PART 1: GETTING STARTED WITH TECHNICAL ANALYSIS
Chapter 1: Introducing Technical Analysis
·
Buy-and-hold (B&H)
o
Returns are not very good at all.
o
Stocks from 1950 to 2018 returned 11.1% annually.
o
B&H is good only if you got in at the bets
time.
o
Eg. If you bought US stocks at the price peak
just ahead of the 1929 crash, it would have taken you more than 20 years to
recover the initial capital
o
From Jan 2000 to Oct 2002, the A&P fell by
50%. If you owned S&P and held throughout the entire period, you lost 50%
of your stake. And you need to make a gain of 100% to get your money back.
·
In technical analysis (TA), it’s the chart that
determines the trading decision, not the underlying fundamentals of the
security.
·
Fundamental analysis (FA) and TA can be combined
to complement one another
·
In TA, the goal is to make profit, and not to
consider owning a security
·
Trend
o
Trend is your friend
o
It is a discernable directional bias in the
price – upwards, downwards, or sideways
·
With TA, you don’t exactly have to know how an
indicator is calculated arithmetically. Just good enough to know what the
indicator is indicating and what decision the indicator is suggesting
·
Time frame
o
Your position on life’s timescale is also
important. You can’t day-trade when you have a day job
o
Fractal – refers to the odd fact that a price
chart on a one-hour timeframe basis is similar to a four-hour timeframe or
daily timeframe or even weekly. Same TA can be applied to any timeframe
·
Rules/discipline to manage risk is important
over the lifetime of the ownership of the security
·
You should be aware of the gain needed to
recover the loss
Chapter 2: Tapping Into the Wisdom of the Crowd
·
Support & Resistance may show on the pages
as hard lines, but in practice they are more like support & resistance
areas. The lines are just approximations
·
TA is the art of identifying crowd behavior, aka
bandwagon effect (momentum investing)
·
Mean-reversion – based on the concept that the
price tends to deviate towards the average. Trading the mean-reversion is to
find the average price over the past period and buying when the price has
deviated to the low side of the range
·
Position Squaring – closing of the position due
to many reasons:
o
Traders think the move is exhausted for the
moment
o
Traders have met the price objective
o
Traders have met the time limit, such as end of
day, week , month or tax period
·
Retracements (corrections, pullback, throwback)
– minor move in the opposite direction of the trend
Chapter 3: Trade What You See: Market Sentiment
·
Technical trader goal is to identify what the
crowd is doing and take advantage of it
·
Primary tools are patters and indicators
·
Sentiment indicators examples:
o
% of stocks above 200-day moving average
o
# stocks above the 52 week high
·
Breathing indicators – measures the degree of
participation by traders
o
Advance/decline ratio indicator - # stocks that
reach higher price in a day/# stocks that reach lower price
·
Put/call ratio – put- right to sell, call- right
to buy. High p/c ration means bears are winning.
·
VIX - Volatility Index
·
Confirmation Bias
o
Belief in a hypothesis and expecting it to
deliver the theoretical outcome without fail. It’s a form of wishful thinking
o
Is dangerous – you stop gathering information
that might jolt you out of the desired confirmation
o
Is the single biggest shortcoming of the
technical trader
·
Anchoring – e.g. you paid $100 for a stock. Now
it has fallen to $50. Holding on to the stock without selling when the price
started falling hoping that the price will come back to $100.
Chapter 4: Gaining Critical Advantage from Indicators
·
Noise – every price series, trending or not, has
a certain amount of noise. Refers to price changes that arise from unforeseen
quarters, can’t be forecasted and tend not to last.
·
Trends
o
Is beginning – eg. MA crossover or patter
breakout
o
Is strong or weak – eg. Momentum, slope of
linear regression
o
Is retracing but will likely resume – eg. RSI
o
Is ending and may reverse – eg. Momentum, MA
cross, or pattern breakout
o
Is range trading – slope of linear regression or
MA
o
Fading the trend – trading a retracement –
opportunistic trading against the trend – requires lightening speed, total
concentration and nerves of steel
·
Convergence – two indicator lines coming closer
– price action moving sideways – generally leads to breakout
·
Divergence – two indicator lines moving farther
apart – one of the few leading indicator
·
Backtesting – or optimization is the process of
testing a hypothesis on historical data
Chapter 5: Managing the Trade
·
Creating your trading plan with 5 rules
o
1. Determine whether a trend exists
o
2. Establish rules for opening a position
o
3. Manage the money at risk by scaling up or
down (adding or subtracting the amount of money in the trade)
o
4. Establish the rules for closing a position –
set stops and targets
o
5. Establish a re-entry rule after being stopped
or after the target is hit
·
Guerrilla trading – sideways-market, when the
price is moving within a range. Get in and get out quickly
·
Types of stops
o
2% stop rule – most famous stop rule is to use
2% of your capital
o
Risk-reward money stops – ratio of potential
gain to potential loss. Eg. 4:1
o
Trailing-stop – dynamic stop that follows the
price
o
Indicator-based stops
§
Last 3-day rule – exit the position if the price
surpasses the lowest low of the preceding three days.
§
Pattern stops. E.gs
·
break of support or resistance
·
the last notable high or low of a time period
(the historic level)
·
stops from other patterns like center
confirmation point of the W in double-bottom or the M in the double top.
§
Moving-average stop – e.g. Breakout beyond a
10-day moving average
o
Volatility-based stops
§
Parabolic stop-and-reverse model – an indicator
that rises by a factor of the average true range as new highs are being recorded.
§
Average true-range stop – stop is set just
beyond the maximum normal range limits.
§
Chandelier exit – sets the stop at a level below
the highest high or the highest close since the entry. The logic is that you
are willing to lose only one-range worth from the bet price that occurred since
the entry.
o
Time stops
§
Money tied up in a trade that’s going nowhere
can be put to better use in a different trade (or a savings account)
§
Clock & calendar stops
·
Time of day is important to consider. E.g. 1st
hour of market opening.
·
In forex, often process retrace at the end of
European trading day, at about 11.00 am in New York
·
Adjusting positions
o
Scaling-in – to increase the size of a position
o
Scaling-out – to reduce the amount of a position
o
Pyramiding – using unrealized hypothetical
profits to enlarge your position. E.g. you started with a $1000 and the trade
has generated another $1000 in paper-profits. Now you borrow against the extra
$1000 to buy more of this high performing security. In this situation if a
catastrophe strikes and the trade goes against you, you risk a huge loss.
·
Measuring the trade – Positive Expectancy
o
Win/Loss ratio – e.g. - $2 gain for every $1
loss. The ratio is 2:1
o
Expectancy = (Avg $ per winning trade x % of
winning trades) – (avg $ per losing
trade x % of losing trades)
o
Capital Goal = Starting Capital + (Expectancy x
Capital stake per trade x # Trades)
§
E.g. if you want to reach a capital of $20,000
with starting capital of $10000, you need to make 76.9 trades per year to
double your money. (given an expectancy of $130 per trade)
PART 2: BUILDING INDICATORS FROM THE GROUND UP
Chapter 6: Reading Basic Bars: How to Pounce on Opportunities
·
Basic Bar – OHLC – open, high, low, close
·
Identifying an uptrend – a series of higher-high
and higher-lows
·
Downtrend – a series of lower highs and lower
lows
·
Choosing an interval
o
Equities – usually, traders look only at hourly
chart
o
Forex – usually, traders look at 4-hour (240
minutes) chart
o
But choosing interval is very subjective
o
It also depends on the volume traded in a
specific interval
·
Liquidity – refers to existing and potential
volume
·
The size of the bars, the position of open and
close in the bar, the open & close relative to previous bars are all
important in reading bars.
Chapter 7: Special Bars – An Early Warning System
·
Daily trading range – difference between high
and low of the period. The size of the range relative to the neighboring bars
is important
·
Spike – a much wider high-low range than the
bars immediately preceding it. Often a sign of important price reversal
·
Gaps – a visible discontinuity between two price
bars on a chart
o
Common gap – appears out of nowhere for no
particular reason. It is mostly a noise.
o
A security with low liquidity, thinly traded,
tends to have more gaps
o
Breakaway gap –
§
Proportionately big compared to the usual
trading range
§
Occurs when the price is only slightly trending
or moving sideways
o
Runaway gap
§
Occurs after a security is already moving in a
trend
§
Breakaway gap starts a trend, runaway gap
continues a trend
o
Exhaustion gap
§
Occurs at the end of a trend
§
Volume is usually low
§
Usually followed by a reversal
o
Island reversals
§
Single isolated price bar with a gap up on one
side and gap down on the other
§
Sometimes 2 or 3 bars can form an island
§
Island reversal at bottom – buy
§
Island reversal at top – sell
·
Trading Range as a tool
o
Range expansion – lengthening of the price bars
over time. Suggests a continuation pattern
o
Range contraction – shortening of the bars –
suggests a trend reversal may be coming
o
Doesn’t tell you about the existing direction of
the price move
o
ATR – Average True Range – usually a 14-period
moving average
§
ATR is not a directional indicator. It is a
measure of volatility
Chapter 8: Redrawing the Price Bar: Japanese Candlesticks
·
Doji – open and close are the same or very near
o
Plain doji – open and close are at center
§
If it appears on an uptrend – bearish doji star
§
If it appears on a downtrend – bullish doji star
o
Dragonfly doji- Long lower shadow
o
Gravestone doji – long upper shadow
·
Shadows
o
Missing shadows
§
Shaven top – no upper shadow – can be white or
black
§
Shaven bottom – no lower shadow – can be white
or black
o
Long upper/lower shadows
·
Hammer – small real-body and long lower shadow -
appears in a down trend
·
Hanging man – small real-body and long lower
shadow - appears in a up trend
·
Harami (“pregnant”) – small real-body after a
bigger shadow.
o
This is a 2-candle pattern
o
If the 2nd
session is a doji, it is called harami-cross
·
Engulfing patterns – 2nd candle is
longer then the 1st
o
Bullish engulfing – 2nd candle is
white
o
Bearing engulfing – 2nd candle is
black
·
Shooting star – long upper shadow and small real
body. Appears after a uptrend
·
Continuation patterns
o
Rising window – upward gap
o
Falling window – downward gap
o
3-white soldiers – 3 large candles in a row.
Confirms the uptrend
o
3-black crows – opposite of 3-white. Confirms a
downtrend
·
6 candles can be of “investment” grade
o
Doji star, bearish engulfing, rising &
falling windows
PART 3: FINDIND PATTERNS
Chapter 9: Seeing Patterns
·
Chart Patterns
- indicators consisting of geometric shapes drawn on a chart.
·
Symmetrical triangle – referred to as coil
·
Continuation patterns
o
alerts you when buying or selling pressure is
pausing
o
ascending triangle
o
descending triangle
o
Dead-cat bounce
§
Starts with a negative fundamental event that
triggers a massive downward move.
§
Avg size of the downward move is 25% but can go
upto 70%
§
The bounce is an upward retracement that may
fool you into thinking the drop is over. The bounce upward sometimes fills part
of the gap
§
One of the most successful patterns delivering a
success rate of nearly 90%
·
Classic Reversal Patterns
o
Double Bottom
§
Looks like a “W”
§
Essentially a retest of the low and predicts a
price breakout to the upside
o
Double Top – “M” - mirror image of the Double
Bottom
o
Triple Top: Head-and-Shoulders
§
Popular because, when the price surpasses the
conformation line, it delivers the expected down move 90% of the time
§
Usually forms after a long uptrend
·
Measured Move
o
Forecast of the upcoming price move after a
chart event
Chapter 10: Drawing Trendlines
·
Zig-zag pattern
o
A line that tracks the price move until the move
reverses by x%. then you start a new line going in the other direction
·
Support & Resistance Lines
o
Initiate a new position on the confirmation,
right after the 3rd touch. Some buy on the 2nd touch
o
Sell as soon as the low of the price bar falls
below the support line
·
Congestion or consolidation
o
Often precedes and follow a breakout
o
If you see sideways movement and can’t find a
trend, widen your timeframe
o
Stop trading until you see the next trend
o
A TRUE TREND-FOLLOWER IS NEVER IN THE MARKET ALL
THE TIME
·
Linear Regression Line – doesn’t take the place
of support or resistance. Can be a supplementary, confirming indicator to
identify trend.
Chapter 11: Transforming Channels into Forecasts
·
Channel drawing
o
A pair of straight line trendlines encasing a
price series
o
Benefits
§
Implies absolute limits and a sense of where you
stand
§
The more often a price touches a support or
resistance line but doesn’t cross, the more reliable you can consider the line
to be
§
If the channel line is broken, you feel certain
that something significant has happened
·
Channeling
o
Buy near the channel bottom & sell near the
channel top – over and over as long as the channel lasts
o
Estimate the future gain or maximum loss using
channel width
·
Linear regression channel
o
A trendline along with to channel based on standard
deviation
o
Some price bars will always break the channel
unlike the hand-drawn channel
o
Self-adjusting unlike hand-drawn channel
·
Breakouts
o
How to best determine false breakout from true
breakouts
o
1st line of defense – configuration
of the breakout bar. Better to wait for the close of the bar, rather than the
low or high of the bar in session
o
Verify with volume
o
Use momentum and relative strength indicators to
confirm
o
A breakout that occurs in the course of an
orderly trend is more meaningful than a breakout that occurs in a disorderly
trend.
o
Blowout – accelerated breakout in the direction
of the trend may signal a immediate/near future breakout in the opposite
direction
PART 4: DYNAMIC ANALYSIS
Chapter 12: Using Dynamic Analysis
·
Moving average – more accurately describes
what’s really going on with the price movement.
o
Trend following, lagging indicator
·
Simple Moving Average
o
Crossovers
§
Crossover trading – buying at the point where
the price crosses above the MA
·
Whipsaws – whipping action of price quickly
moving through the moving average in both directions. Common in sideways market
·
Overtrading – making a lot of trades for only a
net small gain or loss. Almost always results in a net loss because of
brokerage commission and fees
·
Moving average level rule – selling when the MA
level today is lower than yesterday and buying when the MA level today is
higher than yesterday
·
Fixing noise
o
Widening the timeframe
o
Normalizing the price using a formula
·
Golden cross – 50-day MA crossing over 200-day
·
Death cross – 50-day MA crossing under 200-day
·
Adjusting Moving Averages
o
Simple MA, Weighted MA, Exponential MA
o
Buy when shorter MA crosses above the longer MA,
and sell when the opposite happens
o
You can also use 3-way MA or 8 to 10 Mas called
a MA ribbon or rainbow, which shows convergence and divergence
·
Moving Average Convergence & Divergence
(MACD)
o
Indicator line – difference between Higher MA
line and Lower MA line
o
When the indicator line is rising, the two MAs
are diverging, when the line is falling, the averages are converging
o
MCAD is quicker on the trigger than the MA
cross-over, but it is still a lagging indictor
o
MCAD has better predictive power because it gets
you out of the trade quicker or gives an entry before the price advances
o
One of the most reliable indicators
Chapter 13: Measuring Momentum
·
Momentum – speed of price change
·
Example: MACD
·
Simple Momentum: Current price / price x periods
ago
·
Momentum indicator can move up or down only if
the price is accelerating or decelerating.
·
Momentum indicators are excellent confirming
indicators
·
Applying momentum
o
Buy when the indicator crosses above the zero
line. Sell when it crosses below the zero line
o
Zero line = level at which the current price is
same as price x periods ago
o
Divergence
§
Refers to momentum that moves in the direction
opposite to the direction of price trend.
·
Relative Strength Index (RSI)
o
Measures the relative speed of price changes
o
Uses averages over several days instead of
single price point
·
Chande Momentum Indicator – calculates the
difference between the sum of all recent gains and sum of all recent losses and
then divides the result by the sum of all the price movement over the period.
Ranges from -100 to + 100.
·
Average Directional Movement (ADR)
o
DM+ : current high – prior high > prior low –
current low
o
DM- : prior low – current low > current high
– prior high
·
Stochastic Oscillator
o
Measures the relation between high-low range
over x number of days and close to the high or the low over the same period.
o
Don’t use SO in a strongly trending market.
Chapter 14: Estimating Volatility
·
Volatility – measure of price variation
·
Range trading with high volatility is a trader’s
nightmare - solution is to stop trading
during this time. Or move to a lower timeframe
·
Rest of the chapter talks about ATR and Bollinger
Bands. Not too much detail given here
Chapter 15: Ignoring Time to Create Better Timing
·
Tick Bars – you get a tick entry on the chart
only when a minimum number of trades has been achieved.
·
Constant Range Bar – takes only price into
consideration and ignores the time. Eliminates noise and shows only meaningful
price moves
·
Point & figure charts – strips away time and
displays only significant price moves
o
Date is irrelevant and only price matters
o
Start a new column only when the last
directional move is over.
o
Box size – minimum amount that the security
needs to move above the recent high /low before another entry is made on the
chart
o
The smaller the box size, the more sensitive the
chart
o
Support & Resistance
o
Vertical price projection
o
Horizontal projection – when the price is moving
sideways and breakout is about to start
·
P&F can be combined with Mas, Parabolic SAR
or Bollinger Bands to add value
Chapter 16: Combining Techniques
·
Better to have at least two indicators, one to
get an entry signal and 2nd for confirmation of signal
·
Tip: Adjust RSI days to match the wave cycle
(no. of periods between tide and ebb) in a trending pattern
·
Rest of the chapter talks about combining
indicator signals with discretion and judgement and other events.
·
Guerilla trading – very short-term trading lasting
only a few minutes and targeting only a few points of gain. But repeating it
multiple times.
Chapter 17: Judging Cycles and Waves
·
Wyckoff wave – based on 4 market sentiment turning
points
o
1. Accumulation
o
2. Markup
o
3. Distribution
o
4. Markdown
·
Hurst’s Magic Numbers – JM Hurst identified 20 “natural
harmonic” arithmetic wavelength relationships among cycles, including 60
minutes, 160 minutes, 1 day, 5 days, 40 days, and so on up to 17.93 years.
·
Moon and Stars – link between astronomical events
and markets
o
Lunar Cycle Theory
§
Holds that equities perform better starting a
few days after full-moon. Falling market occurs a few days after new moon.
o
Saros cycle – based in the way the moon revolves
around the earth in an elliptical pattern, causing supermoons and eclipses. It is
18 years, 11 days, & 8 hours.
o
Sun Spots – caused by change in temperature that
is caused in turn by a change in magnetic force. Roughly a 11-year solar cycle.
·
Seasonality – rise and fall according to time of
year.
·
Magnificent Mr W.D. Gann (1878-1955)
o
He used astronomy, discovered magic numbers,
applied geometry to charts to derive shorter-term cycles.
o
Gann angle – a line connecting one unit of price
change to next unit.
§
When using slope as support or channel, need to
examine the degree of steepness
·
E.g. 25’ slope means trend is weak, 70’ slope –
trend is flaky and prone to correction. Whereas 45’ slope can show more
strength.
o
Gann’s 50% retracement rule
§
Discovered that retracements occur at one-half
of the original move from the low to the high.
·
The Elliott Wave
o
Foundation of EW is the Fibonacci sequence of
numbers.
o
Basic idea – all price movements have two
segments:
§
1. Impulse wave – the way the crowd wants to
take the price in a trend.
·
Has 5 parts – 3 waves go in the trend direction,
2 in the opposite
§
2. Correction wave –
·
Has 3 parts – 2 waves go against the main trend
direction, 1 goes with it
Chapter 18: The Mind-Blowing Ichimoku
·
Ichimoku means “at a glance”, Kinko means “balance”
·
Places a series of MAs on the chart, and the
crossover delivers the buy/sell signal.
·
Also projects an arithmetic manipulation of the
MAs into the future to create an area of support/resistance (cloud), that is
self-adjusting.
·
Uses a slew of MAs calculated on the high and
low over a period of time, not just close alone.
·
Building an Ichimoku Cloud
o
Uses 3 MAs – 9, 26, & 52 periods
o
Tankan-sen: highest high + lowest low over past
9 periods / 2. “sen” means line
o
Kijun-sen: highest high + lowest low over past
26 periods / 2
o
Senkou span: has 2 parts
§
Part A: (tankan + kijun) / 2 projected out 26
days. Average of shorter term and longer term projected into future
§
Part B: highest + lowest price over past 52
periods / 2. Avg of full year of high and low and thus ultra-long term
§
Part A & B form a cloud or kumo.
o
Chikou span: today’s CLOSE price projected into
26 periods back in time.
·
Using Ichimoku
o
Buy signal – crossover of the two MAs with the
additional condition that current prices must be above the cloud.
·
From Mahesh Patel’s book
o
Buy when
§
Price is above the cloud
§
Tankan crosses above kijun
§
Chikou has lots of space between itself and the
price (implies strong momentum)
§
Price is at least 50 points away from farther edge
of cloud in the opposite direction
§
Entry is less than 200 points from tankan and 300
points from kijun
PART 5: THE PART OF TENS
Chapter 19: Ten Secrets of the Top Technical Traders
·
1. Appreciate Probability – no indicators work
100% of the time. MUST keep track of win-loss ratio and maintain a positive
expectancy.
·
2. Backtesting matters – keep an excel sheet and
track every trade and update it everyday. It takes less than 10 minutes.
·
3. Trend is Your Friend – if you don’t see a
trend, sit back and wait.
·
4. Entries Count as Much as Exits – Buy &
hold is never an optimum methodology.
·
5. Stops aren’t Optional – decide ahead how much
loss you can tolerate, either in cash or percentage terms.
·
6. Treat Trading as a Business – trading decision
should not be based on emotional impulse
·
7. Eat your spinach – losses are inevitable. But
it has to be within the plan. Don’t keep applying the same strategy that made
the loss.
·
8. Technical Stuff Never Goes out of Date –
although technical ideas never go out of date, they do go in and out of style. During
80s, Elliott Wave has been in style, 90s, MACDs, and today, Ichimoku.
·
9. Diversity – diversify choice of indicators
(primary & confirmation non-redundant indicators), and choice of securities,
try trading different securities
·
10. Swallow Hard & Accept Some Math – know when
to hold and when to fold.
Chapter 20: Ten Rules for Working with Indicators
·
Understand the indicator thoroughly before using
it
·
Better to backtest your strategy over long
periods of history
·
Accept that your indicators will fail
·
The rest of the chapter discusses generic rules
that are mentioned all through the book
Book mentions:
·
Investing with the Trend: A Rules-Based Approach
to Money Management
·
Building Reliable Trading Systems- by Keith
Fitschen
·
Technical Analysis by Jack Schwager
·
Profitable Candlestick Trading – by Steve
Bigalow
·
High-Profit Candlestick Patterns – by Steve
Bigalow
·
Encyclopedia of Candlestick Charts – by Tom
Bulkowski
·
Traver Vic: Methods of a Wall Street Master – by
Victor Sperandeo
·
Timing the Market by Curtis Arnold
·
PPS Trading System – by Curtis Arnold
·
Trading Systems and Methods – by Perry Kaufman
·
The New Technical Trader by Tushar Chande
·
Street Smarts: High Probability Trading
Strategies for the Futures and Equity Markets by Larry Connors & Linda
Raschke
·
New Thinking in Technical Analysis, Trading
Models from the Masters, by Rick Bensignor
·
Charting the Stock Market, the Wyckoff Method by
Jack Hutson
·
The Profit Magic of Stock Transaction Timing by J.M.
Hurst
·
The Delta Phenomenon or The Hidden Order in All
Markets by Welles Wilder
·
The Elliot Wave Principle by A.J. Frost
·
Ichimoku Charts, An Introduction to Ichimoku
Kinko Clouds by Nicole Elliott
·
Trading with Ichimoku by Karen Peloille
·
Trading with Ichimoku Clouds, The Essential
Guide to Ichimoku Kinko Hyo Technical Analysis by Mahesh Patel
Resources:
·
www.cyclesresearchinstitute.org
