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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Beware of the overbought-oversold trapMASTERING THE TOOLS PATTERNS VS. INDICATORS Swing traders apply both art and science to uncover market mysteries. The subjective mind studies chart patterns and looks for common shapes from times past. The practical mind rarely trusts the eyes and seeks truth in the cold, hard numbers. Effective trade preparation combines these diverse tasks into a single, well-organized plan. The cooperative brain first digests vast amounts of information to arrive at probabilities regarding the direction of price movement. Then it organizes this output into vision and tactical planning. The mind plays tricks on what the eye perceives. The human brain attempts to construct order from visual chaos and sees promising patterns even in random data. Unfortunately, this false order may tranquilize the eye but lacks truth or predictive power. And it bleeds trading accounts until effective filters stop this noise from passing into the system. Technical indicators apply truth serum to endless chart patterns. They bypass distorted vision and output simplified plots that draw important conclusions about current price activity. Profitable setups depend on seeing reality rather than illusion. Mathematics cross-verify odd chart formations and predict what to expect next. The lower pane reveals hidden characteristics through convergence or divergence with bar information. Some even measure relative position to a cyclical axis. Market mathematics churns blocks of price and volume into well-digested summaries. Swing traders then apply time restraints and compare output to observable price development. This taps a market’s unique 3D mechanics. Use specific time intervals to identify unique trends and conditions within that period alone. Then compare this information to similar statistics from other intervals and conclude what market action will likely do next. Technical indicators flash many false signals. Simple price input often elicits dangerous output. Promising results may point to opportunities that apply to the wrong time frame. Bad exchange or vendor data generate indicator peaks and valleys with no truth. These quirks and limitations frustrate sincere efforts to uncover market clarity. Above all else, learn when indicators offer the keys to the kingdom and when even Bozo the Clown should pass on the revelations. Chart patterns and technical indicators are not created equally. A highly skilled technician can trade successfully using only a bar chart. But the most powerful set of market indicators has little value when viewed in the absence of price. Just try this simple exercise: buy a stock at oversold or sell it at overbought without looking at price. Not a good way to make money. Chart patterns reveal quirks of crowd greed-fear behavior. They represent universal fractals that repeat over and over again through all time frames. Best of all, they point to exact locations for lowrisk trade opportunities. But neophytes should never rely on patterns alone for trade execution. Triangle and flag reading takes little effort, while technical indicator interpretation requires serious study. So many borderline participants walk the easier path and fail miserably when their profit depends on precise application of these powerful tools. MANAGING TECHNICAL TOOLS Physics teaches that energy sources leave telltale signatures in the form of exhaust or radiation. Similarly, chart patterns with true predictive power emit evidence that mathematics can detect and measure. When trading signals converge through both types of analysis, odds sharply increase that the opportunity will produce a valid result. Understand two common indicator quirks and shorten the learning curve. First, well-known authors publish endless variations of the same few technical studies. Stick with the classics until they stop working or limit personal trading style. Second, all technical indicators suffer from the same limitation: they only work through certain market phases and not others. Identify primarily conditions in advance of setup analysis to avoid false readings. Beware of the overbought-oversold trap. This convenient terminology implies a trading response when oscillators push into extreme territory. But this questionable strategy robs profits in trending markets. For example, common wisdom says to sell when Stochastics punches above 80 or to buy when it drops below 20. But this response fails during major breakouts and breakdowns. Always look to the pattern first before trying to interpret a technical indicator, and remember Martin Zweig’s classic advice that “the trend is your friend.” Use both pattern analysis and technical indicators to predict future price movement. But the indicator must support the pattern rather than the other way around. Patterns handle reward:risk measurements as well as price targets and identification of the optimum execution target. Apply indicators to uncover hidden divergence and flag impending reversals. For example, don’t buy congestion in anticipation of a breakout when Stochastics rolls over sharply from an overbought state. Or avoid short sales in bear markets when RSI turns up from an oversold state. Trading tools must address both numbers and emotions to locate promising setups. While stateof-the-art software builds very complex buy-sell signals, most indicators miss the emotional tension that ultimately drives price change. Turn to the visual examination of recurring price and volume patterns for this essential task. Effective pattern analysis uncovers crowd behavior as it finds signal within the random noise of stock charts. Classic formations contain response fractals that predict how volatility and price movement will evolve over time. A seasoned pattern reader can often ignore mathematics (and fundamentals) when underlying price development paints a sharp picture. But most swing traders still need to apply math-based indicators to verify important observations and filter bias. Recognize the unique appearance of each technical indicator. Many print characteristic patterns, while others oscillate between two extremes. For example, On Balance Volume (OBV) can display a head and shoulders formation with the same predictive power as its better-known cousin. But even the most effective indicators emit both signal and noise. Learn when to listen to their distinctive message and when to ignore them. Every good analysis should validate current conditions through both forward (strength) oscillators and backward (momentum) indicators. Popular oscillating tools, such as RSI and Stochastics, identify overbought-oversold markets. Moving averages and MACD look back and measure momentum change. Or swing traders can just draw simple trendlines and channels in all time frames and use those instead as primary momentum tools. Build custom settings to address specific styles and personal goals. Modern trading software features dozens of prepackaged indicators that study different aspects of market behavior. Learn how these common tools respond to changing conditions, and then examine their calculations in detail. Slowly adjust settings and look at the resultant shift in output. Over time, small changes will add considerable horsepower to profit performance. Apply analysis tools equally to all time frames. But adjust indicator settings to the special characteristics of each holding period. Many strategies work best when the math aligns to the common crowd view. This taps its herd behavior and allows the swing trader to anticipate its next move. For greater flexibility, toggle between popular and custom settings to review the differences in signal output. Pack indicators into 5-minute and 60-minute charts to track the intraday markets. Fill both upper and lower plots with layered information so that a single glance effectively captures current conditions. Apply 5-8-13 Bollinger Bands to identify short-term trends and intraday S/R. Place a smoothed five-bar stochastics under candlesticks to measure oscillation between buying and selling behavior. Then plot a classic 12-26-9 MACD histogram beneath the 60-minute bars to visualize broad intraday swing cycles. Apply classic 20-day Bollinger Bands to track crowd behavior for swing positions from 1 day to 3 weeks. Plot a 14 day, smoothed RSI beneath price to measure longer-term overbought-oversold conditions. If possible, observe daily volume with a color-coded histogram that marks up days in green and down days in red. Place a 60-day volume moving average right across the spikes to signal when individual sessions draw unexpected interest. And always toggle between daily and weekly views for all indicators to view broad cycles that may affect position management. PRICE, TIME, AND VOLUME Build indicator knowledge through study of the core elements of price, time, and volume. Largescale technical analysis requires highly complicated math inputs to gauge public sentiment and broad cash flows. But common data bits effectively measure individual stocks. The vast majority of popular indicators use only simple snapshots of price and/or volume over specified points in time. Many oscillators measure the distance between a bar’s closing price and range high to predict underlying buying power. Price itself represents the ultimate leading indicator with these simple tools. But keep in mind that derivative calculations always emit slower information than the data itself. While this smoothing process benefits swing traders who tend to act too quickly, it can also generate late signals. Time invokes an indicator’s power as it compares key values and marks developing trends. Periodbased snapshots sum up this price-volume activity and quantify relative movement. Fresh calculations then examine each new piece of data so the swing trader can make informed predictions about future price direction. Indicator time frames destroy the best tool’s effectiveness when they don’t align properly with current cycles or holding period. Alternatively, resonant time readings with mediocre tools will generate startling accuracy in prediction. Study of market volume has two primary functions. First, it attempts to measure actual levels of accumulation and distribution hidden under the massive flow of the ticker tape. Second, it gathers up the crowd’s divergent impulses and evokes graphic images of their herd behavior. Volume indicators comprise a significant subset of all technical analysis. But they offer far less useful information than most price-based tools. The lack of a simple linear relationship between volume and price change frustrates attempts to make accurate predictions. Volume leads the crowd as often as it lags, and it always seems to make perfect sense in hindsight. Timing trades to volume signals alone yields very poor results. Always combine volume study with price action before making important decisions. Swing traders should apply a simple histogram and accumulation-distribution overview to most charts. But move on quickly to more urgent matters unless the emotional crowd demands a more detailed examination. |
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