First steps

Which way is the market moving? How far up or down will it go? And when will it go the other way? These are the basic concerns of the technical analyst. Behind the charts and graphs and mathematical formulas used to analyze market trends are some basic concepts that apply to most of the theories employed by today's technical analysts.

  1. Map the Trends

    Study long-term charts. Begin a chart analysis with monthly and weekly charts

    spanning several years. A larger scale "map of the market" provides more visibility

    and a better long-term perspective on a market. Once the long-term has been

    established, then consult daily and intra-day charts. A short-term market view

    alone can often be deceptive. Even if you only trade the very short term, you will

    do better if you're trading in the same direction as the intermediate and longer

    term trends.

  2. Spot the Trend and Go With It

    Determine the trend and follow it. Market trends come in many sizes -- long-term,

    intermediate-term and short-term. First, determine which one you're going to trade

    and use the appropriate chart. Make sure you trade in the direction of that trend.

    Buy dips if the trend is up. Sell rallies if the trend is down. If you're trading the

    intermediate trend, use daily and weekly charts. If you're day trading, use daily and

    intra-day charts. But in each case, let the longer range chart determine the trend,

    and then use the shorter term chart for timing.

  3. Find the Low and High of It

    Find support and resistance levels. The best place to buy a market is near support

    levels. That support is usually a previous reaction low. The best place to sell a

    market is near resistance levels. Resistance is usually a previous peak. After a

    resistance peak has been broken, it will usually provide support on subsequent

    pullbacks. In other words, the old "high" becomes the new "low." In the same way,

    when a support level has been broken, it will usually produce selling on subsequent

    rallies -- the old "low" can become the new "high."

  4. Know How Far to Backtrack

    Measure percentage retracements. Market corrections up or down usually retrace a

    significant portion of the previous trend. You can measure the corrections in an

    existing trend in simple percentages. A fifty percent retracement of a prior trend is

    most common. A minimum retracement is usually one-third of the prior trend. The

    maximum retracement is usually two-thirds. Fibonacci retracements of 38% and

    62% are also worth watching. During a pullback in an uptrend, therefore, initial buy

    points are in the 33-38% retracement area.

  5. Draw the Line

    Draw trend lines. Trend lines are one of the simplest and most effective charting

    tools. All you need is a straight edge and two points on the chart. Up trend lines are

    drawn along two successive lows. Down trend lines are drawn along two successive

    peaks. Prices will often pull back to trend lines before resuming their trend. The

    breaking of trend lines usually signals a change in trend. A valid trend line should

    be touched at least three times. The longer a trend line has been in effect, and the

    more times it has been tested, the more important it becomes.

  6. Follow that Average

    Follow moving averages. Moving averages provide objective buy and sell signals.

    They tell you if existing trend is still in motion and help confirm a trend change.

    Moving averages do not tell you in advance, however, that a trend change is

    imminent. A combination chart of two moving averages is the most popular way of

    finding trading signals. Some popular futures combinations are 4- and 9-day

    moving averages, 9- and 18-day, 5- and 20-day. Signals are given when the

    shorter average line crosses the longer. Price crossings above and below a 40-day

    moving average also provide good trading signals. Since moving average chart lines

    are trend-following indicators, they work best in a trending market.

  7. Learn the Turns

    Track oscillators. Oscillators help identify overbought and oversold markets. While

    moving averages offer confirmation of a market trend change, oscillators often help

    warn us in advance that a market has rallied or fallen too far and will soon turn.

    Two of the most popular are the Relative Strength Index (RSI) and Stochastics.

    They both work on a scale of 0 to 100. With the RSI, readings over 70 are

    overbought while readings below 30 are oversold. The overbought and oversold

    values for Stochastics are 80 and 20. Most traders use 14-days or weeks for

    stochastics and either 9 or 14 days or weeks for RSI. Oscillator divergences often

    warn of market turns. These tools work best in a trading market range. Weekly

    signals can be used as filters on daily signals. Daily signals can be used as filters for

    intra-day charts.

  8. Know the Warning Signs

    Trade MACD. The Moving Average Convergence Divergence (MACD) indicator

    (developed by Gerald Appel) combines a moving average crossover system with the

    overbought/oversold elements of an oscillator. A buy signal occurs when the faster

    line crosses above the slower and both lines are below zero. A sell signal takes

    place when the faster line crosses below the slower from above the zero line.

    Weekly signals take precedence over daily signals. An MACD histogram plots the

    difference between the two lines and gives even earlier warnings of trend changes.

    It's called a "histogram" because vertical bars are used to show the difference

    between the two lines on the chart.

  9. Trend or Not a Trend

    Use ADX. The Average Directional Movement Index (ADX) line helps determine

    whether a market is in a trending or a trading phase. It measures the degree of

    trend or direction in the market. A rising ADX line suggests the presence of a strong

    trend. A falling ADX line suggests the presence of a trading market and the absence

    of a trend. A rising ADX line favors moving averages; a falling ADX favors

    oscillators. By plotting the direction of the ADX line, the trader is able to determine

    which trading style and which set of indicators are most suitable for the current

    market environment.

  10. Know the Confirming Signs

    Include volume and open interest. Volume and open interest are important

    confirming indicators in futures markets. Volume precedes price. It's important to

    ensure that heavier volume is taking place in the direction of the prevailing trend.

    In an uptrend, heavier volume should be seen on up days. Rising open interest

    confirms that new money is supporting the prevailing trend. Declining open interest

    is often a warning that the trend is near completion. A solid price uptrend should be

    accompanied by rising volume and rising open interest.

    Technical analysis is a skill that improves with experience and study. Always be a

    student and keep learning.

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