1. Psychology is the key: People deceive themselves and play games with themselves. Lying to other is bad enough, buy lying to yourself is hopeless. Were you anxious to jump in or afraid of losing? Did you procrastinate before picking up the phone? The feelings of thousands of traders merge into huge psychological tides that move the markets.
2. Getting of the emotional Roller coaster: The majority of traders ride an emotional roller coaster and miss the essential element of winning – the management of their emotions. Their inability to manage themselves leads to poor money management of their accounts.
3. You can succeed in trading only if you handle it as a serious intellectual pursuit. Emotional trading is lethal. To help ensure success, practice defensive money management. A good trader watches his capital as carefully as a professional scuba diver watches his air supply.
4. Successful trading stands on three pillars: psychology, market analysis and trading systems, and money management.
5. Why do most traders lose and wash out of the markets? Emotional and thoughtless trading are two reasons, but there is another. Markets are actually set up so that most traders must lose money. The trading industry kills traders with commissions and slippage.
6. Like casino, trading industry is NOT a zero-sum game, it is a minus-sum game. Winners receive less than what losers lose because the industry drains money (commissions and slippage ) from the market.
7. Commission: Shop for the lowest possible commissions, and design a trading system that will trade less often. Your trades must be based on clearly defined rules. You have to analyze your feelings as you trade, to make sure that your decisions are intellectually sound. You have to structure your money management so that no string of losses can kick you out of the game.
8. There are three kinds of slippage: common, volatility-based and criminal. Common slippage is due to a spread between buying and selling (the bid and the ask) prices. Slippage rises with market volatility. The third kind of slippage is caused by criminal activities of floor traders. To reduce slippage, trade liquid markets and avoid thin and fast-moving markets. Go long or short when the market is quiet. Use limit orders. Buy or sell at a specified price. Keep a record of prices at the time when you placed your order and have your broker fight the floor on your behalf when necessary.
9. If you blame excess commissions on a broker and slippage on a floor trader, you give up control of your trading life. Try to reduce both, but take responsibility for them.
10. A successful trader is a realist. A successful trader must identify his fantasies and get rid of them.
11. The Brain Myth: “I lost because I didn’t know trading secrets.” This fantasy helps support a lively market in advisory services and ready-made trading systems. The losers do not know that trading is intellectually fairly simple. Good traders are often shrewd, but few of them are intellectuals. Intelligent and hardworking people often fail in trading.
12. The Undercapitalization Myth: “If only I had a bigger account, I could have stayed in the market a little longer and won.” A trader who wants to survive and prosper must control his losses. You do that by risking only a tiny fraction of your equity on any single trade. Give yourself several years to learn how to trade. Do not start with an account bigger than $20,000, and do not lose more than 2 percent of your equity on any single trade. Learn from cheap mistakes in a small account.
13. The Autopilot Myth: Some traders try to develop an automatic trading system, while others buy one from the experts. However, markets always change and defeat automatic trading systems. Yesterday’s rigid rules work poorly today and will probably stop working tomorrow.
14. There are three types of gurus: market cycle gurus, magic method gurus, and dead gurus.
For many decades, the U.S. stock market has generally followed a four-year cycle. Significant bear market lows occurred in 1962, 1966, 1970, 1974, 1978, and 1982. the broad stock market has normally spent 2.5 and 3 years going up and 1 or 1.5 years going down. (1970, Edson Gould, 1978, Joseph Granville, 1984, Robert Predhter).
Market cycle gurus are creatures of the stock market, but "method gurus" are more prominent in the derivative markets, especially in the future markets. A magic method guru sells a new set of keys to market profits. As soon as enough people become familiar with a new method and test it in the markets, it inevitably deteriorates and starts losing popularity. Markets are forever changing, and the methods that worked yesterday are not likely to work today and even less likely to work a year from now. (Jake Bernstein, Peter Steidlmayer)
Dead gurus include R.N.Elliott and W. D. Gann.
The public wants gurus, and new gurus will come. As an intelligent traders, you must realize that in the long run, no gurus is going to make you rich. You have to work on that yourself.
15. Trading is a very hard game. A trader who wants to be successful in the long run has to be very serious about what he does. He cannot afford to be naive or to trade because of some hidden psychological agenda.
16. Most failures in life are due to self-sabotage. We fail in our professional, personal, and business affairs not because of stupidity or incompetence, but to fulfill an unconscious wish to fail. The mental baggage from childhood can prevent you from succeeding in the markets. You have to find your weaknesses in order to change. Keep a trading diary -- write down your reasons for entering and exiting every trade. Look for repetitive patterns of success and failure.
17. You need to be aware of your tendency to sabotage yourself. Stop blaming your losses on bad luck or on others and take responsibility for the results. Start keeping a diary -- a record of all your trades, with reasons for entering and exiting them. Look for repetitive patterns of success and failure. Those who do not learn from the past are condemned to repeat it.
18. Your feelings have an immediate impact on your account equity. You may have a brilliant trading system, buy if you feel frightened, arrogant, or upset, your account is sure to suffer. When you recognize that a gambler's high or fear is clouding your mind, stop trading. Your success or failure as a trader depends on controlling your emotions. You are responsible for every trade that you make. Most traders with good systems wash out of the markets because psychologically they are not prepared to win.
19. Most amateurs feel like geniuses after a winning streak. It is exciting to believe that you are so good you can bend your own rules and succeed. That's when traders deviate from their rules and go into a self-destruct mode. You need to make trading as objective as possible. Keep a diary of all your trades with "before and after" charts, keep a spreadsheet listing all your trades, including commissions and slippage, and maintain very strict money management rules. You may have to devote as much energy to analyzing yourself as you do to analyzing the markets.
20. Profits make traders feel powerful and give them an emotional high. They try to get high again, put on reckless trades, and give back their profits. Most traders cannot stand the pain of a string of severe losses. They die as traders after hitting rock bottom and wash out of the markets. The few survivors realize that the main trouble is not with their methods, the trouble is with their thinking. They can change and become successful traders.
21. When you admit that you have a personal problem that causes you to lose, you can begin building a new trading life. You can start developing the discipline of a winner.
22. Brokerage records indicate that 90 out of 100 people trading today will probably be gone form the markets a year from now. They will hit rock bottom, crumble, and leave.
23. As a trader, you have to take your first step and say: “ I am a loser, I am powerless over losses.” Now you have to struggle to trade without losses, one day at a time. We have to draw a line between a businessman’s risk and a loss. A trader must take a businessman’s risk, but he may never take a loss greater than his predetermined risk. You need to define your businessman’s risk – the maximum amount of money you will risk on any single trade. There is no standard dollar amount, just as there is no standard business. A sensible trader never risks more than 2 percent of account equity on any trade.
24. Keep good trading records: the date and price of every entry and exit, slippage, commissions, slops, all adjustment of stops, reason for entering, objective for exiting, maximum paper profit, maximum paper loss after a stop was hit, and any other necessary data.
25. Losers Anonymous. “Good morning, my name is Alex, and I am a loser. I have it in me to do serious financial damage to my account.”
26. When we act in the market the way we do in our everyday life, we lose money. Your success of failure depends on your ability to use your intellect rather than act out your emotions. A trader who feels overjoyed when he wins and depressed when he loses cannot accumulate equity because he is controlled by his emotions. If you let market make your feel high or low, you will lose money.
27. The market is like an ocean – it moves up and down regardless of what you want. The market does not know you exist. You can never control the market but you can learn to control yourself. A professional trader uses his head and stays calm. Only amateurs become exited or depressed because of their trades. Emotional decisions are lethal in the markets.
1. Decide that you are in the market for the long haul – that is, you want to be a trader even 20 years from now.
2. Learn as much as you can. Read and listen to experts, but keep a degree of healthy skepticism about everything. Ask questions, and do not accept experts at their work.
3. Do not get greedy and rush to trade – take your time to learn. The market will be there with more good opportunities in the months and years ahead.
4. Develop a method for analyzing the market – that is, “If A happens, then B is likely to happen.” Markets have many dimensions – use several analytic methods to confirm trades. Test everything on historical data and then in the markets, using real money. Markets keep changing – you need different tools for trading bull and bear markets and transitional periods as well as a method for telling the difference.
5. Develop a money management plan. Your first goal must be long-term survival; your second goal, a steady growth of capital; and your third goal, making high profits. Most traders put the third goal first and are unaware that goals 1 and 2 exist.
- Be aware that a trader is the weakest link in any trading system. Go to a meeting of Alcoholics Anonymous to learn how to avoid losses or develop your own method for cutting out impulsive traders.
28. Winners think, feel, and act differently than losers. You must look within yourself, strip away your illusions, and change your old ways of being, thinking, and acting. Change is hard, but if you want to be a professional trader, you have to work on changing your personality.
29. “Bulls make money, bears make money, but hogs get slaughtered”. Hogs are greedy. They get slaughtered when they trade to satisfy their greed. Sheep are passive and fearful followers of trends, tips, and gurus. Whenever that market is open, bulls are buying, bears are selling, hogs and sheep get stampled underfoot, and the undecided traders wait on the sidelines.
30. Each price represents a momentary consensus of value between buyers, sellers, and undecided traders at the moment of transaction. There is a crowd oftraders behind every pattern in the chart book. Crowd consensus changes from moment to moment. Prices, volume, and open interest reflect crowd behavior. So do the indicators that are based on them. This makes technical analysis similar to poll-taking. Both combine science and art: They are scientific to the extent that we use statistical methods and computers; they are artistic to the extent that we use personal judgement to interpret our findings.
31. The market is a huge crowd of people. Each member of the crowd tries to take money away from other members by outsmarting them. The market is a uniquely harsh environment because everyone is against you, and you are against everyone. In trading, you compete against some of the brightest minds in the world while fending off the piranhas of commissions and slippage. When you analyze the market, you are analyzing crowd behavior. Crowds behave alike in different cultures on all continents.
32. Most people feel a strong urge to join the crowd and to "act like everybody else." This primitive urge clouds your judgment when you put on a trade. A successful trader must think independently. He needs to be strong enough to analyze the market alone and to carry out his trading decisions. The crowd may be stupid, but is stronger than you. Crowds have the power to create trends (whether right or wrong). Never buck a trend. Never argue with the crowd. You do not have to run with the crowd, but you should never run against it.
33. The only reason there is money in the markets is that other traders put it there. The money your want to make belongs to other people who have no intention of giving it to you. Trading means trying to rob other people while they are trying to rob you. It is like a medieval battle.
34. Trying to reduce insider trading is like trying to get rid of rats on a farm. Pesticide keep them under control but do not root them out.
35. All exchanges must meet three criteria: an established location, rules for grading merchandise, and defined contract terms.
36. One biggest advantage or individual trader (against institutional traders) is that he is free to wait for the best trading opportunities. Most private traders fritter this advantage by overtrading. An individual who wants to succeed against the giants must develop patience and eliminate greed. Remember, your goal is to trade well, not to trade often.
37. The first principle of advisory newsletter writing is: “If you have to make forecasts, make a lot of them.” Whenever a forecast turns out right, double the volume of promotional mail.
38. Group members may catch a few trends, but they get killed when trends reverse. When you join a group, you act like a child following a parent. Markets do not care about your well-being. Successful traders are independent thinkers.
39. People change when they join crowds. They become more credulous and impulsive, anxiously search for a leader, and react to emotions instead of using their intellect. An individual who become involved in a group becomes less capable of thinking for himself.
40. You start losing you independence when you watch prices like a hawk and feel elated if they go your way and depressed if they go against you; when you start trusting gurus more than yourself and impulsively add to losing positions or reverse them; when you do not follow your own trading plan. When you notice what is happening, try to come back to your senses; if you can not regain your composure, exit your trade.
41. Many traders are puzzled why markets always seem to reverse immediately after they dump their losing position. This happens because crowd members are gripped by the same fear – and everybody dumps at the same time. Once the fit of selling has ended, the market has nowhere to go but up. Optimism returns to the marketplace, and the crowd feels greedy and goes on a new buying binge. Crowds are primitive, and your trading strategies should be simple.
42. Your human nature prepares you to give up your independence under stress. When you put on a trade, you feel the desire to imitate others and overlook objective trading signals. This is why you need to develop and follow trading systems and money management rules. They represent your rational individual decisions, made before you enter a trade and become a crowd member.
43. Price is the leader of the market crowd.
44. You need to base your trades on a carefully prepared trading plan and not jump in response to price changes. It pays to write down your plan. You need to know exactly under what conditions you will enter and exit a trade. Do not make decisions on the spur of the moment, when you are vulnerable to being sucked into the crowd. You can succeed in trading only when you think and act as an individual. The weakest part of any trading system is the trader himself.
45. You have to observe yourself and notice changes in your mental state as you trade. Write down your reasons for entering a trade and the rules for getting out of it, including money management rules. You must not change your plan while you have an open position.
46. Technical analysis is applied social psychology. It aims to recognize trends and changes in crowd behavior in order to make intelligent trading decisions. Charts are the windows into mass psychology. When you analyze charts, you analyze the behavior of traders. Technical indicators help make this analysis more objective.
47. Why prices went up? It is not because there are more buyers than sellers. The number of stocks bought and sold in any market is always equal. Prices move up or down because of changes in the intensity of greed and fear among buyers and sellers.
48. Winners feel rewarded when price move in their favor, and losers feel punished when price moves against them. Crowd members are main blissfully unaware that when they focus on price they create their own leader. Traders who feel mesmerized by price swings create their own idols. When individuals try to control a market, they usually end up badly, such as the Hunt brothers.
49. An individual has a free will and his behavior is hard to predict. Group behavior is more primitive and easier to follow. When you analyze markets, you analyze group behavior. You need to identify the direction in which groups run and their changes. The longer a rally continues, the more technicians get caught up in bullish sentiment, ignore the danger signs, and miss the reversal. This is why it helps to have a written plan for analyzing the markets. We have to decide in advance what indicators we will watch and how we will interpret them.
50. Major bull and bear markets result from fundamental changes in supply and demand. Even if you know those fundamental factors, you can lose money trading if you are out of touch intermediate- and short-term trends. They depend on the crowd's emotions. Technical analysis is the study of mass psychology. It is partly a science and partly an art.
51. Political poll-taking is a good model of technical analysis. A market technician must rise above party affiliation. Be neither a bull nor a bear, but only seek the truth. A biased bull looks a chart and says, "Where can I buy?" A biased bear looks at the same chart and tries to find where he can go short. A top-flight analyst is free of bullish or bearish bias.
52. Many traders believe that the aim of a market analyst is to forecast future prices. This is wrong. Read the market and manage yourself. Prices seldom rally very hard immediately after a bad decline.
53. Successful trading stands on three pillars. You need to analyze the balance of power between bulls and bears. You need to practice good money management. You need personal discipline to follow your trading plan and avoid getting high in the markets.
54. The biggest problem in charting is wishful thinking. Each person sees what's on his mind. They project their hopes, fears, and fantasies onto the charts.
55. Early chartists wrote that stock market tops were sharp and fast, while bottoms took a long time to develop. That was true in their deflationary era, but the opposite has been true since the 1950s. Now bottoms tend to form quickly while tops tend to take longer.
56. The opening price of a daily or a weekly bar usually reflects the amateurs’ opinion of value. The closing prices of daily and weekly bars tend to reflect the actions of professional traders. The high of each bar represents the maximum power of bulls during that bar. The low of each bar represents the maximum power of bears during that bar. The closing tick of each bar reveals the outcome of a battle between bulls and bears during that bar. The distance between the high and the low of any bar reveals the intensity of conflict between bulls and bear.
57. Slippage is usually lower in quiet markets. It pays to enter your trades during short or normal bars. Tall bars are good for taking profits. Trying to put on a position when the market is running is like jumping on a moving train. It is better to wait for the next one.
58. The logical flaw of Efficient Market theory is that it equates knowledge with action. People may have knowledge, but the emotional pull of the crowd often leads them to trade irrationally. A good analyst can detect repetitive patterns of crowd behavior on his charts and exploit them.
59. Random Walkers deny that memories of the past influence our behavior in the present.
60. Nature’s Law is the opposite of Random Walkers. Mystics claim that there is a perfect order in the markets, which they say move like clockwork in response to immutable natural laws. Those who believe in perfect order in the markets accept that tops and bottoms can be predicted far into the future.
61. It is better to draw support and resistance lines across the edges of congestion areas instead of extreme prices. The edges show where masses of traders have changed their minds, while the extreme points reflect only panic among the weakest traders. Amateurs tend to follow breakouts, while professionals tend to fade (trade against) them.
62. Support and resistance exist because people have memories. In uptrends, bears who sold short feel pain and bulls feel regret that they did not buy more. Both feel determined to buy if the market gives them a second chance. The pain of bears and regret of bulls make them ready to buy, creating support during reactions in an uptrend. Resistance is an area where bulls feel pain, bears feel regret and both are ready to sell.
63. The strength of every support or resistance zone depends on three factors: its length, its height, and the volume. The longer a support or resistance area – its length of time or the number of hits it took – the stronger it is; As support and resistance levels grow old, they gradually become weaker. Losers keep washing out of the markets, replaced by newcomers who do not have the same emotional commitment to old price levels. The taller the support and resistance zone, the stronger it is. 7 percent is better than 3 percent, and 3 percent is better than 1 percent; The greater the volume of trading in a support and resistance zone, the stronger it is.
64. Trading Rules:
1. Whenever the trend you are riding approaches support or resistance, tighten your protective stop. A protective stop is an order to sell below the market when you are long or to cover shorts above the market when you are short. This stop protects you from getting badly hurt by an adverse market move. A trend reveals its health by how it acts when it hits support or resistance. If it is strong enough to penetrate that zone, it accelerates, and your tight stop is not touched. If a trend bounces away from support or resistance, it reveals its weakness. In that case, your tight stop salvages a good chunk of profits.
2. Support and resistance are more important on long-term charts than on short-term charts. Weekly charts are more important than dailies. A good trader keeps an eye on several timeframes and defers to the longer one. If the weekly trend is sailing through a clear zone, the fact that the daily trend is hitting resistance is less important. When a weekly trend approaches support or resistance, you should be more inclined to act.
3. Support and resistance levels are useful for placing stop-loss and protect-profit orders. The bottom of a congestion area is the bottom line of support. If you buy and place your stop below that level, your give that uptrend plenty of room. More cautions traders buy after an upside breakout and place a stop in the middle of a congestion area. A true upside breakout should not be followed by a pull back into the range.
65. Markets spent most of their time in trading ranges. Most breakouts from trading ranges are false breakouts. Professionals expect prices to fluctuate without going very far most of the time. They wait until an upside breakout stops reaching new highs or a downside breakout stops making new lows. Then they pounce – they fade the breakout (trade against it) and place a protective stop at the latest extreme point. It is a very tight stop, and their risk is low, while there is a big profit potential from a pull back into the congestion zone. The risk/reward ration is so good that professionals can afford to be wrong half the time and still come out ahead of the game. The best time to buy an upside breakout on a daily chart is when your analysis of the weekly chart suggests that a new uptrend is developing.
66. When you go long in an uptrend or sell short in a downtrend, you have to give that trend the benefit of the doubt and not be shaken out easily. It pays to buckle your seat belt and hang on for as long as the trend continues. When you trade in a trading range, you have to be nimble and close out your position at the slightest sign of a reversal.
67. Identifying trends and trading rangers is one of the hardest tasks in technical analysis. Most people cannot accept uncertainty. They have a strong emotional need to be right. They hang onto losing positions, waiting for the market to turn and make them whole. Trying to be right in the market is very expensive. Professional traders get out of losing traders fast without fuss or emotions.
68. There are several methods to identifying trends and trading ranges. When they contradict one another, it is better to pass up a trade.
1. Analyze the pattern of highs and lows. When rallies keep reaching higher levels and declines keep stopping at higher levels, they identify an uptrend. The pattern of lower lows and lower highs identifiers a downtrend, and the pattern of irregular highs and lows points to a trading range.
2. Draw an up trendline connecting significant recent lows and a down trendline connecting significant recent highs. The slope of the latest trendline identifies the current trend.
3. Plot a 13-day of longer exponential moving average. The direction of its slope identifies the trend. If a moving average has not reached a new high or low in a month, then the market is in a trading range.
4. Several market indicators, such as MACD and Direction system, help identify trends. The Directional system is especially good at catching early stages of new trends.
69. Patience is a virtue for a trader.
70. Waiting for pullbacks while a trend is gathering steam is an amateur's game. If you trade multiple positions, you can buy a third in anticipation, a third on a breakout, and a third on a pullback. Always follow the 2 percent money management rule. No matter how attractive a trade is, pass it up if it requires a wider stop.
71. Money management tactics are different in trends and trading ranges. It pays to put on a smaller position in a trend but use a wider stop. Then you will be less likely to get shaken out by reactions while you keep risk under control. You may put on a bigger position in a trading range but use a tighter stop.
72. Finding good entry points is extremely important in trading ranges. You have to be very precise because the profit potential is so limited. A trend is more forgiving of a sloppy entry, as long as you trade in the direction of the trend. Old traders chuckle: "Do not confuse brains with a bull market." When you cannot tell whether the market is in a trend or in a trading range, remember that professionals give the benefit of the doubt to trading ranges. If you are not sure, stand aside.
73. Professionals love trading ranges because they can slide in and out of positions with little risk of being impaled on a trend. Since they pay low or no commissions and suffer little slippage, it is profitable for them to trade in gently fluctuating markets. Those of us who trade away from the floor are better off trying to catch trends. You can trade less frequently during trends, and your account suffers less from commissions and slippage.
74. Markets exist in several timeframes simultaneously. The market may look like a buy on a daily chart but a sell on a weekly chart, and vice versa. The signals in different timeframes of the same market of the same market often contradict on another. When professionals are in doubt, they look at the big picture (such as triple screen trading system), but the amateurs focus on the short-term charts.
75. The most important feature of a trendline is its angle -- it identifies the dominant market force. When a trendline points up, it shows that bulls are in control. Then it pays to buy with a protective stop below the trendline. When a trendline points down, it shows that bears are in control. Then it pays to sell short and protect your position with a stop above the trendline. Modern computerized tool for identifying trends include moving averages, the Directional system, and MACD.
76. It is better to draw a trendline through the edges of congestion areas. Those edges show where the majority of traders have reversed directions. Technical analysis is poll-taking -- and polltakers want to track opinions of masses, not a few extremists. Panic dumping by bulls at the bottoms and panic covering by bears at the tops create extremes, which appear as long "tails" on the charts. The extreme points are very important. A bar that looks like a finger sticking out of a tight chart pattern provides a valuable reference point for short-term traders. A tail shows that a certain price has been rejected by the market. It usually leads to a swing in the opposite direction. As soon as you recognize a tail, trade against it. Place your protective stop halfway through the tail. If the market starts "chewing its tail", it is time to get out.
77. Three screen system:
1. Screen One: Identify the weekly trend using a trend-following indicator and trade only in its direction. The tools include the slope of MACD-Histogram between its latest bars, or Directional system, or the slope of a 13-week exponential moving average.
2. Screen Two: Apply an oscillator to a daily chart. Use daily declines during weekly uptrends to find buying opportunities and daily rallies during weekly downtrends to find shorting opportunities. The tools include Stochastic, Williams %R, Force Index and Elder-ray.
3. Screen three: Intraday breakout. When the weekly trend is up and a daily oscillator decline, it activates a trailing buy-stop technique. Place a buy order one tick above the high of the previous day.
78. Trend-following indicators include: moving averages, MACD, MACD-histogram, the Directional System, On-Balance Volume, Accumulations/Distribution, and others. Trend-following indicators are coincident or lagging indicators -- they turn after trends reverse.
79. Oscillators help identify turning points. They include Stochastic, Rate of Change, Smoothed Rate of Change, Momentum, the Relative Strength Index, Elder-ray, the Force Index, Williams %R, the Commodity Channel Index. Oscillators are leading or coincident indicators and often turn ahead of prices.
80. Miscellaneous indicators provide insights into the intensity of bullish or bearish market opinion. They include the New High-New Low Index, the Put-Call Ratio, Bullish Consensus, Commitments of Traders, the Advance/Decline Index, the Traders' Index.
81. Moving Average:
The Simple MAs have a fatal flaw -- they change twice in response to each price. First, it change when a new price is added to the MA. Secondly, MA changes again when an old price is dropped off at the end of the moving average window, which causes a false alarm.
The most important message of a moving average is the direction of its slope. It pays to tie EMA length to a cycle if you can find it. A moving average should be halfthe length of the dominant market cycle. Trouble is, cycles keep changing their length and disappearing. Rule of thumb: The longer the trend yhou are trying to catch, the longer the moving average you need. You need a bigger fishing rod to catch a bigger fish. A 200-day MA works for long-term stock investors who want to ride major trends. Most traders can use an EMA between 10 and 20 days. A MA should not be shorter than 8 days to avoid defeating its purpose as a trend-following tool. I am using a 13-day EMA.
When the EMA rises, it shows that the trend is up and the market should be traded from the long side. The best time to buy is when prices return to their EMA -- not when they are high above it. Those trades offer a better risk/reward ratio.
The favorite approach of Donchian, was to use crossovers of 4-, 9-, and 18-day MAs. Trading signal were given when all three MAs turned in the same direction. His method only worked in strongly trending markets.
MAs help you identify and follow trends, but they lead to whipsaws in trading ranges.
82. The Directional System:
Trade only from the long side when +DI13 is above -DI13. Trade only from the short side when-DI13 is above+DI13. The best time to be long is when both +DI13 and ADX are above -DI13 and ADX rises. This shows that the uptrend is getting stronger. Go long and place a protective stop below the latest minor low.
When ADX declines, it shows that the market is becoming less directional. There are usually many whipsaw, just as there are turbulences in the water during the change of tide. When ADX points down, it is better not to use a trend-following method.
When ADX falls belowboth Directional lines, it identifies a flat,sleepy market. Do not use a trend-following system but start getting ready, because major trends emerge from such lulls.
The single best signal of the Directional system comes after ADX falls below both Directional lines. The longer it stays there, the strongerthe base for the next move. When ADX rallies from below both Directional lines, it shows that the market is waking up from a lull. When ADX rises by four steps (i.e., from 9 to 13) from its lowest point below both Directional lines, it "rings a bell" on a new trend. It shows that a nre bull market or bear market is being born. Buy if +DI13 is on top and place a stop below the latest minor low. Sell short if -DI13 is on top and place a stop abovethe latest minor high.
The Directional system is uniquein telling you when a major new trend is likely to begin. It rings a bell once or twice a year in any givenmarket.
Martin Pring compares trend-following indicators and oscillators to the footprints of a man walking his dog on a leash. The proper way to draw the horizontal reference lines on the charts is to place them so that an oscillator spends only about 5percent of it timebeyound each line. Place overbought and oversold lines so that they cut across only the highest peaks and the lowest valleys of an oscillator for the past six months. Readjustthese linesonce every three months. Oscillators work spectacularly well in trading ranges, but they give premature and dangerous trading signals when a new trend erupts from a range. An oscillatro canstay overbought for weeks at a time when a new, strong uptrend begins, giving premature sell signals. Oscillators give their best trading signals when they diverge from prices. Valid divergences are clearly visible -- they seem to jump from the charts. If you need a ruler to tell wheather there is a divergences, assume there is none.
83. Momentum and Rate of Change
Momentum and Rate of Change measure trend acceleration -- its gain or loss of speed. They usually reach a peak before tghe trend reaches its high and reach a bottom before prices hit their low. As long as oscillators keep reaching new hights, it is safe to hold long position. As long as they keep reaching new lows, it is safe to hold short positions. As a rule of thumb, it pays to keep oscillator windows fairly narrow. Use wide windows for trend-following indicators whose goal is to catch trends. Use narrow windows for oscillators to detect short-term changes in the markets. Momentum RoC share a flaw with simple moving averages -- they jump twice in respose to each piece of date. Smoothed RoC takes care of this problem.
Each price reflects the consensus of value of all market participants at the moment of transaction. When Momentum or RoC rises to a new peak, it shows that the optimism of the market crowd is growing, and prices are likely to rally higher. When prices rise but Momentum or RoC falls, it warns you that a top is near -- it is time to think of taking profits on long positions or tightening stops. If prices reach a new high but Momentum or RoC reaches a lower top, the bearish divergence givesa strong sell signal.
There are times when Momentum and RoC act not as leading but as coincident indicators. This happens in the markets when t he crowd gets hit by a major piece of bad news and this "overhead obstacle" sends RoC and prices down together.
1. When the trend is up, buy whenever RoC decliens below its centerline and ticks up.
2. If you hold a long position and prices begin to slide, see whether RoC has reached a record peak before this pullback. A new peak in RoC shows a high level of bullish energy, which is likely to lift the market to its previous high or higher.
3. A break in a trendline of Momentum or RoC often precedes a break of a price trendline by a day or two. When you see a leading indimcator break a trendline, prepare for a break in the price trend.
84. Williams %R:
It measures the capacity of bulls and bears to close prices each near the edge ofthe recent range. Wm%R confirms trends and warns of their upcoming reversals.It measures the placement of each closing price in relations to the recent high-low range. Wm%R is closely related to Stochastic.
A rule of thumb with all oscillators -- when in doubt, make them shorter. This isthe opposite of trend-following indicators -- when in doubt make them longer. Oscillators with narrow windows help catch short-term reversals. If you work with cycles, make Wm%R equal half the cycle length. A 7-day window as well as 7-week window fits Wm%R fine.
Wm%R gives three types of trading signals. They are, in order of importance, bullish or bearish divergences, failure swing, and overbought-oversold readings.
1. Divergences between prices and Wm%R rarely occure. They identify the best trading opportunities. WhenWm%R rises above its upper reference line, falls, and then cannot rise above that line during the next rally, it creates a bearish divergence. It shows that bulls are losing their power and the market is likely to fall.
2. Crowds tend to swing from one extreme to the other. Wm%R seldom reverses in the middle of its range. When Wm%R stops rising in the middle of a rally and turns down without reaching its upper reference line, it produces a failure swint. This shows that bulls are especially weak and gives a sell signal.
3. Overbought and oversold: When Wm%R falls below its lower reference line, it marks a potential market bottom and gives a buy signal. The overbought and oversold signals tend to work well during flat trading ranges. They becoe premature and dangerous when the market enters a trend. Use long-term trend-following indicator to identify the major trend. If a weekly chart shows a bull market, take only buy signals from daily Wm%R, and ignore the sell signal.
85. Stochastic
Stochastic tracks the relationship of each closing price to the recent high-low rang. It gives three types of trading signals: divergences, the level of Stochastic lines, and their direction.
1. Bull divergence. As soon as Stochastic turns up from its second bottom, it gives a strong buy signal: Go long and place a protective stop below the latest low in the market. The best buy signals occur when the first bottom is below the lower reference line and the second is above it.
2. Overbought and oversold.. These signals work fine during trading ranges but not when a market develops a trend.
When you identify an uptrend on a weekly chart, wait for daily Stochastic lines to decline below their lowr referecen line. Then without waiting for their crossover or an upturn, place a buy orfer avove the high of the latest price bar. Once you are long, place a protective stop below the low of the trading day or the previous day, whichever is lower.
The shape of Stochastic's bottom often indicates whether a rally is likely to be strong or weak. If the bottom is narrow and shallow, it shows that bears are weak and the rally is likely to be weak. It is better to take only strong buy signals.
Do not buy when Stochasticis overbought and do not sell short when it is oversold. This rule filters out most bad trades.
3. Line Direction. When both Stochastic lines are headed in the same direction, they confirm the short-term trend. When prices rise and both Stochastic lines rise, the uptrend is likely to continue. When prices slide and both Stochastic lines fall, the short-term downtrend is likely to continue.
Stochastic can be used in any timeframe, including weekly, daily, or intraday. Weekly Stochastic usually changes its direction one week prior to weekly MACD-Histogram. If weekly Stochastic turns, it warns you that trend-following MACD-Histogram is likely to turn the next week. It is a signal to tighten stops on existing positions or start take profits.
If you use Stochastic as a stand-alone oscillator, a longer Stochastic is preferable. If you use Stochastic as part of a trading system, combined with trend-following indicators, then a shorter Stochastic is preferable.
Trading the crossovers of Stochastic works differently, depending on whether the market is in a trend or in a trading range.
86. Relative strength index:
RSI measures the strength of any trading vehicle by monitoring changes in its closing prices. It is a leading or a coincident indicator - it is never a laggard. The pattern of RSI peaks and valleys does not change in response to the width of its time window. Trading signals become more visible with shorter RSI, such as 7 or 9 days.
87. There are three ways to measure volume:
a. The actual number of shares or contracts traded, like NYSE. This is the most objective way of measuring volume.
b. The number of trades that took place, like London Stock Exchange.
c. Tick volume is the number of price changes during a selected time, such as 10 minutes or an hour. It is called tick volume because most changes equal to 1 tick. Most futures exchanges in the United States do not report intraday volume, and day-traders use tick volume as its proxy.
88. Crowd Psychology of volume.
Volume reflects the degree of financial and emotional involvement, as well as pain, of market participants. A trade begins with a financial commitment by two persons. The decision to buy or sell may be rational, but the act of buying or selling creates an emotional commitment in most people. Buyers and sellers crave to be right. They scream at the market, pray, or use lucky talismans. Volume reflects the degree of emotional involvement among traders.
Each tick takes money away from losers and gives it to winners. When prices rise, longs make money and shorts lose. When prices fall, shorts gain and longs lose. Winners feel happy and elated, while losers feel depressed and angry. Whenever prices move, about half the traders are hurting. When prices rise, bears are in pain, and when prices fall, bulls suffer. The greater the increase in volume, the more pain in the market.
Traders react to losses like frogs to hot water. If you throw a frog into a boiling kettle, it will jump in response to sudden pain, but if you put a frog into cool water and heat it slowly, you can boil it alive. If a sudden price change hits traders, they jump from pain and liquidate losing positions. The same losers can be very patient if their losses increase gradually.
You can lose a great deal of money in a sleepy market, such as corn, where a one-cent move costs only $50. If corn goes against you just a few cents a day, the pain is easy to tolerate. If you hang on, those pennies can add up to thousands of dollars in losses. Sharp moves, on the other hand, make losers cut their losses in a panic. Once weak hands get shaken out, the market is ready to reverse. Trends can last for a long time on moderate volume but can expire after a burst of volume.
Who buys from a trader who sells his losing long position? It may be a short seller taking profits and covering shorts. It may be a bargain hunter who steps in because prices are "too low." That bottom-picker assumes the position of a loser who washed out-and he either catches the bottom or becomes the new loser.
Who sells to a trader who buys to cover his losing short position? It may be a savvy investor who takes profits on his long position. It also may be a top-picker who sells short because he thinks that prices are "too high." He assumes the position of a loser who covered his shorts, and only the future will tell whether he is right or wrong.
When shorts give up during a rally, they buy to cover and push the market higher. Prices rise, flush out even more shorts, and the rally feeds on itself. When longs give up during a decline, they sell and push the market lower. Falling prices flush out even more longs, and the decline feeds on itself. Losers who give up propel trends. A trend that moves on steady volume is likely to continue. Steady volume shows that new losers replace those who wash out. Trends need a fresh supply of losers the way builders of the ancient pyramids needed a fresh supply of slaves.
Falling volume shows that the supply of losers is running low and a trend is ready to reverse. It happens after enough losers catch on to how wrong they are. Old losers keep bailing out, but fewer new losers come in. Falling volume gives a sign that the trend is about to reverse.
A burst of extremely high volume also gives a signal that a trend is nearing its end. It shows that masses of losers are bailing out. You can probably recall holding a losing trade longer than you should have. Once the pain becomes intolerable and you get out, the trend reverses and the market goes the way you expected, but without you! This happens time and again because most amateurs react to stress similarly and bail out at about the same time. Professionals do not hang in while the market beats them up. They close out losing trades fast and reverse or wait on the sidelines, ready to re-enter.
Volume usually stays low in trading ranges because there is relatively little pain. People feel comfortable with small price changes, and trendless markets seem to drag on forever. A breakout is often marked by a dramatic increase in volume because losers run for the exits. A breakout on low volume shows little emotional commitment to a new trend. It indicates that prices are likely to return into their trading range.
Rising volume during a rally shows that more buyers and short sellers are pouring in. Buyers are eager to buy even if they have to pay up, and shorts are eager to sell to them. Rising volume shows that losers who leave are being replaced by a new crop of losers.
When volume shrinks during a rally, it shows that bulls are becoming less eager, while bears are no longer running for cover. The intelligent bears have left long ago, followed by weak bears who could not take the pain. Falling volume shows that fuel is being removed from the uptrend and it is ready to reverse.
When volume dries up during a decline, it shows that bears are less eager to sell short, while bulls are no longer running for the exits. The intelligent bulls have sold long ago, and the weak bulls have been shaken out. Falling volume shows that the remaining bulls have a higher level of pain tolerance. Perhaps they have deeper pockets or bought later in the decline, or both. Falling volume identifies an area in which a downtrend is likely to reverse.
This reasoning applies to long and short timeframes. As a rule of thumb, if today's volume is higher than yesterday's volume, then today's trend is likely to continue.
89. Trading Rules of volume.
As a rule of thumb, "high volume" for any given market is at least 25 percent above average for the past two weeks, and "low volume" is at least 25 percent below average.
• High volume confirms trends. If prices rise to a new peak and volume reaches a new high, then prices are likely to retest or exceed that peak.
• If the market falls to a new low and the volume reaches a new high, that bottom is likely to be retested or exceeded. A "climax bottom" is almost always retested on low volume, offering an excellent buying opportunity.
• If volume shrinks while a trend continues, that trend is ripe for a reversal. When a market rises to a new peak on lower volume than its previous peak, look for a shorting opportunity. This technique does not work as well at market bottoms because a decline can persist on low volume. There is a saying on Wall Street: "It takes buying to put stocks up, but they can fall of their own weight."
• Watch volume during reactions against the trend. When an uptrend is punctuated by a decline, volume often picks up in a flurry of profit taking. When the dip continues but volume shrinks, it shows that bulls are no longer running or that selling pressure is spent. When volume dries up, it shows that the reaction is nearing an end and the uptrend is ready to resume. This identifies a good buying opportunity. Major downtrends are often punctuated by rallies which begin on heavy volume. Once weak bears have been flushed out, volume shrinks and gives a signal to sell short.
You can use a moving average to define the trend of volume. The slope of a 5-day exponential moving average of volume can define volume's trend. You can also draw trendlines of volume and watch for their breakouts. Volume breakouts confirm price breakouts.
