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Unformatted text preview: DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 Sponsored by:   7 Tips to Charting Trends Day Trading By Dr Michael Green PAGE 1 DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 Disclaimer Day Trading: 7 Tips to Charting Trends Dr Michael Green gained a BSc and PhD in Mining Engineering from Nottingham University. He began working in the London in the 1980s as a Resources Analyst with Buckmaster & Moore and then Greenwell Montagu Securities. Subsequently, he became Head of Research at Everett Financial which focused on the small cap market. Since 2006, Michael has been an independent analyst specialising in growth companies and resources sectors. No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this publication can be accepted by the publisher, sponsor or author. The author may have a position in any or all of the specific investments or investment categories mentioned in this publication. MarketViews™ is a dianomi service and some of the companies or investments mentioned may be clients of dianomi. MarketViews is published by dianomi ltd, One America Square, Crosswall, London EC3N 2SG. MarketViews and dianomi are trademarks of dianomi ltd. © dianomi 2016. All rights reserved. Email us: [email protected] Website: Twitter: Contents This report is sponsored by: Seven tips to charting trends ......................... Page 3 Where and when to use .................................. Page 7 Capital management ..................................... Page 7 Glossary of terminology................................. Page 7 Guardian Stockbrokers 14 City Road, London, EC1Y 2AA T. 020 7638 6996 F. 020 7638 6997 E. [email protected] PAGE 2 DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 Charting trends and the whole science of technical analysis can trace its origins back a couple of centuries. These are proven techniques which forecast future share price movements based on investigating past price performance. For day traders it is all about gaining an edge. Technical analysis as well as the other main school of thought in the financial world, fundamental analysis can provide this. Fundamental analysis requires the detailed analysing of complex economic factors including: company financial statements (balance sheet, cash flow statement and income statement), business prospects, competitors and markets to determine what a company was worth. Charts are much easier to read than taking in the whole host of data required for fundamental analysis. It does seem that charting trends offers day traders a short cut to successful trading. History tends to repeat itself and technical analysis relies on examining the behaviour of the stock market to determine the future trend in share prices. The stock chart is the most important tool for technical analysts. The share price is the point at which buyers and sellers meet and is determined by the forces of supply and demand. With the stock chart providing a detailed look of where buyers and sellers have met over weeks, months and years. For traders seeking to make money by predicting future share price performance, stock charts essentially act as the rear view mirror giving a clear view of what has happened in the past. For day trading based on charting trends it is important to set a price target and ensure that the risk-reward ratio is strongly in your favour. This is achieved by filtering out plays where there is insufficient upside potential. Traders do need to be well-disciplined and patient to wait for good opportunities to arise. Trades should be executed in a calm and methodically manner. This is in an effort to override itchy fingers and the natural desire to push the button and enter a trade right away, which may lead to entering the market late. There is also the age old problem of chasing the market, which is entering the market ahead of an expected movement. Coming into a trade too late or too early are both proven ways to lose money. Below we provide seven tips for successfully charting trends. Tip 1 – Seeking support At the heart of technical analysis lies the concept that important levels in the past for a stock price will be important levels once again in the future. There are levels which offer support and resistance to the share price. Once a support or resistance levels is broken, the share price seems to move further in the same direction with renewed vigour. This is a breakout and this renewed vigour comes from the movement being spotted by the crowd, who then rush to open buy and sell positions. Support and resistance levels are all about supply and demand, as if demand weakens the share price falls back. The support level is where the buying pressure is strong enough to stop the share price falling any more. Whereas at the resistance level, selling pressure is strong enough to stop the share price climbing higher. Once the share price breaks through a resistance level, it Support and resistance lines Royal Mail - 6 month chart, daily prices PAGE 3 DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 then serves to become the new support level. The strength of resistance and support levels depends on how long they have been in place and also the volume of shares traded at any level. A breakout happens when the share price moves beyond a support or resistance level. An upside breakout is seen to be a bullish sign, with the support level sufficient to keep the share price from going any lower. Pullbacks occur when the price breaks down through a support level which then becomes a resistance level and the price may rebound off this level to continue falling. Moving averages Tesco - 1 year chart, daily prices, 20 day and 50 day moving averages Tip 2 – Trend is your friend Tip 3 – Watching the volume Tip 4 – Moving averages Like many old City sayings “the trend is your friend” really does ring true as more success is enjoyed by taking positions in the direction of the prevailing trend rather than betting against it. The range varies on requirements, but day traders can actually establish the trend on stocks to a within just a few minutes, whereas the long term investors probably look for trends that have been going on for years. Volume measures the level of participation by the crowd and can act to confirm trends and chart patterns. It is classified in two ways. Firstly, stocks are tagged as being under accumulation when more shares are being bought than sold. Secondly, stocks are said to be under distribution when shares are being sold more heavily than bought. Probably the most widely used technical indicators are moving averages. Such analysis gives a better view of the performance of a share price over a longer period of time. The most popular moving averages used are 20 day, 50 day and 200 day. Plotting moving averages on the same chart as the share price reveals how the present performance compares to the past. The moving average lags the share price with, for example, the daily point on the chart for the 50 day moving average quite simply is the sum of the closing price for the last 50 days divided by 50. There are three types of trends – up, down or range bound, where the price basically moves sideways swinging back and forth between a lower and upper limit for sustained period. All these three trends tend to continue over time. An uptrend is a positive slope defined when a share price makes successive higher highs and higher lows which indicates that net demand is increasing even as the price rises. A break in the uptrend line reveals that net demand has fallen heralds a change in trend. Both accumulation and distribution can result in a movement in a share price. Shares under accumulation will often go up a while after the buying has started. The converse is true, that share under distribution often fall a while after the selling has started. Share price rallies need the support of the crowd and watching the volume can help traders visualise this facet of behaviour. PAGE 4 Moving averages are used to highlight buying and selling opportunities. A buying opportunity is triggered if the shorter moving average is climbing and crosses the longer average. The signal for a selling opportunity is registered when the shorter moving average is heading downwards and crosses the long term average. Some of the simplest techniques are the DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 These patterns have been seen over many decades and are deemed to be either bullish or bearish. The best known patterns are: head and shoulders, flags, double tops, double bottoms and triangles. Tip 7 – Candlesticks Relative strength indicator (RSI) ARM Holdings - 3 year chart, weekly prices, RSI best and technical analysis involving moving averages can be quite persuasive. Tip 5 – Relative strength Another well-used technical indicator is the relative strength index (RSI) which is a momentum indicator. It shows when the market in a stock is overbought or oversold and thereby highlights the possibility of a reversal of a trend. RSI compares the upward and downward momentum in the closing prices of a stock. The RSI is calculated by adding up the number of points gained on up days and dividing that number by the sum of all points gained and lost over typically a 14-day period. Essentially it is a percentage scale that runs from 0 to 100. Anything above 70 demonstrates that a stock is overbought where the price has probably been climbing too fast and a turn round is due to take place. If the RSI is below 30, that shows the stock is oversold as the share price has fallen too far too fast and is due to move higher, which is seen as a buy signal. This is another important tool, used by technical traders to filter out opportunities and increase the probability of success of a trade. Tip 6 – Historical patterns One of the oldest forms of technical analysis involves the analysis of patterns in stock charts. It harks back to the work of Charles Dow an American reporter who co-founded Dow Jones & Company in 1882 and seven year later founded “The Wall Street Journal”. Pattern analysis is based on the precept that share prices can behaviour in a number of ways with history repeating itself which some have put down to the psychology of crowds and herd instinct. By spotting a classic pattern, traders might have an insight into the direction of the future share price. PAGE 5 A candlestick chart shows an easy to grasp picture of the action going on in the share price. The technique dates back to a legendary rice trader in old Japan. The candlestick shows the opening, high, low and closing prices for each time period required. This technique is really identifying the simple relationship between the opening and closing price. If the candle is hollow (candle outline not shaded in) then the close price was higher than the opening price which demonstrates buying pressure. If the candle is filled (shaded in) then the closing price is lower than the opening price revealing selling pressure. Using these Japanese candlestick signals in combination with western technical analysis has been demonstrated to increase the probability of success, because candlesticks can be an excellent timing tool. Many traders have candlestick charts on their screens because they look nice but do not know how to use them. This is a shame as price movements alongside investor psychology that is built into candlestick signals are really good indicators of a change in investor sentiment. There are only about a dozen major candlestick patterns that need to be followed. So just like head and shoulders and double bottoms, traders ought to get to know candlestick formations like the Gravestone Doji and the Dark Cloud Cover. DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 Where and when to use Technical analysis is a vital resource but it has got to be used in the right situations. The best stocks for day trading are the larger stocks that make up the FTSE 350 index or big US stocks as they all have good trading volumes. This is necessary because traders will need to be able to buy, sell and get out when they need to, rather than when the market allows. So any of those illiquid shares with wide bidoffer spreads are best avoided. There are important catalysts like news flow and quarterly results for share price action which need to be watched. One particular area that is worthy of some attention is seeking out stocks with good earnings momentum, where a company is exhibiting accelerated growth in earnings. Companies with earnings momentum are not that hard to spot and include stocks with four successive quarters of growth in earnings per shares and where the earnings multiplier is consistently rising. stock market indices, commodities and foreign exchange. These represent highly attractive markets due to the volumes of trading which serves to reduce spreads and dealing costs. It has to be pointed out that technical analysis and charting trends seem to work best in moderately volatile markets. The traditional charting methods are less reliable during periods when the market is in a welldefined trend or in times of hypervolatility. If the market is enjoying a strong upward run, then resistance levels will be continuously broken and there will not be enough time for new resistance levels to be formed. As for hyper-volatility, situations like the 2008 financial crisis which saw chart-based day traders suffer alongside fundamental investors in the stock market rout. This might be worth bearing in mind with the Brexit referendum vote and its aftermath which has the capacity to create big volatility. A good guide to the level of volatility is the Vix Index or the fear index as it has been tagged. If the Vix is over 20, share prices are unlikely to hold technical levels. resistance levels can be useful guides of where to position the stop-loss as can be moving averages. Only day trade with money that you really can afford to lose. Its best to put the trading funds in a separate account and for safety sake this figure should not exceed 20% of your capital. It is easy to get carried away but the amount risked on each trade is ideally limited to 10% of the trading capital. If you load up on a one situation you might not be able to take advantage of better opportunities that might arise. Glossary of terminology Bear – A term given to an investor that seeks to make gains from a decline in a share price or a stock market over a period of time. Bull – An investor is referred to as a bull, if that person seeks to make gains from an increase in a share price or a stock market over a period of time. A good place to look for earnings momentum stocks are in sectors with high cost base like pharmaceuticals and some of the big tech stocks like Facebook and Amazon. This is because growth in sales can result in a big growth in earnings. Professional traders using analysis based on charting trends have reportedly seen good performance from trading in these earnings momentum stocks as such companies’ share prices have been moving upwards strongly in a series of successive higher trading ranges. Technical analysis is a powerful set of tools that can be used not just for the individual company shares but also Earnings multiplier – Also called price Capital management earnings ratio (P/E ratio). Liquidity – The ability of a stock market to absorb buys and sells without there being a drastic change in the share price. One of the keys to successful day trading is good capital management. A disciplined approach to money management allows risk to be reduced. This is all about protecting the downside risk to ensure that loses made do not wipe out profits made on the successes. Most importantly, stop-loss positions should be used to limit risk and preferably put in place when the trade is opened. Support and PAGE 6 Spread – Bid-offer spread is the difference between the bid and offer prices of a share. Vix Index – VIX is the symbol for the CBOE Volatility Index which measure the volatility of S&P 500 options. It is essentially a fear index which illustrates the market’s expectation of stock market volatility over the next 30 days. 9 COMMODITY TIPS FOR 2016 | MAY 2016 9 COMMODITY TIPS FOR 2016 | MAY 2016 Sponsored Advertisement: DAY TRADING: 7 TIPS TO CHARTING TRENDS | JUNE 2016 Sponsored Advertisement: Sponsored Advertisement: Avoiding Mistakes with help from Guardian Avoiding Mistakes with help from Guardian Avoiding Mistakes with help from Guardian Guardian, via one to one meetings, will talk you through your trading Guardian, via one to one meetings, strategy, objectives and how to will talk you through your trading Guardian, via one to one meetings, manage your expectations. You will strategy, objectives to will talk you through and your how trading also benefit from useful information manage your expectations. You will strategy, objectives and how to online to help you make the most of also benefit useful information manage yourfrom expectations. 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