Charts

VARIOUS TRADING TOOLS :

1) CANDLE STICK CHART :                                                  

The Japanese have been using candlestick charts since the 17th century to analyze rice prices. Candlesticks were introduced into modern technical analysis by Steve Nison in his book Japanese Candlestick Charting Techniques.

Candlesticks contain the same data as a normal bar chart but highlight the relationship between opening and closing prices. The narrow stick represents the range of prices traded during the period (high to low) while the broad mid-section represents the opening and closing prices for the period.

• If the close is higher than the open - the candlestick mid-section is hollow or shaded blue/green.
• If the open is higher than the close - the candlestick mid-section is filled in or shaded red.

The advantage of candlestick charts is the ability to highlight trend weakness and reversal signals that may not be apparent on a normal bar chart.

Shadow and Tail

The shadow is the portion of the trading range outside of the body. We often refer to a candlestick as having a tall shadow or a long tail.

• A tall shadow indicates resistance;
• A long tail signals support.

Candlestick Colors

For improved presentation, Incredible Charts uses colors such as red and blue/green to indicate filled or hollow candlesticks:

• Blue (or green) candlestick if the close is higher than the open;
• Red candlestick if the open is higher than the close (i.e. the candlestick is filled);
• The same color as the previous day, if the open is equal to the close.

Candlestick Patterns :

Long Lines

The long white line is a sign that buyers are firmly in control - a bullish candlestick.
A long black line shows that sellers are in control - definitely bearish.

Marubozu Candlesticks

Marubozu are even stronger bull or bear signals than long lines as they show that buyers/sellers have remained in control from the open to the close -- there are no intra-day retracements.

Doji Candlesticks

The doji candlestick occurs when the open and closing price are equal.
An open and close in the middle of the candlestick signal indecision. Long-legged dojis, when they occur after small candlesticks, indicate a surge in volatility and warn of a potential trend change. 4 Price dojis, where the high and low are equal, are normally only seen on thinly traded stocks.

Dragonfly

The dragonfly occurs when the open and close are near the top of the candlestick and signals reversal after a down-trend: control has shifted from sellers to buyers.

Hammer and Gravestone

The hammer is not as strong as the dragonfly candlestick, but also signals reversal after a down-trend: control has shifted from sellers to buyers. The shadow of the candlestick should be at least twice the height of the body.
A gravestone is identified by open and close near the bottom of the trading range. The candlestick is the converse of a hammer and signals reversal when it occurs after an up-trend.

Hanging Man

A hammer that occurs after an up trend is called a 'hanging man' and is a bearish signal.

Dark Cloud

A Dark Cloud pattern encountered after an up-trend is a reversal signal, warning of "rainy days" ahead.

Piercing Line

The Piercing Line is the opposite of the Dark Cloud pattern and is a reversal signal if it appears after a down-trend.

Engulfing Candlesticks

Engulfing patterns are where the body of the second candlestick 'engulfs' the first. They often follow or complete doji, hammer or gravestone patterns and signal reversal in the short-term trend.

Harami Candlestick

A Harami formation indicates loss of momentum and often warns of reversal after a strong trend. Harami means 'pregnant' which is quite descriptive. The second candlestick must be contained within the body of the first, though the shadows may protrude slightly.

Star Formations

Stars are similar to gaps. A long body followed by a much shorter candlestick with a short body, where the bodies must not overlap -- though their shadows may.

Morning Star

The Morning Star pattern signals a bullish reversal after a down-trend. The first candlestick has a long black body. The second candlestick gaps down from the first (the bodies display a gap, but the shadows may still overlap) and is more bullish if hollow. The next candlestick has a long white body which closes in the top half of the body of the first candlestick.

Evening Star

The Evening Star pattern is opposite to Morning Star and is a reversal signal at the end of an up-trend. The pattern is more bearish if the second candlestick is filled rather than hollow.

Doji Star

A Doji Star is weaker than the Morning or Evening Star: the doji represents indecision. The doji star requires confirmation from the next candlestick closing in the bottom half of the body of the first candlestick.

Shooting Star

With a Shooting Star, the body on the second candlestick must be near the low -- at the bottom end of the trading range -- and the upper shadow must be taller. This is also a weaker reversal signal than the Morning or Evening Star.
The pattern requires confirmation from the next candlestick closing below half-way on the body of the first.

Rising Three Methods

The Rising Method consists of two strong white lines bracketing 3 or 4 small declining black candlesticks. The final white line forms a new closing high. The pattern is definitely bullish.

Falling Three Methods

The bearish Falling Method consists of two long black lines bracketing 3 or 4 small ascending white candlesticks, the second black line forming a new closing low.

Evaluation

While candlesticks may offer useful pointers as to short-term direction, trading on the strength of candlestick signals alone is not advisable. Jack Schwager in Technical Analysis conducted fairly extensive tests with candlesticks over a number of markets with disappointing results.

2) SIMPLE MOVING AVERAGE :

                                                                       

How to Calculate the Simple Moving Average

The simple moving average (SMA) is the most basic of the moving averages used for trading. The simple moving average formula is calculated by taking the average closing price of a stock over the last “x” periods. To mathematically represent this equation you can use the following formula:
“x” simple moving average = (sum of closing prices for “x” period)/x period.
Let’s take a look at a simple moving average example with MSFT.  The last five closing prices for MSFT are: 28.93+28.48+28.44+28.91+28.48 = 143.24 To calculate the simple moving average formula you divide the total of the closing prices and divide it by the number of periods. 5-period SMA = 143.24/5 = 28.65.
As you can see from the formula there is no weight provided to the most recent activity or a particular period with heavier volume or price volatility.  So, the shorter the “x” period used the greater the average is susceptible to significant swings as a result of volatile price movement.

Popular Simple Moving Averages

In theory there are an infinite number of simple moving averages.  If you are thinking you will come up with some weird 46 SMA to beat the market let me stop you now.  It is important to use the most common SMAs as these are the ones the majority of traders will be using on a daily basis.  While I do not advocate you following everyone else, it is important to know what other traders are looking at for clues.  Below are the most common SMAs used in the market: 5 – SMA – For the hyper trader.  This short of an SMA will constantly give you signals.  The best use of a 5-SMA is as a trade trigger in conjuction with a longer SMA period.

5 Period SMA

10-SMA – popular with the short-term traders.  Great swing traders and day traders.

10 SMA

20-SMA – the last stop on the bus for short-term traders.  Beyond 20-SMA you are basically looking at primary trends.

20-SMA

50-SMA – use the trader to gauge mid-term trends.

50-SMA

200-SMA – welcome to the world of long-term trend followers.  Most investors will look for a cross above or below this average to represent if the stock is in a bullish or bearish trend.

200-SMA

Basic Rules for Trading with the SMA

Most traders will tell you to trade simple moving average crossovers of and the profits will fall from the heavens. Well, unfortunately this is not accurate. Often time’s stocks will tick over or under moving averages to only continue in the primary direction. This will leave you on the wrong side of the market and down on your positions. Below are a few ways to make money trading the SMA.

Going with the Primary Trend

1. Look for stocks that are breaking out up or down strongly
2. Apply the following SMAs 5,10,20,40,200 to see which setting is containing price the best
3. Once you have identified the correct SMA, wait for the price to test the SMA successfully and look for price confirmation that the stock is resuming the direction of the primary trend
4. Enter the trade on the next bar

Fade the Primary Trend Using Two Simple Moving Averages

1. Locate stocks that are breaking out up or down strongly
2. Select two simple moving averages to apply to the chart (ex. 5 and 10)
3. Make sure the price has not been touching the 5 SMA or 10 SMA excessively in the last 10 bars
4. Wait for the price to close above or below both moving averages in the counter direction of the primary trend on the same bar
5. Enter the trade on the next bar

Video of a Simple Moving Average Strategy

The below video shows an example of a simple moving average crossover strategy.  While this trade would have worked in your favor, please remember this is not always the case.

Real-Life Example going with the primary trend using the SMA

The simple moving average is probably one of the most basic forms of technical analysis.  Even hard core fundamental guys will have a thing or two to say about the indicator.  A trader has to be careful, since there are unlimited number of averages you can use and then you throw the multiple time frames in the mix and you really have a messy chart. Below is a play-by-play for using a moving average on an intraday chart.  In the below example we will cover staying on the right side of the trend after putting on a long position. The below chart is from TIBCO (TIBX) on June 24, 2011.

Simple Moving Average Example

Notice how the stock had a breakout on the open and closed near the high of the candlestick.  A breakout trader would use this as an opportunity to jump on the train and place their stop below the low of the opening candle.  At this point you can use the moving average to gauge the strength of the current trend.  In this chart example we are using the 10-period simple moving average.

Simple Moving Average - When to Sell

Now looking at the chart above, how do you think you would have known to sell at the $26.40 level using the simple moving average?  Let me help you out here.  You would have had no clue.  Far to many traders have tried to use the simple moving average to predict the exact sell and buy points on a chart.  A trader might be able to pull this off using multiple averages for triggers, but one average alone will not be enough.  So save yourself the time and headache and use the averages to determine the strength of the move. Now take another look at the chart.  Do you see how the chart is starting to rollover as the average is starting to flatten out.  A breakout trader would want to stay away from this type of activity, since the money in this example grows as the stock increases in price.  Now again, if you were to sell on the cross down through the average, this may work some of the time, but over time you will end up losing money after you factor in commissions.  If you don’t believe me, try simply buying and selling based on how the price chart crosses up or under a simple moving average.  Remember, if it was that easy, every trader in the world would be making money hand over fist.

Flat Simple Moving Average

Let’s take another look at the simple moving average and the primary trend.  I like to call this the holy grail setup.  This is the setup you will see in books and seminars.  Simply buy on the breakout and sell when the stock crosses down beneath the price action.  The below is an intraday chart of Sina Corporation (SINA) from June 24, 2011.  Look at how the price chart stays cleanly above the 20-period simple moving average.

Simple Moving Average - Perfect Example

Isn’t that a beautiful chart?  You buy on the open at $80 and sell on the close at $92.  A quick 15% profit in one day and you didn’t have to lift a finger.  The brain is a funny thing.  I remember seeing a chart like this when I first started out in trading and then I would buy the setup that matched the morning activity.  I would look for the same type of volume and price action, only to later be smacked in the face by reality when my play did not trend as well.  This is the true challenge with trading, what works well on one chart, will not work well on the other.  Remember, the 20-SMA worked well in this example, but you can not build a money making system off one play.

Real-Life Example going against the primary trend using the SMA

Another way to trade using the simple moving average is to go counter to the trend.  One of the more higher probability plays is to counter gap moves.  There have been a number of studies regarding gaps.  Depending on the period in the stock market (60s flat line, late 90s boom, or volatility of the 2000s) its a safe assumption that gaps will fill 50% of the time.  Another validation a trader can use when going counter is a close under or over the simple moving average.  In the example below, FSLR had a solid gap of ~4%.  After the gap the stock trended up strongly.

FSLR Short

You have to be very careful with counter approaches.  If you are on the wrong side of the trade, you and others with your position will be the fuel for the next leg up. Let’s fast forward a few hours on the chart.

FSLR Short Trend

Whenever you go short and the stock does little to recover and/or the volatility dries up, you are in a good spot.  Notice how FSLR continued lower throughout the day; unable to put up a fight.  Now let’s jump forward one day to July 1, 2011 and guess what happened?  You got it, the stock pulled back and the gap was filled.

FSLR Gap Filled

Summary

If you haven’t already figured it out, the simple moving average is not an indicator you can use as a standalone trigger.  Now, that doesn’t mean that the indicator can’t be a great tool for monitoring the direction of a trend or helping you determine when the market is getting tired after an impulsive move.  Think if the SMA as a very basic compass.  If you want detailed coordinates you will need other tools, but you at least have an idea of where you are headed.