Category: Technical Analysis


Patterns on a Chart

Filed Under: Technical Analysis by Bill — 3 Comments
December 16, 2008

In prior post I’ve been talking about moving averages, support and resistance, and indicators as tools in technical analysis.  The next few post on TA I’d like to talk about chart patterns.  Patterns in charts are perhaps the oldest TA, often credited with early Japanese rice traders using candlestick patterns.  The human brain is a pattern recognizing machine and particularly notices when something changes from the pattern it’s currently on.  The brain loves change!

There are as many chart patterns as there are people to package them up and sell them on the internet.  Oh did I mention for only $9.99 you too can have… no I’m just kidding.  I won’t give away my secrets that cheap! :)

Some of the more well knows patterns are:

I’ll talk about these in more detail this week, but the main point I want to make today is these patterns aren’t just based on cool images, but market psychology.  People in mass tend to react in a predicatble way.  If you see the path in the chart early then there is potential to make some money, not recognizing what is taking place can get you run over.  Even if your fundamentals are correct – mass psychology and can definately over ride pure facts and logic longer than you can stay solvent.

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Trading Bollinger Bands

Filed Under: Glossary, Technical Analysis by Bill — 1 Comment
December 10, 2008

Bollinger Bands, invented by John Bollinger, are a simple moving average (often 20 period moving average) with a plus 2 standard deviation (the standard deviation is calculated using the same prices as the moving average) and a -2 standard deviation.

Standard Deviation Calculation

Some general notes and uses about trading bollinger bands:

  • Bollinger Bands use of 20 period moving average and +/- 2 standard deviation should be adjusted and/or optimized for the style of trading or investing you are doing.
  • Just because 2 standard deviation is generally assumed to mean 95% of the time a stock will fall between these two areas.  Remember this assumes a normal curve and a sufficient sample size, neither of which you have with this tool.  Don’t factor a 95% success rate with this tool.
  • The price tends to rise on the upper bollinger band and falls down the lower band.
  • If the price closes outside of the band this is generally a sign of a price continuation not a reversal.  Volume indicators is a good tool to verify with this.
  • Remember Bollinger Bands factor volatility and trend, so if you use confirmation signals it needs to not be correlated with either volatility (like a market volatility index (VIX)) nor trend.

Remember you have to learn to make the tools work in your strategy to make money, not make the tool your strategy.

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MACD – Moving Average Convergence Divergence

Filed Under: Technical Analysis by Bill — 3 Comments
November 11, 2008

What’s A MACD?

For those of you with a deep love of spreadsheets here is how the Moving Average Convergence Divergence is calculated:

First you plot the difference of a long term EMA (Exponential Moving Average) (26 day is common) from a short term EMA (12 day is common) and this is your MACD.  Then on the same chart you plot an EMA (9 day is common) of the MACD which is called your signal line.

If you don’t feel like doing all that most charting software will do this for you I just like love Excel.

How To Use The MACD?

MACD Chart

One uses the MACD to quickly notice cross overs of the longer term and shorter term EMA, trends in the divergence of the short term and long term EMAs, or recognizing points where the divergence between the two EMA has become so large that it historically shows an overbought or oversold condition.

If you look at the chart from left to right the first note of interest is the zero line crossing.  This notes the point where the short term moving average has just become equal to the long term moving average.  These cross overs indicate a change in direction with momentum just like when we discussed moving average crossovers in a previous post. 

The next note of interest is the downward cross.  This is where the signal line crosses the MACD.  This also indicates a change in stock price direction.  Obviously this can be an upward change in direction also.

The final point is the zero line resistance.  Just like how a long term moving average can be a support and resistance line for the price of the stock, the zero line or where the two moving averages are equal, often provides support and resistance for the MACD preventing the crossover of the to moving average indicators.  This is useful to know because it is often beneficial to wait for the MACD to actually cross the zero line to help reduce the number of times you are whipsawed.

A good trading strategy will use the MACD as one indicator just not the only indicator.  RSIand volume are often used in conjunction with other chart patterns, indicators, and fundamental analysis to help create a higher percentage win trading strategy.

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Relative Strength Index

Filed Under: Glossary, Technical Analysis by Bill — 2 Comments
November 2, 2008

The relative strength index is a moving indicator that measures the magnitude of recent gains or losses relative to each other.  The index is generated using the following equation:

RSI = 100 – (100/(1+(average of x days up closing price / average of x days down closing price))

There is no right point on the indicator, it is just a repeatable tool that can be built into your general trading plan.  However, in general a stock is thought to be over bought when the RSI is greater than 70 and oversold when the RSI is less than 30.  I often refer to crossing the 50 in my trading plans as I believe this is an indicator that the trend is set and momentum is on your side.

Again, do remember not to use RSI index as a sole trading strategy, it is only a tool. 

Here’s an example:

Large price fluctuations can really throw RSI into a frenzy so make sure your aware of macro situations involving your trades.

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