previous resistance high to recent support low
before the flag rally and is subtracted from the entry
price for the bear flagpole price target.
Notes
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TECHNICAL ANALYSIS
22
A pennant is a short-term continuation
pattern that forms over a few days or
weeks and can be either bullish or bearish.
Pennants appear when a stock channels
between symmetrical support and
resistance levels that are sloping toward
one another.
The flagpole is the price difference from
the previous support low to the recent
resistance high before the pennant
consolidation and is added to the entry
price for the price target. In this example
the flagpole is about $3.50.
Notes
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TECHNICAL ANALYSIS
23
An ascending triangle is a pattern that appears
during an uptrend when a stock begins to
consolidate between a horizontal resistance level
and a rising support level. To be a valid ascending
triangle, the price must bounce twice off both the
support and resistance levels. The pattern forms
over weeks to months and is usually complete when
the price is about three-quarters of the way to the
apex of the triangle.
The price target is the widest point of the triangle
added to the resistance breakout price. In this
example the difference between support and
resistance is about $3.50.
Notes
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TECHNICAL ANALYSIS
24
A descending triangle is a pattern that appears
during a downtrend in which the stock begins to
consolidate between a horizontal support level and
a falling resistance level. To be a valid descending
triangle, the price must bounce twice off the
support and resistance levels. The pattern will
usually complete when price is about three-quarters
of the way to the apex of the triangle.
The price target is the widest point of the triangle
subtracted from support. In this example the
difference between resistance and support is about
$6.
Notes
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TECHNICAL ANALYSIS
25
A symmetrical triangle is a consolidation of an
intermediate-term trend, which usually spans a
couple of weeks to months and can appear in
either an up- or downtrend. The lower highs show
weakness in the trend, and the higher lows show
strength.
The price target is the widest point of the triangle
added to a breakout of resistance for a bullish trade
or subtracted from a breakout of support for a
bearish trade. In this example the distance between
support and resistance is about $17.
Notes
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TECHNICAL ANALYSIS
26
A wedge is a multi-week trend that moves in the
opposite direction of the intermediate-term trend.
This trend lasts weeks to months. It can appear in
either an intermediate-term uptrend or downtrend.
The trendlines sloping toward each other indicate
weakness in the short-term trend.
Notes
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TECHNICAL ANALYSIS
27
When price reaches similar highs and lows multiple
times, the pattern forms a rectangle. These patterns
are consolidations of intermediate-term trends and
last several weeks to months. The parallel support
and resistance levels can be horizontal or have a
slight slope.
Other rectangle patterns include:
▪▪ Double top
▪▪ Double bottom
▪▪ Triple top
▪▪ Triple bottom
▪▪ Head and shoulders top
▪▪ Inverse head and shoulders
The price target is the price difference between
support and resistance added to a resistance
breakout for a bullish trade and subtracted from
a support breakout for a bearish. This example is
a bearish breakout of support and the measuring
distance is about $6.
Notes
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TECHNICAL ANALYSIS
28
You are already familiar with Fibonacci lines as
potential support and resistance levels. However,
in this section we will discuss how Fibonacci
retracements can also be used to determine a
target price.
Notes
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TECHNICAL ANALYSIS
29
The key to this analysis lies in how the Fibonacci
is drawn. Instead of drawing from support to
resistance, start at resistance and draw down to
support for uptrends. For downtrends start at
support and draw up to resistance. This will put the
extensions above the price action.
Notes
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TECHNICAL ANALYSIS
30
In the case of a bear flag pattern, you could
easily use the common measuring technique that
assumes the flag occurs at the halfway point and
price should move down again an equal or greater
distance than the initial drop.
Notes
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TECHNICAL ANALYSIS
31
For the same bear flag pattern, try drawing a
Fibonacci line backwards, from support up to
resistance, to provide a target. In this case, the
target is similar to the bear flag measurement, and a
little easier perhaps.
Notes
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TECHNICAL ANALYSIS
32
With intermediate trend targets, when price pulls
back to a retracement level and then breaks
through the 100 percent level, it may reach 162
percent. If the trend continues, it could also reach
the 262 percent level or ultimately the 423 percent
level over the following weeks or months.
Notes
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TECHNICAL ANALYSIS
33
When finding short-term price targets using price
patterns, use the width of the pattern to project
your target by either adding or subtracting from the
breakout point.
When finding short-term price targets using
Fibonacci levels, draw the lines backwards to project
the 161.8 levels.
Notes
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TECHNICAL ANALYSIS
34
It is important to identify trends and support and
resistance levels. Draw current trendlines, price
patterns and Fibonacci lines. You can also use the
text notes within ProphetCharts® to annotate your
findings. In addition to drawing your findings onto
your charts, it is also important to monitor your
charts often to watch for potential breakout points
and entry signals.
Notes
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TECHNICAL ANALYSIS
35
The adage “The trend is your friend” is mentally
tattooed on every successful trader’s mind—trading
with the trend can help increase your trading
success ratio. Trending indicators help you take
advantage of market periods when a prevailing trend
is the driving force.
Moving averages are the most commonly used
trend-identifying tool. Moving averages smooth
price action to avoid the static of erratic price
movements.
Notes
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TECHNICAL ANALYSIS
36
There are several ways to calculate a moving
average. A simple moving average is calculated
by averaging closing prices over a specific time
period. For example, to apply a 20-day simple
moving average to a stock, take the closing
prices for the past 20 days, including the current
day, add them together and divide the sum by
20 (the number of days you are analyzing). This
produces the arithmetic mean for the past 20
days’ closing prices.
Notes
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TECHNICAL ANALYSIS
37
An exponential moving average (EMA) is calculated
by averaging the closing prices during a specific time
period also. However, the calculation gives more
weight to the most recent days when determining the
average. A 20-day EMA for a stock takes the closing
prices for the past 20 days, including the current
day, and multiplies each number by a corresponding
weighted percentage.
Investors use EMAs when they need faster signals.
The drawback to an EMA is that it can be much more
volatile. This volatility may increase the number of
bad signals as the moving average jumps around.
Notes
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TECHNICAL ANALYSIS
38
One of the simplest methods involving moving
averages is using them as a support line in an
uptrend and as a resistance line in a downtrend.
With this method, you would enter the stock as the
price bounces up off support and short the stock as
the price bounces down from resistance.
Moving averages generally are more responsive
than a manual trendline and can help identify
various entry and exit signals. As with many
technical analysis methods, choosing the indicator’s
length is a subjective process. Short-term investors
usually like a short-term moving average.
Notes
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TECHNICAL ANALYSIS
39
Often, you will find that one indicator will
complement the signals displayed in another
indicator. Some investors will use two or more
indicators as added confirmation or a filter for entry
and exit signals.
Notes
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TECHNICAL ANALYSIS
40
When a stock is trending up, it will spend a greater
amount of time above its moving average. For this
reason, investors look to enter into stocks that have
crossed above their moving average. Exit strategies
are also often planned around the price dropping
back below the moving average.
Notes
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TECHNICAL ANALYSIS
41
The one green arrow method is an example of a
system that pays close attention to where the price is
in relation to its moving average.
Notes
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TECHNICAL ANALYSIS
42
Be sure to check the posture of the overall market
before determining your own posture. Remember,
it is easier to swim with the current.
Market Forecast™ for Market Posture:
When the SPX Market Forecast Intermediate
Term Green Line is rising or in the upper zone the
market posture is bullish. A bullish market posture
gives permission to look in the Portfolio Technical
page for a One Green Arrow entry signal on a
stock.
The Market Forecast indicator can also be added
as a study in ProphetCharts®.
Notes
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TECHNICAL ANALYSIS
43
In any strategy that requires you to own shares
of stock, it is wise to have a solid fundamental
foundation.
Notes
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TECHNICAL ANALYSIS
44
Determine your entry signal ahead of time. When
the time comes to enter your position, there should
be no more decision making because the decision
has already been made long in advance by your
rules.
Notes
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TECHNICAL ANALYSIS
45
Before entering any position, you should already
know what your exit strategies are.
What will you do if the trade goes poorly?
What will you do if the trade goes well?
To see where a stop would be 3% below the 30-day
MA, use the Moving Average Envelope study on
ProphetCharts ®.
To add a Moving Average Envelope study go to
Studies > Apply Studies > scroll down to and click on
Moving Average Envelope (Simple) > click on Apply
Study button > click on Edit Study icon > in the
Study Editor box type 30 in the Period field > type
3.0 in the Percent Shift field > uncheck the check
mark in the upper box > click on the OK button > in
the Apply Studies box click on the Save Study Set
button > in the Save Study Set box click the circle
Save a new Study Set named: and type in a name in
the field > click OK > in the Apply Studies box click
OK.
Notes
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TECHNICAL ANALYSIS
46
As you have seen, moving averages can provide
potential support and resistance levels. Using more
than one moving average, however, adds greater
credibility to support and resistance levels created
by a single moving average.
This technique provides context for your trades. If
the moving averages prescribe bullish strategies,
then your odds for success may be increased
when you go long. If the moving averages prescribe
bearish trades, then your odds for success may
be increased when you go short. Using multiple
moving averages makes your decision-making
process more efficient.
Crossovers for Posture
Chart setup:
Five-year chart with weekly candles
10-period exponential moving average
40-period exponential moving average
10 crosses above 40 = Bullish posture
10 crosses below 40 = Bearish posture
Notes
Each is confirmed on third candle (third week) after
the cross
This establishes the intermediate-term trend.
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TECHNICAL ANALYSIS
47
Bands are effective tools not only for identifying
support and resistance, but also for helping establish
limits and stops.
Notes
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TECHNICAL ANALYSIS
48
You create a moving average envelope by plotting a
simple moving average, then plotting two additional
lines parallel to the moving average—one line above
the moving average line and one line below it. The
two parallel lines are separated from the moving
average line by a set percentage that is determined
by you. These two parallel lines create the envelope.
Notes
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TECHNICAL ANALYSIS
49
When choosing a percentage for your moving
average envelope, select a time frame that not only
fits your investing style but also goes well with the
price action of the stock under consideration.
Notes
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TECHNICAL ANALYSIS
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Bollinger Bands® are similar to moving average
envelopes with one key distinction—they reflect
volatility. You construct Bollinger Bands by applying
a simple moving average (usually 20 days) to a
stock and then applying an envelope to the moving
average. Each side of the envelope is placed two
standard deviations—a statistical term used for
telling you how tightly all various examples are
clustered around the mean in a set of data—of
historical volatility away from the moving average.
This means the range between the two Bollinger
Bands at any given time represents 95 percent of
the price movement, or trading range, for the past
20 days.
Notes
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Oscillators and other indicators are invaluable for
technicians hoping to identify accurate entry and
exit signals. Using oscillators increases your ability
to identify extremes in market sentiment and take
advantage of the principle of contrary opinion.
Notes
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TECHNICAL ANALYSIS
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There are multiple uses for oscillators. You
will use them to identify confirmation of price
movement, lack of confirmation—divergence—
and for potential entry and exit signals.
Notes
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TECHNICAL ANALYSIS
53
The MACD indicator is calculated using two
exponential moving averages (EMAs). The first
moving average is a short-term average— usually
eight periods in duration. The second moving
average is a longer moving average—usually 17
periods in duration. Both averages are calculated on
a daily basis. Surprisingly, neither is directly reflected
on the MACD indicator. The first line of the MACD
indicator is actually the difference between these two
moving averages. The second line is usually a nineperiod EMA of the difference between the other two
moving averages.
Notes
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TECHNICAL ANALYSIS
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Often, when the MACD is hitting a low point and
beginning to rise, price is doing the same thing.
This is especially true during an upward trend.
Notes
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TECHNICAL ANALYSIS
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Divergences suggest that the current trend is
getting weak. They are also predictive signals for
determining potential market tops and bottoms
and are created by most oscillators.
Notes
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TECHNICAL ANALYSIS
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The stochastic indicator is an oscillator that moves
between zero and 100, with an overbought range
above 80 and an oversold range below 20. It is
created using a calculation that measures how close
the stock is closing to its extreme high or low during
a specific period. As the stock closes closer to its
high, the stochastic indicator line moves upward.
As the stock closes closer to its extreme lows, the
stochastic indicator line moves downward.
Notes
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TECHNICAL ANALYSIS
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The stochastic indicator has two lines. The fastermoving line is called %K and the slower-moving line,
which is actually just a smoother version of %K, is
called %D. These lines trigger buy and sell signals
when %K crosses above or below %D.
Notes
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TECHNICAL ANALYSIS
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Like the MACD, the stochastic indicator will often
give an early warning of possible future trend
reversals by way of divergences.
Notes
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TECHNICAL ANALYSIS
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The RSI is calculated by comparing the average
prices of positive closes with the average prices of
negative closes. The RSI line will fall as the negative
closes begin to outweigh the positive closes. The
RSI line will rise as the momentum shifts and the
positive closes begin to outweigh the negative
closes. The RSI is specifically used as an overbought
and oversold indicator. You should not confuse the
RSI with relative strength (RS), which refers to a
comparison between the stock’s performance and
the performance of another benchmark or index.
Notes
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TECHNICAL ANALYSIS
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Remember, you may treat oscillators like the
price. Draw lines to identify trend and support and
resistance levels.
Notes
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TECHNICAL ANALYSIS
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Be alert when the trendlines drawn on your
oscillators do not match the trendlines drawn on the
price chart. Again, this is a sign of weakness in the
current trend.
Notes
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TECHNICAL ANALYSIS
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This oscillator can be used in channeling and
trending markets. The CCI is an interesting indicator
because, although it is used as an oscillator,
its calculation is similar to Bollinger Bands®. It
measures the distance from the market price to the
moving average and turns that distance into a ratio.
The CCI can identify excess buying pressure when
it is above 100 and excess selling pressure when it
is below −100. It can also be used as a traditional
oscillator by showing overbought and oversold
divergences.
Notes
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TECHNICAL ANALYSIS
63
Like the MACD, stochastic and RSI indicators, CCI
divergences will appear to warn of weakness in the
current trend.
Notes
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TECHNICAL ANALYSIS
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As discussed earlier, investors will often combine
indicators for confirmation of entry and exit signals.
It is important not to add too many indicators to
your rules as it can result in too much or too little
trading. Some indicators will tell you essentially the
same thing that other indicators do. Pay attention to
how closely correlated your indicators are.
Notes
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TECHNICAL ANALYSIS
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The indicators and techniques discussed so far can
help you begin trading more proficiently. However,
there is a great tendency for investors to bounce from
one set of indicators and strategies to another without
a real strategy.
Notes
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TECHNICAL ANALYSIS
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Creating profitable trading rules is the most
important step in your trading career. Though
this may require some time and effort at first,
remember that the most successful strategies
are often the simplest ones. The real challenge is
writing specific entry, exit and position sizing rules
and applying them consistently.
What to Buy = Watch List Criteria
Fundamental criteria
Trend
Volume
Set up
When to Buy = Entry Rules
Price action
Volume requirements
Oscillator confirmation
When to place orders
Order types
How Much to Buy = Money Management
Amount of total capital at risk
_____% of net liquid value -or$____ per trade
Portfolio draw down or heat
When to Sell = Exit Rules
Notes
Target price
Stop loss
Time stop
Stop adjustment
Routine = Daily, Weekly, Monthly
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TECHNICAL ANALYSIS
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Backtesting is an important first step toward
developing a profitable trading strategy. Backtesting
is the process of testing your entry and exit rules on
a chart.
To backtest, pick a stock chart and identify the entry
and exit points according to your written rules. List
the entry price, exit price and net gain or loss in a
trade journal or spreadsheet. For your backtesting
to be of any value, you should establish and follow
specific rules.
After backtesting one stock, select another. You
should backtest your rules on several stocks in
multiple markets—up, down and sideways.
It is easy to cheat in backtesting and look forward a
few days before deciding if you would have placed a
trade. If possible, do your backtesting with another
person. Your backtesting buddy will be helpful in not
only keeping you honest, but also in analyzing the
chart and applying your rules.
Backtesting doesn’t give a good sense of the
passage of time while trading, nor does it give you a
feel for the emotional aspects of trading. However,
it will give you an idea of whether your rules are
specific and repeatable.
Notes
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TECHNICAL ANALYSIS
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Before trading a plan, you need to know what
results to expect. This means you should know
approximately how much you expect to profit,
on average, per trade. If you don’t know what to
expect, you don’t really know what you are risking.
Expectancy is an approximation of what you
expect to make or lose on average per trade from
a specific set of rules.
Expectancy Example:
50 total trades
20 winners = 40% of total trades
30 losers = 60% of total trades
Average winner = $550
$11,000/20 = $550
Average Loser = $150
$4,500/30 = $150
Notes
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TECHNICAL ANALYSIS
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The guiding principle behind technical trading
is to manage your losses and put the odds of a
successful trade in your favor. By concentrating on
the real numbers behind a system or indicator, you
can move beyond guesswork. This will ultimately
lead to the defeat of an investor’s worst enemy—lack
of discipline. Good luck, have fun and prepare for the
best.
Notes
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Notes
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Notes
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Notes
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Notes
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TD-IEG1055 4/15