The technical analyst has to note trends, watch technical oscillators and indicators, and follow other trading rules in the framework of technical analysis.
There are various trading strategies: one is based on the acquisition of the underestimated actions, others on the fundamental researches, among other examples. Today we will consider trading rules for the technical analyst.
The following 10 rules are intended for technical analysts because they are based on the technical analysis, i.e. on Dow Theory.
John Murphy is the author of these rules, the American analyst who is named “the king of the technical analysis”.
10 trading rules based on the technical analysis
All these rules are rather simple, maybe you even know them. But the knowledge and skill application are different matters. If you don't put these rules into the practice you will remain simply “clever clogs” and won't take any benefit.
- Find the trends
- Catch a strong trend and follow it
- Find support and resistance
- Know the amount of corrections
- Draw lines of a trend
- Follow moving averages
- Consider indicators
- Watch warning signals
- Distinguish a trend from casual long movements of the market
- Watch confirmation signals
Let's consider each rule more detailed now.
1. Find the trends
No matter are you going to enter the market for long or for the short period, it is necessary to begin the technical analysis with studying of an overall market picture. As a first step study the fluctuations and trends on the maximum chart with large periods in week or month. When the overall picture of the market movement becomes clear to you, you pass to more detailed scale to have the idea that occurs within the quarter and month. And only then go deep to day and intra-day charts.
If you start with a narrow picture of the market (i.e. to day and intra-day charts), without studying the bigger period, you can see the picture of the market incorrectly, and rush to a wrong conclusion.
An important aspect of all these steps is that at each level, it is necessary to find trends: both long and short-term.
2. Catch the strong trend and follow it
After the first step, define for yourself, what trend you will follow. It can be a long-term, intermediate or short-term trend. Depending on the period of your chosen trend, use the corresponding chart and scale.
Always follow the chosen trend, and don't trade against a trend. If you will choose the ascending trend - buy dips; if you will choose the descending trend – sell rallies.
For detection of a trend very important to use charts with a longer period, but less long — for a choice of the accurate moment for the transaction.
3. Find support and resistance levels
The technical analyst has to find support and resistance levels very fast.
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 crossed one of these lines and moved further.
4. Know the retracement of corrections
On trends, there are periods of corrections. These corrections are the movements of the price in an 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 entry into the market because shortly after correction, the main trend will continue the movement.
For the right use of corrections, the trader should know what represent their relative sizes approximately. Often, corrections retrace from 30 to 70% of the current trend. 50% correction — the most widespread. At the ascending trend, correction for 30-35% — a frequent place of purchases.
Also, don't forget to use Fibonacci's levels, i.e. 38% and 62%.
5. Draw the trend lines
Even if you don't have special software for the technical analysis, you should apply trend lines on the chart. In fact, lines of a trend are very simple: three points and direct piece.
Alternative types of charts, such as Renko, Kagi and the Tic-tac-toe, will help to find and draw the trend line more easily.
Remember that the ascending lines of a trend are put from below the prices and the descending lines of a trend are put from above the prices.
Breakdown of the line of a trend signals a turn of the movement of the price. The longer trend line has been used, the more important it is.
6. Follow moving averages
Keep track of moving averages overlays. The best technique is to put 2 or more moving averages and to watch their crossings. When the slower line crosses faster it is a sign of a trend turn.
Moving averages can't predict the price, but can show where it moves comparing with last prices. Most effectively moving averages work in the trending market.
7. Take indicators into consideration
Track oscillators with their help, you will be able to define the moments when the market is overbought and oversold. Different types of moving averages can warn a trend turn, but indicators and oscillators can help to predict sharper changes.
The most popular indicators — Relative Strength Index (RSI) and Stochastics, which display the price in percentage terms from 0 to 100. Values of indicators more than 70 mean that the tool is overbought and if the value of the indicator fell lower than 30 — is oversold.
You remember about divergences in values of indicators and the prices: if the price and the indicator move diversely, usually it is a precautionary sign of a turn.
8. Watch warning signals
Use the difficult and complex indicator Moving Average Convergence Divergence (MACD). This indicator allows looking more deeply at the price nature and to predict changes with timing advantage.
9. Distinguish a trend from casual long movements of the market
Use the Average Directional Movement Index (ADX) to distinguish a real essential trend of the trading market. You watch the value of the ADX indicator: if the value rises - trend increases and if falls — weakens.
Distinguishing a trend the technical analyst can choose a certain strategy which is suitable for this moment.
10. Watch the confirming signals
Volume and open interest are important confirming indicators in the futures market. Remember that volume changes quicker than the price, thereby showing where the price will move soon. Open interest gives the chance to predict sharp growth. To the contrary, if open interest decreases, fewer investors want to buy the tool.
It is possible to base trading strategy on different data. Based on certain data it is possible to select the different trading strategy. But if you trust in a strong form of efficiency of the financial markets, and chose the technical analysis as a method of the security analysis, conform to the above-mentioned trading rules for the technical analyst, you will be accompanied by success in the Forex.