In the environment of active futures trading, technical analysis is the premier method of study. It is an examination of price action, as influenced by market participants, and traders use it to craft trade-related decisions, rules, strategies, and systems.
There are literally hundreds of technical trading rules, each with various applications on the marketplace. Let’s take a look at five of the most common rules.
1. The Trend Is Your Friend
It’s almost a cliché, but the old market saying “the trend is your friend” is one of the most popular trading rules. A trend is a directional move in price, commonly evaluated via pricing charts.
There are many strategies designed for spotting and engaging trending markets. Trendlines, moving average crossovers and momentum oscillators are a few examples. However, when dealing with trends, there are two simple rules to live by:
- Market entry is most favorable in concert with the prevailing trend
- Avoid going against the prevailing trend
Trend recognition offers traders a means of limiting risk and possibly realizing extraordinary rewards. Although a basic concept, always remember that “the trend is your friend!”
2. Respect the Fibonacci Sequence
The Fibonacci sequence is a series of integers where each represents the sum of the two preceding numbers. Also known as the “golden ratio,” Fibonacci numbers are found throughout nature and frequently applied to the realm of active futures trading. Fibonacci expansions, spirals and retracements are several of the most commonly used in technical analysis.
Fibonacci retracements are a popular tool for measuring a counter-trend move in a directional market. In practice, they measure the percentage of a retracement, or pullback, from a periodic extreme. The Fibonacci retracement sequence is as follows:
Traders use Fibonacci retracements to determine rules for market entry and to align profit targets and stop losses. The most commonly scrutinized levels among traders are 38.2% and 61.8%.
3. Know the Location of Support and Resistance
Price levels where moving averages, Fibonacci retracements and other technical indicators fall are referred to as areas of support and resistance. Support and resistance levels act as self-fulfilling prophecies — if enough traders respect the same ones, they function as barriers for price extension or launch points for new trends.
After determining the presence of support and resistance, guidelines for implementing the levels into a trading strategy are relatively simple:
- Enter orders to the long (buy) from support
- Enter orders to the short (sell) from resistance
Support and resistance levels are useful in determining forthcoming tendencies in price action. In addition, traders frequently use them to identify market entry points or to locate stop losses.
4. All Trends Must End
Understanding when a pricing trend has ended is a key element in active trading. While the goal of many strategies is to capitalize on trending markets, eventually the move becomes exhausted and the party’s over.
Spotting the end of a trend is a fine art. A common way of succeeding at this task is to determine when a market becomes “overbought” or “oversold.” This can be accomplished through the use of a group of technical tools known as oscillators.
Two of the most common oscillators are the Relative Strength Index (RSI) and Stochastics. Both assign a numeric value from 0 to 100 to the periodic price action of a security. A high reading shows that a market is becoming overbought, while a low reading suggests oversold. Values that approach the extremes are signals of trend exhaustion and possible market reversal.
5. Multi-Time Frame Analysis Is Key
Understanding the market dynamic over several different periods can be extremely useful in identifying both market state and potential entry points. Traders can place prolonged trends or consolidating price action into the proper context by observing monthly, weekly, daily and intraday charts.
The tenets of multi-time frame analysis are relatively straightforward:
- Identify the macro market state by using longer-term pricing charts
- Establish current trading conditions via shorter-term or intraday charts
The key element to remember when using multiple time frames is that longer time frames are more relevant to market behavior than shorter ones. For instance, when day trading, market state is best determined by a weekly or daily chart. After the condition of the market is established, you can use intraday charts to craft a plan for entry and exit.
Using Technical Trading Rules
Integrating technical analysis into your approach to the markets can be a daunting task. There are hundreds of tools and indicators to choose from, each with a unique function. Using technicals to develop a set of viable trading rules requires a skill set developed from experience and extensive study.
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