FUNDAMENTALS 1/2_FUNDAMENTALS 2/2_TECHNICALS 1/2_TECHNICALS 2/2_PSYCHOLOGY_TRADING PLAN


TECHNICALS 2/2

We will continue our technicals now with the use of the technical indicators offered by xStation, and we will expand further with more material that can be used in trading.

Trend indicators are used for detecting trends in financial markets. Indicators of this group are inefficient in periods of flat. Trend indicators point to the price movement direction. The following trend indicators are available with xStation:

Average Directional Index - ADX

An indicator used in technical analysis as an objective value for the strength of trend. ADX is non-directional so it will quantify a trend's strength regardless of whether it is up or down. ADX is usually plotted in a chart window along with two lines known as the DMI (Directional Movement Indicators). ADX is derived from the relationship of the DMI lines. Analysis of ADX is a method of evaluating trend and can help traders to choose the strongest trends and also how to let profits run when the trend is strong.

 

Bollinger Bands

A band plotted two standard deviations away from a simple moving average, developed by famous technical trader John Bollinger. Bollinger Bands consist of a middle band with two outer bands. The middle band is a simple moving average that is usually set at 20 periods. A simple moving average is used because the standard deviation formula also uses a simple moving average. The look-back period for the standard deviation is the same as for the simple moving average. The outer bands are usually set 2 standard deviations above and below the middle band.

In trending times, anything above the upper bound of the bb channel is a sell signal and anything below the lower bound is a buy signal. The 20 SMA in the middle acts as technical support/resistance in either situation. When no trend in the instrument, you can trade in between the 2 standard deviations and consider the upper and lower bound as resistance and support levels of a sideways movement.

Moving Average

The Moving Average Technical Indicator shows the mean instrument price value for a certain period of time. When one calculates the moving average, one averages out the instrument price for this time period. As the price changes, its moving average either increases, or decreases.

There are four different types of moving averages: Simple (also referred to as Arithmetic), Exponential, Smoothed and Weighted. Moving Average may be calculated for any sequential data set, including opening and closing prices, highest and lowest prices, trading volume or any other indicators. It is often the case when double moving averages are used.

The only thing where moving averages of different types diverge considerably from each other, is when weight coefficients, which are assigned to the latest data, are different. In case we are talking of Simple Moving Average all prices of the time period in question, are equal in value. Exponential Moving Average and Linear Weighted Moving Average attach more value to the latest prices.



The most common way to interpreting the price moving average is to compare its dynamics to the price action. When the instrument price rises above its moving average, a buy signal appears, if the price falls below its moving average, what we have is a sell signal.

This trading system, which is based on the moving average, is not designed to provide entrance into the market right in its lowest point, and its exit right on the peak. It allows to act according to the following trend: to buy soon after the prices reach the bottom, and to sell soon after the prices have reached their peak.

Moving averages may also be applied to indicators. That is where the interpretation of indicator moving averages is similar to the interpretation of price moving averages: if the indicator rises above its moving average, that means that the ascending indicator movement is likely to continue: if the indicator falls below its moving average, this means that it is likely to continue going downward.

Here are the types of moving averages that can be applied on xStation charts:

  • Simple Moving Average (SMA)
  • Exponential Moving Average (EMA)
  • Smoothed Moving Average (SMMA)
  • Linear Weighted Moving Average (LWMA)

Exponential Moving Average

A type of moving average that is similar to a simple moving average, except that more weight is given to the latest data. The exponential moving average is also known as "exponentially weighted moving average". This type of moving average reacts faster to recent price changes than a simple moving average. In general, the 50- and 200- EMAs are used as signals of long-term trends, with the 10- and 20- work better in short term intraday trading. In fact, you can adjust the ema based on your trading style and combine more than two emas with other indicators.

Envelopes

Envelopes Technical Indicator is formed with two Moving Averages, one of which is shifted upward and another one is shifted downward. The selection of optimum relative number of band margins shifting is determined with the market volatility: the higher the latter is, the stronger the shift is.Envelopes define the upper and the lower margins of the price range. Signal to sell appears when the price reaches the upper margin of the band; signal to buy appears when the price reaches the lower margin.



The logic behind envelopes is that overzealous buyers and sellers push the price to the extremes (i.e., the upper and lower bands), at which point the prices often stabilize by moving to more realistic levels. This is similar to the interpretation of Bollinger Bands (BB). A type of pattern used in technical analysis to predict a reversal in the current trend. A fractal pattern consists of five bars and is identified when the price meets the following characteristics:

  1. A shift from a downtrend to an uptrend occurs when the lowest bar is located in the middle of the pattern and two bars with successively higher lows are positioned around it.
  2. A shift from an uptrend to a downtrend occurs when the highest bar is located in the middle of the pattern and two bars with successively lower highs are positioned around it.

Fractal signals are most useful when used in conjunction with other technical indicators, such as Fibonacci retracement or various moving averages. It should be noted that this is not a widely used indicator, so it may not be available for every type of charting application. But various third parties have developed various plug-ins which make using fractals possible.

Ichimoku Kinko Hyo

A technical indicator that is used to gauge momentum along with future areas of support and resistance. The Ichimoku indicator is comprised of five lines called the tenkan-sen, kijun-sen, senkou span A, senkou span B and chickou span. This indicator was developed so that a trader can gauge an asset's trend, momentum and support and resistance points without the need of any other technical indicator. When defining the dimension of parameters, four time intervals of different length are used. The values of individual lines composing this indicator are based on these intervals:

  • Tenkan-sen shows the average price value during the first time interval defined as the sum of maximum and minimum within this time, divided by two;
  • Kijun-sen shows the average price value during the second time interval;
  • Senkou Span A shows the middle of the distance between two previous lines shifted forwards by the value of the second time interval;
  • Senkou Span B shows the average price value during the third time interval shifted forwards by the value of the second time interval.



Chikou Span shows the closing price of the current candle shifted backwards by the value of the second time interval. The distance between the Senkou lines is hatched with another color and called "cloud". If the price is between these lines, the market should be considered as non-trend, and then the cloud margins form the support and resistance levels.

  • If the price is above the cloud, its upper line forms the first support level, and the second line forms the second support level;
  • If the price is below cloud, the lower line forms the first resistance level, and the upper one forms the second level;

If the Chikou Span line traverses the price chart in the bottom-up direction it is signal to buy. If the Chikou Span line traverses the price chart in the top-down direction it is signal to sell.

Kijun-sen is used as an indicator of the market movement. If the price is higher than this indicator, the prices will probably continue to increase. When the price traverses this line the further trend changing is possible. Another kind of using the Kijun-sen is giving signals. Signal to buy is generated when the Tenkan-sen line traverses the Kijun-sen in the bottom-up direction. Top-down direction is the signal to sell. Tenkan-sen is used as an indicator of the market trend. If this line increases or decreases, the trend exists. When it goes horizontally, it means that the market has come into the channel.

Parabolic SAR

Parabolic SAR Technical Indicator was developed for analyzing the trending markets. The indicator is constructed on the price chart. This indicator is similar to Moving Average with the only difference that Parabolic SAR moves with higher acceleration and may change its position in terms of the price. The indicator is below the prices on the bull market (Up Trend), when the market is bearish (Down Trend), it is above the prices.

If the price crosses Parabolic SAR lines, the indicator turns, and its further values are situated on the other side of the price. When such an indicator turn does take place, the maximum or the minimum price for the previous period would serve as the starting point. When the indicator makes a turn, it gives a signal of the trend end (correction stage or flat), or of its turn.

The Parabolic SAR is an outstanding indicator for providing exit points. Long positions should be closed when the price sinks below the SAR line, short positions should be closed when the price rises above the SAR line. It means one should trace the movement of Parabolic SAR and hold open positions only in the direction of this movement. It is often the case that the indicator serves as a trailing stop line.

If the long position is open (i.e., the price is above the SAR line), the Parabolic SAR line will go up, regardless of what direction the prices take. The length of the SAR line movement depends on the scale of the price movement.

 

Standard Deviation

Standard Deviation — value of the market volatility measurement. This indicator describes the range of price fluctuations relative to Moving Average. So, if the value of this indicator is high, the market is volatile, and prices of bars are rather spread relative to the moving average. If the indicator value is low, the market can described as having a low volatility, and prices of bars are rather close to the moving average.

Normally, this indicator is used as a constituent of other indicators. Thus, when calculating Bollinger Bands one has to add the symbol standard deviation value to its moving average.

The market behavior represents the interchange of high trading activity and languid market. So, the indicator can be interpreted easily:

  • if its value is too low, i.e., the market is absolutely inactive, it makes sense to expect a spike soon;
  • otherwise, if it is extremely high, it most probably means that activity will decline soon.

 

 

Oscillators show price deviation from its average value. Oscillators help to predict the approaching correction or the direction of price oscillation phase. Oscillators best suit the purpose of decision making when there is no vivid trend in the market.

Average True Range

Average True Range Technical Indicator (ATR) is an indicator that shows volatility of the market. It was introduced by Welles Wilder in his book "New concepts in technical trading systems". This indicator has been used as a component of numerous other indicators and trading systems ever since.

Average True Range can often reach a high value at the bottom of the market after a sheer fall in prices occasioned by panic selling. Low values of the indicator are typical for the periods of sideways movement of long duration which happen at the top of the market and during consolidation. Average True Range can be interpreted according to the same principles as other volatility indicators. The principle of forecasting based on this indicator can be worded the following way: the higher the value of the indicator, the higher the probability of a trend change; the lower the indicator’s value, the weaker the trend’s movement is.

 

Bulls/Bears Power

Everyday trading represents a battle of buyers ("Bulls") pushing prices up and sellers ("Bears") pushing prices down. Depending on what party scores off, the day will end with a price that is higher or lower than that of the previous day. Intermediate results, first of all the highest and lowest price, allow to judge about how the battle was developing during the day.

It is very important to be able to estimate the Bulls/Bears Power balance since changes in this balance initially signalize about possible trend reversal. This task can be solved using the Bulls/Bears Power oscillator developed by Alexander Elder as the difference between the lowest price and 13-period exponential moving average (LOW - EMA).

Application

This indicator is better to use together with a trend indicator (most frequently Moving Average):

  • if trend indicator is up-directed and the Bears Power index is below zero, but growing, it is a signal to buy;
  • it is desirable that, in this case, the divergence of bases were being formed in the indicator chart.

 

Commodity Channel Index Technical Indicator (CCI)

This indicator measures the deviation of the assets price from its average statistical price. High values of the index point out that the price is unusually high being compared with the average one, and low values show that the price is too low. In spite of its name, the Commodity Channel Index can be applied for any financial instrument, and not only for the wares. There are two basic techniques of using Commodity Channel Index:

  1. Finding the divergences: The divergence appears when the price reaches a new maximum, and Commodity Channel Index cannot grow above the previous maximums. This classical divergence is normally followed by the price correction.
  2. As an indicator of overbuying/overselling: Commodity Channel Index usually varies in the range of ±100. Values above +100 inform about overbuying state (and about a probability of correcting decay), and the values below 100 inform about the overselling state (and about a probability of correcting increase).

 

MACD

Moving Average Convergence/Divergence (MACD) is a trend-following dynamic indicator. It indicates the correlation between two Moving Averages of a price. The Moving Average Convergence/Divergence (MACD) Technical Indicator is the difference between a 26-period and 12-period Exponential moving averages (EMA). In order to clearly show buy/sell opportunities, a so-called signal line (9-period moving average of the indicator) is plotted on the MACD chart. The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the Moving Average Convergence/Divergence: crossovers, overbought/oversold conditions, and divergences.

Crossovers

The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the Moving Average Convergence/Divergence rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.



Overbought/Oversold Conditions

The MACD is also useful as an overbought/oversold indicator. When the shorter moving average pulls away dramatically from the longer moving average (i.e., the MACD rises), it is likely that the symbol price is overextending and will soon return to more realistic levels.

Divergence

An indication that an end to the current trend may be near occurs when the MACD diverges from the symbol. A bullish divergence occurs when the Moving Average Convergence/Divergence indicator is making new highs while prices fail to reach new highs. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.

 

Momentum

The Momentum Technical Indicator measures the change of price of a financial instrument over a given time span. There are basically two ways to use the Momentum indicator:

  • As a trend-following indicator analogous to Moving Average Convergence/Divergence (MACD). In this case a signal to buy occurs if the Momentum indicator makes up a trough and starts rising; a signal to sell occurs when it reaches peak and turns down. You may want to plot a short-term moving average of the indicator to determine when it is bottoming or peaking. Extremely high or low values of Momentum imply continuation of the current trend. Thus if the indicator reaches extremely high values and then turns down, the further price growth should be expected. In any case, a position should be opened or closed only after prices confirm the signal generated by the indicator.
  • As a leading indicator. This method assumes that the final phase of an up-trend is usually accompanied by a rapid price increase (when everyone expects prices to go higher), and that the end of bears' market is characterized by rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization. When market approaches a peak there is a sharp leap of the Momentum indicator. After that it starts to fall while prices keep on growing or move horizontally. Analogous to that, at the market bottom Momentum sharply falls and then turns up long before prices start growing. Both of these situations result in divergences between the indicator and prices.

 

Relative Strength Index

The Relative Strength Index Technical Indicator (RSI) is a price-following oscillator that ranges between 0 and 100. When Wilder introduced the Relative Strength Index, he recommended using a 14-period RSI. Since then, the 9-period and 25-period Relative Strength Index indicators have also gained popularity. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the Relative Strength Index then turns down and falls below its most recent trough, it is said to have completed a "failure swing". The failure swing is considered a confirmation of the impending reversal.

The following signals of Relative Strength Index are used in chart analyzing:

  • Tops and Bottoms
    The Relative Strength Index usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart.
  • Chart Formations
    The RSI often forms chart patterns such as head and shoulders or triangles that may be or may not be visible on the price chart.
  • Failure Swing (Support or Resistance breakout)
    This is where the Relative Strength Index surpasses a previous high (peak) or falls below a recent low (trough).
  • Support and Resistance levels: The Relative Strength Index shows, sometimes more clearly than price themselves, levels of support and resistance.
  • Divergences
    As discussed above, divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the Relative Strength Index. Prices usually correct and move in the direction of the RSI.

 

Stochastic Oscillator

The Stochastic Oscillator Technical Indicator compares where a security’s price closed relative to its price range over a given time period. The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line. There are several ways to interpret a Stochastic Oscillator. Three popular methods include:

  • Buy when the Oscillator (either %K or %D) falls below a specific level (for example, 20) and then rises above that level. Sell when the Oscillator rises above a specific level (for example, 80) and then falls below that level.
  • Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.

Look for divergences. For instance: where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.

In technical analysis, this is a momentum indicator measuring overbought and oversold levels, similar to a stochastic oscillator. It was developed by Larry Williams and compares an asset’s close to the high-low range over a certain period of time, usually 14 periods. It is used to determine market entry and exit points. The Williams %R produces values from 0 to -100, a reading over 80 usually indicates the product as oversold, while readings below 20 suggests that is overbought.

 

Accelerator Technical Indicator (AC)

It simply measures acceleration and deceleration of the current driving force. This indicator will change direction before any changes in the driving force, which, it its turn, will change its direction before the price. If you realize that Acceleration/Deceleration is a signal of an earlier warning, it gives you evident advantages.The nought line is basically the spot where the driving force is at balance with the acceleration. If Acceleration/Deceleration is higher than nought, then it is usually easier for the acceleration to continue the upward movement (and vice versa in cases when it is below nought).

Multiple time frame analysis is the process of monitoring the same asset over different time periods. You would usually use 3 time periods. The first time period should be used for Direction, the second should be used for Confirmation of direction, and the third one should be used to provide entry and exit points.

The highest time frame (TF1) is used to generate the overriding trend. This is for example the longer term chart. The middle time frame (TF2) is the most versatile time frame. The time period is picked based on how long you want to hold onto a trade. The smallest time frame (TF3) is used to gain an even more granular insight into the trend

Note – you should by now begin to understand the concept of trends within trends. E.g. the main trend may be down, the second time frame may be flat and the smallest may be up. If you have this case, you have confusing arguments to buy sell, hence you should not trade.

You should only look to trade when all 3 charts are pointing to the market moving in the same direction.

Examples:

  • Longer term traders may choose weekly, daily and 4HR charts
  • Shorter term trades might choose 4HR, 1HR and 15min charts

One of the best volatility index you can find. Wilder originally developed the ATR for commodities but the indicator can also be used for stocks and forex. Simply put, a currency pair experiencing a high level of volatility will have a higher ATR, and a low volatility currency pair will have a lower ATR.

Trading the News 

 


Sometimes we have to watch the price movement carefully, and we have to wait for a candle to close while usinf multi time frame charts. This enables us to identify possible fake breakouts like the one in our example.
In this example many traders looking at the 15min chart were waiting for a breakout after 2-3 candles and started entering the market with short positions.



Only those who were waiting for a clear confirmation on a 1-hour or 4-hour chart could see the big reversal.



We must be very careful when we want to enter or exit a trade, and an oscillator could really help us to define overbought and oversold areas for a currency pair.
 

The US GDP number has just been announced which came in a lot better than expected. This will cause a rise in the level of risk taking in the market. Therefore you expect equity markets to rally, and safer haven assets such as Gold to fall in price.
Oil is a commodity which should see its price rally. The main reason is, an increase in global growth should see an increase in the demand for commodities such as oil, used for production etc.

When the number is released, you may not be able to get into the market initially. The strategy should be to be patient and look for opportunities to buy. In this case, as we have made a new high, we would look to buy on a dip to the fast moving average (red line), placing a stop below the slow moving average.

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