Moving Averages are one of the most basic technical analysis method of the financial market. They are basically the averages of the past prices, and when plotted on the chart, they can indicate the prevailing trend. If the closing price of the bar is above the Moving Average, the trend is up and vice versa if it is below.
Many systems and variations of them are used and tested. The one I found out to be favorable to me is that I do not place trades when the Moving Averages get crossed, nor would I place a trade if the closing price is on the other side of the bar. Rather, I found out that I like the system where the crossing bars highs and lows serve as an entrance point. I would place my trades few pips higher than the high of the bar that crossed the Moving Average from below and do just the opposite for the down cross. The other side of the price extreme would serve as a stop loss order.
However, the problem with any system exclusively based on Moving Averages is that it will go through long periods of losses. This is because markets can and do trade sideways, without a significant trend. And that can extend over a long period of time. So, just as well as a system based on them makes money in big trends as it captures all big moves, it can just as severely lose it all in a choppy market.
Yet for me they are not completely useless as many traders would make you think. Here is sincerely how I find it most useful:
-I use it as a base to measure how other systems stack against it. For me, my moving average system serves as a bench mark, meaning if the newly developed system that I back test can not handily beat the results of moving averages, then it is useless.
-It can be used as a decent filter for getting rid of a lot of average and small probability trades even when trading on fundamental data.
-Many systems can employ them successfully if they are combination with the other indicators (see this post on the trading system that combines Moving Averages and Stochastic).
When I first started to look into trading, before historical testing programs came out, I used it in spreadsheets, and played with them by building my systems inside. Now there are much easier ways to test them, but I think I learned a lot by crunching numbers inside worksheets.
Showing posts with label Technical Analysis. Show all posts
Showing posts with label Technical Analysis. Show all posts
3/26/2010
Technical Analysis- Broad Background
Technical analysis refers to the method of analyzing markets based on their historical price movements. It is in contrast to fundamental analysis which deals with macro and micro economical influences. So, a fundamental analyst would look at the morning unemployment news and how it may move the markets. However, a technician would consider how prices have moved during past months, days, or hours, and based on that information alone would decide the most likely future price movement.
It is not a new science although it proliferated with the development of computers. Japanese had used it for centuries for analyzing the rice market by developing charting system called Candlesticks. And in the 1930’s Ralph Elliot developed his own technical analysis currently referred to Elliot Wave Principles. Volumes of the book have been written on both analysis and in many financial circles are followed to this day.
Naturally, present day technical analysis has grown in complexity, but it can roughly be divided in two separate areas: one that is easily programmable, and one that is, just like Candlestick or Elliot Waves previously mentioned, mostly dependent on visual recognition.
Visual recognition analysis consists of charting. Here the most important factor is the drawing of trend lines by connecting with the straight line most significant highs or lows (significant meaning one that sticks out and is easily noticeable in the chart – the high of the last bar would not be significant if current bar would have a higher high). Actually the lines drown offer sort of supply and demand lines, points at where buyers are rushing in (lines connecting the lows) and points where sellers are flooding the market (lines connecting the highs). In trends often these lines will form a channel of a price movement serving as an indicator of when to buy and sell.
Equally important is noting the points of resistance and support. When price can not close above certain level, stated level is referred to as the resistance. Support points are just the opposite as they indicate points where market stops on the way down. These points often reflect psychological barriers to trend continuation. They increase in significance longer they are present and with each unsuccessful attempt to cross them. But when the market brakes though them, it creates a strong signal that the further trend is ready to develop.
Further study of the charts will reveal different formations, such as Flag or Triangle formations. Usually they can be found in areas of congestion, or side way movements. They are not necessarily indicative of the change in trend, but rather that the trend will continue once the pattern is broken.
Programmable technical analysis basically consists of previously established and well defined formulas . One of the most often used is the Moving Average indicator. It is an average of the past closing prices. When the price crosses it and closes on the “other” side of it, it can serve as an indicator of the ending of the trend or the starting of the new one.
Also, very popular is the Bollinger Band which is derived by adding and subtracting two standard deviations of closing prices from their moving average. Importance is given to the area where prices move above or below the bands. Other standardized indicators with programmable formulas behind them include Stochastic, Oscillators, Relative Strength Index (RSI), and others. These often serve as secondary indicators, and can pin point areas of excessive buying or selling which usually results in contra moves. Also, closely watched by many traders is the volume representing the level of executed transactions, which when looked with other indicators can reveal the strength of underlying price move.
However, technical analysis does not need to end there. After studying the markets, you can actually create your very own technical indicator with the use of programmable platforms such as TradeStation, MetaTrader or others.
The benefit of all this technical analysis is that it takes most of subjectivity out of the trade planning and reserves the trading decision to statistically proven method. In other words, with technical trading you are trying to be like a casino, trying to put the odds of winning in your favor.
Extremely important to note here is that none of this systems work hundred percent of the time and each should be tailored to one’s personality. Crucially important is the discipline, proper money management and a risk allocation.
If you think this is all too technical to even be considered, please be advised that majority of the most successful traders base their trading signals on technical analysis. So, if people that make millions think they can not live without them, why should you?
Check here for the previous Technical Analysis post.
It is not a new science although it proliferated with the development of computers. Japanese had used it for centuries for analyzing the rice market by developing charting system called Candlesticks. And in the 1930’s Ralph Elliot developed his own technical analysis currently referred to Elliot Wave Principles. Volumes of the book have been written on both analysis and in many financial circles are followed to this day.
Naturally, present day technical analysis has grown in complexity, but it can roughly be divided in two separate areas: one that is easily programmable, and one that is, just like Candlestick or Elliot Waves previously mentioned, mostly dependent on visual recognition.
Visual recognition analysis consists of charting. Here the most important factor is the drawing of trend lines by connecting with the straight line most significant highs or lows (significant meaning one that sticks out and is easily noticeable in the chart – the high of the last bar would not be significant if current bar would have a higher high). Actually the lines drown offer sort of supply and demand lines, points at where buyers are rushing in (lines connecting the lows) and points where sellers are flooding the market (lines connecting the highs). In trends often these lines will form a channel of a price movement serving as an indicator of when to buy and sell.
Equally important is noting the points of resistance and support. When price can not close above certain level, stated level is referred to as the resistance. Support points are just the opposite as they indicate points where market stops on the way down. These points often reflect psychological barriers to trend continuation. They increase in significance longer they are present and with each unsuccessful attempt to cross them. But when the market brakes though them, it creates a strong signal that the further trend is ready to develop.
Further study of the charts will reveal different formations, such as Flag or Triangle formations. Usually they can be found in areas of congestion, or side way movements. They are not necessarily indicative of the change in trend, but rather that the trend will continue once the pattern is broken.
Programmable technical analysis basically consists of previously established and well defined formulas . One of the most often used is the Moving Average indicator. It is an average of the past closing prices. When the price crosses it and closes on the “other” side of it, it can serve as an indicator of the ending of the trend or the starting of the new one.
Also, very popular is the Bollinger Band which is derived by adding and subtracting two standard deviations of closing prices from their moving average. Importance is given to the area where prices move above or below the bands. Other standardized indicators with programmable formulas behind them include Stochastic, Oscillators, Relative Strength Index (RSI), and others. These often serve as secondary indicators, and can pin point areas of excessive buying or selling which usually results in contra moves. Also, closely watched by many traders is the volume representing the level of executed transactions, which when looked with other indicators can reveal the strength of underlying price move.
However, technical analysis does not need to end there. After studying the markets, you can actually create your very own technical indicator with the use of programmable platforms such as TradeStation, MetaTrader or others.
The benefit of all this technical analysis is that it takes most of subjectivity out of the trade planning and reserves the trading decision to statistically proven method. In other words, with technical trading you are trying to be like a casino, trying to put the odds of winning in your favor.
Extremely important to note here is that none of this systems work hundred percent of the time and each should be tailored to one’s personality. Crucially important is the discipline, proper money management and a risk allocation.
If you think this is all too technical to even be considered, please be advised that majority of the most successful traders base their trading signals on technical analysis. So, if people that make millions think they can not live without them, why should you?
Check here for the previous Technical Analysis post.
2/22/2010
How I Like to Use RSI
From all the technical tools at my disposal, one of my most favorite is RSI or Relative Strength Index. It is an index measuring a momentum of a market direction with formula as follows:
RSI=100-(100/(1+RS)) where
RS = Average of x days up closes / Average of x days down closes
So basically, you just have to select parameter of X days to chart the RSI. My favorite parameter for RSI is 20, so I am measuring on daily basis roughly last month of market strength. I also use it with hourly charts with same parameter of 20 which represents almost entire day.
I like to use it as a ‘contrarian’ signal which means going against the prevailing trend. It is because the signal is very decent in identifying tops and bottoms with overbought and oversold lines. For that purpose I select zones when RSI is over 70 for overbought or under 30 for oversold.
The red arrows shows when RSI is over 70 and present overbought zones, and the green ones indicates oversold zones with RSI under 30.
In all those cases I would consider trading it with placing stops below most current lows or above most current highs. That way if the signal proves wrong, and the market continues its trend I am fully protected. Remember that no signal works 100 percent of the time.
If I already have previously established position while tracking RSI, I would certainly like to use it to show me when to take profit, thus getting out of part of my long position when RSI is over 70, and out of my short positions when RSI drops below 30.
A lot of variations can be used here, including different levels of overbought and oversold as well as working with different number of bars. But then, that is for you to figure out what suites you the most.
RSI=100-(100/(1+RS)) where
RS = Average of x days up closes / Average of x days down closes
So basically, you just have to select parameter of X days to chart the RSI. My favorite parameter for RSI is 20, so I am measuring on daily basis roughly last month of market strength. I also use it with hourly charts with same parameter of 20 which represents almost entire day.
I like to use it as a ‘contrarian’ signal which means going against the prevailing trend. It is because the signal is very decent in identifying tops and bottoms with overbought and oversold lines. For that purpose I select zones when RSI is over 70 for overbought or under 30 for oversold.
The red arrows shows when RSI is over 70 and present overbought zones, and the green ones indicates oversold zones with RSI under 30.
In all those cases I would consider trading it with placing stops below most current lows or above most current highs. That way if the signal proves wrong, and the market continues its trend I am fully protected. Remember that no signal works 100 percent of the time.
If I already have previously established position while tracking RSI, I would certainly like to use it to show me when to take profit, thus getting out of part of my long position when RSI is over 70, and out of my short positions when RSI drops below 30.
A lot of variations can be used here, including different levels of overbought and oversold as well as working with different number of bars. But then, that is for you to figure out what suites you the most.
1/26/2010
Candlesticks Reversal Patterns
Used for over 300 years, candlestick chart patterns provide viable tools in determining the present and the future nature of the market.
One of the candles most widely tracked is the one called Doji. It is formed when the openings and the closings of the bar are very close to each other, thus forming a cross pattern. They present a very strong warning especially if they are positioned right after a long red or green candle.
Doji is indicative of the weakness of the existing trend. It shows that buyers and sellers are equally matched, thus raising a red flag to anyone expecting the trend to go on. This indecision in the marketplace portrayed by Doji usually results in the change of the market direction. The future bar should be closely watched to see if the market can brake to new lows/highs.
Another reversal patterns consists of the Hanging Man and the Hammer formations. They are both formed when the opening and the closing prices are in proximity of the bar high with the low of the bar being significantly lower. Good criterion for these formations to be valid is if the length of the down leg is 3 or more times larger than the difference between the open and the close.
Hanging Man formation occur in up trends, and after a long up bars are indicative that the market is running out of steam and may reverse. The same but opposite is the true of the Hammer.
The third reversal pattern is called Shooting Star and Inverted Hammer. They are similar to previously stated formation, but the full body of the candle (the difference between open and close) is located close to the low of the bar.
Yet another reversal pattern is Dark Cloud Cover. It is identical to a normally considered reversal bar pattern when after a long up bar, market opens up, establishes a new high, but closes significantly lower than previous bar close. For the reverse signal to be valid, the half of previous bar body has to be pierced. The same but the opposite is true with Piercing Line which signals reversal of down trend.
Please note that these indicators have a better probability of success if they are part of a significant trend. If these patterns occur in a narrow trading range, they tend to be less reliable.
One of the candles most widely tracked is the one called Doji. It is formed when the openings and the closings of the bar are very close to each other, thus forming a cross pattern. They present a very strong warning especially if they are positioned right after a long red or green candle.
Doji is indicative of the weakness of the existing trend. It shows that buyers and sellers are equally matched, thus raising a red flag to anyone expecting the trend to go on. This indecision in the marketplace portrayed by Doji usually results in the change of the market direction. The future bar should be closely watched to see if the market can brake to new lows/highs.
Another reversal patterns consists of the Hanging Man and the Hammer formations. They are both formed when the opening and the closing prices are in proximity of the bar high with the low of the bar being significantly lower. Good criterion for these formations to be valid is if the length of the down leg is 3 or more times larger than the difference between the open and the close.
Hanging Man formation occur in up trends, and after a long up bars are indicative that the market is running out of steam and may reverse. The same but opposite is the true of the Hammer.
The third reversal pattern is called Shooting Star and Inverted Hammer. They are similar to previously stated formation, but the full body of the candle (the difference between open and close) is located close to the low of the bar.
Yet another reversal pattern is Dark Cloud Cover. It is identical to a normally considered reversal bar pattern when after a long up bar, market opens up, establishes a new high, but closes significantly lower than previous bar close. For the reverse signal to be valid, the half of previous bar body has to be pierced. The same but the opposite is true with Piercing Line which signals reversal of down trend.
Please note that these indicators have a better probability of success if they are part of a significant trend. If these patterns occur in a narrow trading range, they tend to be less reliable.
1/16/2010
Introduction to Candlesticks
One of the oldest tools to analyze markets was developed by Japanese in the 18th century in order to follow the rice market. They would draw a bar of each trading day, noting high, low, open and close, and paint the distance between open and close in a rectangle shape so that each bar would somewhat resemble a candle, thus the name of Candlestick Charting the way we call it today.
During past centuries, the technique has not been lost and came to the western world at the start of 20th century. Recently actually it has progressed to the point that most of the decent charting software offers it as a charting option.
Please note that each bar that has the closing price higher than the opening price is painted with the lighter color (in this case light greenish color), while the darker colored candles represent bars where the open is higher than the close (the red color). Most charting software offer ways to customize the colors, so you can tailor them to your liking.
The most basic way to look at the candlesticks is to notice ones that set themselves apart from the rest, especially in size. A long green candles represent bars where buyers were predominant force and pushed the market higher during the trading interval. It is indicative of an up trend and thus such candle normally signals a buy signal. The same but the opposite is true for the long red candle which signals a down trend.
See below how the trading opportunities existed to sell the market after the long red candle presented itself.
Those indicators go well with a trading strategy of trading in the direction of the trend. Maybe Japanese never heard of expression “Trend is your friend” and “Go with the flow”, but it seems they knew how to identify trends long before western traders did.
In the second part of candlesticks analysis I plan to show some of the most famous candlesticks patterns, and after that I can demonstrate how I actually use them in combination with other technical tools.
Look at this post for further Candlesticks info.
During past centuries, the technique has not been lost and came to the western world at the start of 20th century. Recently actually it has progressed to the point that most of the decent charting software offers it as a charting option.
Please note that each bar that has the closing price higher than the opening price is painted with the lighter color (in this case light greenish color), while the darker colored candles represent bars where the open is higher than the close (the red color). Most charting software offer ways to customize the colors, so you can tailor them to your liking.
The most basic way to look at the candlesticks is to notice ones that set themselves apart from the rest, especially in size. A long green candles represent bars where buyers were predominant force and pushed the market higher during the trading interval. It is indicative of an up trend and thus such candle normally signals a buy signal. The same but the opposite is true for the long red candle which signals a down trend.
See below how the trading opportunities existed to sell the market after the long red candle presented itself.
Those indicators go well with a trading strategy of trading in the direction of the trend. Maybe Japanese never heard of expression “Trend is your friend” and “Go with the flow”, but it seems they knew how to identify trends long before western traders did.
In the second part of candlesticks analysis I plan to show some of the most famous candlesticks patterns, and after that I can demonstrate how I actually use them in combination with other technical tools.
Look at this post for further Candlesticks info.
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