I think it was at the p6chat xmas party last Friday when a couple of guys asked me when i intend to resume participating in the stock market. Of course my boring reply was "when i see the market resume a clear and strong uptrend". Now why do I, as well as many other traders who trade with the trend, find this important? The answer is because if I align my long trades with an uptrend, I am stacking the odds in my favor so that most of my trades will be profitable.
You see, in an uptrend, the sum of the rallies are larger than the sum of the declines in prices, this is a fact, period, end of story. Mathematically, this phenomenon accounts for the positive slope of the uptrending price action. Using this simple observation, there are certain generalities to be gleaned in the characteristic of price action during an uptrending environment. Since trends appear in the price charts, which are 2 dimensional, these generalities will be limited to the variables of time and price which corresponds to the x and y axis. The logical expectations are: (a) in an uptrend, odds are in favor of each rally being bigger than the ensuing correction (b) in an uptrend, odds are in favor of rallies occurring in longer duration than the declines (c) if an index is in an uptrend (notwithstanding some component stocks weighted heavier than others), odds are in favor that there are more component stocks in an uptrend rather than otherwise.
So there you go.. each time I open a position in an uptrending environment - the odds of a, b, and c, above are all working in my favor. Now that doesnt mean that I will be making money all the time (THATS WHAT PROTECTIVE STOPS ARE FOR), but it surely allows me a heightened sense of trading confidence knowing that my trades stand a good chance of being in the money. It also doesnt mean that there are no profitable trades to be made in a downtrend or consolidation - there may be a few, but they are considered high risk since the odds are not in my favor. Remember - there's no sure thing in the stock market. So wouldnt you want the odds to be in your favor when you trade?
More on trends and other building blocks of technical analysis next time .. Cheers !
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* ELLIOT WAVE PRINCIPLE: KEY TO MARKET BEHAVIOR by Frost and Prechter
* FIBONACCI APPLICATIONS & STRATEGIES FOR TRADERS by Robert Fischer
* FORECASTING FINANCIAL MARKETS: THE PSYCHOLOGY OF SUCCESSFUL INVESTING by Tony Plummer
* JAPANESE CANDLESTICK CHARTING TECHNIQUES by Steve Nison
* POINT & FIGURE COMMODITY & STOCK TRADING TECHNIQUES by Kermit Zieg Jr.
* PROFIT MAGIC OF STOCK TRANSACTION TIMING by J.M.Hurst
* TECHNICAL ANALYSIS EXPLAINED by Martin Pring
* TECHNICAL ANALYSIS OF STOCK TRENDS by Edwards and Magee
* TECHNICAL ANALYSIS OF THE FINANCIAL MARKETS by John Murphy
This blog is committed to the serious study and valid understanding of technical analysis and its objective application to stock selection, risk management and execution primarily in the context of trading stocks listed in the Philippine Stock Exchange (PSE).
Whipsaw
CFTe (Certified Financial Technician, International Federation of Technical Analysts) * Member, Technical Analysts Society of Singapore (TASS) * CFC (Certified Financial Consultant, Institute of Financial Consultants) * CIPM (Certificate in Investment Performance Measurement, Institute of Financial Consultants) * B.S.C. * M.B.A *
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Whipsaw's Library
* CYCLES: A TRIBUTE TO J.M.HURST by Brian Millard
* ELLIOT WAVE PRINCIPLE: KEY TO MARKET BEHAVIOR by Frost and Prechter
* FIBONACCI APPLICATIONS & STRATEGIES FOR TRADERS by Robert Fischer
* FORECASTING FINANCIAL MARKETS: THE PSYCHOLOGY OF SUCCESSFUL INVESTING by Tony Plummer
* JAPANESE CANDLESTICK CHARTING TECHNIQUES by Steve Nison
* POINT & FIGURE COMMODITY & STOCK TRADING TECHNIQUES by Kermit Zieg Jr.
* PROFIT MAGIC OF STOCK TRANSACTION TIMING by J.M.Hurst
* TECHNICAL ANALYSIS EXPLAINED by Martin Pring
* TECHNICAL ANALYSIS OF STOCK TRENDS by Edwards and Magee
* TECHNICAL ANALYSIS OF THE FINANCIAL MARKETS by John Murphy
* TECHNICAL ANALYSIS: THE COMPLETE RESOURCE FOR FINANCIAL MARKET TECHNICIANS by Kirkpatrick and Dahlquist
TECHNICAL ANALYSIS EDUCATION
(Excerpts from J.Murphy)
BASIC PREMISE OF TECHNICAL ANALYSIS
1. Market action discounts everything.
2. Prices move in trends.
3. History repeats itself.
"The technician believes that anything that can possibly affect the price - fundamentally, politically, psychologically, or otherwise - is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required. All the technician is actually claiming is that price action should reflect shifts in supply and demand. If demand exceeds supply, prices should rise. If supply exceeds demand, prices should fall. This action is the basis of all economic and fundamental forecasting."
"The concept of trend is absolutely essential to the technical approach. The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. There is a corollary to the premise that prices move in trends - a trend is more likely to continue than to reverse. Another way to state this corollary is that a trend in motion will continue in the same direction until it reverses. " (p.3)
"Much of the body of technical analysis and the study of market action has to do with the study of human psychology. Chart patterns, for example, which have been identified and categorized over the past one hundred years, reflect certain pictures that appear on price charts. These pictures reveal the bullish or bearish psychology of the market. Since these patterns have worked well in the past, it is assumed that they will continue to work well in the future. They are based on the study of human psychology, which tends not to change."
BASIC TENETS OF THE DOW THEORY
1. Averages discount everything.
2. The market has 3 trends.
3. Major trends have 3 phases.
4. The averages must confirm each other.
5. Volume must confirm the trend.
6. A trend is assumed to be in effect until it gives definite signals that it has reversed.
TREND FOLLOWING
"The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends."
SPOTTING REVERSALS
"The most difficult task for a Dow theorist, or any trend follower for that matter, is being able to distinguish between a normal secondary correction in an existing trend and the first leg of a new trend in the opposite direction." (p.29)
REVERSAL SCENARIOS (p.29)
1. Failure swing
2. Non-failure swing
CLASSIFICATION OF TRENDS
1. Major (or primary)
2. Intermediate (or secondary)
3. Near term (short term or minor)
TRADING TIME HORIZON
"As a general statement, most trend following approaches focus on the intermediate trend, which may last for several months. The near term trend is used primarily for timing purposes. In an intermediate uptrend, short term setbacks would be used to initiate long positions." (p.54)
THE ELEMENTS OF SUCCESSFUL TRADING
1. Price forecasting
2. Trading tactics
3. Money management
TRADING TACTICS
1. Tactics on breakouts
2. The breaking of trendlines
3. The use of support and resistance
4. The use of % retracements
5. The use of gaps
MONEY MANAGEMENT
1. Maximum loss limit per trade
2. Risk reward ratio
3. Fund allocation
PROTECTIVE STOPS
"For purposes of placing protective stops, support and resistance levels are most valuable." (p.401)
BUILDING BLOCKS OF TECHNICAL ANALYSIS
1. Support and resistance
2. Trendlines and channels
3. Percentage retracements
4. Speed resistance lines
5. Gaps
6. Reversal days
(Excerpts from M.Pring)
ONE AND TWO-BAR PRICE PATTERNS
One and two-bar patterns reflect changes in psychology that have very short term influence on prices.
1. Outside bars
2. Inside bars
3. Two bar reversal
4. Key reversal bars
5. Exhaustion bars
6. Pinocchio bars
BASIC PREMISE OF TECHNICAL ANALYSIS
1. Market action discounts everything.
2. Prices move in trends.
3. History repeats itself.
"The technician believes that anything that can possibly affect the price - fundamentally, politically, psychologically, or otherwise - is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required. All the technician is actually claiming is that price action should reflect shifts in supply and demand. If demand exceeds supply, prices should rise. If supply exceeds demand, prices should fall. This action is the basis of all economic and fundamental forecasting."
"The concept of trend is absolutely essential to the technical approach. The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. There is a corollary to the premise that prices move in trends - a trend is more likely to continue than to reverse. Another way to state this corollary is that a trend in motion will continue in the same direction until it reverses. " (p.3)
"Much of the body of technical analysis and the study of market action has to do with the study of human psychology. Chart patterns, for example, which have been identified and categorized over the past one hundred years, reflect certain pictures that appear on price charts. These pictures reveal the bullish or bearish psychology of the market. Since these patterns have worked well in the past, it is assumed that they will continue to work well in the future. They are based on the study of human psychology, which tends not to change."
BASIC TENETS OF THE DOW THEORY
1. Averages discount everything.
2. The market has 3 trends.
3. Major trends have 3 phases.
4. The averages must confirm each other.
5. Volume must confirm the trend.
6. A trend is assumed to be in effect until it gives definite signals that it has reversed.
TREND FOLLOWING
"The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends."
SPOTTING REVERSALS
"The most difficult task for a Dow theorist, or any trend follower for that matter, is being able to distinguish between a normal secondary correction in an existing trend and the first leg of a new trend in the opposite direction." (p.29)
REVERSAL SCENARIOS (p.29)
1. Failure swing
2. Non-failure swing
CLASSIFICATION OF TRENDS
1. Major (or primary)
2. Intermediate (or secondary)
3. Near term (short term or minor)
TRADING TIME HORIZON
"As a general statement, most trend following approaches focus on the intermediate trend, which may last for several months. The near term trend is used primarily for timing purposes. In an intermediate uptrend, short term setbacks would be used to initiate long positions." (p.54)
THE ELEMENTS OF SUCCESSFUL TRADING
1. Price forecasting
2. Trading tactics
3. Money management
TRADING TACTICS
1. Tactics on breakouts
2. The breaking of trendlines
3. The use of support and resistance
4. The use of % retracements
5. The use of gaps
MONEY MANAGEMENT
1. Maximum loss limit per trade
2. Risk reward ratio
3. Fund allocation
PROTECTIVE STOPS
"For purposes of placing protective stops, support and resistance levels are most valuable." (p.401)
BUILDING BLOCKS OF TECHNICAL ANALYSIS
1. Support and resistance
2. Trendlines and channels
3. Percentage retracements
4. Speed resistance lines
5. Gaps
6. Reversal days
(Excerpts from M.Pring)
ONE AND TWO-BAR PRICE PATTERNS
One and two-bar patterns reflect changes in psychology that have very short term influence on prices.
1. Outside bars
2. Inside bars
3. Two bar reversal
4. Key reversal bars
5. Exhaustion bars
6. Pinocchio bars
Copyright (c) Whipsaw 2011. All rights reserved.
DISCLAIMER. Posts appearing in this blog are solely intended for the study, research, and practical application of technical analysis and do not constitute recommendations or solicitations to invest or trade in specific stock securities. The author does not guarantee the accuracy of the charts and the underlying data that are hereby gratefully acknowledged as having been invariably sourced from the Phil Stock Exchange, CitisecOnline, BigCharts, StockChart, and YahooFinance websites.
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