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Average True Range: Average True Range is one measure of volatility of a given market. The measure was created by J. Welles Wilder, Jr. in his 1979 book “New Concepts in Technical Trading Systems”.
Average True Range is based on the True Range, which is defined as the greatest of three measures:
•The difference between the greatest high and the greatest low
•The absolute value of the current high minus the latest close
•The absolute value of the current low minus the latest close
As a rule, fourteen measurements of the True Range are used in deriving the ATR. These measurements can be taken for four different time intervals: within a day, daily, weekly and monthly. The first ATR in a series is simply the average of the TR for fourteen periods. Future ATRs in the series are derived by the following algorithm:
•Multiply the previous 14-day ATR by 13.
•Add the current ATR.
•Divide the sum by 14.
The measurement is useful due to its sensitivity to large fluctuations in the value of a currency across several periods of measurement, even when the difference between the high and low values for a single period is very small (which would falsely indicate a low overall volatility.)
$CTIX BarChart Trader's Cheat Sheet
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Trader's Remorse ~ Weaknesses of Technical Analysis
Not all technical signals and patterns work. When you begin to study technical analysis, you will come across an array of patterns and indicators with rules to match. For instance: A sell signal is given when the neckline of a head and shoulders pattern is broken. Even though this is a rule, it is not steadfast and can be subject to other factors such as volume and momentum. In that same vein, what works for one particular stock may not work for another. A 50-day moving average may work great to identify support and resistance for IBM, but a 70-day moving average may work better for Yahoo. Even though many principles of technical analysis are universal, each security will have its own idiosyncrasies.
Daily Candlestick Chart for DISK
[img]stockcharts.com/c-sc/sc?s=DISK
Trend lines can offer great insight, but if used improperly, they can also produce false signals. Other items - such as horizontal support and resistance levels or peak-and-trough analysis - should be employed to validate trend line breaks. While trend lines have become a very popular aspect of technical analysis, they are merely one tool for establishing, analyzing, and confirming a trend. Trend lines should not be the final arbiter, but should serve merely as a warning that a change in trend may be imminent. By using trend line breaks for warnings, investors and traders can pay closer attention to other confirming signals for a potential change in trend.
The uptrend line for VeriSign (VRSN) was touched 4 times, and seemed to be a valid support level. Even though the trend line was broken in Jan-00, the previous reaction low held, and did not confirm the trend line break. In addition, the stock recorded a new higher high prior to the trend line break.
Daily Candlestick Chart for TLFX
[img]stockcharts.com/c-sc/sc?s=TLFX
Scale Settings
High points and low points appear to line up better for trend lines when prices are displayed using a semi-log scale. This is especially true when long-term trend lines are being drawn or when there is a large change in price. Most charting programs allow users to set the scale as arithmetic or semi-log. An arithmetic scale displays incremental values (5,10,15,20,25,30) evenly as they move up the y-axis. A $10 movement in price will look the same from $10 to $20 or from $100 to $110. A semi-log scale displays incremental values in percentage terms as they move up the y-axis. A move from $10 to $20 is a 100% gain, and would appear to be a much larger than a move from $100 to $110, which is only a 10% gain.
In the case of EMC, there was a large price change over a long period of time. While there were not any false breaks below the uptrend line on the arithmetic scale, the rate of ascent appears smoother on the semi-log scale. EMC doubled three times in less than two years. On the semi-log scale, the trend line fits all the way up. On the arithmetic scale, three different trend lines were required to keep pace with the advance.
In the case of Amazon.com (AMZN), there were two false breaks above the downtrend line as the stock declined during 2000 and 2001. These false break outs could have led to premature buying as the stock continued to decline after each one. The stock lost 60% of its value three times over a two year period. The semi-log scale reflects the percentage loss evenly, and the downtrend line was never broken.
Daily Candlestick Chart for GWIV
[img]stockcharts.com/c-sc/sc?s=GWIV
$KLDO BarChart Trader's Cheat Sheet
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Daily Candlestick Chart for HIMR
[img]stockcharts.com/c-sc/sc?s=HIMR
Random Walk Theory
With "random walk", Malkiel asserts that price movements in securities are unpredictable. Because of this random walk, investors cannot consistently outperform the market as a whole. Applying fundamental analysis or technical analysis to time the market is a waste of time that will simply lead to underperformance. Investors would be better off buying and holding an index fund.
Malkiel offers two popular investment theories that correspond to fundamental analysis and technical analysis. On the fundamental side, the "Firm-Foundation Theory" argues that stocks have an intrinsic value that can be ascertained by discounting future cash flows (earnings). Investors can also use valuation techniques to ascertain the true value of a security or market. Investors decide when to buy or sell based on these valuations.
On the technical side, the "Castle-in-the-Air Theory" assumes that successful investing depends on behavioral finance. Investors must determine the mood of the market - bull or bear. Valuations are not important because a security is only worth what someone is willing to pay for it.
Random walk theory jibes with the semi-strong efficient hypothesis in its assertion that it is impossible to outperform the market on a consistent basis. This theory argues that stock prices are efficient because they reflect all known information (earnings, expectations, dividends). Prices quickly adjust to new information and it is virtually impossible to act on this information. Furthermore, price moves only with the advent of new information and this information is random and unpredictable.
In short, Malkiel attributes any outperformance success to lady luck. If enough people try, some are bound to outperform the market, but most are still likely to underperform.
Disparity Index: The disparity index is a percentage measurement for the position of the current closing price of an asset relative to that asset's moving average. Traders commonly attribute this measurement to Steve Nison, based on his book Beyond Candlesticks.
The disparity index can take either a positive or a negative value. A positive value indicates that the asset's price is rapidly increasing, while a negative value indicates that the price is rapidly decreasing. A value of zero means that the asset's current price is exactly consistent with its moving average.
The disparity index crossing the zero line reflects an extremely rapid change in the trend of a given asset, and is therefore a strong early-warning indicator of the asset's increasing momentum.
Nison's book suggests that the disparity index can indicate whether an asset is overbought (in the case of a positive value) or oversold (in the case of a negative.) Since overbought and oversold assets are very vulnerable to rapid price reversals, the disparity index is a good indicator of when following the trend of a given asset might be a dangerous proposition.
Methods to Establish Support and Resistance?
Support and resistance are like mirror images and have many common characteristics.
Highs and Lows
Support can be established with the previous reaction lows. Resistance can be established by using the previous reaction highs.
The above chart for Halliburton (HAL) shows a large trading range between Dec-99 and Mar-00. Support was established with the October low around 33. In December, the stock returned to support in the mid-thirties and formed a low around 34. Finally, in February the stock again returned to the support scene and formed a low around 33 1/2.
Daily Candlestick Chart for IVFH
[img]stockcharts.com/c-sc/sc?s=IVFH
$LCCTF BarChart Trader's Cheat Sheet
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Daily Candlestick Chart for GOVX
[img]stockcharts.com/c-sc/sc?s=GOVX
Scale Settings for Trend Lines
High points and low points appear to line up better for trend lines when prices are displayed using a semi-log scale. This is especially true when long-term trend lines are being drawn or when there is a large change in price. Most charting programs allow users to set the scale as arithmetic or semi-log. An arithmetic scale displays incremental values (5,10,15,20,25,30) evenly as they move up the y-axis. A $10 movement in price will look the same from $10 to $20 or from $100 to $110. A semi-log scale displays incremental values in percentage terms as they move up the y-axis. A move from $10 to $20 is a 100% gain, and would appear to be a much larger than a move from $100 to $110, which is only a 10% gain.
In the case of EMC, there was a large price change over a long period of time. While there were not any false breaks below the uptrend line on the arithmetic scale, the rate of ascent appears smoother on the semi-log scale. EMC doubled three times in less than two years. On the semi-log scale, the trend line fits all the way up. On the arithmetic scale, three different trend lines were required to keep pace with the advance.
In the case of Amazon.com (AMZN), there were two false breaks above the downtrend line as the stock declined during 2000 and 2001. These false break outs could have led to premature buying as the stock continued to decline after each one. The stock lost 60% of its value three times over a two year period. The semi-log scale reflects the percentage loss evenly, and the downtrend line was never broken.
Descending Trendline: Descending trendlines are a variety of trendlines, one of the most fundamental tools for technical analysis. Descending trendlines are simply trendlines with a negative slope, indicating falling prices. There are two types of descending trendlines: descending top trendlines, in which the high prices for an asset are falling, and descending bottom trendlines, in which the low prices for the asset are falling.
The rules for trading using descending trendlines are the same as the rules for trading with trendlines in general. A descending top trendline is a measure of the resistance to an asset's price, and traders consider a break in price through the descending top to be buy signal for the asset. A descending bottom trendline is a measure of the support in an asset's price, and traders consider a break in price through the descending bottom to be a sell signal for the asset. Many traders consider it necessary for additional signals to appear on the chart before a broken descending trendline is confirmed, and before those traders will take the appropriate market action.
$IRCE BarChart Trader's Cheat Sheet
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Daily Candlestick Chart for MXDHF
[img]stockcharts.com/c-sc/sc?s=MXDHF
Elder Impulse System ~ Timeframe
The Elder Impulse System can be used across different timeframes, but trading should be in harmony with the bigger trend. Elder recommends setting your trading timeframe and then calling it intermediate. Multiply this intermediate timeframe by five to get your long-term timeframe. Traders using daily charts for an intermediate timeframe can simply move to weekly charts for a long-term timeframe. The choice is not as clear cut for smaller or longer timeframes. A little judgment is required. Traders using 10-minute charts to chart their "intermediate" timeframe can use 60-minute charts for their "long-term" timeframe. Investors using weekly charts can base the bigger picture on monthly charts. Once the trading timeframe is decided, chartists can then use the longer timeframe to identify the bigger trend. This can even be accomplished using one chart. Chart 2 shows daily bars with the Elder Impulse System and the 65-day exponential moving average, which is five times the 13-day EMA. The long-term trend is considered up when SPY is above the 65 day EMA or when MACD (1,65,1) is positive.
Again, other methods for determining the weekly trend can be used instead of using the MACD(1,65,1) zero crossover on the daily chart. We will use that technique in this article to simplify the charts and discussion.
$HYSR BarChart Trader's Cheat Sheet
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Daily Candlestick Chart for ONCS
[img]stockcharts.com/c-sc/sc?s=ONCS
Trading Range
Trading ranges can play an important role in determining support and resistance as turning points or as continuation patterns. A trading range is a period of time when prices move within a relatively tight range. This signals that the forces of supply and demand are evenly balanced. When the price breaks out of the trading range, above or below, it signals that a winner has emerged. A break above is a victory for the bulls (demand) and a break below is a victory for the bears (supply).
After an extended advance from 27 to 64, WorldCom (WCOM) entered into a trading range between 55 and 63 for about 5 months. There was a false breakout in mid-June when the stock briefly poked its head above 62 (red oval). This did not last long and a gap down a few days later nullified the breakout (black arrow). The stock then proceeded to break support at 55 in Aug-99 and trade as low as 50. Here is another example of support turned resistance as the stock bounced off 55 two more times before heading lower. While this does not always happen, a return to the new resistance level offers a second chance for longs to get out and shorts to enter the fray.
In Nov/Dec-99, Lucent Technologies (LU) formed a trading range that resembled a head and shoulders pattern (red oval). When the stock broke support at 60, there was little or no time to exit. Even though there is a long black candlestick indicating an open at 59, the stock fell so fast that it was impossible to exit above 44. In hindsight, the support line could have been drawn as an upward sloping neckline (blue line), and the support break would have come at 61. This is only 1 point higher and a trader would have had to take action immediately to avoid a sharp fall. However, the lows match up rather nicely on the neckline, and it is something to consider when drawing support lines.
After Lucent declined, a trading range was established between 40.5 and 47.5 for almost two months (green oval). The resistance level of the trading range was well marked by three reaction peaks at 47.5. The support level was not as clearly marked, but appeared to be between 40 and 41. Some buying interest began to become evident around 44 in mid- to late-February. Notice the array of candlesticks with long lower shadows, or hammers, as they are known. The stock then proceeded to form two up gaps on 24-Feb and 25-Feb, and finally closed above resistance at 48. This was a clear indication of demand winning out over supply. There were still two more opportunities (days) to get in on the action. On the third day after the breakout, the stock gapped up and moved above 56.
Price Discounts Everything
This theorem is similar to the strong and semi-strong forms of market efficiency. Technical analysts believe that the current price fully reflects all information. Because all information is already reflected in the price, it represents the fair value, and should form the basis for analysis. After all, the market price reflects the sum knowledge of all participants, including traders, investors, portfolio managers, buy-side analysts, sell-side analysts, market strategist, technical analysts, fundamental analysts and many others. It would be folly to disagree with the price set by such an impressive array of people with impeccable credentials. Technical analysis utilizes the information captured by the price to interpret what the market is saying with the purpose of forming a view on the future.
Daily Candlestick Chart for WNYN
[img]stockcharts.com/c-sc/sc?s=WNYN
$FIND BarChart Trader's Cheat Sheet
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The Elder Impulse System is designed to catch relatively short price moves. Elder notes the following: "The Impulse System encourages you to enter cautiously but exit fast. This is the professional approach to trading, the total opposite of the amateur's style. Beginners jump into trades without thinking too much and take forever to get out, hoping and waiting for the market to turn their way."
In addition to trading setups, the Elder Impulse System can be used to prevent bad trades by consulting it before entering a trade. Use the Impulse System to confirm bullish or bearish setups. Traders can ignore bullish setups when the Impulse System is not in full-blown bull mode (green bars) and ignore bearish signals when the system is not in full-blown bear mode (red bars). The impulse system can also be used to anticipate patterns or reversals. If you think a bull flag is taking shape or support from a Fibonacci retracement is near, the Impulse System can be used to identify a short-term reversal for confirmation.
Daily Candlestick Chart for ATYG
[img]stockcharts.com/c-sc/sc?s=ATYG
Support and Resistance Zones
Because technical analysis is not an exact science, it is useful to create support and resistance zones. This is contrary to the strategy mapped out for Lucent Technologies (LU), but it is sometimes the case. Each security has its own characteristics, and analysis should reflect the intricacies of the security. Sometimes, exact support and resistance levels are best, and, sometimes, zones work better. Generally, the tighter the range, the more exact the level. If the trading range spans less than 2 months and the price range is relatively tight, then more exact support and resistance levels are best suited. If a trading range spans many months and the price range is relatively large, then it is best to use support and resistance zones. These are only meant as general guidelines, and each trading range should be judged on its own merits.
Returning to the analysis of Halliburton (HAL), we can see that the November high of the trading range (33 to 44) extended more than 20% past the low, making the range quite large relative to the price. Because the September support break forms our first resistance level, we are ready to set up a resistance zone after the November high is formed, probably around early December. At this point though, we are still unsure if a large trading range will develop. The subsequent low in December, which was just higher than the October low, offers evidence that a trading range is forming, and we are ready to set the support zone. As long as the stock trades within the boundaries set by the support and resistance zone, we will consider the trading range to be valid. Support may be looked upon as an opportunity to buy, and resistance as an opportunity to sell.
What is a dividend?
A dividend is money that a company gives to its shareholders when it has extra profit. Since the shareholders own the company, they deserve its profits. However, sometimes companies want to use these profits to help grow their business and decide not to distribute dividends, at least for a while.
Daily Candlestick Chart for BRWC
[img]stockcharts.com/c-sc/sc?s=BRWC
Ascending Triangle: An Ascending Triangle is a price action formation signal based on continuation pattern theory.
Continuation patterns also include symmetrical triangles, descending triangles, wedges, flags, rectangles and pennants and are essentially technical patterns that are expected to lead to the continuation of an existing trend. Continuation patterns are considered a powerful trading tool as they usually result in extremely low risk trading opportunities and spectacular returns.
An ascending triangle demonstrated within a chart pattern is recognized as having a bullish position and occurs as a result of price highs and price lows that have begun to converge so that they, in effect, form a point. If a line is drawn above and below the pattern the top line will appear straight whilst the bottom will slope upwards at an angle.
Ascending triangles are considered to be at their most reliable when occurring during an uptrend, and a buy order should be placed on a break above the upper resistance area of the triangle. If however, the pattern is proved to be false, or if the ascending triangle pattern should fail, then it is advisable to sell when the market breaks out and below the triangle.
$GFSZF BarChart Trader's Cheat Sheet
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Daily Candlestick Chart for NFDS
[img]stockcharts.com/c-sc/sc?s=NFDS
Internal Trend Lines
Sometimes there appears to be the possibility for drawing a trend line, but the exact points do not match up cleanly. The highs or lows might be out of whack, the angle might be too steep or the points might be too close together. If one or two points could be ignored, then a fitted trend line could be formed. With the volatility present in the market, prices can over-react, and produce spikes that distort the highs and lows. One method for dealing with over-reactions is to draw internal trend lines. Even though an internal trend line ignores price spikes, the ignoring should be within reason.
The long-term trend line for the S
ADX: The average directional index, or ADX, was developed by J. Welles Wilder as a measure of a current market trend's strength. The ADX is derived from two directional indicators, known as DI and DI-, which are in turn derived from the directional movement index (DMI).
ADX is calculated by finding the difference of DI and DI-, as well as the sum of DI and DI-. The difference is divided by the sum, and the resulting number multiplied by 100. The product is known as the directional index, or DX. A moving average is then taken of DX, typically over a fourteen-day period (although any number of periods can be used.) This final moving average is the ADX.
The ADX takes the form of a number from 0 to 100. A value of 0 indicates that the market is equally likely to move in either a positive or negative direction, meaning that there is no overall market trend. A value of 100 indicates that the market is exclusively moving in either a positive or negative direction, indicating an extremely strong trend. Values of greater than 60 are uncommon in practice, and any value of greater than 40 is considered to be a strong trend. Any value less than 20 is considered to be a weak trend, and may signal an upcoming reversal. Because the ADX is derived from both positive and negative directional indicators, it only measures the magnitude of a trend rather than its direction.
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