OPTION TRADER TECHNIC: [9.2] Chart analysis and technical indicators

There so many indicators invented over the years that, so often, a beginner is confused of which to choose. Here are some common ones that may assist you in your trading.

Here are a few indicators used in the sample charts:-

Candlestick

Candlestick charts were first used by the Japanese. These patterns are quite useful in identifying reversals. Using candlestick charts instead of bar charts helps to anticipate market sentiment for short term, say the next few days for instance (for a daily price candlestick chart).

Moving averages

Moving averages are usually plotted over the price chart. These are used to identify buying and selling signals. Common averages in use by analysts may include the following:-

50 day simple moving average

100 day simple moving average

200 day simple moving average

There are also some who use these:-

5 day simple moving average

20 day simple moving average

Some may like to use exponential moving averages (EMA) instead of simple moving averages (SMA). However, as we need a combination of a few indicators, there should not be much of a difference between simple average or exponential average.

Bollinger band

This indicator is useful to identify trend reversals; that is when the price trend is switching from a bullish uptrend to a bearish downtrend. Normally the experienced trader also uses the MACD as a confirmation.

MACD or Momentum or GMMA

These are some of the common indicators that analysts use to determine change of trends. I find that the GMMA (Guppy Multiple Moving Averages) is more useful as it has a pattern of 2 trends – one is a set of shorter periods which represent the smaller day traders and the other is a set of longer periods which represent the so called “big boys” or institution investors (funds houses).

There are also many traders who use RSI and Stochastic Oscillator to determine movements from a too high level (or overbought) to that of a too low level (or oversold). RSI or Relative Strength Index is based on closing prices and not moving enough. When the index touches the upper “overbought” zone, the prices can still move up trend quite a bit. Hence, most of those who use RSI may also include Stochastic. This sounds so confusing so I suggest that as a beginner, try this:-

Money Flow Index (MFI) which is another version of RSI but also includes volume. Since the market is a combination of price and volume, this indicator should be easier to work with.

Example 1 (chartnexus.com)

Combination of indicators:-

Candlestick chart (easier to look out for change of sentiments)
5 day SMA (when 5 SMA crosses over the 12 SMA will be signs of buy/sell opportunities)
12 day SMA
Bollinger bands (to confirm trend direction)
GMMA (to re-confirm trend direction. In this example, as long as red band of lines do not drop below the green band of lines, the uptrend should still be intact)
Momentum (either this or GMMA should be enough)

Example 2 (freestochcharts.com)

Candlestick chart (for change of sentiments)
5 day SMA (signs of buy/sell opportunities)
12 day SMA
Bollinger bands (confirm trend direction)
Momentum (either this or MACD should be enough)\
MACD (to confirm trend direction, bullish or bearish. Lines above the zero bar are bullish and below it will be bearish)

Example 3 (chartnexus.com)

Candlestick chart (for change of sentiments)
5 day SMA (signs of buy/sell opportunities)
Bollinger bands (confirm trend direction)
MFI (to confirm trend direction, bullish or bearish. Above the upper thick line is overbought, or too high. Dotted bar in the centre is the zero line)
GMMA (to reconfirm trend direction)

Other than the indicators, we can also draw lines on the chart to show up or down trend. We can also draw resistance and support lines. However, you may draw boxes (example of Darvas Box theory) to make it easier to read upper resistance and lower support zones.

Darvas Box is first used by Nicholas Darvas to trade stocks. (Read his book: How I made $2million in the stock market)

Another writer Frank Watkins whose book Darvas Box Trading described how the theory is put to practice in share trading.

The box starts from the last top pivot point to the last low point. Prices move inside the box and any breakout above or below signals buy or sell.

For further free education:-

STOCKCHARTS.COM

CHART PATTERNS

Try this:

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:chart_patterns

CANDLESTICK

Refer to: http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:introduction_to_cand

TECHNICAL INDICATORS

Try stockcharts.com chart school. It is free education.