BY MPFX

When looking at a chart we have the option to view the price formations in four main styles, these are: Line, Bar, Candle and Point and Figure. All of these have their strengths and weaknesses and which style you choose will be a matter of personal preference. 

I personally elect to use three of the four types with point and figure the one I never use. This works for me but there are many Technical Traders out there who trade with great success using only P&F so as already stated this really is a personal choice that you will have to make.

The line chart is the one most of us would have seen many times before and is usually plotted using closing price data. 

This chart is good for visualizing  the overall trend of a stock and on some charting programs it will allow you to see more data over a longer time span. 

It's use is limited as it is basically what I call a one dimensional chart as it uses only one form of data. 

Good for glancing, but not for analyzing.

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Bar charts are probably the most widely used by traders and not only give us the closing price but also the high, low and opening prices. 

As traders we need to know as much as possible about a stock and its movements and these bars are the perfect tool for the job. 

With a single glance at one of these bars we can get a feel for how investors traded this stock for the day and their general sentiment towards it. 

Small bars ( or bodies as they are Technically called ) are a sign the market maybe consolidating its position or thinking about its nest move.

Long bodies could indicate the market is again on the move and looking to test new levels. 

Some charting packages will only show the close on the bar, many traders elect to use this style with great success. Some say the opening price does not give a true indication of market sentiment and choose to ignore it. 

There is a marked difference when drawing trend lines on a line chart compared to a bar chart. With a bar chart you get the entire trading range and a trend line can be drawn using these ranges as opposed to only using closing price data on a line chart. To make this more clear please refer to diagrams opposite. 

These two charts are identical except one is a line chart and one is a bar. The trend lines drawn in are the same for both charts based on the bar chart only.

In the circled areas you can see the clear difference between the two. 

With a bar chart we are drawing trend line based on trading ranges rather than end of day closing prices.

By doing this we are allowing ourselves a better chance of gaining a lower entry price and a higher exit level. We also increase the range in which the stock may trade thus allowing greater profit margins.

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Candle stick charting was developed by the Japanese several centuries ago and has undergone a resurgence in popularity in recent times. This form of chart is by far my personal favorite and I usually use it exclusively. Although more complex to understand, once mastered, candle charts can give you the best overall view of market sentiment. In this section I will give you a brief summary of candles but the purchase of a book dedicated to candle charting should be a must for anyone serious about developing their charting skills.

Candles are similar to bar charts in that they show all four data components ( open , close, high and low ) but that  is where the similarities end.

Candle charts use rectangular boxes that join the open and closing prices together, and use vertical thinner lines to define the trading range. The boxes are called the ' Real Body ' and the thin trading range line are called the ' wicks or shadow '.

If the closing price is higher than the opening price the body will be white, if the closing price is lower than the opening price the body will be black.

Opposite is a basic list of common candle stick formations.

A = Open/close the same. large trading range.

B = Open/close the same. small trading range.

C = Open/close the same.   no trading range

D = Open close the same. Market tested higher levels but failed to close any higher than open.

E = Open close the same. Market tested lower levels but failed to close lower than open.

The correct term for a line that represents a price that opened and closed at identical levels is ' Doji '

F = Doji with market testing higher levels but refusing to close above open. Also known as a ' Hammer ". The appearance of a hammer at the top of a trend could suggest lower prices may follow. Bearish sign.

G = Doji with market testing lower levels but refusing to close below open. Also known as Hammer. The appearance of a hammer at the bottom of a trend could suggest higher prices may follow. Bullish sign.

H = Hammer with close higher than open. Bullish at bottom

I = Hammer with close lower than open. Bullish at bottom.

J = Hammer with close higher than open. Bearish at top.

K = Hammer with close lower than open. Bearish at top.

Please note that Hammers are also referred to as ' umbrella lines ".

L & M = Both of these are known as spinning tops. They represent small trading ranges and are important in some candle chart patterns. Again where they occur is of the up most importance.

Opposite are 3 examples of Hammers. The bottom two are bullish while the top one is Bearish.

The appearance of Dark clouds is not a good sign. It is formed with a white real body followed by a Larger black real body that closed lower than the previous days close. 

As mentioned at the start of this chapter Candle stick charting is so involved that the purchase of a book solely dedicated to this subject should be must for any serious trader.

I have only scratched the surface of this invaluable method of charting in this chapter. 

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Moving Averages have been around for many centuries and helps the trader to try and eliminate some of the volatility that is associated with stock prices. There are three main types of moving averages:   Simple, Exponential and Weighted.

I personally use only Simple M/As for my trading. This suits my trading style and all examples shown here are based on this.

I suggest that you experiment with all 3 on the same stock to see how all three behave just that little bit differently.

Moving averages are basically the share price smoothed out over a set time frame. They are calculated by adding all the closing prices together for a set number of days and then dividing this total by that set number of days. So for a 20 day m/a we use the last 20 days of data. As new data becomes available the earliest entry is replaced with the latest entry thus keeping our 20 day total intact.

As most charting packages automatically construct all three types of moving averages I believe that time is better spent here explaining how to trade using them as opposed to their how they are mathematical made up. 

The first and most basic method for the use of m/a's is to wait till the price of the stock crosses over the m/a.

This works as both a buy and sell signal and is one of the most widely used methods.

The key to this method is the time frame. The basic rule is the longer the time frame the less false signals. This is fine but with this you also get the longer the time frame the later the buy or sell signal.

Day traders and short term speculative traders may elect for shorter time spans than a long term, more cautious trader. Ranges from 9 days to 24 months can be used.

The most common used by traders would be 9, 20, 25, 30, 50, 75, and 100 days.

I advise that you run tests on a stock you are familiar with, changing the m/a time frame to see the differences in entry and exit levels. 

As we have already discussed trend lines we can now apply them together with a m/a on the same chart.

We now how have two indicators giving us signals.

Sell Signal = 50 m/a crossed to the downside and support line has been broken.

Buy Signal = 50 m/a crossed to upside and resistance line has been broken.

Interesting to note that the 50ma gave a sell signal before the support was broken but gave a buy signal after the resistance was broken.

The second method for the use of m/a's is to apply Multiple Moving Averages.

This is the preferred method by many traders and the method I personally elect to use. 

It involves the use two or more moving averages at the same time which are set at different times spans.

When the moving averages cross each other, either a buy or sell signal is generated.

When the faster moving average ( 25ma ) crosses above a slower moving average ( 50ma ) it is classed as a Buy signal.

When the faster moving average crosses below the slower moving average it is classed as a Sell signal.

Once again the time frames used have a great impact on where the signals are generated on the charts.

I advise running numerous tests adjusting the time frames on both m/a's. Make sure you use the same stock for the tests. This method is by far the best way to truly understand moving averages and will allow you develop your own set of trading criteria.

Some traders like to use up to 6 moving averages at a time believing that when all the averages converge to the same spot on the chart a change of trend is very near.

As you can see from charts opposite, by the time we use four m/a's the chart begins to look very busy. This method definitely its merits as the lines converging is sometimes the first indictor to get the attention of the Technical Trader and is a sign that this stock should be placed in the ' watch closely basket '.

In summary I would like to advise that the best way to gain a real understanding of moving averages is to run tests. Please keep in mind that once you have tested the ma's on the one stock and you are comfortable with the settings you have chosen, try testing those settings on at least 50 others stocks to see if they still show the same results. The more time spent testing, the more comfortable you will be when making your trading decisions.

In closing I have included a chart opposite with the settings I use when trading. It is of PBL and is a current chart. I have included all signals that are relevant that have been discussed so far. PLEASE do not just copy my settings and take them as gospel. This works for me and may not be suitable for you, PLUS it will not aid in your own development as a trader, please take the time to run the tests, you will be more than rewarded in the end.

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The four charts below are all of the same stock with only the time frames changed on the m/a. 

The longer the time frame the less false signals.

Above and below are the same stock with only five days added to both m/a's in the one below. It is interesting to note that such a small change can effect the timing of the signals.

Below are all the same stock with a moving average added each time. It is of PBL daily.

MACD indicators are yet a further extension of the moving average theory. They are part of the Momentum indicator family.

MACD simply stands for Moving Average Convergence Divergence.

The most common form used by traders is the MACD Histogram. It is constructed by measuring the convergence and the divergence of two moving averages.

The most widely used time frame is a 12,26,9 macd.

 The 12 and 26 ma's are divided and plotted as the Blue line, the 9 ma is plotted as the Red line.

A horizontal line is drawn and is used as the point when these two moving averages are at the exact same level. ( The 12,26 macd crosses the 9 ma) This is called the  Equilibrium Line . 

A dotted line is usually added which represents the zero line.

Bars are used as a visual aid in determining the position of the faster moving average in relevance to the slower moving average.

Bars pointing above the Equilibrium Line indicate that the Macd average is above the 9 day moving average.

Bars pointing below the Equilibrium Line indicate that the Macd average is below the 9 day moving average.

There are 3 mains ways to trade when using Macd's.

The first is use the crossing of the m/a's as a signal. 

A buy signal is given when the bars first point above the equilibrium line.

A sell signal is given when the bars first point down below the equilibrium line.

The chart opposite shows two buy and two sell signals. It is interesting to note where the signals given correspond to the price action on the main chart. The first two signals are pretty much spot on, but after the second sell signal was given, the price moved higher before moving down again. On the second buy signal the price drifted lower before moving up again. The second sell signal was too low and the second buy signal was too high. This is important because traders who set tight stop losses on their trades run the risk of getting out of their trade only to watch the stock rebound.

 This is why it is so important not to rely on only one technical indicator, it is the culmination of many indicators that are positive or negative at the same time.

On this next chart we have five signals being generated by the Macd. 

The Red circle indicates 4 sell signals occurring within 2 weeks of each other. This is a what I mean by more than one indicator turning negative at same time, it does not have to happen on the same day.

The Pink circle indicates that although the price did drop on both sell signals, the support line remained intact. The price only crossed the 20ma on the first sell signal but remained above on the second. 

The 20 ma remained above the 50ma on both sell signals.

The second method used with Macd's is the Convergence / Divergence method.

Convergence means two separate objects heading towards the same meeting point.

Divergence means two separate objects moving away from a meeting point.

For the use in trading we are interested in the convergence or divergence of the price chart and the indicator that we have selected, in this case Macd.

What we are looking for is lower lows on the price chart and higher lows on the Macd. This creates a buy signal or at least should alert the trader to a possible trend reversal.

Using this method is a good visual aid for seeing that a trend is slowly running out of steam. Nearly all momentum indicators exhibit these converge / diverge properties. Most technical traders use what is called a lead indicator. This is the indicator that is the first to show signs of an impending trend change. Momentum indicators are usually high on this list.  

The same applies when we are searching for sell signals. Instead of the lines converging, this time we are looking for divergence of the price and the Macd.

We are looking for the price to be making higher highs but the Macd to be setting lower highs.

We are looking for the price to be making higher highs but the Macd to be setting lower highs.

Again these signals are only part of the equation when look to buy and sell. If a trader only looks to use one indicator he will get caught out more times than not, but on the other hand, I believe the use of too many indicators is just as a fatal mistake as using only one. It is a fine balance of the indicators that you feel most comfortable with.

The third method used is to use the macd line crossing the zero line as a buy signal and the macd line making a clear break of the histogram bars as a sell signal.

This method creates the least amount of buy and sell signals but also the least amount of false signals.

This method is also the slowest to generate a signal and is good for the longer term trend changes.

Of course it still generates false signals like ALL indicators so advice mentioned already above about multiply signals should be heeded.

Time Fames.

Choosing which time frames to use varies greatly and experimentation is by far the best way to educate yourself. Again use the same stock and adjust the settings of the macd to see the difference in where buy and sell signals are being generated.

Some standard time frames are :

12, 26, 9   

8, 17, 9   

12 ,25, 9

Please take the time to do your OWN experimentation.

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  by  MPFX

As you can see above a faster Macd gives an earlier buy signal but gives many more false signals.

Stochastic indicators  are part of the momentum indicator family and are extremely useful for determining whether a stock has moved into an overbought or oversold area.

There are usually 2 lines plotted on the standard stochastic, these are the %K and the %D lines.

%K is a moving average of a stocks past trading range relative to its current price. 

%D is a moving average of the %K line.

These lines are plotted on a chart with a range of 0 - 100.

As most charting packages do all these calculations for us I believe that time is better spent learning to read them as opposed to their mathematical make up.

Once again there a several ways to trade using the stochastic indicator.

The first is by the use of bands at the 20 and 80 mark. 

A stock is considered overbought ( Sell Signal ) when the stochastic is at or above the 80 level.

A stock is considered oversold ( Buy Signal ) when the stochastic is at or below the 20 level.

Of course this does not mean sell when it hits 80 and buy when it reaches 20, as false signals are common place as the chart opposite illustrates.

It does however indicate that the trend, in either direction, is running out of steam.

The second method is to buy and sell at the crossing of the %K and %D lines. This is the same method applied to 2 multiple m/a's on a price chart.

Once again there are many false signals given using this method. On the chart opposite you can see 5 signals being given. Only 2 of these are valid and would have resulted in profit or saved losses.

The third method that can be used is by the addition of trend lines to the stochastic chart in the exact same manner as you would on a price chart.

As the chart opposite illustrates the down trend ( Blue Line ) has clearly been broken by both lines.

This works for both up trends and down trends.

What levels to set your stochastic at will have to be a personal preference to suit the type of trader you are.

The default on most charting programs is set to 20 & 9. Once again I strongly recommend experimenting with the levels to find a combination which best suits your trading style.

On the chart opposite I have included examples of three different settings. You can clearly see that the slower stochastic, the less false signals.

My personal preference for stochastic on a daily chart are 17 and 9.

If using intra-day charts these numbers could possibly go as low as 5 and 3.

Please take the time to experiment.

SUMMARY

After much back testing I have found that the best way to use stochastic indicators is to combine the entire above mentioned rules.

On the chart opposite you can see these confirmations occurring.

The top sell signal shows 2 out of our 3 rules confirmed, while the bottom buy signals shows all 3.

Once again it is time to put all that has been mentioned so far onto the one chart.

The chart opposite shows a combined total of 10 positive signals from 4 different indicators.

Throughout this editorial I have stressed the point that T/A is a combination of many signals given at the one time and this is an excellent example of this.

The chart opposite is of BDL dated 30-10-2001.

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This is a current chart of BDL