Introduction to Technical Analysis

Traders are constantly searching for different trading systems, refreshing ideas, and new innovations to better refine their trading plans. By investigating the works of the forefathers of technical analysis, Traders can gain an immense knowledge of the workings of the financial markets. Technical analysis is based on three basic premises. First, the market is a discounting mechanism, which means that every fact or information pertaining to the market is already been discounted in the price since there are individuals and groups with large interests and pockets, who are armed with the latest research and findings, and who can afford to stay on top of the latest developments in the market. Second, technical analysis involves the study of mass psychology and the repetition of price patterns or formations. Since crowds behave similarly, price patterns will repeat again and again. Third, markets are either consolidating or trending. When the market is trending, the odds are that the market will continue to trend. The forefathers of technical analysis wrote extensively about technical set ups relating to the markets and noted their own observation pertaining to the mental and psychological aspects of trading as well. Having the trading plan and technical set ups account for nearly ten percent of your success as a trader. Your ability to make timely trade executions and to stay head and shoulders above the crowd accounts for about 90 percent of your success as a trader. Charles Dow, a prolific author and a journalist pioneered the art of technical analysis. He wrote his own observations in a series of editorials and articles in the Wall Street Journal around 1901-1903. Robert Rhea, William Hamilton, and Samuel A. Nelson compiled and formalized Dow work into a body of theories. Each of these authors wrote books in his turn. Samuel Nilson wrote ABC of stock speculation. For example, among the basic tenets of the Dow Theory is that there will always be three different price fluctuations in the market. The primary, the secondary, and the minor trend, which is respectively synonymous to saying daily, weekly, and yearly fluctuations. Successful traders include more than one time frame in their analyses to have a full picture of the whole structure of the market. The hourly chart can be used in conjunction with the daily chart. The daily chart can be used in conjunction with the weekly chart. Equally, Charles Baucker, Richard Wyckoff, Ralph Nelson Elliott made significant contributions to the art of technical analysis. Richard Schabacker, The father of the art of technical analysis in principle, pioneered the concept of chart patterns. He introduced terms such as head and shoulders, triangles, flags. He is also the first individual to use trendlines to define support and resistance levels. Richard Wyckoff coined the concept of testing, and examined meticulously market actions and reactions. He observed and looked for nuances in chart patterns to analyze how a specific price pattern may emerge. For instance, he looked at how the market shook bulls (buyers) before a major rally. Elliott is credited with the concept of waves and that, not only charts, but also waves form patterns, which will repeat themselves again and again. For instance, he introduced the concept of impulse wave which tend to happen in the direction of the trend.

MOMENTUM INDICATORS

Momentum indicators, also called oscillators, are used in technical analysis to measure the velocity of price changes (momentum) both up and down. Every momentum indicator is an oscillator as it oscillates between two extreme levels. These extremes are commonly known as overbought and oversold levels. When an oscillator reaches the upper extreme level, it is said to be overbought. When an oscillator reaches the lower extreme level, this condition is known as oversold. The horizontal line in between these extremes is referred to as the equilibrium line. The Relative Strength Index (RSI), the moving average convergence/divergence (MACD), and the stochastic index are widely used momentum indicators.

RELATIVE STRENGTH INDEX (RSI)

Momentum oscillator developed by J.Welles Wilder in the late 1970s and discussed in his book, New Concepts in Technical Trading Systems. RSI measures the relative strength of the present price movement as increasing from 0 to 100. There are many variations of RSI in use today although Wilder emphasized using a 14 period and setting the significant levels of RSI at 30 for oversold (signaling upturn) and 70 for overbought (signaling downturn). The averages of up days and down days for 14 day periods are plotted. If the financial instrument makes a new high but the RSI does not move beyond its previous high, this divergence suggests reversal. When RSI bounces down and falls below its most recent trough that signals a price reversal.

STOCHASTIC INDEX

Oscillator which measures overbought and oversold conditions in a financial instrument based on moving averages and relative strength concepts. In its simplest form, the stochastic index is expressed as a percentage of the difference between the low and the high price of a financial instrument during the stochastic chosen period. For instance, if the stochastic period is 14days and the high in that period was 50 and the low 40, the difference would be 10. If the price at the time of the calculation of the stochastic index was 40, the stochastic reading would zero. At a price of 50, the stochastic would be 100. At 45, the stochastic would be 50. The stochastic index normally plots a 5 day moving average of the stochastic. Lines representing the 25 percent and 75 percent levels refer to oversold and overbought conditions respectively. If the stochastic index falls below the 25 percent line, that suggests an oversold condition. When the stochastic index rises above the 75 percent line that indicates an overbought condition. An upward reversal through the 25 percent line is a positive breakout and a downward reversal through the 75 percent line is a negative breakout, indicating new uptrend and downtrends respectively.

MOVING AVERAGE CONVERGENCE/DIVERGENCE (MACD)

Oscillator developed by Gerald Appel which measures overbought and oversold conditions. MACD, pronounced MACD, makes use of three exponential moving averages a short one, a long one, and a third, which is the moving average of the difference between the other two and represents a signal line on the MACD graph. (MACD is typically shown as a histogram, which plots the difference between the signal line and the MACD line. Trend reversals are signaled by the convergence and divergence of these moving averages. When the histogram crosses the zero line upward, that suggests a positive breakout (a buy signal). If the histogram crosses the zero (equilibrium line downward (a sell signal), that indicates a negative breakout. One of the most popular MACD indicators in use is the 8/17/9 MACD. On a daily MACD, the short moving average would be 8 days, the long one 17 days, and signal line 9 days. On a weekly MACD, the same applies but those same numbers would refer to weeks rather than days. Again, we suggest you to trade with virtual money for as long as possible, before trading your own funds. We will continue this practice of sending educational e-mails in order to help you obtain further knowledge about various financial markets.

Pivot Point Trading

You are going to love this lesson. Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.

The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels.

The pivot level and levels calculated from that are collectively known as pivot levels.

Every day the market you are following has an open, high, low and a close for the day (some markets like forex are 24 hours but generally use 5pm EST as the open and close). This information basically contains all the data you need to calculate the pivot levels
The reason pivot point trading is so popular is that pivot points are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).
Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.

If you would rather work the pivot points out by yourself, the formula I use is below:

Resistance 3 = High + 2*(Pivot - Low)

Resistance 2 = Pivot + (R1 - S1)

Resistance 1 = 2 * Pivot - LowPivot Point = ( High + Close + Low )/3

Support 1 = 2 * Pivot - High

Support 2 = Pivot - (R1 - S1)

Support 3 = Low - 2*(High - Pivot)

As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.

If the market opens above the pivot point then the bias for the day is for long trades as long as price remains above the pivot point. If the market opens below the pivot point then the bias for the day is for short trades as long as the market remains below the pivot point.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

A perfect set up would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.

This all looks pretty straight forward.
Unfortunately life is not that simple and we have to deal with each trading day the best way we can. I have picked a day at random from last week and what follows are some ideas on how you could have traded that day using pivot points.

On the 12th August 04 the Euro/Dollar (EUR/USD) had the following:

High - 1.2297

Low - 1.2213

Close - 1.2249

This gave us:

Resistance 3 = 1.2377

Resistance 2 = 1.2337

Resistance 1 = 1.2293

Pivot Point = 1.2253

Support 1 = 1.2209

Support 2 = 1.2169

Support 3 = 1.2125

Trading Zones

Learn how to dramatically increase the probability of trading any market. Watch the video to see how Mark McRae increases his odds.IMPORTANT - Please read below before starting the video.
The video uses two free programs called Flash and Shockwave. Nearly all computers have these programs installed. To find out if you do, simply try to watch the video. If it starts playing then you are good to go.
Click the "To Watch Video Now - Click Here" link below and the video will start playing in a new window. Enjoy!
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Powerband Trading System Download

I have a neat little trading system for you that Dean Saunders gave me. He's the guys I told youabout yesterday who came up with Blade Forex.
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USD & JPY Recover

By Korman Tam
10/20/2008 2:30:00 PM
Read Full Article
The dollar and yen recovered from overnight losses against the majors, edging higher during the New York session. The greenback recovered from its lows against the euro at 1.3530 to climb higher to 1.3289 while bouncing back versus the sterling from 1.7516 toward the 1.71-figure. Meanwhile, the yen advanced sharply from 179.18 versus the pound to the 174-level and from 138.54 against the euro to the 135-handle. The major equity bourses were relatively stable, with both the Dow Jones and S&P 500 up by over 2% in afternoon trading and the Nasdaq higher by over 1%. Crude oil also crept, edging above $74 per barrel to $74.20.
Fed Chairman Bernanke testified before Congress earlier, warning that the economy will likely remain weak over the coming quarters and suggesting that it is currently in a serious slowdown. Bernanke said it would be appropriate for Congress to consider another economic stimulus package, adding that any fiscal package should be significant and also include improved access to credit. He said there were encouraging signs in the credit markets but added that it was too soon to assess. Further, Bernanke said that stabilization of the financial markets will not quickly eliminate the economic challenges. His somber assessment in the economy raises the scope for the FOMC to cut rates by at least 25-basis points at its two-day policy meeting next week.
US Treasury Secretary Paulson elaborated in greater detail the plan to inject capital into banks. He said the banks are expected to employ the new capital and to strengthen efforts to help homeowners avoid foreclosure. Paulson said financial institutions controlled by foreign entities would not be eligible for the program. Lastly, he stressed that the bank share purchase plan should be viewed as investments rather than expenditures and that he expects no taxpayer cost as a result.( More.. )
Read the rest of this article at Forexnews.com

Forex Lessons

Video Network Clip: Commodity Currencies Ed Ponsi of FXEducator.com Author and educator Ed Ponsi looks at commodity currencies like the red-hot Aussie from a fundamental and technical perspective.Watch now

"Cash Basis" - How it Works

The cash market is also called the “prompt” market, the “physical” market or the “spot” market. All futures markets are based upon some type of underlying cash or physical market. A futures market must be tied to some type of physical market, in order to keep the futures market price fairly valued and actively traded. For example, in the corn futures there is the “cash” corn that farmers harvest and deliver to their local elevators. In the crude oil futures, there is the physical crude oil that is refined into various industrial forms, such as gasoline. In gold, there is the world “spot” market and London cash fixings. The same situation applies to other raw commodities futures. All have some type of an underlying cash market. U.S. Treasury Bond futures also have a cash market, which is the actual debt sold at auction by the U.S. Treasury Department, via bonds, notes and bills. Stock index futures also have a cash market, which are the actual individual stocks that are bought and sold on stock exchanges. Many cash market products are actually deliverable at designated locations to offset an existing position in the futures market. Grain futures are one example of a deliverable commodity against existing futures market positions. There are some futures markets that are cash-settled only, such as feeder cattle futures and the stock indexes. Cash Market “Basis” Cash basis is defined as the cash price of the commodity minus the futures price of the commodity. Basis can be positive or negative depending on the factors that determine basis. These factors include local supply and demand for the raw commodity, supply and demand for transportation, variations in the commodity’s quality and the futures contract specifications, and the availability of substitutes for the commodity. Generally, transportation expenses makes up the largest portion of cash basis. Changes in cash basis are not as volatile as changes in cash market or futures prices. Changes in basis tend to follow seasonal patterns. At harvest, grain supplies are generally more plentiful, resulting in a higher demand for transportation services and an increased cost to move grain (weaker basis). Post-harvest improvement in basis often occurs because of increased availability of transportation services at a better price, and improvements in local supply and demand conditions. Country grain elevators base the price they will pay farmers for their grain on the price of grain futures at the Chicago Board of Trade. For example, a grain elevator in central Nebraska will likely have a wider basis than will a grain elevator located on the Mississippi River in Dubuque, Iowa. Reason: Shipping costs to get grain from the elevator in central Nebraska to the Gulf of Mexico are more than the shipping costs of the elevator located in Dubuque, Iowa, shipping to the Gulf of Mexico. For example, the cash soybean price quote from a grain elevator in Nebraska might be “28 cents under the May futures contract.” Whereas the cash soybean quote from a Dubuque elevator might be “8 cents under the May futures contract.” And at the Gulf of Mexico, cash soybeans could be quoted at “30 cents over the May contract.” See how the basis “narrows” as the cash grain gets closer to its final shipping destination. The cash basis at the Gulf of Mexico includes the transportation costs of getting the grain to that major shipping destination. Changes in cash basis levels are closely watched by futures traders. Commercials go to great lengths to keep history and study various cash basis levels for the markets in which they are involved. It is a laborious process. Changes in cash basis levels signal changes in demand coming from the end-users and changes in supply coming from the producers of the raw commodity.

By Jim Wyckoff