10 Rules of Technical Trading by John Murphy21.05.2015
In what direction will go the market? How far it'll get up or down? And when it will change the direction? These are the basic questions of a technical analyst. Additionally to diagrams, graphics and mathematical formulas used in the analysis of market trends, there are some basic concepts that can be applied to most of the theories used by today's technical analysts.
John Murphy, a master in technical analysis of futures markets, based on his thirty years of experience, has developed ten fundamental rules of technical trading. These rules are intended to help to explain the general idea of technical trading for novices and simplify the trading methodology for more experienced practitioners. These principles define the key tools of technical analysis and how to use them to identify the possibility of selling and buying.
Mr. Murphy was the technical analyst for CNBC. For seven years he led the popular show "Tech Talk" and is the author of three best-selling books on the subject: "Technical Analysis of the Financial Markets", "Intermarket Technical Analysis" and "The Visual Investor".
Here are ten of the most important rules of technical trading by Mr. Murphy:
1. The overall trend Map
You should study long-term charts. Start the charts analysis with monthly and weekly charts spanning several years. A larger scale "map of the market" provides better visibility of the long-term prospects for the market. Once the long-term trend is installed, review the day and intraday graphics. The short-term view on its own is often misleading. Even if you trade only in the small time scale, you will do better if you make a transaction in the same direction as the intermediate and longer-term trend.
2. Determine the trend and follow it
The market trends come in many sizes: long-term, intermediate and short-term. First, determine what you are going to trade and use the appropriate chart. Make sure you trade in the direction of the trend. Buy below, if the trend is up. Sell at the top, if the trend goes down. If you're trading the intermediate trend, use daily and weekly charts. If you are a day trader, use daily and intraday charts. But in any case, let a longer-term chart determine the trend, and then use a short-term chart for the deciding the entry into the transaction.
3. Find its highs and lows (the trend's)
Find the support and resistance levels. The best place to buy is about the level of support. The best place for the sale is about the level of resistance. Once the resistance line was broken, it will usually be the support in 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 signify the selling on subsequent ascents: now the old "low" may become the new "high".
4. Calculate the pullbacks
Measure the correction with percentages. The market corrections up or down usually recover a significant portion of the previous trend. You can measure the correction of the current trend in simple percentages. Fifty percent for the restoration of the prior trend is most common. The minimum recovery is typically one-third of the prior trend. The maximum recovery is usually two-thirds. Fibonacci level 38% and 62% is also worth watching. Therefore, during pullback of an uptrend, the point of purchase is at the level of 33-38%.
5. Mark the line
Draw trend lines. The trend lines are one of the easiest and most effective tools. All that you need is a straight line and two points on the chart. The uptrend lines are marked by two successive lows. The downtrend lines are drawn on two consecutive peaks. The prices will often fall back to trend lines before resuming their trend movements. Violation of the trend line usually signals a trend change. A reliable trend line must touch the price at least three times. The longer the trend line, the stronger it is, and the more it has been tested, the more important it becomes.
6. Follow the averages
Follow the moving averages. Moving averages provide objective buy and sell signals. They will tell you that the current trend is still in force, and help to confirm the change. However, moving averages do not tell you in advance about an inevitably change in trend. The chart of combination of two moving averages is the most popular way of finding trading signals. Here are some popular combinations: the 4 and 9-day moving averages, as well as 9 and 18-day, and 5 and 20-day. Signals are given when the shorter average line crosses the longer. The intersection of the price above and below the 40-day moving average, also provide good trading signals. Since moving average lines follows the trend indicators, they work best in developing markets.
7. Examine reversals
Follow the oscillators. They help identify overbought and oversold level of the market. While moving averages confirm the trend change, the oscillators often warn us in advance that the market has grown, or fallen too far and will soon return. Two of the most popular are the Relative Strength Index (RSI) and Stochastics. They both work on a scale from 0 to 100. For RSI, values over 70 indicate overbought, while below 30 means oversold. Overbought and oversold for Stochastics are 80 and 20. Most traders use 14-day or weekly stochastics and 9 or 14 day or weekly RSI. The divergence of the oscillator often warns of market returns. Weekly signals can be used as filters on daily signals. Daily signals can be used as filters for daily charts.
Trade on MACD. The Indicator (MACD) Moving Average Convergence Divergence (founded by Gerald Appel) combines the intersection of moving averages into a system with the overbought/oversold elements of an oscillator. A buy signal comes when the faster line crosses below the slow line up and both lines - below zero. A sell signal occurs when the faster line crosses the slow down over the top of the zero mark. Weekly signals are more important than daily ones. MACD histogram is based on the difference between the two lines and gives even earlier warnings of trend changes. It is named "histogram", because it uses vertical bars to show the difference between the two lines on the chart.
9. Trend or not?
Use the ADX. The Average Directional Movement Index (ADX) helps to determine whether the market is in a trend or in the hallway. ADX measures the degree of trend or direction of the market. Increasing ADX line suggests the presence of a strong trend. Falling ADX line suggests the presence of a corridor and no trend. Increasing ADX line suggests using moving averages; falling ADX - using oscillators. By creating ADX lines, the trader is able to determine which trading style and which set of indicators is most suitable for the current market situation.
10. Take note of the confirmations
These include the volume and the open interest. Volume and open interest are important indicators of confirmation in the markets. The volume precedes the price. It is important to ensure that there is a greater volume in the direction of the prevailing trend. In an uptrend, a larger volume should be seen in the days of growth. Increasing of the open interest confirms that new money is supporting the prevailing trend. The decline of open interest often warns that the trend is near completion. The uptrend should be accompanied by rising volume and rising open interest.
The technical analysis is a skill that is improved with experience and learning. Always be a student and keep learning!
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