The technical analyst should distinguish trends, watch technical slips and indicators, and follow other trading rules based on technical analysis.
The following 10 rules are intended for technical analysts because they are based on the technical analysis. You will find these trading rules very useful.
The author of these rules is John Murphy, the American analyst who is called "the king of the technical analysis".
Trading rules based on the technical analysis:
- Look for a trend
- Find a strong trend and follow it
- Find support and resistance
- Know the corrections value
- Draw the trend lines
- Follow moving averages
- Consider indicators
- Keep an eye on warning signals
- Distinguish a trend from accidental long market movements
- Keep an eye on signals confirmation
1. Look for a trend
Regardless of long or short market entry, it is necessary to start the technical analysis from studying the market situation. At first study fluctuations and trends on the maximum chart with the big periods as week or month. When the overall picture of market movement becomes clear to you, go to more detailed scale to have an idea that occurs within the quarter and month. And only then go deep to day and intra-day schedules.
If you start directly from a narrow picture of the market (day and intra-day schedules), without studying the bigger period, you can understand the market picture wrong and jump to incorrect conclusions.
An important aspect of all these steps is that at each scale it is necessary to find trends: both long and short-term.
2. Find a strong trend and follow it
After the first step, select what trend are you going to follow. It can be a long-term, medium-term or short-term trend. Depending on the period of chosen trend, use the corresponding chart and scale.
Always follow the chosen trend, and don't trade against a trend. If you chose the ascending trend, buy on minimums and bottoms; if — sell the descending at peaks and maximums.
It is important to remember that it is necessary to use charts with a longer period for trend detection, but with less long — for a choice of the accurate transaction moment.
3. Find support and resistance
An important technical analysis element is supported/resistance couple. The task of the technical analyst — to be able to find support and resistance quickly.
Sell when resistance is confirmed; buy when the price is reflected from support.
Also, remember that resistance can turn into support and vice versa if the price has crossed one of these lines and moved further.
4. Know the corrections value
All trends have corrections periods. Corrections are movements of the price in the opposite direction of a trend but which aren't rather full to be considered as trend lines. For the technical analyst, such corrections are an opportunity for market entry, because right after correction the main trend continues its movement.
To use the corrections properly in the financial markets, the trader have to see their approximate value. Often, corrections borrow from 30 to 70% of the current trend. 50% correction — the most widespread. In case of the ascending trend, correction for 30-35% — a frequent buy place.
Also, don't forget to use Fibonacci's levels - 38% and 62%.
5. Draw the trend lines
Even without having near at hand special programs for the technical analysis, you can and you ought to apply trend lines on the chart. In fact, trend lines are very simple: three points and direct piece.
Remember that the ascending trend lines are put from below the prices (i.e. contact points — minimum), and the descending trend lines are put from above the prices (contact points — maximum).
The breakdown of a trendline signals a turn of price movement.
The more contact points are to a certain trend line, the more important and essential it is.
6. Follow moving averages
Keep an eye on overlays of moving averages lines. The best technique is to put 2 or more moving averages lines and to watch their crossings. When the slower line crosses the faster one it is a sign of a trend turn.
It is worth remembering that moving averages can't predict the price, but can show where it moves regarding last prices. Using the moving averages during a trend is the most efficient way to use them.
7. Consider indicators
Put different slips and indicators: with their help, you will be able to determine the moments when the price is overstated or underestimated. Different types of moving averages can warn a trend reversal, but indicators and slips can help to predict sharper changes.
The most popular indicators are stochastic and relative strength index - RSI, which display the price in percentage wise from 0 to 100. If indicator values are more than 70 that mean that the tool is overbought and if the indicator value fell lower than 30 — the tool is oversold.
But keep in mind the divergence in indicator values and the prices. If the price and the indicator move diversely, usually it is a warning sign of a trend reversal.
8. Keep an eye on warning signals
Use the difficult and complex indicator Moving average convergence/divergence, MACD. This indicator allows to look more deeply at the price nature and to predict changes with a time benefit.
9. Distinguish a trend from accidental long market movements
Using such indicator as the Average directional index (ADX) the trader can distinguish a real essential trend from the period of the biddings. Keep watching the ADX indicator value, if the value rises, the force of trend increases and if falls — weakens.
Depending on that, a trend now or not, the technical analyst can choose a certain strategy which is suitable for this period. For example, during the active biddings and in case of high variability, it is possible to resort to the method of dollar cost averaging.
10. Keep an eye on signals confirmation
Besides the data on the biddings use volume and open interest (the total amount of unrealized transactions). Remember that the amount changes quicker than the price, thereby showing where the price will move soon. Open interest shows as far as traders are interested in tool purchase too, thereby giving the chance to predict a sharp growth. To the contrary, if open interest decreases, fewer investors want to purchase the tool.
You can build your trading strategy using different data. But if you trust in a strong form of efficiency of the financial markets, and chose the technical analysis as a method of security analysis, conform to the above-mentioned rules of stock exchange trading for the technical analyst, you will be accompanied by trading success.