Technical Analysis For Dummies
Book image
Explore Book Buy On Amazon
Technical analysis can give you an edge in beating the stock market. How, exactly, do you do that? Here are 16 technical analysis secrets to becoming a skilled technical analysis trader:
  • Don’t let the seeming complexity of technical analysis scare you off. The technical analysis workspace is a chart showing the price of a security over time. The tools you use in that workspace are indicators. You learned about charts in grade school and the arithmetic behind indicators is usually nothing more than the basic addition, subtraction, multiplication, and division from grade school. In a nutshell, technical analysis can be stunningly simple. You can go on to make it more complicated, but you don’t have to — you can keep it simple.
  • The core concept of technical analysis is to trade with the trend. If your indicators tell you the security is trending upward, buy it. When it stops trending upward, sell it. If you don’t know what’s going on, don’t trade. Don’t fall into the value trap — that a high-quality security will come back after a fall. It may, but you may have to live a long time to see it happen. While you’re waiting, you’re missing opportunities to build capital.
  • Every indicator works. Indicators are effective in identifying both buying opportunities and warnings for when you should get out and sell. The technical analysis world has devised dozens of indicators, and you can’t hope to use them all. There is no single best indicator, but there are a few best indicators for you. The best indicators for you are the ones whose inner workings you understand and the ones you are comfortable trusting because they perform well consistently and reliably for you.
  • Every indicator fails sometimes. Accept that all trading, including trading using technical analysis, sometimes results in losses. Losses can arise because the market goes haywire and behaves in a bizarre and abnormal way, while your indicators were chosen to work well under normal conditions. This is the luck factor and doesn’t mean your indicator skill is faulty. Similarly, every indicator has the potential to lead you into a trade that delivers gigantic gains. It’s still abnormal market behavior and doesn’t mean your indicators are magical and your indicator skills exceptional.
  • Don’t trade at all if you can’t accept losses. Acknowledge that you’ll take losses, and that you must control them ruthlessly to preserve capital. The biggest cause of losses isn’t bad indicators; it’s failure to admit your indicators are sometimes wrong and you need to intervene to control losses. Technical analysis is about making money, not about proving your indicators are right. You can’t make money if you can’t control the occasional loss. The tool for managing losses is the stop-loss order. No trader is successful over the long run without using stop-loss orders.
  • Interpret what the indicator is saying about crowd sentiment. Indicators measure whether a security is trending, the strength of the trend, and when the trend is running out of steam. No indicator measures everything, so understand which aspect of crowd sentiment your technical indicators is focused on.
  • Take an empirical approach. See what you’re looking at on the chart. Don’t let confirmation bias, more commonly known as wishful thinking, skew your vision. Accept the evidence of your eyes. When you misinterpret a chart, go back and find what you missed.
  • Use at least two indicators. One technical indicator is better than none; just using the 200-day moving average on the Dow or S&P 500 would have saved your bacon in all the bear market downturns. Then apply a second indicator to get the confirmation effect that improves your odds of being right.

You’ll never be 100 percent right 100 percent of the time, so confirmation is a must. But avoid analysis paralysis that comes from demanding so much confirmation from so many indicators that you hardly ever get a signal. Use indicators that work well together without duplicating the ruling concept.

  • Use multiple time frames for confirmation. When you have the same buy/sell signal in the six-hour, daily and one-week time frame, you have confidence that the indicator is telling you the truth. You won’t get multiple time frame confirmation all the time but look for it anyway. When in doubt, expand your time frame to the weekly chart from the daily chart — seeing the big picture may help.
  • Dismiss people who say “market timing doesn’t work.” They’re people who couldn’t get it to work for themselves. The crowd who say technical analysis doesn’t work includes some well-known and highly successful fund managers and pundits. But a higher number of well-known and successful fund managers do use technical analysis. Millions of people, from high-level experts to the ordinary Joe, use technical analysis in one form or another today. Every U.S. broker offers technical charting capability. They wouldn’t do that if traders didn’t demand it.
  • Don’t trade for amusement or excitement or to make a point. The purpose of trading is to make money — period. If you’re trading for entertainment or excitement or to prove some philosophical or political point, you’ll almost certainly lose your shirt. For amusement, go to the movies. For excitement, buy a motorcycle or ride a roller coaster. To make a political point, write a letter to the editor.
  • Use fundamentals to select securities, not to trade them. Nobody says you have to trade junky securities. High-class “value” securities are trending. Junky securities are trending. Both can offer the same opportunities and the same risk of loss. You’re free to trade only the securities you like on a fundamental basis, but you use fundamentals to select securities, not to set a trading regime.
  • Devise a trading plan and stick to it. Indicators are sometimes wrong and you’ll take losses. Compensate for the shortcomings of indicators by imposing strict risk-management controls. Examine your track record and don’t lie to yourself about your track record. Examining losses may uncover a surprisingly simple way to avoid losses in the future. Examining gains may disclose some personal talent on which you can build. And never override your trading plan. The trading plan has two components — the signals generated by your indicators and your stop-loss and take-profit rules. You can’t control the indicators or the market while a trade is in progress, but you need to control yourself. Establish your trading rules when you’re unemotional for times when you’re emotional to overcome bad decision-making.
  • Plan every trade and never trade without a profit target and a stop loss. Trading is not a savings plan; it’s a pathway to building capital. Establish your best-case profit as well as your worst-case loss. Trading and investing aren’t gambling — they’re a business, with probable outcomes that you can estimate. Take money off the table once in a while and put it somewhere safe. Capital allocated to trading is not “savings.” It is always at some risk when it is actively placed in a market. Reduce trading after a big loss and a big gain alike. Pace your trading to the amount of money you have. Don’t overtrade, but don’t get paralyzed by uncertainty, either.
  • Beware of self-appointed expert advisors. You can’t evaluate an advisor unless you can judge both the indicator system and the trading rule regime, and you can do that only if you have first tried to do some designing yourself. Everyone trades the same indicator on the same security in a different way, and no one way is the right way.

If you take guidance from gurus, figure out their strengths and weaknesses, and verify their work with your own. Don’t take tips from anyone you have not pre-qualified. Don’t give tips, either, unless you’re quitting your day job to set up an advisory business.

  • Seek the “Eureka!” moment. Technical analysis contains thousands of ideas, with new combinations of indicators, new types of securities, and new trading technologies being invented all the time. A lot of it is intimidating and frightening, but persevere — you never know when you might come across something that resonates with you and turns out to be the key concept in a new and improved, and successful, trading regime.

About This Article

This article is from the book:

About the book author:

Barbara Rockefeller is an international economist and forecaster who specializes in foreign exchange. A pioneer in technical analysis, she also led the way in combining technical and fundamental analysis. Barbara publishes daily reports using both techniques for central banks, professional fund managers, corporate hedgers, and individual traders.

This article can be found in the category: