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This book is not a recommendation recommendation to buy buy or sell, but rather rather contains guidelines to interpreting various various analysis methods. methods. This information information should only be used by investors who who are aware aware of the risks inherent inherent in securities trading. trading. Equis Interna Int ernation tional, al, Rob Robert ert Deel, Deel, Pri Price ce Headl Headley ey,, Mik Mike e Hurley Hurley, Ste Steve ve Nison Nison,, Bar Barbar bara a Star Star, Simon Sherwoo Sherwood, d, Daryl Guppy Guppy, and John Bollinger Bollinger accept accept no liability whatso whatsoeve ever r for any loss arising from such use of this book or its contents. ©2003 Equis Interna International tional,, Inc. MetaStock is a registered trademark of of Equis International. All other names are trademarks of their respective owners.
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Contents Introd Int roduct uction ion:: Sec Secre rets ts from from Succe Successfu ssfull Trad raders ers . . . .4 It’ss Your Money It’ Money, Tak ake e Control…! Control…! . . . . . . . . . . . . . . . 7 BY ROBERT DEEL
How to Manage the Highs and Lows in Trading . . . 13 BY PRICE HEADLEY
My Secret Secret to to Mark Market Internals Internals . . . . . . . . . . . . . . . . . 19 BY MIKE HURLEY
Using Candle Charts to Spot . . . . . . . . . . . . . . . . . . 23 the Early Turning Signals—The Basics B Y ST S T EV E V E N IS I S ON O N , C MT MT
Catch that Trend! Directional Strength . . . . . . . . . . . 31 and How to Find It B Y BA BA R BA B A R A S TA TA R , P H .D . D.
One Custom MetaStock MACD...to go! . . . . . . . . . . . 37 BY SIMON SHERW SHERWOOD OOD
Understanding Understan ding the the Crowd Crowd . . . . . . . . . . . . . . . . . . . . 43 BY DARYL GUPPY
Bollinger Bollin ger Band Band Basics Basics . . . . . . . . . . . . . . . . . . . . . . . 49 BY JOHN BOLLINGER
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Introduction Secrets from Successful Traders
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ere it is! Some of the most valuable trading insights for winning in today’s “tough markets”are waiting to be discovere discovered d in this book. This is your your opportunity to “learn from the Pro’s. Pro’s.” So get ready to collect the latest strategies and tips on critical topics facing traders today. First, Robert Deel gives you his “16 Rules of Investology Inves tology..” Compiled from his 20 ye years ars of experience experience,, this checklist will keep you from making many of the common mistakes traders make. You’ll learn how to better manage the difficult highs and lows in trading from Price Headley. He sh sho ows you how psyc psycholo hologica gicall factors, factors, suc such h as perf perfectio ectionism, nism, fear fear,, and lack of confidence can cause disastrous results in yourr trading, and how you how you you can ov overcome ercome them. Studies show that the vast majority of stocks follow the trend in the overall market. Mike Hurley discusses market internals, and how how they can help you measure measure what what the overall stock market is really doing. Steven Nison shows you how candle charts can help you spot early turning signals and enhance your trading power.. You’ll learn how this powerful tool can give you power you a jump jum p on the compet competiti ition, on, pr pres eserv erve e capital capital,, and “op “open en new and unique doors of analysis.”
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Barbara Star discusses two powerful indicators that help you detect detect,, not only only tren trend d direc direction, tion, but stre strength ngth as well. Learn how to use them them to avoid avoid trading pitfalls pitfalls by signaling changes in price movement.
Discover the power of the MACD from Simon Sherwood. Le Lear arn n wha whatt it is is,, wha hatt it ca can n do do, an and d ho how to create your own customized MACD to fit your unique trading program. Daryl Guppy takes on some tough trading questions, such as, wha whatt signifies a rally rally...or a trend? He shows you you how his Guppy Multiple Moving Average can help make these initial decisions.
Last, but certai Last, certainly nly not leas least, t, John Bollinger , creator of Bollinger Bollinger Bands, Bands, discu discusses sses 15 basic basic rules for for using these these popular bands. Learn how how they can significantly significantly boost your your trading potential. As Robert Deel mention mentionss in his article, article, pro profess fessiona ionall traders have made millions in the last three years because they have learned how to make money when it’s going down, do wn, as well well as up up. Now it’s time to discover those secrets of success. Enjoyy this book, and “Ha Enjo “Happy ppy Tradi Trading”. ng”.
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It’s your money, take control...! BY ROBERT DEEL
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aking control in the management of your money in today’s world is perhaps one of the most important financial imperatives facing us all. Thi Thiss checklis checklistt should serve serve you you well, well, and possibl possiblyy keep keep you you from becoming a victim of the market and false media information. In my twenty-one years of trading experience I have found these rules to be an invaluable way of keeping me focused on the trade. Deel’s 16 Rules of Investology
1. TR TRAD ADE E WIT WITH H A PLAN PLAN Set objectives objectives before before you you ever ever buy. Define all outcomes — not only what you yo u will do when it goes right, but what what you will do if you you are wrong. wrong. Determine the amount of capital you are willing to lose and conversely, define when you you will take take profits. Letting the market market take awa awayy your profits by holding on to a losing trade trade is not a good strategy strategy.. Write out a trading plan on paper paper and follow follow it. it. Do not become a causality of emotionallyy involved emotionall involved buy or selling. selling. Trade with a plan. 2. SCR SCREE EEN N YOUR TR TRADE ADESS To select trading vehicles vehicles you must have have a predefined method. Select a method based based on price momentum momentum and and trend. Don’ Don’tt guess what what the future is going going to be, be, trade the the current current trend directi direction. on. Your method method must must consider your your individual time frame and risk tolerance. Alw Always ays address address liquidity liquid ity,, sector rota rotation, tion, and technical technical factors when when screeni screening ng stocks. stocks. 3. AL ALW WAYS LOOK AT AT A CHART Never buy a stock stock without without looking at a chart chart of the stock stock first. Look at at the one-year one-year trading range. range. Ascertain where where you you currently are in the trend and what what that that trend is. Also determine if the chart chart reflects a stock stock split. spli t. Nev Never er trade trade agains againstt the trend. trend. Buyi Buying ng and and selling selling decisio decisions ns are are technical in nature nature.. Fundamentals will never tell tell when to buy buy or sell a stock. Alw Always ays look look at a chart for entry and exit timing timing decisions.
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4. ST STA AY WITH WITH A TRE TREND ND Your probabilities of success are far greater if you stay with a definable mark mar ket trend. Sta Statisti tisticall callyy, thes these e trends provide provide better better profit potential potential with a lower lower amount of risk. A good rule of thumb thumb is to watch watch a 50-day 50-day exponentiall moving average exponentia average of the close. close. This moving avera average ge represents represents the intermediate trend trend of a stock. stock. A 12-day exponential exponential moving moving average average represents repr esents short-term trend. The use of of these two moving moving avera averages ges should yield excellent excellent results in keeping keeping you you in the trend. If you percei perceive ve the trend beginning beginning to change, change, act accordingly accordingly by by taking profits profits or placplacing stops to protect your capital and locking in a profit. 5. USE MONEY MONEY MAN MANAGEME GEMENT NT TEC TECHNIQ HNIQUES UES Determine the probable dollar losses of your trading plan or investment style based on your your trading record record for the current year year.. Then devise devise a way to generate income through passive sources. Cutting a loss quickly is the best money management you can have. Too many times traders fall in love love with stock, stock, holding on as the stock stock begins beg ins to dec declin line e. Ne Neve verr use a hedgin hedgingg strat strategy egy,, suc such h as option options, s, to justify holding on to a losing position. The use of of money money mark market, bond, and stoc stock k divide dividend nd income income to to offset losses in your trading portfolio is an excellent technique. Covered call options may be an appropriate way to generate income for your your portfolio to offset losses. losses. Be careful careful here because you you can write covere cov ered d calls into into obli oblivion. vion. If the stock stock is going going against against you, you, sell it. it. If you you are going going to hold a trade ove overnight, rnight, never risk more than 3% of your your availa available ble capital capital.. If you you are going going to day trade trade,, an excelle excellent nt rule of thumb is to only risk 1% of your capital in any one trade. 6. BU BUY Y AND AND SEL SELL L ON CONFI CONFIDE DENCE NCE Many times you won’t feel quite right about a buy or sell decision. If this feeling persists after you have done all your research and you have follow foll owed ed the rules to this this point, don’ don’tt take take the trade. trade. Too many times times individuals indi viduals try to rationalize rationalize a decision. Don’t try to find a good reason for making a bad decision. Your decision must must be a confident one. 7. BUY ONLY ONLY LIQUID LIQUID STOCKS STOCKS AND LIQUID LIQUID MARKETS MARKETS Stay with major markets and stocks with millions of shares in the float. Make sure the average trading volume is enough for you to sell all of your yo ur position on any given given day. day. By following this rule you you should be
It’s your money, take control...!
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assured of a reasonab reasonably ly good good execution execution of your trade. trade. Don’t buy buy stocks trading trad ing at at the lowe lowerr end of the the price range range.. Gene Generall rallyy speaking, speaking, do not buy stocks that don’t have good trend characteristics or predictability. True professional traders avoid them and so should you. 8. DON DON’T ’T BUY BUY OR SELL SELL ON HO HOT TIP TIPSS More money money has been lost on hot tips tips than is in the U.S. U.S. Treasury reasury.. While this is an exag exagger gerati ation, on, it does make make the point clear clear.. If someone someone tells you you about an investment investment or trade, trade, resear research ch the recommendation recommendation before before you you put your your money into into it. Most novice novice investors investors and traders traders fall victim to tips every day. Please don’t don’t fall for the story no matter how good it sounds. Alw Always ays use technical technical analysis analysis to make make your your buy and sell decisions,, and buy sions buy or sell sell based based on on facts. facts. 9. DO NOT NOT DOLLAR DOLLAR COST COST AVERA VERAGE GE If your timing decision decision was wrong wrong on an aggressiv aggressive e stock, don’t make make the problem problem worse by trying to buy a stock that that is going lower lower.. The probability is is that you you will only only compound the loss. I call this technique disaster cost avera averaging. ging. Don’t buy buy a stock stock until the trend is evident. evident. Dollar cost averaging averaging is good good for your broker broker,, but if you continue continue this techniqu tec hnique, e, the ‘bro ‘brok ker’ you will become. become. 10.. NO ONE WI 10 WINS NS 100 100 % OF THE THE TIM TIME E Many people enter the stock market focused only on the profits and do not consider consider the losses. losses. If you think think for one minute minute you you are going going to win one one hundred hundred perc percent ent of the time time,, you are are wrong wrong.. Los Losing ing is just just part part of the cost of doing business. Your goal is to make make sure you you control the risk and not blindly blindly put your your money at at risk, lik like e a buy and hold investor.. You must come to the realization that you will never learn how investor to win until you you first learn how to lose. lose. How you you handle loss loss psychologpsychologically is truly the difference between an amateur and a professional. Professional traders don’t react the same way as an amateur to loss. When Whe n a professional professional trader loses, loses, he or she simpl simplyy says says next . The heyy don don’’t take the loss personally. 11. AL ALW WAYS USE USE STOPS STOPS The proper proper use of stops will will protect profits profits and limit your your losses. Look at stops as as profit profit and loss insur insurance ance.. Wh When en you you enter enter a trade, trade, you place place a stop to limit the loss loss in case the trade trade goes against against you. you. When the trade trade becomes profitab profitable, le, yo you u use them to lock lock in a profit. profit.
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Anyone who would argue against risk control by discouraging the use of stops is a fool fool indeed. In effect they are saying saying you you should put your yo ur capital at unlimited risk. Does this make make any sense to you you?? Of course not, but that is exactl exactlyy what what a buy and hold hold investor investor does all the time. Most investors investors do not use stops because they are afraid of being stopped out. This is a psychological psychological problem problem of of not wanting to be wrong, wron g, or having having to admit admit to yoursel yourselff you you lost lost on a trade trade.. It certainl certainlyy isn’t based on logic or strategy strategy.. Remember Remember,, alw always ays use stops if you you are carrying a trade over night. 12.. I DON’T 12 DON’T HA HAVE VE TIM TIME E Make the time or suffer the Make the consequences. consequences. If you you are too too busy to manage your your money, money, maybe you’ you’re re too busy. busy. Take a look at your portfolio and if you you lost half of your your money without knowing knowing it, yo you u can congratucongratulate yourself yourself on being too too busy. Was it worth worth it? Probably Probably not. It doesn’t doesn’t make much sense to work yourself to death and have nothing to show for it. You must take take time to educate yourself and take take control of your future. 13. BE PA PATIENT AND AND LET TIME TIME BE YOUR FRIEND Making money safely safely takes time. time. The only only time to hurry is when you’re you’re in troub tr ouble le.. Rem Rememb ember er,, “Ev “Everyda erydayy is not not a tradin tradingg day”. day”. Onl Onlyy trade trade when when the secto sectorr, mar mark ket, and the the correla correlatin tingg stocks stocks are are in trend. trend. Jus Justt because because you yo u want to trade trade doesn’t doesn’t mean you you should. Only trade trade when the probaprobabilities are in your your favor favor,, and let the market market come to you. The market is going to do what it is going to do and what you want is irrelev irre levant. ant. Don’ Don’tt become addicte addicted d to the action. action. You are not an action action junky.. You are a high probabil junky probability ity trader. trader. Profits are made the old fashioned ione d way way, one trade trade at a time. time. Be patient patient and and make make time your your friend friend instead of your enemy. 14. LEAR LEARN N FROM YOUR MIST MISTAKES The most successful traders and aggressive investors learn from their mistakes. mistak es. Many even even go as far as writing down what what went went wrong and analyzin anal yzingg the probl problem. em. Mista Mistak kes can be be costly costly, so use them as as learning learning experiences and don’t make the same mistake twice. Unfortunately a large number of people are doomed to make the same mistakes mistakes over and over again. This behavior behavior is usually a sign of emotional reactions to price momentum and the absence of any well thought out strategy strategy.. My father once told me that that the best education
It’s your money, take control...!
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was to learn learn from the mistakes mistakes of others. Most people people fail in the market market not because because of technology technology or a lack lack of of information, information, but because because of emotional emotion al reactions, reactions, and never never learning from from their mistak mistakes es and the mistakes of others. 15. KNO KNOW W HOW HOW TO SHOR SHORT T STOCK STOCK Markets do not go up all the time, Markets time, a painful lesson lesson some have have learned over ov er the last last three yea years. rs. From the ye year ar 2000 to the present present time, time, we hav have e experienced one of the most agonizing bear markets in the last 70 years. Does this bear market mean that you can’t make money? No. Wha hatt has has the the trend been for most of the last three years? The obvious answer is down. Common sense sense says you are to follow follow the the trend. So if the trend trend has been down, wh whyy haven’t haven’t you you been shorting stocks? The reason reason is sadly fear and ignorance ignorance.. Only 2 % of the American public public ever ever shorts a stock stock in their lifetime. lifetime. This is shocking shocking when you you understand that markets markets and stocks fall 67% to 80% faster than they rise. In other words shorting stocks tends to compound money faster than buying buying a stock stock to go go long. long. Plus Plus,, if you you can can make make money money when when the the market mark et is going down down and when it goes up, up, wha whatt is it that you have have to be afraid of? Professional traders have made millions the last three years. You must learn to short stocks if you are to have any chance of being successful in today’s today’s markets. markets. Fear and ignorance must be overcome overcome because you must know how to short. 16.. FOL 16 FOLLO LOW W THE RU RULE LESS Some people are doomed to make the same mistakes over and over again. aga in. Usin Usingg this this set of 16 trad trading ing rules, rules, whi which ch has been been compi compiled led from over over 20 years years of experience, experience, should keep keep you you from making many many common mistakes. If you follow Deel’ Deel’ss Rules of Investology, Investology, you have have a much much better chance cha nce of success success than than someone someone who doesn’ doesn’t. t. Al Alwa ways ys remembe rememberr, ther there e is never never any guarantee guarantee of success. But if you you are properl properlyy educated and and develop dev elop the the correct correct mindset, mindset, you have have a major major advan advantage tage.. Don’ Don’tt become one of the sheep led to the slaughter by media nonsense. You must make your own fortune and control your financial destiny. Always Alw ays remember remember,, it’ it’ss your money. Tak ake e control…and follow follow the rules. Robert Deel is an internationally recognized trading expert, and has trained groups of traders throughout the U.S., Europe, Europe, Asia, and Canada. Canada. He is the author of Trading the Plan and The Strategic Electronic Day Trader. He is also the President and CEO of Tradingschool.com, a school that trains individual and professional traders from all over the world.
How to Manage the Highs and Lows in Trading BY PRICE HEADLEY
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n order to manage manage your your emotions effectiv effectively ely when when trading, yo you u need to create a written plan that you can review regularly to stay focused on your your goal goal of of trading trading succe success. ss. By writing writing down down your your plan, plan, you put put yourself in the top 3% of individuals who have written goals and plans, giving gi ving you an immediate immediate edge on most most traders. Mak Make e sure you you have have answered answ ered these questions, questions, which are covered covered in in further depth in my my book, Big Trends Trends in Trading: Trading: 1) How will you you enter enter trades? trades? The key to good good entries entries is is putting putting on trades where there is relatively low risk compared to much higher reward. rew ard. You should also write down a clear catalyst catalyst for the expecte expected d stock move. 2) How will will you you exit exit trades? trades? You should should define an initial initial stop stop point for your yo ur trade, trade, at the point where where the trend is inva invalidated. lidated. You will also need a ‘trailing stop’ technique to protect your your profits. 3) Wh What at type type of orders orders will will you you use to to enter and exit? exit? Whe When n entering, entering, I like like to use limit limit orders, orders, goo good d for the day day only only, whi while le exits exits are are often market mark et orders. Wh Why? y? Because limit limit orders allow me to define my my risk and reward reward clearl clearlyy on the entry of a trade, trade, while when when I need to get out, mark market et orders allow allow immediate immediate exit exit compared compared to the risk of missing my exit with a limit order. 4) How much much capital capital will will you you need to trade trade successful successfully? ly? The There re are economies of scale as you increase the amount of capital you trade with. Costs rel relate ated d to comm commissi issions, ons, quote syste systems ms and and equipm equipment ent begin to diminish as the percentage of capital invested goes up. 5) Wh What at percenta percentage ge of your your capital capital will will you you invest invest in each each trade? trade? The The amount of capital I typically use is 10% per trade in my own accounts. I know traders who who commit commit anywhere anywhere from from 5% of their account acco unt per trade trade,, to 20% of their their account account per trade trade.. Your goal goal should be to keep portfolio risk per trade at less than 2% per trade. For exampl example, e, if you you invest invest 20% of of your your portfolio portfolio in a trade trade,, a 10% loss loss on that position would lead to a 2% loss on your portfolio. 13
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6) How many many positions positions will you you focus focus on at at once? I like like to concentr concentrate ate my portfolio portfolio on my my best ideas, ideas, plus I like like to stay focused focused on on how each stock stock is acting. If my portfolio is too big (I’d (I’d say more than seven stocks stoc ks is too many to focus focus on), then I will lose focus focus and invariab invariably ly miss an exit on a trade that I should have previously exited. 7) Wh What at will will your your Tra rading ding Journa Journall look lik like? In my Trad rading ing Journa Journal, l, I note daily observati observations, ons, particul particularl arlyy related related to my ability ability to execute my trading trading plan. plan. I also commit commit to doing a post-tra post-trade de analysis analysis every every month. mon th. I note wh what at I did did right right and and wrong, wrong, and seek seek to to learn learn from from mismistakes tak es to minimize future future errors in similar circumsta circumstances, nces, whil while e also looking for winning patterns where I seek to repeat big successes. 8) Wha Whatt is your your Position Position Review Review process? process? I suggest you hav have e an end-ofend-ofday routine to clos close e your your day day. Review yo your ur trades, trades, and assess if you you follow foll owed ed your your plan. plan. Kee eep p a log of of all your your trades trades,, and mak make comments on each position. 9) Wha Whatt is your your Prepara Preparation tion process before trading? trading? You need defined time to prepare for the next trading day and build up your trading confidence.. I prepare confidence prepare after the close for for the next day’s day’s trading, which allows me to formulate a plan of action BEFORE I get into the heat of battle. This keeps keeps my trading proactive proactive instead of reactive. reactive. 10) Wha Whatt broker will you you use? Most traders mistakenly mistakenly think that commissions are are the number one factor they can control. control. In reality, commissions are a small cost compared to the broker’s effectiveness at executing executing your trade. trade. Your focus should be finding f inding a broker who gets you speedy and fair execution of your orders. Once you you have have defined these these facets of your your trading plan, plan, you are are in an excellent position to have a strategy to control your emotions when trading.. Mak trading Make e sure to review review your your plan on a regular regular basis to create create effeceffective trading habits. Psychological Issue #1 in Trading: Perfectionism
Why do we let losses ride and cut profits short? Perfectionism tends to keep traders from taking their losses quickl quicklyy, as they are too concerned concerned about looking good to others and not wanting wanting to admit they are wrong. wrong. This leads leads to the dreaded dreaded hope for a return to ‘brea ‘break keve even’, n’, to get out without a loss. But does the market care about where you bought the stock? NO! The market is going going to go wherever wherever it wants to go go, and your job is to see that that trend, recognize when when you you are not in tune with it, and get out of such trades.
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We all have have this tremendous desire desire to prove prove ourselves right. But in the markets markets,, we should concern concern ourselves more with with making money than the amount of times we are are proved proved right. This means means winning ideas need to be ridden ridden longer than than average average,, while losers losers need to be cut short quicklyy. Our school quickl school training training says says there is one right answer answer,, but in the markets there are many ways to win. Perfectionism cannot only keep keep you you hanging on to losers losers too long, it can also keep keep you you out of the best performing performing stocks. stocks. On stocks that that rally rally sharply, I sometimes have have to fight the feeling that I’ve I’ve already missed missed out on the mov move. e. In retros retrospect, pect, many of these these stocks stocks go on to much much bigger bigger gains than the initial gain I missed. Traders tend to desire a perfect entry, entry, and this leaves leaves them them on the sidelines sidelines during major major trends. trends. It is these huge trending trades trades that carry my portfolio historically historically, so I have have to make sure I am participating in these big moves. Ironicallyy, perfectionism does not lead to higher Ironicall higher performance or greater grea ter happiness. Perfectionism can destroy destroy your enjoyment enjoyment of trading. Focusing on flaws and mistakes depletes depletes energy. energy. This may escalate escalate to panic-like panic-lik e states prior prior to making the trade, trade, impairing objective objective performperformance.. At some ance some point point perfec perfectioni tionist st standar standards ds get get set too too high, high, and life life is is measured in in units of accomplishment. accomplishment. The drive drive to be perfect perfect becomes self-defeating, self-defea ting, as the indi individual vidual often places the intense pressure pressure on himself hims elf,, whi which ch can become become cripplin crippling. g. Perfectionists share a belief that perfection is required to be accepted by others. The reality reality is that acceptance acceptance cannot be gained through through performance or other external factors like money or social approval. Instead, Inste ad, selfself-acce acceptanc ptance e is at the the root of happine happiness. ss. Ultim Ultimate ately ly you you must must be the one who must must live live with yourself. yourself. If others think you’re you’re perfect, but you you yourself are never never happy, then perfectionism is not helping you you to grow and develop to your fullest potential. One way to be less of a perfectionist is to set one goal and make it process pro cess orien oriented, ted, inste instead ad of of being being focuse focused d on the outcom outcome. e. If you you achieve achiev e the goal to improve improve your your trading via that that goal, you win no matmatter the outcome. outcome. Perfectionists often often seek to control uncontrolla uncontrollable ble factors in a trade trade.. For examp example le,, wai waiting ting for for all all the risk risk to be out and everything to look perfect (the quality of the fill on the exit especially), hoping or ‘willing’ a better outcome outcome by doubling doubling down down on a loser loser,, etc. When a trader focuses focuses on these “uncontrolla “uncontrollables”, bles”, he is more likely likely to tighten up and and resist pulling the trigger trigger and exiting exiting a losing losing trade, trade, or he’ll miss out on a new n ew winner that th at has moved ‘too far fa r.’ By focusing on on a process that you can control (such as to focus on only five stocks at a
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time, or work work on implementing your your entries and exits exits consistently consistently with a small amount amount of money to improve improve your your ability ability to execute execute trades, or another process-oriented process-oriented goal), goal), you build confidence confidence in your your ability ability to execute your trading plan. Based on these perfectionist tendencies, I recommend recommend the following following entry strategy for perfectionists. Enter half a position as soon as you you see an opportunity that generates at least three times the reward for the risk at the current market market price. price. Then place the remaining remaining half at at your desir des ired ed ‘pe ‘perfe rfect’ ct’ ent entry ry price. price. For exits exits,, al alwa ways ys place place mark market orders, orders, as the tendency for the perfectionist is to try to get a better exit price with a limit, which often results results in missing the exit on the way way down. down. Psychological Issue #2 in Trading: Fear
One of my subscrib subscribers, ers, Vince ince,, rec recentl entlyy wrote to me:“Y me:“Your our commenta commentary ry is truly excellent. excellent. And your your ‘batting avera average’ ge’ has been exceptional exceptional during during this most awful market market that that I have ever ever seen. Do you have have any general general advice that you would be willing to offer on a very serious problem that I — and perhaps many others — am experiencing in recent weeks? The length of this bear market — and the substantial financial damage that it’s it’s inflicted on me at at my age (51), has seriously seriously damaged my my investment psychology. Consequentlyy, while I read Consequentl read and believ believe e your your judgment judgment calls, calls, I haven’ haven’tt been able able to to get mysel myselff to act — to pull pull the trigge triggerr, to try to begin begin to rebuild reb uild from the carna carnage ge — for sev several eral month months. s. So So,, I guess guess you might might sa sayy I’m suffering from the the “deer caught in the headlights” headlights”syndrome syndrome.. Whic Which h results res ults in experi experienci encing ng losses, losses, and not not experien experiencing cing the the gains. gains. The These se violent moves moves in both directions, directions, changing on a dime without notice, notice, with an overall overall 2 1/2 year huge down-move down-move cumulati cumulative ve,, hav have e left me at sea. How does one begin to work work oneself oneself out of this state of mind after what we have been through?” Vince is suffering suffering from the fear of trading trading that, that, after a string of losses, many traders experience experience at one time or another another. The reality reality is that human beings tend to do things that either maximize pleasure or minimize pain. pain. Not pulling the trigger on trades trades becomes becomes a way way for for traders to minimize mini mize pain, pain, beca because use mentall mentallyy, the thought thought is that that we we are not not causing causing ourselves any any more damage if we we do not trade. The problem problem is that we we then remain stuck in a state of fear until we can TRUST our method again and start taking trades. This is why why it’s it’s so critical to have have a trading plan that that is tested, one we’ll we’ll be able able to stick stick with it.
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Here’s a game plan for getting yourself back on track:
1. Define Define Your Trad rading ing Plan Plan — If you alrea already dy have have a plan plan,, ree reexami xamine ne it. Are you you following your your rules for entry, entry, exit and money management? management? Does your plan still have an edge in the current market conditions? 2. “If In Doub Doubt, t, Get Out Out”” — Who say sayss you you ha have ve to tra trade de ev every ery day day?? If If you yo u are not pulling the trigger on your your trades, it is because you you lack lack confidence in yourself yourself or your your plan. Try taking a step back back for a short while while.. Cons Conscious ciously ly decid decide e not to to trade trade real real dolla dollars, rs, but work work on paper paper trading trading your your buy buy and sell sell signals signals.. Sure Sure,, it’ it’ss not the same as trading real real dollars, but this step step allows you you to work work on executing executing your yo ur trading plan. I have have found systematic systematic trading to be much much easier than discretionary discretionary trading, because it helps take take my my ego out of the equation. I focus instead instead on the execution execution of buy and sell signals, signals, as opposed to my my ego wanting wanting to be proved proved right. Paper trading trading will allow you to get refocused on execution of your ideas. 3. Mea Measur sure e Your Resul Results ts — Too often often trade traders rs may may have have a good good plan plan,, but then lose sight sight of measuring their results on a regular regular basis. Wha Whatt happens is that that 90% of your trades trades may be done properly properly, but it is those 5-10% of your your trades that that eat you you up with big losses. losses. If you monitor your results closely closely, you should start to devel develop op a “Success Profile”which Profile” which defines what what your your best trades trades look lik like. e. Once a trade trade doesn’tt fit this Success Profile doesn’ Profile anymore anymore,, yo you u should look to exit exit— — whether at at a profit or a loss loss — as your your edge no longer longer exists. Psychological Issue #3 in Trading: Lack of Confidence
In trading as in life, life, how you you think determines the results results you you achieve achieve.. Many traders traders are filled filled with doubts and and a lack lack of self-confidence, self-confidence, so you you need to coach yourself through tough times with positive and self-motivating beliefs. Check to see if you possess the traits and beliefs of winning traders, including: 1. My tradi trading ng object objectiive vess are are perfec perfectl tlyy clea clearr, and I trul trulyy belie believe ve I will will achiev ach ieve e these these goals. goals. If you you have have the the belief belief that that you you will will win, you increase your your chances chances of trading to win. In order to have have this level level of conviction, yo you u must must have have a thoroughly thoroughly tested plan. plan. You also also must must have a clear vision of how you will proceed with your plan in order to reach your your goal. The more more you can visualize visualize your your goals being
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Price Headley
achieved, the more you will strengthen achieved, strengthen your your internal belief belief and confidence that you will reach your goals. I have have cr crea eated ted a pla plan n to achie achieve ve my my tradi trading ng goa goals. ls. I’m sur sure e you’ you’ve ve heard the saying “I didn’t plan to fail; I failed f ailed to plan.”Without plan.”Without a plan, your yo ur results results will tend to be mixed and uninspiring. uninspiring. Commit to writing down your trading plan and reviewing it regularly. I prep prepar are e my my plan plan befor before e the tra tradin dingg day day starts starts.. If you you don’ don’tt have have a plan of action action once the trading trading bell rings, rings, you are moving moving from the proactive proacti ve mentality mentality into a reactive reactive approach approach.. I contend that the more reactiv reactive e you you become, the more you you will get in late to market market moves mov es and dramatically dramatically diminish your your reward-to-risk reward-to-risk ratio ratio.. I prepare after the close close for the next day’ day’s trading, seeking to stay proacti proactive ve and a step ahead of the rest of the crowd. I regular regularly ly monito monitorr my trad trading ing results results to to measure measure my progr progress ess towar toward d my goals. goals. Trading results tend to follow a zig-zag zig-zag approach approach similar to how a plane is guided guided to its destination. destination. At periodic steps steps along the wayy, if a pilot wa pilot is off off course, course, he will will set a new new course course towar towards ds the target. targ et. Thi Thiss is called called course course corre correction ction.. Once you you have have define defined d your your trading target, target, yo your ur periodic evalua evaluation tion should lead lead you you to assess assess what is taking you off course and encourage you to make the necessary corrections to get you back on target. I quickly quickly disca discard rd nega negati tive ve emoti emotions ons that that can can hurt my my trading trading resul results. ts. When you you lose, lose, learn from the experience and put it behind behind you. you. You cannot afford to dwell on a loss once the trade is complete. You have to have total focus on the new moment and forget about the past, sav save e for the time you you allocate allocate to evaluating evaluating past past trades (which should be done outside market hours).
6. I am focu focuse sed d on the the mar mark ket durin duringg the tra tradin dingg day day, and not eas easil ilyy distracted by by non-market non-market acti activities vities during trading trading hours. This can can be a tough one for many many traders who who have have many many responsibilities. responsibilities. If this is the case, case, define the time you will be focused focused on the mark market et and make arrangements not to be interrupted. Price Headley is founder and chief analyst at BigTrends.com, which provides daily education and recommendations for active traders of stocks, futures and options. He is also author of the investment bestseller, Big Trends in Trading.
My Secret to Market Internals BY MIKE HURLEY
Why care about market internals?
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ut simply, mark market et internals offer a very direct way way of measuring how the stock market is really doing doing.. Muc Much h like like the doctor doctor who who monitors monitors a patient’s patient’s pulse and blood pressure pressure,, savvy technicians technicians can glean a great deal of insight from observing the trends in breadth and leadership.. The four ship four basic numbers numbers I work work with include: include: •
Up Volume:The volume of shares traded on up ticks.
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Down Volume:The volume of shares traded on down ticks.
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New Highs:The number of stocks making a new 52-week high.
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New Lows:The number of stocks making a new 52-week low.
While studies vary vary on the exact exact figure, figure, all show show that the vast majority of stocks follow follow the trend in the overall market. market. This makes makes a ‘top-down’ approach absolutely critical to both investors and traders alike. Art or Science?
A great great deal of work work had been been done in this this area, in large part due to the ease in quantifying quantifying these measureme measurements. nts. Norman Fosbac Fosback’ k’s, s, High Low example,, while Gerald Gerald Appe Appell has conceived conceived Logic Index is a good example numerous numer ous valuable valuable indicators indicators in this area. While rules are very very attractive attractive to system testers, it seems that that no two tops or or bottoms are exactly exactly alike alike,, and the market rarely cooperates by flashing the perfect signal at just the right time! While clearl clearlyy more subjective subjective,, actually analyzing the data often leads to more profitable results. A good example of how to use market internals is with the 1998 market. ke t. After a strong strong move move early early in the year year (A),stocks (A), stocks consolida consolidated ted their gains in Spring (B). The breakout breakout in June looked great great until mid-July, mid-July, which whic h is when things got a little dicey technically. technically. Specificall Specificallyy, as the S&P was scoring new all-time highs,the highs, the number of stocks scoring new 52week highs was falling woefully short of what had been seen in Feb19
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Mar.This formed a major divergence on the chart chart (C), and gave huge warning that the rally may be in trouble. While obviously a very valuable piece of information, it also highlights the lack of specifici spec ificity ty,, whi which ch can be a problem for many traders and invves in esto tors. rs. Af Afte terr al all, l, whe here re the sign signal, al, and wh what at exactly is the you do when these should you divergences appear? Sell as the S&P approaches the round number of 1200? Tighten existing stops? Well…yes! Well…yes! Whichever fits your individual style and risk-toler risktolerance ance.. The critic critical al poin po ints ts is is,, th tha at market internals were wer e clearl clearlyy not in gear with with the rall rallyy, and are literall literallyy shouting a warning to those willing to listen. As stocks stocks declined declined through through July & Au August, gust, leadership continued continued to deteriora deter iorate te.. In class classic ic fashion, fashion, eac each h time the number number of Net New Lows Lows scored a ‘lower ‘lower-low’ -low’ it was a sign of further furt her weakness ahead for the market averages av erages (D). New lows lows exceed new new highs by 40-1 on on several several occasions (E), an indica indicator tor often often used used to mark mark mark market et bottoms bottoms.. Usin Usingg it as a mechanicall system would have mechanica have clearly clearly been a mistak mistake e however however,, as it signaled “Buy” “Buy”the the S&P at 1081 1081 — just in time for the next leg down! down! “Panic selling”(as defined by down volume comprising at least 90% of up and down down volume volume combined) occurred three three times in Augu August st (F), with “panic “pan ic buying” buying”seen seen on Septembe Septemberr 8th (G). Wh While ile this pattern pattern is usually seen at at bottoms, it is often often better to wait for internals to diverge before diving diving back back into the mark market. et. Leadership did in in fact trace out out a ‘higher-low’ ‘higher -low’ in October, October, offering a much better entry point from from a risk-management point of view. view. While it’s it’s certainly possible to catch falling knives, knives, it’s much safer to wait for them to stick in the ground! Another great example of how important it is to look behind the scenes is with the market market of 1999-2000. Few noticed the NASDAQ’ NASDAQ’ss surge through thro ugh the 3000 3000 mark mark in Nov Nov. (A), mu much ch less less thought thought it would would amount amount to
My Secret to Market Internals
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much, gi much, given ven the wo worries rries over over “Y2K “Y2K”. ”. Breadth and leadership clearly confirmed the move by scoring new highs of their their own, own, whi which ch made the market a ‘screaming buy’ howev however er,, for anybody who happened to be paying attention. January saw many well known chartists highlight the ‘double top’ in the NASD NASDAQ AQ,, mark market et internals internals remaine rem ained d strong, strong, sug suggest gesting ing stocks stocks were still in good shape technically (B).. In Marc (B) March h how howev ever er,, it was was a very very differen diffe rentt story. Spec Specific ificall allyy, the first first run at 5,000 showed nearly 400 net new highs while the second garnered nere d only only 50. Up volum volume e was was also also quite qui te weak eak.. As a res result ult,, bot both h form formed ed major divergences on the charts (C). While no one knew precisely what lay ahead for the NASDAQ NASDAQ,, these dramatic dramatic divergences divergences told all to at least be very careful, careful, and to take take any break break of support support in the 4500 4500 area area very seriously. Those who who play the short short side would have have found an ideal ideal entry at (D), as the NASD NAS DAQ made a classic classic ‘dead-ca ‘dead-catt bounce’, and then failed at what had been critical support. ‘Earning’ your money.
The bottom bottom line line is, whe whether ther you you trade trade or inves investt in individu individual al stocks, stocks, or marmarkett based vehicles ke vehicles such as as the exchange exchange traded funds or mutual mutual funds, the very first step in your analysis should be with overall market. Put simpl simplyy, whe when n the mark market et speaks speaks,, it pays pays to listen listen!! Mike Hurley is a Chartered Market Technician, and 20-year market veteran. He has served as the Technical Analyst for Preferred Capital Markets, E*OFFERING and SoundView Technology Group, as well as publisher of the Sector Fund Timer. Timer. His research is widely followed and he is frequently quoted throughout the financial media, including: Dow Jones, Bloomberg and CNBC. He currently manages money based on his proprietary market timing methods, and can be reached at:
[email protected].
Using Candle Charts to Spot the Early Turning Signals—The Basics B Y ST EV E N IS ON, C MT
What are Candlestick Charts?
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andle cha charts rts are Japa Japan’ n’ss most popula popularr, and oldest, oldest, form of techn techni-ical analysis. analysis. They are are older than point and figure and bar charts. Amazingl Amaz inglyy, candl candlestic estick k charting charting techniques techniques,, used for genera generations tions in the Far Far East, wer were e unknown to the West until I revealed revealed them in my first book Japanese Candlestick Charting Techniques back in 1991 B.C (Before Candles). Japanese Japanes e candlestick candlestick (also called candle) candle) charts, charts, so named because the lines look like like candles with their their wicks, wicks, are Japan’ Japan’ss most popular form of technical technical analysis. analysis. Candle charts charts are over over 1,000 1,000 years years old and as such are older than Western bar charts and point and figure charts. Yet, amazingl amazinglyy, these charts charts were were unknown to the Western world world until recentlyy. Candle trading techniques recentl techniques have have now become become one of the most discussed forms forms of technical technical analysis analysis around around the world. world. Almost every every technical analysis software package and Internet charting service now has candle candle charts. This attests to their popularity popularity and usefulness. This article is a very basic introduction to candle charting techniques. nique s. But even even with the primary primary candl candle e signals signals discu discussed, ssed, you will will discover how candles open avenues of analysis not available anywhere else. My goal here is to provide provide a sense sense of the potential that that the candles can offer. What are the Benefits of Candle Charts? Candle charts are easy to understand: Any Anyone one,, from the first-t first-time ime chartist to the seasoned professional can easily harness the power of candle candl e charts. charts. Thi Thiss is becau because se,, as will will be show shown n later later,, the same same dat data a that that is required to draw the candlestick chart is the same as that needed for the bar bar chart chart (the (the high high,, lo low w, ope open n and clos close). e). 23
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Candlestick charting tools will give you a jump on the competition: Candle charts charts not only show the the trend of the move, move, as does a bar chart, but, unlik unlike e bar cha charts, rts, cand candle le charts charts also also sho show w the forc force e underpinni underpinning ng the move move.. In additio addition, n, man manyy of the candle candle signa signals ls are are give given n in a few few sessions,, ra sions rather ther than than the weeks weeks often often needed needed for for a bar cha chart rt signal. signal. Th Thus, us, candle charts will help you enter and exit the market with better timing. Candlestick charting tools will help preserve capital: In this volatile vola tile environment, environment, capital preserva preservation tion is just as important as capital accumulation. accumul ation. You will discover discover that the candles shine in helping you preserve capital since they often send out indications that a new high or low may not be sustained. Candle charting techniques are easily joined with Western chartBecause use candle candle charts charts use the same same data as a bar chart, chart, it ing tools: Beca means that any of the technical analyses used with bar charts (such as moving mo ving av avera erages, ges, tre trendlin ndlines, es, retr retracem acements ents,, Boll Bollinger inger Bands Bands,, etc etc.) .) can be employ empl oyed ed with candle candle charts. charts. How Howev ever er,, cand candle le charts can can send signals signals not available with bar charts.
Candlestick Candlestic k charts charts can be used used in stoc stocks, ks, futur futures, es, and any any mark market that that has an open open,, hig high, h, lo low w and and clos close e. And the theyy can can be use used d in all tim time e frames—from intraday to weekly.
CONSTRUCTING CONSTRUCTIN G THE CANDLESTICK LINES
Exhibit 1
The broad part of the candlestick line in Exhibit 1 is called the real body. The rea reall body body represents the range between the session’s open and close. If the close of the session is above abo ve the open, open, then the real real body is white white.. If the real body is bla blac ck, the clos close e of the session is lower than the open. The thin lines above and below the real body are the hese se ar are e the the shadows. The session’s price extremes.
Using Candle Charts to Spot the Early Turning Signals—The Basics
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The shadow above the real body is called the upper shadow and the peak of the upper shadow shadow is the high high of the session. session. The shadow shadow under under the real body is the lower shadow and the bottom of the lower shadow is the session’s low. Candle lines can be drawn drawn for all time frames, frames, from intraday intraday to monthly month ly charts. charts. For exampl example, e, a 60-minu 60-minute te candle candle line uses uses the open, open, high,, lo high low w and close close of that that 60-min 60-minute ute period; period; for a daily daily chart chart it would would be the the open, open, hig high, h, lo low w and clos close e for the day day. On a week weekly ly chart chart the the candle would would be based based on Monday’ Monday’ss open, the high and low of the week, and Friday’ Friday’ss close close.. Notice that the candles to the left in Exhibit 1 have no real bodies. These are examples of doji (pr (pronoun onounced ced doe-gee doe-gee). ). A doji is a candle candle in which whic h the opening and close are are the same. Doji represent represent a market market that is in balance between between the forces of supply supply and demand. We will look more at the doji in one of the chart examples below. While Whi le the candlestic candlestick k line uses the the same data data as a bar chart, chart, the color of the candlestick’s real body and the length of the candle line’s real body and shadows convey an instant x-ray into who’s winning the battle between the bulls bu lls and the bea bears. rs. For instanc ins tance e, wh when en the real real body body is blac bl ack, k, tha thatt means means the stock stock closed below its opening price. This gives you an instant picture of a positive or negative close. Those of us who stare at charts for hours at a time find candlesticks are not only easy on the eyes, ey es, they conv convey ey strong strong visual Exhibit 2 signals sometimes missed on bar charts.
Spinning Tops
The logo of our firm is “Helping Clients Spot Market Turns Before the Competition”. This is because one of the most pow powerful erful aspects aspects of candle charts is that they will often provide reversal signals not available
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Steve Nison, CM CMT
with traditional bar charting techniques. techniques. Let’ Let’ss take take a look at at this aspect with a “spinning top.” As mentioned previously previously, one of the more powerful powerful aspects of candle charts is the quick visual information they relay about the market’s heath. hea th. For exampl example, e, a small small real body body (white (white or blac black) k) indicat indicates es a periperiod in which the bulls bulls and bears are more in a tug of war. war. The Japanese Japanese have ha ve a nickname nickname for for small small real bodies bodies —”sp —”spinning inning tops”, tops”, beca because use of their resemblance resemblance to the tops tops we had as children. children. Such small small real bodies bodies give gi ve a warning that that the market’ market’ss trend may be losing momentum. momentum. As the Japanes Jap anese e phrase it, the “mar “mark ket is losing its breath. breath.” A spinning top is illustrated in Exhibit 2. Let’s look at an example of how candle charts will often help you preserve capital, capital, a benefit so important in today’ today’ss volatile volatile environment. environment. In this scenario I will illustrate how a candle chart can help you avoid a potentially losing trade from the long side. I have have two charts charts below below.. The top top chart chart (Exhibit (Exhibit 4) is a bar chart. chart. On chart cha rt 3, on the are area a circl circled, ed, the stoc stock k looks looks strong strong since since it is making making consecutivel consecuti velyy higher closes. closes. It looks like a stock stock to buy. buy. Using the same same data data as on the bar chart, we now now make make a candle candle chart (Exhibit 4). Note the different different perspective perspective we we get with the the candle chart cha rt than with the bar bar chart. chart. On the candl candle e chart, chart, in the same cir circl cled ed area, are a, ther there e are a serie seriess of small small real real bodies bodies — whi which ch the Jap Japanese anese call “Spinning “Spi nning Tops” ops”.. Smal Smalll real real bodies bodies hint that that the prior trend trend (i.e. (i.e. the rally) could be losing its breath. As such, such, whi while le the bar chart chart makes makes it look attra attracti ctive ve to buy buy, the candle chart shows there is indeed a reason for caution about going long— the small small real real bodies bodies illustra illustrate te the bulls bulls are are losing losing force force.. Thu Thus, s, by using using
Exhibit 3
Exhibit 4
Using Candle Charts to Spot the Early Turning Signals—The Basics
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the candle chart, chart, a trader would would likely likely not buy buy in the circled circled area and and thus help avoid a losing trade. This is but one example of how candles can help you preserve capital. cap ital. Warre arren n Buffet Buffet has two rules: Rule 1— Don’ Don’tt lose mone moneyy. Rule 2— Don’t forget rule 1. 1. Candles shine at helping helping you you preserve preserve capital. capital. Doji
As the real body body shrinks we ultimatel ultimatelyy wind up with a doji. As shown on the right side of Exhibit Exhibit 1, a doji is when when the open and and close close are the same same.. The doji indicates a market in complete balance between supply and demand.. Since a doji session demand session represe represents nts a market market at a juncture juncture of indecision, they can often be an early early warning warning that a preceding preceding rally rally could could be losing steam. Indeed, with a doji doji the the Japanese Japanese wo would uld say say, “the mark market et is tired”. tired ”. (K (Keep eep in mind a clo close se over over the doji would would “refr “refresh” esh”the the market.) market.) Properl Pro perlyy used, used, candl candle e charts charts may may not only only help impr improv ove e profits, profits, but will assist in preserving preserving capital. They can do this by helping you you avoid avoid a potential losing trade or exiting a profitable trade early. Exhibit 5 shows an example of the latter. The horizontal horizontal line in Exhibit Exhibit 5 shows shows a resistance resistance area area near 135. A tall white candle candle pierces pierces this resistance resistance in early early March. But observe what what unfolded the next next session—the doji. doji. This doji doji line hinted the bulls bulls had lost full control of the market (note: it does not mean that the bears have have taken control). This is a classic classic example example of the power power of candle candle charting techtechniques. Specifical Specifically ly, within one session session we we were were able able to see a visual visual clue clue via the doji that while while the marke markett was maintaining maintaining its highs, highs, the doji shoutshouted that the bulls bulls were were not in complete control. control. So while the mark market et
Exhibit 5
Exhibit 6
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Steve Nison, CM CMT
looked healthy looked healthy from the outside, outside, the internals (as shown shown by the doji) were were relaying the fact that this stock was not as healthy as one would think. The Hammer
We now look at a specific type of candle line that has a very long lower shadow called a hammer hammer (Exhibit (Exhibit 6). So called because the mark market et is trying to hammer out out a base. base. The criteria for the hammer hammer are: are: 1. Th The e real real body body is is at at the uppe upperr end of of the tra tradin dingg range range.. 2. Th The e color color of the the real real bod bodyy can can be bla black ck or whit white e. 3. A bullis bullish h long long lowe lowerr shadow shadow tha thatt is at least least twice the heigh heightt of the the real body. 4. It sh shou ould ld ha havve no no, or a very very sh shor ort, t, up uppe perr sha shado dow w. The hammer reflects the market insights obtained from a candle chart-specifically chart-specifica lly,, the hammer’ hammer’ss extended lower shadow shows that the market rejected lower price levels to clos lose e at, at, or nea nearr, the hig highs hs of the the sessi se ssion. on. Fro rom m my ex exper perien ience ce,, mo most st times when there is a hammer the market may not immediately move up,, but may ral up rally ly slig slightl htlyy, or trade trade lat lat-erall er allyy, and the then, n, aft after er expa expandi nding ng on on Exhibit 7 a base base,, then ral rally ly. If the the mark market et closcloses under the lows of the hammer longs should be reconsidered. Candle charts can be used in all time frames— frames— from intra-day intra-day, day to weekly wee kly. In the intra-day intra-day chart chart (Exhibit (Exhibit 7), there are are two two back-to-ba back-to-back ck hamhammers (denoted (denoted by the arrow). arrow). Thes These e dual hammers hammers took on extra signifisignificance since they confirmed a support level shown by the dashed line. This is a classic example of the power and the ease with which one can combine the insights of candle charts (the hammers) with classic western trading signals (the support line) to increase the likelihood of a market turn. This synergy synergy of candle charts charts and western western technical technical tools should should provide a powerful weapon in your trading arsenal.
Using Candle Charts to Spot the Early Turning Signals—The Basics
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Engulfing Patterns
An engulfing pattern is a two-candle patt tte ern rn.. A bearish engulfing pattern (shown on the leftt in Exhibit 8) is formed forme d when, when, durin duringg a ral rally ly a black real body wraps around a white whi te real real body body. A bullish engulfing pattern (on the right in Exhibit 8) is complete comp leted d when, when, during a descen descent, t, a white real body envelopes the Exhibit 8 prior black real body. The engulfing pattern is illustrative of how the candles can help provide greater understanding into the behavior behavior of of the mark markets. ets. For example exam ple,, a bullish bullish engulfi engulfing ng pattern pattern reflects how the bulls have wrested control of the market from the bears. bea rs. A bearish bearish engulfin engulfingg pattern pattern shows how a superior force of supply has has overwh overwhelmed elmed the the bulls. bulls. The Japan Ja panese ese wil willl say say, for ins instanc tance e, tha thatt Exhibit 9 with a bearish engulfing pattern that “the bulls are immobilized”. Exhibit 9 shows how a bullish engulfing pattern in early October called a reversal reversal for IBM. IBM. This bullish bullish engulfing pattern pattern was especially especially potent because it reinforced reinforced a support support area set by a hammer hammer.. Once again this underscores the increased likelihood of a turn if there is more than one signal confirming confirming support-in this case case,, we had a hammer and and a bullish engulfing pattern.
Candles and the Overall Picture
Remember a basic principle: principle: candle charting techniques techniques are a tool and not a system. system. Effecti Effective ve candle candle charting techniques techniques require not only an understandi unders tanding ng of the candle candle patterns, patterns, but a policy policy of using using sound, coherent cohe rent tradin tradingg strategie strategiess and tactics. tactics. The These se include include using using stops, stops, deter deter--
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mining the risk and reward reward aspect of a potential trade, trade, observing where where a candle pattern pattern is in relation relation to the overal overalll trend, and monitoring the mark mar ket’ et’ss action action after after a trade trade is placed placed.. By understan understanding, ding, and using, using, these trading trading principles, you will be in a position to most most fully enhance the power of the candles. This is only only a basic introduction introduction to candle charts. charts. There are many more patterns, concepts and trading techniques that must must first be considered. side red. But even even with these these basic conce concepts, pts, you can can see how the cancandles open new and unique doors of analysis. May the candles light your path to profits! Steve Nison, CMT, CMT, is acknowledged as the leading authority on candlestick charts. He is founder and President of CANDLECHARTS.COM which provides educational products and advisory services to institutions and private traders. He is the author of Japanese Candlestick Charting Techniques and Beyond Candlesticks. Steve’s work has been highlighted in financial media around the world, including the Wall Street Journal , Institutional Investor, Worth Magazine, and Barron’s. To sign up for his free bi-weekly newsletter, visit www.candlecharts.com.
Catch that Trend! Directional Strength and How to Find It B Y B A R B A R A S TA T A R , P H . D. D.
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raders usually favor moving averages to help them determine price trend. tre nd. But But,, tw two o other other popul popular ar indic indicat ators, ors, the Mov Moving ing Ave vera rage ge Convergence/ Divergence (MACD) and the Average Directional Index (ADX), (ADX), can help traders traders detect not only only trend trend direction but trend trend strength as well. The MA MACD CD,, crea created ted by Geral Gerald d Appel Appel,, is a momentum momentum indica indicator tor that that often identifies price direction as it rises and falls above or below its trigger line and its zero line. The ADX, part of the Directional Movement Movement system developed developed by Wells Wilde ilderr, is designed designed to detect detect the strength strength of price move movement ment.. ADX values values in the 20 to 30 range indicate mild to moderate trending behavior while valuess above value above 30 usually signify signify a strong trend. A rising ADX indicates indicates that prices are trending, but does not reveal reveal the direction direction of that that trend. Plot the ADX 14 indicator above the MACD on the same price chart, as shown shown in Figure Figure 1, and patterns emerge emerge that that show both trend strength strength and trend direction.
Figure 1 The ADX indicator rises when it detects a growing trend, but does not indicate the direction of the trend. Add the MACD, however, and the trend direction becomes easier to see.
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Three Patterns
Three dist Three distinct inct,, and prof profita itable ble,, pa patterns tterns ap appea pearr frequen frequentl tlyy. The These se patpatterns do not not detect tops and bottoms, but can can help traders confirm confirm a trend. They are are especially especially useful for for those traders who who prefer shorter shorter-term trades. Confirming Pattern The confirming pattern occurs when both the ADX and the MACD MACD rise and fall in unison unison with price. price. Wh When en the indicators rise together they identify up trending price movement that presents bullish traders an opportunity to enter the long side of a trade. The stro strongest ngest,, and most ideal ideal,, trad trading ing config configura uration tion occu occurs rs when when the the ADX begins to rise and the MACD rises above its trigger line and also above abov e its zero line. The level level from which which the ADX rises does not matter. matter. In the Confirming Confirming pattern, pattern, whe when n price changes changes direct direction ion so do both the ADX and MACD to indicate a loss of momentum and/or a potential trend change. The Confirming pattern was evident on the daily Merrill Lynch price chart during the October through December 2002 period (See Figure 2). Both indicators rose in October confirming the price move from the $30 to $40 level. level. Both indicators indicators declined declined in early early November November as prices dipped, but rose again again later later that month when when price moved moved toward toward $45. $45. The indicators declined in December to reflect the falling to sideways price action.
Figure 2 When the ADX and MACD rise and fall in unison with price, it creates a Confirming pattern. An up trend is in progress when both indicators rise together.
Catch that Trend! Directional Strength and How to Find It
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Diverging Pattern The diverging pattern identifies down trending price move mo vemen ment. t. Her Here e, the indic indicat ators ors move move in oppos opposite ite dire directi ctions ons.. Th The e ADX ADX rises to indicate indicate that it has found found a trend, but the MACD MACD declines declines which which indicates that that the direction direction of the developing developing trend is down. Its mirrormirrorimage formation makes it an easy pattern to spot visually. This is a good pattern to follow for traders who are bearish and want to short a stock. stock. It also serves serves to warn warn those traders traders who might might wish to take a long position that they should wait for a more favorable time. The strongest pattern occurs when the ADX rises while the MACD falls below its trigger line line and also below its zero zero line. Two distinct Diverging patterns appeared on the Delta Air Lines chart in Figure 3 as prices took a nosedive from May through October 2002. Figure 3 When the ADX rises but the MACD declines, look for falling prices.
Converging Pattern This pattern has an upward bias following a steep decline dec line.. In it the ADX rolls rolls ove overr and begins begins to decline decline,, signi signifying fying that that the strength stre ngth of the trend trend has weak weakened. ened. At the same same time the MA MACD CD,, whi which ch has been below below its zero zero line, line, begins rising toward toward the zero line. Visually, the declining ADX and rising MACD seem to be converging toward each other.. Although this pattern other pattern sometimes marks marks the beginning of a new new up trend, more often than not it is a countertrend rally rally that produces produces a parpartial retracement of the price decline. Figure Fig ure 4 shows shows the Converging Converging pattern pattern on a chart of Exelon Corp., Corp., an electric utility holding company. company. Following the decline decline in the June-July 2002 time time period that that took the stock stock below the the $40 price level level,, price began moving moving up into August. August. It was able able to retrace retrace some of its loss by climbing above above $50 before declining declining again. The MACD MACD reflected the ris-
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Barbara Star, Ph Ph.D.
ing prices by crossing above its dotted trigger line and moving up to (and in this case, case, throu through) gh) its zero zero line as the ADX ADX stopped rising and and moved moved down to form the Converging pattern. This is an enticing pattern, pattern, but often not as profitab profitable le as the others because moves moves can be short-lived short-lived and, even though the MACD MACD rises, prices may move sideways instead of upward.
Figure 4 The converging pattern occurs after a decline. The ADX moves down and the MACD moves up as price retraces some of its losses.
A Trading Example
Traders could have profited from many of the patterns signaled by the ADX-MACD duo on the Coca Cola price chart from February to August 2002. Area A in February February marked a Converging Converging pattern pattern that gave gave way in
Figure 5 Many trading opportunities presented themselves during a seven-month period as all three patterns appeared at various times on the Coca Cola price chart.
Catch that Trend! Directional Strength and How to Find It
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March to a rising Confirming pattern in area B that rode price up until the end of Ap April. ril. Prices stalled and decline declined d slightly in in May (area (area C) to form a dec declinin liningg Confirmin Confirmingg pattern. pattern. In June, June, a rising rising Confirm Confirming ing patpattern re-emerged briefly (area D) only to fail as prices broke support in area are a E and produced produced a Divergi Diverging ng pattern. pattern. Fi Finall nallyy, a Convergi Converging ng pattern pattern (area F) appeared appeared in late late July as prices moved moved up into Aug August, ust, retracing about 50 percent of the decline. Could you have profited from any of the six areas identified by ADXMACD patterns? Summary
The patterns displayed by the ADX and MACD combination appear on charts cha rts of commo commoditie dities, s, inde indexes xes and mutual mutual funds as well well as as stocks. stocks. Not only do they have have profit profit potential, the patterns patterns signal changes changes in price movement mov ement which which can help avoid avoid trading pitfalls. This dynamic dynamic duo may be worth adding to your trading arsenal. Barbara Star, Ph.D., (818) 224-4070, is a former vice-president of the Market Analysts of Southern California. She is a frequent contributo contributorr to the magazine, The Technical Analysis of Stocks and Commodities. A former university university professor professor,, Dr. Dr. Star currently currently provides provides individual individual instruction instructio n and consultation to those interested in learning technical analysis. Her e-mail address is
[email protected]
One Custom MetaStock MACD...to go! B Y S I M O N S H E R WO O D
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hese days we are extremely lucky to have so many great books around on the mystical subject of Technical Analysis— ‘the study of market mark et action, action, prim primaril arilyy through through the use use of cha charts, rts, for the purpo purpose se of of forecasting future price trends’ (Joh (John n Murphy). Murphy). Most of these these books books have have been written in recent recent times (i.e. after I was was born!) hitting the shelve shelvess in the late late eighties and then on on through the nineties, and some even in very recent times...the noughties. Whilst this is of great benefit to the just starting tec techni hnical cal ana analy lyst, st, it can also be a bit like like the old elephant elephant and chain theory theory.. If a baby eleelephant is tied up with a chain chain to a post, post, it will walk walk as far as as the chain chain will allow and no further. further. The area that that it can move in is therefore therefore restricte res tricted d to a circle circle,, with the radiu radiuss being the the length length of the chain. chain. Now Now,, once the elephant elephant is fully fully grown, grown, the chain chain can be replaced replaced with a flimsy piece of rope. rope. And even even though the elephant elephant could easily easily break break the rope, rop e, it believes believes that that it can only only move move within the ‘cir ‘circl cle’, e’, so it never never tries to move outside of the box...I mean circle. This ‘story’ is often used by motivational motivational speakers speakers to illustrate how we humans sometimes impose restrictions on ourselves that may not be as valid as we think. Now you are probably wondering how this is connected to Technical Analysis Anal ysis and and the MACD MACD.. Well, it goes goes like like this. this. Whe When n we first first discov discover er the wonders wo nders of the MACD MACD,, or any indicato indicator/osc r/oscilla illator tor for that that matter matter, we use the default values values — those either recommended recommended by the crea creator tor or the ones that that the softw software are automati automaticall callyy uses. Some Sometime timess ‘we ‘we’’ fall into the trap of not wanting wanting to move outside outside the circle. circle. We are told the default value va luess are are x, y and and z, and tha thatt is wha whatt we use use.. Th The e point point of the the elep elephan hantt story is that we can move outside the ‘circ ‘circle’ le’ and in the case of the MACD MA CD,, use differ different ent value values. s. Of course course to do this this we we will need need the right software (please note that NO elephants were harmed during the writing of this piece). Fortunately MetaStock is a lot more flexible than most charting software.. Not only do you ware you have have complete flexibility flexibility as far as indicator/osci indicator/oscil-llator parameters parameters are concerned, but you you can create your your VER VERY Y OWN indicators with the Indicator Builder and MetaStock Formula Language. 37
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Simon Sherwood
The Moving Average Convergence / Divergence (MACD) ...what it is, who created it, and how to build it in MetaStock.
The MACD MACD was created by Gerald Appel. Appel. You will find detailed descriptions on how to use it in every good book on Technical Analysis (books by Ach Achelis elis,, Murph Murphyy, Pring and and Schwa Schwager ger to name a few few, plus MetaS MetaStoc tock k Online Onlin e Help). Help). To summariz summarize, e, it consists consists of of two lines lines — one one being being the difference between two exponential moving averages (of the closing price) referred referred to as the FAST FAST line, line, and the other being an exponential exponential moving avera average ge of the FAST FAST line, often called the SIGNAL SIGNAL or SLOW line. line. Generally buy and sell signals are given when these two lines cross each eac h other. other. How Howev ever er,, plea please se note that that the MACD MACD is usually usually used in conjunction with other indicators to form part of your overall entry/exit strategy — it is not used by itself.
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WHEN USED CORRECTLY CORRECTLY, THE MACD WILL GIVE BOTH BUY AND SELL SIGNALS AS FOLLOWS: •
•
SELL signals happen when the FAST line crosses above the SIGNAL line BUY signals are the reverse—when the FAST line crosses below the SIGNAL line.
This can be further fine tuned by only taking BUY or SELL signals when they occur either above or below the zero line respectively. THE DEFA DEFAUL ULT T VALUES VALUES ARE AS A S FOLLOWS: •
•
FAST Line: 12-period exponential exponential moving moving average average of of the Close — 26 period exponential moving average of the Close SIGNAL Line: 9-period moving average of the FAST FAST Line.
On page 38 is an example of the stock standard MACD straight from MetaStock (using the built in MACD from the Indicator QuickList). Now whilst whilst these values values may may work, work, there is nothing to say that that we can’t change them! But why would we want to change them? Well, it is quite possible possible that we we might find other values values to use that that give giv e better results results in a particular marke market, t, or are better suited suited to our style of trading trading.. For instance instance,, tra traders ders have have been been known known to use differe different nt values values for the MACD MACD on different different stocksand stocksand commodities, commodities, believing that each each stock stoc k has its own ‘perso ‘personali nality’. ty’. For now, now, we are are just going going to work with with one set of values and create create our own own personalized custom MACD MACD.. The values we we will use are 3, 8 and 13 (as used by Tom Bierovic). Bierovic). Creating a custom MACD
We will use the MetaStock Formula Language (MFL) function ‘mov’ for Moving Av Average erage.. This function calculates calculates the requested type of moving average of a specified data array (like the Closing Price) over a particular number number of periods. periods. This may may sound very very confusing but believe believe me,, it’ me it’ss not. Th The e functio function n looks looks lik like this: this: mov(C,, 3, E) — thi mov(C thiss will will plot plot a Thr Three ee (3) (3) period period Expo Exponen nentia tiall (E) mov moving ing average of the Closing Price (C) . I won’t go into the other possible values for the parameters; I’ll keep keep it simple for now. now. Now that that we know how how to use the ‘mov’ function we
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Simon Sherwood
can build build the entire MACD MACD,, believ believe e it or not! Here it is, the whole thing using the custom values: •
FAST Line: mov(C, 3, E) — mov(C, 8, E)
•
SLOW Line: mov(mov(C, 3, E) — mov(C, 8, E), 13, E)
In the Indicator Builder, this can be simplified to the following: •
Fast:=mov(C, 3, E) — mov(C, 8, E);
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Slo Sl ow: w:=m =mo ov( v(F Fas ast, t, 13 13,, E) E);;
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Fast;
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Slow;
Please note that the ‘input’ function could easily be added added to this to make mak e changing values values easier. easier. I’ I’ve ve added added a zero line and made the SLOW Line dashed dashed.. Her Here e is what what it looks lik like: e:
We could go one step step further and add the MACD MACD Histogram. Ther There e is sometimes confusion with with the Histogram, as some some people people plot the MACD MAC D and then change one of the plotted lines to ‘Histogram’ style —
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I must stress that that this is NOT the MACD MACD Histogram. The MACD MACD Histogram is actually actually the difference difference between the the FAST FAST and SLOW SLOW lines, plotted in the ‘Histogram’ style style.. Here’ Her e’ss that that chart chart again, again, comp complete lete with with the MACD MACD Histogr Histogram, am, zer zero o line...in fact everything: Once I have have built built my my Custom Custom MACD MACD,, thing thingss get even even easier easier.. Using more of MetaStock’ MetaStock’ss built-in power power,, I can create a screen template template and a button on the custom toolbar. toolbar. Now all I have have to do is click click one button button
and I can see my my Customized MACD MACD,, complete with MACD MACD Histogram. Histogram. The hard hard stuff’s stuff’s all done... done... the only thing left left to do is try to work out out what the heck it all means!!! Good luck and ‘Keep on Charting’! Simon Sherwood, author of MetaStock® in a Nutshell (John Wiley & Sons), works in an investment center that specializes in providing resources to Educated Investors. He runs the Center’s MetaStock User Group, as well as trains MetaStock users one-on-one and in groups. Email: metashell@bigpond.
[email protected]; com; http://au.groups.yahoo.co http:// au.groups.yahoo.com/group/metashell m/group/metashell
Understanding the Crowd BY DARYL GUPPY
In trading, there are three key questions: •
Is this a short-lived rally or a trend?
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Is this really a trend change?
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Is this price pullback in a rising trend an opportunity to join the trend, tren d, or a signal signal that that the the trend trend is ending? ending?
T
echnical analysis indicators are generally designed to answer one or more of these questions. questions. The answe answers rs help us to select better trading trad ing opportun opportunities ities,, and to trade trade them them in the corre correct ct way way. It is no good trading trading a rally rally as a major trend trend change. change. It calls for different different techniques, and we we need a method method to decide when the rall rallyy has ended and the downtrend resumed. I use a Guppy Multiple Moving Average to help make these initial decisions deci sions.. Once the best best opportuni opportunity ty has has been been found, found, and the the nature nature of the opportunity opportunity identifie identified, d, I then turn to other tools tools to fine-tune fine-tune the entry ent ry,, def define ine and and manag manage e the risk, risk, and to mana manage ge the the trade trade.. Th The e Guppy Guppy MMA relies on understanding the fractal f ractal repetition repetition of relatio relationships nships across multiple multiple time frames. It helps us to understand the behavior behavior of the two most important groups groups in the mark market et — traders and investors. investors. When traders traders use two or more moving moving averages, averages, their attention attention is usually focused focused on the point of the crossover crossover.. This is a distraction distraction from the more important messages contained in moving average relationships. The Guppy Guppy MMA uses the moving avera averages ges to track track the activity activity of traders and inve investors, stors, and to understand the difference between price and value. Value is what we we believe a stock stock is worth. We make this decision based on our future future expectations. expectations. Price is what what we pay pay to buy the stock stock today. When everybody everybody agrees on price and value there is no market. market. You can walk to the nearest Wal-Mart and see agreement on price and value in action. It is not very very exciting and and not very profitable profitable if we want to buy an item and later sell it at a profit. The financial market is driven by the difference between price and 43
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Dar yl Guppy
value. When some traders value. traders see a stock selling selling at $50 they believe believe it is under valued. valued. They buy buy because they believe believe they they can make make a profit on the difference between the current price and the future future value. value. When we we expand this concept to the broader market we observe periods where there is relativ relative e agreement on value value and price. The market market moves sideways. wa ys. At other times there there is a wide disagreement disagreement on price and value so the market moves quickly. Traders make these decisions more rapidly rapidly than investors. Traders are always alw ays probing to see if current price is good good value. value. Traders lead the market. mark et. Inv Investors estors follow follow.. Trade raders rs cannot maintain maintain their momentum momentum unless investors follow follow, and the Guppy Guppy MMA highlights these relationships. relationships. Applying the Guppy MMA
Before we apply apply the Guppy MMA, MMA, we start start with an observation observation of the beha beh avio viorr of the gr group oup of sho short-t rt-term erm ave vera rages ges.. Th These ese ar are e 3, 5, 10, 12 and 15-day exponential exponential moving averages averages.. When these averages averages compress, compress, they tell us that short-term traders are in agreement on price and value. Inevitably a few traders see an opportunity to make a dollar because they believe believe the market market is incorrectly incorrectly valued. valued. They start buying. buying. To get stock stoc k they have have to outbid outbid their their competit competitors. ors. Thi Thiss causes causes a separa separation, tion, or spreading in the short-term group group of avera averages. ges. Other traders pick pick up on the price moves, moves, and before long we we see a wide separati separation on of the shortterm group. At its widest, this separation separation tells us us that value value has moved moved well well away away from price. price. You probably probably know the feeling feeling.. Despera Desperate te to buy a stock stock that is moving exactl exactlyy as you you anticipated, anticipated, you end up chasing it to the top price of the day. day. Next morning you realize realize you you have have paid much more than you you should should have have.. Wh When en you, you, and other other traders traders reach reach this this concluconclusion, the sell selling ing starts starts,, and the wide spr spread ead in the the short-te short-term rm group group rapidly rapid ly collapses. collapses. Compressio Compression n is followed followed by expansion and follow followed ed again by compression. compression. Agreement on on value is follow followed ed by disagreement disagreement about value value,, and then followed followed by agreement agreement about about value. value. Investors Inve stors show the same relationship relationships, s, and these are are captured captured with the th e lo long ng te term rm gr grou oup p of of av aver erag ages es.. The hese se ar are e 30 30,, 35 35,, 40 40,, 45 45,, 50 an and d 60 60 day day exponentiall moving avera exponentia averages. ges. The compression compression and expansion expansion does not develop as quickly as with the short term group but the same behaviors are repeated repeated on a longer time time frame. frame. When the long term group of averaverages spreads out it tells us that the trend is well supported.
Understanding the Crowd
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Combine these two groups into a single display and we create a Guppy MMA. This is availa available ble as a standard Metastock Metastock template template in the template menu list. There are four areas of importance in applying this indicator. •
•
•
•
The compression compression and expansion relationships relationships in the short-term group of averages. The compression and expansion relationship in the long-term group of averages. The relationship and degree of separation between the short-term group and the long-term group. The crossover area and the nature of this crossover.
The accompanying chart shows how we use the Guppy MMA to identify the most appropriate appropriate trading opportunity. opportunity. We start with the first trading question: Is this a short-lived short-lived rally rally or a trend? Prices break above the downtrend line in area A on the bar bar chart. chart. We confirm confirm the probability of a rally by using the Guppy MMA. The short-term group has compres comp ressed, sed, but whe when n the the rallyy starts the long-term rall group is more widely spread. For this rally to succeed the traders have to convince the investors that this stock has a good future future.. We know this is more likely when the longterm group compresses and turns upw upward ards. s. It would would be unusual for traders to rapidly turn around investor sentiment when the long-term group is well spread apart. This is most likely a rally opportunity and has the
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Dar yl Guppy
potential to deliver deliver an 11% profit. We might not be comfortable trading trading the rallyy, but we are interested rall interested in the deve developing loping potential for a trend change. change. The Guppy Guppy MMA helps answer answer the second trading question: question: Is this really a trend change? Prices rebound from the trend line and by the time they get to 77, we are are interested. The relationship relationship between between the two groups groups of moving ave vera rages ges,, sho shown wn in area area B1, B1, is now now quite quite diffe differe rent. nt. Th Ther ere e is no hold holding ing the traders back. This group group of averages averages is moving moving sharply upwards upwards with no sign of faltering. Ther There e is a smooth expansion expansion in this group group suggesting suggesting steady buying support. The investors investors are are also taking notice of the latest price price moves. moves. The long-term group group has remained remained compresse compressed d — agreei agreeing ng on value — since the first rally. rally. Now they compress compress further before also moving moving sharply upwards upwar ds and expanding. expanding. This group group contains a 30-day and a 60-day 60-day moving average average,, and we would would expect expect these to lag behind behind price action if we we were wer e looking just at at moving avera average ge crossovers. crossovers. By understanding the developing devel oping relationship relationship in this long-term long-term group, group, traders quickly quickly identify the developing investor support. The crossover of the two groups on moving averages is on the upside and confirms this bullish bullish trend change. change. How However ever the the relationship relationship in area B1 is different different from that in area area A1, and this difference difference confirms a trend change.. Relying on moving change moving average average crossov crossovers ers alone does not give give the trader sufficient information to make good decisions. These relationships suggest there is a high probability that this is the start of a new new and strong strong up trend, trend, led by traders traders and and supported supported by investo inv estors. rs. Thi Thiss opportunity opportunity offers offers a 49% return. Plucking up the courage to enter on a price pullback in a rising trend tren d is made easy with the the Guppy Guppy MMA. In area area C, the initia initiall trend trend momentum fails and prices collapse collapse.. The reaction reaction of the long-term group of averages averages tells tells us this is a buying opportunity. opportunity. The group is well well separated separ ated and when when prices fall as traders traders take profits, the investors investors step in to buy stock stock at cheaper cheaper than than expected prices. prices. The long-term long-term group does not compress and continues to move upwards. Traders who took early profits can buy back into the trend around 88, confi confident dent that that the underlyi underlying ng trend trend is intact. intact. Trad raders ers and inve investors stors who missed out on the initial trend break now have an opportunity to join the trend trend and collect collect a 30% return. It is the relationsh relationship ip between between the long-term group of avera averages ges that confirms the trend trend strength. This relarelationship is not revealed if we use just a 10-day and 30-day moving average combination.
Understanding the Crowd
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Analysis on historical charts always looks good because we already know what what has happened in the future. future. These notes are are drawn from my my analysiss of this stock analysi stock in real real time. time. I opened a personal trade in area B and rode the trend trend using the Guppy Guppy MMA to deliver deliver the exit exit signal. This is my my primary tool for understanding the trend, the probability probability of a trend change,, and the nature change nature of trading trading opportunity. opportunity. Daryl Guppy is a private security and derivatives trader. He is the author of Market Trading Tactics, Better Stock Trading and Chart Trading . He publishes a weekly internet newsletter that highlights trading techniques. He speaks regularly on trading in Asia, the United Sates and Australia. He can be contacted via www www.guppytrader .guppytraders.com. s.com.
Bollinger Band Basics BY JOHN BOLLINGER
Bollinger Bands are available on MetaStock and most charting software.. They have ware have become popular popular primarily because because they answer answer a question every investor investor needs to know: Are prices high or low? What are Bollinger Bands?
Bollinger Bands are curves drawn in and around the price structure on a chart that provide provide a relativ relative e definition of high and low. low. Prices near the upper band are high prices, while prices near the lower lower band are are low. low. The base of the bands is a moving average that is descriptive of the intermedia interm ediate-te te-term rm trend. trend. Thi Thiss avera average ge is known known as the mid middle band, band, and its default length is 20 periods. periods. The width of the bands is is determined by a measure measure of vola volatility tility,, called standard standard deviation. deviation. The data data for the volatilvolatility calculation is the same data that was used for the moving average. The upper and lower bands are drawn at a default distance of two standard deviations from the average. THESE ARE THE STAND STANDARD ARD BOLLINGER BOLLIN GER BAND FORMULAS: Upper band = Middle band + 2 standard deviations Middle band = 20-period moving average Lower Low er band = Middle Middle band – 2 standard standard deviations deviations Learning how to use Bollinger Bands effectively cannot be fully explaine exp lained d in this article article.. How Howev ever er,, the followi following ng rules serve serve as a good good starting point. 15 Basic Rules for Using Bollinger Bands
1. Boll Bollinger inger Bands pro provide vide a rela relati tive ve defini definition tion of high high and and low low. 2. That That rela relati tive ve defin definition ition can be be used used to compa compare re price price action action and indicator action to arrive at rigorous buy and sell decisions.
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John Bollinger
3. Appr ppropr opria iate te indi indica cators tors can be deri derive ved d from from mom moment entum, um, vo volum lume e, sentim sen timent ent,, ope open n int inter eres est, t, int inter er-ma -mark rket et da data, ta, etc etc.. 4. Vola olatili tility ty and trend trend alread alreadyy have have been deplo deployyed in the construc construction tion of Bollinger Bollinger Bands, so their use for confirmation of price action action is not recomme recommended. nded. 5. The indic indicato ators rs used used for confi confirmati rmation on should should not be dire directl ctlyy relat related ed to one another. another. Two indicators indicators from the same category category do not increase confirmation. confirmation. Av Avoid oid colinearity. 6. Bollin Bollinger ger Ban Bands ds can be used used to clar clarify ify pur pure e pric price e patte patterns, rns, suc such h as as M-type M-typ e tops tops and and W-type bottom bottoms, s, mome momentum ntum shift shifts, s, etc etc.. 7. Pric Price e can can — an and d doe doess — wal alk k up up the the up uppe perr Bo Boll llin inge gerr Ban Band d and and down the lower Bollinger Band. 8. Closes Closes out outsid side e the the Bolli Bollinge ngerr Bands Bands can be cont contin inua uatio tion n signa signals, ls, not reversal signals—as is demonstrated by the use of Bollinger Bands in some very successful volatility-breakout systems. 9. The defaul defaultt paramet parameters ers of 20 periods periods for the movi moving ng ave averag rage e and standard deviation deviation calculati calculations, ons, and the two two standard devia deviations tions for the band bandwidth width are just that that,, defaul defaults. ts. The actua actuall paramet parameters ers needed needed for any given market/task may be different. 10. The aver average age deploy deployed ed should not be the best one for crossov crossover er signals. Rather,, it should be descriptive Rather descriptive of the intermediate-term intermediate-term trend. 11. If the ave averag rage e is length lengthened, ened, the numbe numberr of standar standard d devia deviations tions needss to be increased need increased simultan simultaneous eously ly;; from 2 at at 20 periods, periods, to 2.1 at 50 peri periods ods.. Lik Likew ewise ise,, if the the ave avera rage ge is is shorte shortened ned,, the nu numbe mberr of standard deviations deviations should be reduced; reduced; from 2 at 20 periods, to 1.9 at 10 periods. 12. Bollinger Bollinger Bands Bands are are based upon upon a simple simple moving moving aver average age.. Thi Thiss is because a simple moving average is used in the standard deviation calculation and we wish to be logically consistent. 13. Be careful careful about about making statistical statistical assumpti assumptions ons based on the use use of the standard deviation calculation in the construction of the bands. The sample size in most deployments of Bollinger Bands is too small for statistical statistical significanc significance, e, and the distributions distributions involve involved d are rarely normal. 14. Indicato Indicators rs can be be normalize normalized d with %b %b,, elim elimina inating ting fixe fixed d threshol thresholds ds in the process.
Bollinger Band Basics
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15.. Fin 15 inal allly, ta tags gs of the the ba band ndss are are ju just st tha that, t, ta tags gs,, no nott sign signal als. s. A tag tag of of the the upper Bollinger Bollinger Band is is NOT in-and-of-itself a sell signal. signal. A tag of the the lower Bollinger Band is NOT in-and-of-itself a buy signal. These rules outline the basic guidelines for using Bollinger Bands. For a more more comprehensi comprehensive ve understanding of the bands, I suggest that that you read “Bollinger On Bollinger Bands” . Th This is book book starts starts with with the the basics, builds to the complex complex and teaches teaches the technical technical analysis analysis process, inclu including ding which which indicators indicators to use and how how to read read charts. charts. It is available at www.BollingerBands.com. John Bollinger, CFA, CMT is probably best known for his Bollinger Bands, which have been widely accepted and integrated into most of the analytical software currently in use. He is the president of Bollinger Capital Management, a money management firm, and publishes two newsletters, The Capital Growth Letter and Group Power . He has five financial websites: www.EquityTrader.com, www .EquityTrader.com, www.FundsTrader.com, www.FundsTrader.com, GroupPower.com, www.BollingerBands.com and www.BollingerOnBollingerBands.com.
