Price Charts

• Novice traders erroneously tend to look for the Holy Grail indicator. There

is none. Before relying on any indicator, try making mechanical systems that trade directly off price action. It will help you develop a feel and intuition for price dynamics. Learn to use your intuition and anticipate price movement. Mob psychology is to react to the market, a strategy that generally loses.

• The most important market price patterns to identify are uptrends and downtrends. An uptrend is the successive occurrence of higher highs and higher lows. A downtrend is the successive occurrence of lower highs and lower lows. Trends run along support and resistance lines that tend to continue until broken with a direction now in the opposite direction.

• Become familiar with support and resistance lines. Breakouts and breakdowns from these lines are popular strategies but they are not easy to apply due to many false breakouts or breakdowns depending on which market you trade. However, the cup and handle breakout pattern strategy works very well in a bullish market.

• Volume leads price. When a stock breaks out of a consolidation pattern on increasing volume, for example, it is considered a valid breakout and the expectation is that price will move higher. However, if a breakout is followed by lethargic volume, it is considered suspect.

• Price congestion may be viewed as a memory of the market that can influence future price movement. If price is moving about within a region of low congestion, there are few traders to counteract the moves and the price movement is considered mobile. Further, when prices move toward lower congestion, the move is likely to continue and the price is again considered mobile. Conversely, when prices move either within high congestion or toward a region of higher congestion, then price is considered immobile.

Indicators

• There are two categories of indicators: those that work in trending markets and those that work in nontrending (trading) markets. An indicator that works well in a trading market will constantly give signals opposite the trend for a strong trending security. When a security is in a nice uptrend, ignore overbought sell signals. Conversely, if you apply an indicator that works well in trending situations to a nontrending security, you will trade often but will end up selling at about the same level as the purchase price.

• Moving averages reduce the noise (jaggedness) in price time series, but their inherent delay or lag sometimes hinders their effectiveness, because late trade

Part I

signals can cost you profit. More advanced, low-lag moving averages are available either publicly or commercially.*

• Sentiment indicators have limited value because the public is aware of the value of taking a contrarian position, which in turn affects the sentiment indicators themselves. As for flow-of-funds indicators, although they are effective in measuring the capacity of market participants, they fail to measure the intention of the participants to put those reserves to work.

• Traders should never depend on one indicator exclusively. Each indicator solves only one piece of the puzzle. Traders can realize an indicators true value by using it in concert with other (dissimilar) indicators to provide an overall composite picture of an issues underlying trend strength and direction. The more evidence there is to support the indicators confirmation of one another, the more valid the conclusion-and the higher the probability of profit.

• One of the biggest traps most aspiring technicians fall into is following several indicators with different names, all of which measure the same thing. To better evaluate varied perspectives on the market, follow a handful of indicators that measure different aspects of market behavior.

• Never apply any technical indicator to a market or stock blindly. Always look at the whole range of an indicators value before assessing its meaning.

Placing Trades

• Although this may sound backward, learn to exit the market first. To do so, enter the market at arbitrary times and develop profitable stops and exit strategies. Try to stay in the good trades and exit the bad trades with a small loss. It can be done, and you will learn a tremendous amount in a very short time.

• If the net expected return for an intended trade is a positive number, then you have a good trade or sound entry. If it is a negative number, then you should avoid that trade.

• Once you are in a trade and, better still, before entering a trade, you should place a stop in the market. Placing stops will minimize your losses, help to ensure profits, and reduce risk. Place stops in an area that, if hit, will prove your analysis wrong. You will need to determine your risk parameters and examine the type of market and trade you are in. Will this trade last three days or three weeks?

• Once you have placed the initial stop, you then need to monitor the position. When is the appropriate time to bring your stops to breakeven? Determine

Popular advanced moving averages include DEMA (Difference Exponential Moving Average), developed by Patrick Mulloy (see Technical Analysis of Stocks and Commodities, January 1994), the Kalman filter, developed by Rudolf Kalman (see Kalman Filtering, by Grewal and Andrews, Prentice Hall, 1993), and JMA (Jurik Moving Average), developed by Mark Jurik (see http: www.jurikres.com/catalog/ms ama.htm).

whether you will take a predetermined amount out of the market or will trail the market until you get stopped out. If you decide to use a trailing stop, you will have several to choose from.

Money Management

• A key to any successful trading venture is money management, which can consist of factors like the number of contracts to trade, the number of markets to trade in, exiting a position and loss control. A trader should spend 70 percent of his time on developing and using money management and 30 percent of their time looking for low-risk, high-profit trading opportunities.

• Accept that you have a lot to learn and your initial performance will likely be poor. Avoid going broke by trading small lots in relatively stable markets. For example, try trading the bond market before the S&P.

• Know how much your account size needs to be, and what portion you may not use for placing trades. Assume you will need about three times margin to trade one futures contract with relative safety from drawdowns. As a rule of thumb, you can increase your survival against losing streaks by putting at risk only 5 percent of your capital per trade.

• Some risk may be controlled with good exit strategies, so predetermine your exit points before you trade.

• Measure your progress with equity charts. If you suffered a losing streak, take a breather to regain composure. Do not ever say, "Ill make it up on the next trade."