Technical Analysis is a useful tool for any trader and particularly so for one who trades with a short time horizon. Even those that remain sceptical as to its usefulness still pay attention to it as so many other traders are using it to some degree.
The basic tenet of Technical Analysis is that the market, which is made up of the actions of individual traders, is prone to repetitions which can observed and used to trade off.
Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications by John J. Murphy is a great primer for the novice trader.
At any one time there are many individuals that are active in one particular market. Each has a different expectation of what the market will do in the future. Each has a different time horizon when placing a trade. Each has a different tolerance for assuming risk. Each has a different trading style and strategy. The actions of each individual, each acting in a unique manner will cause the price to move in what may seem to be a random manner.
Indeed for the most part the price does move randomly. However, there will be times when the aggregate actions of each individual – or a sub-set of individuals – are correlated. These actions are observable and they create well defined patterns.
Technicians seek to exploit these patterns, using them as a basis for their trading strategies. Other traders may simply use these patterns as a guide of when to enter or exit trades in combination with other analysis.
Getting the Charts Right
Line: these charts simply show the closing price for the period you have chosen and as a result they leave out a lot of useful information.
Bar chart / Candlesticks: these charts show four key bit of information per line: the opening level, the low point reached in the period, the high point reached in the period and the closing level.
This gives a lot more information than a simple line graph, compare the following bar chart to the previous line chart.
Finally, when trading a specific market it is useful to look at more than one time period. A weekly or daily chart is useful to show the longer term price action. Any patterns, levels or trends shown on this chart will be more significant than those shown on a chart will a shorter time frame. It is useful to combine this with a chart showing half-hourly bars or less depending on how frequently you are trading.
When using charts, I notice that if I change the charting timeframe from say, 1 minute to 1 hour I note that it seems to give a quite different trend and an uptrend can even change to a downtrend – how do you interpret this?
This is true – the trend does change if you choose a different time period to chart; so might see an upwards trend on a weekly chart, and down on an hourly chart, up on a 5 minute chart…etc In essence, you have to consider the timeframe you are trading. If you are looking to trade over a few days, then you should be looking at daily charts. It also makes sense to use more than one time frame, say daily and weekly as the weekly would then provide an outline of the main trend while the daily chart could serve highlight entry and exit points.
Personally, I am not big on chart patterns. Firstly I do not see so called heads and shoulders formations. I see the market as topping or bottoming. I do not see saucers, triple tops, V bottoms, W bottoms or the like. I know these patterns exist if one looks hard enough but my type of trading does not rely on such wizardry.
I am not a fan of applying price targets to my trading either. They are very off putting. The trading mantra ‘let your profits run’ should be reason enough to avoid anchoring the mind on potential profit targets. With some of the major chart patterns it is supposedly possible to work out exactly where the market is headed. Maybe thats why I do not use chart patterns. For the same reason I do not look at fibonacci numbers. I do not believe the market is pre ordained. Ditto for delta turning points, cycles of any timeframe or Bradley Turn Dates. Maybe these work, but they are not for me.
Strip everything away and all that matters is the market. In its crudest form the market is represented by up and down bars on charts. And the the best representation of what the market is doing comes from the tried and trusted trend line.
This is just a brief introduction to technical analysis and how it can be used with spread betting for profit – but you – what do you think of Technical Analysis?