1 0 Tag Archives: Market trend
post icon

Technical analysis of stock trends

If you have ever indulged in any form of stock trading, you would definitely have taken a look at a price chart at some point in time to study price movements. For many investors and analysts, a stock price chart is the starting point for carrying out an analysis and even people who do not believe in technical analysis use charts from time to time. Charts can provide a lot of information in a very short space of time.

For instance, if you are looking at long-term investment, you can take a quick look at a price chart of say five years and determine at a single glance how investors have been rewarded. If you see a lot of upward and downward price movements, obviously the stock is much more volatile than a stock where the movement is relatively even. However, if you know how to read a chart properly, that is a lot more information you can gather and then these simple self-evident facts.

It is important to remember that charts can generate two types of trading information that can be used to forecast future price movements. A continuation pattern suggests that the trend being studied will continue while a reversal pattern suggests that the direction of the trend is about to reverse. Charging does not pretend to be an exact science [except to its most ardent proponents] and the use of patterns and their identification can be a difficult process which involves subjective judgment.

A fundamental principle of technical analysis is that a market’s price reflects all relevant information, so their analysis looks at the history of a security’s trading pattern rather than external drivers such as economic, fundamental and news events. Price action also tends to repeat itself because investors collectively tend toward patterned behavior – hence technicians’ focus on identifiable trends and conditions

While fundamental analysts examine earnings, dividends, new products, research and the like, technical analysts examine what investors fear or think about those developments and whether or not investors have the wherewithal to back up their opinions; these two concepts are called psych (psychology) and supply/demand. Technicians employ many techniques, one of which is the use of charts. Using charts, technical analysts seek to identify price patterns and market trends in financial markets and attempt to exploit those patterns. Technicians use various methods and tools, the study of price charts is but one. Technicians using charts search for archetypal price chart patterns, such as the well-known head and shoulders or double top/bottom reversal patterns, study technical indicators, moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants, balance days and cup and handle patterns. Technical analysts also widely use market indicators of many sorts, some of which are mathematical transformations of price, often including up and down volume, advance/decline data and other inputs. These indicators are used to help assess whether an asset is trending, and if it is, the probability of its direction and of continuation. Technicians also look for relationships between price/volume indices and market indicators. Examples include the relative strength index, and MACD. Other avenues of study include correlations between changes in options (implied volatility) and put/call ratios with price. Also important are sentiment indicators such as Put/Call ratios, bull/bear ratios, short interest, Implied Volatility, etc.
There are many techniques in technical analysis. Adherents of different techniques (for example, candlestick charting, Dow Theory, and Elliott wave theory) may ignore the other approaches, yet many traders combine elements from more than one technique. Some technical analysts use subjective judgment to decide which pattern(s) a particular instrument reflects at a given time and what the interpretation of that pattern should be. Others employ a strictly mechanical or systematic approach to pattern identification and interpretation.
Technical analysis is frequently contrasted with fundamental analysis, the study of economic factors that influence the way investors price financial markets. Technical analysis holds that prices already reflect all such trends before investors are aware of them. Uncovering those trends is what technical indicators are designed to do, imperfect as they may be. Fundamental indicators are subject to the same limitations, naturally. Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.

Characteristics of technical analysis

Technical analysis employs models and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, business cycles, stock market cycles or, classically, through recognition of chart patterns.
Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the facts of the company, market, currency or commodity. Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team.
Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. In the 1960s and 1970s it was widely dismissed by academics. In a recent review, Irwin and Park reported that 56 of 95 modern studies found that it produces positive results but noted that many of the positive results were rendered dubious by issues such as data snooping, so that the evidence in support of technical analysis was inconclusive; it is still considered by many academics to be pseudoscience. Academics such as Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of the efficient-market hypothesis. Users hold that even if technical analysis cannot predict the future, it helps to identify trading opportunities.
In the foreign exchange markets, its use may be more widespread than fundamental analysis. This does not mean technical analysis is more applicable to foreign markets, but that technical analysis is more recognized as to its efficacy there than elsewhere. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987, most academic work has focused on the nature of the anomalous position of the foreign exchange market. It is speculated that this anomaly is due to central bank intervention, which obviously technical analysis is not designed to predict. Recent research suggests that combining various trading signals into a Combined Signal Approach may be able to increase profitability and reduce dependence on any single rule.

Go to the article »
02. Feb, 2012
post icon

Daytrading Stocks During a Bear Market

The US stock market appears to have entered a new bear market since its high at the end of April. While Wall Street generally defines a bear market as a 20% decline, the average bear market drops quite a bit more. As of this writing, the market has declined over 14% from its April high.

Daytrading stocks during market declines can prove to be quite the challenge for day traders no matter how much experience they have. This is due to the fact that market volatility has a tendency to increase during most market declines, whether they are short term corrections or the typical bear market. This increase in volatility can wipe out the trading capital of even the experienced trader if they do not adjust their trading.

Generally speaking, after large run-ups in stock prices, or in any market, there will be violent pull-backs. While this increase in volatility can produce some big directional moves, there may be sizable intraday swings that can catch a trader off guard.

With this in mind, how does a daytrader prepare for these changing conditions? Well, most daytraders are not in the business of forecasting market direction, but it can be very helpful to pay attention to some technical and psychological indicators that may provide a clue regarding market direction. Those indicators include price and volume, the TRIN, New 52 week highs and lows, the advance/decline line, the number of bullish vs. bearish investors, etc. A more detailed discussion regarding these indicators is more suitable for another article.

When a day trader becomes aware that the market character has changed to a bearish tone, then it is time to adjust their thinking when it comes to managing trades. First of all, due to the usual increase in market volatility, the trader should scale back position size. While it may have been reasonable to trade 1,000 shares in a stock during a bull move, 500 shares might be more reasonable in a bear move. The novice day trader will think they are losing out on a sizable profit opportunity by trading smaller during these major down moves. The experienced trader realizes that it is more important to preserve capital for time periods when the market is more predictable and less volatile.

One other issue facing daytraders during these bear markets is that the market has a tendency to have sharp intraday reversals, and there tends to be more sizable opening gaps. As some day traders actually do carry positions over night, it is a good idea to carry smaller positions over night due to the greater risk of a market reversal.

The day trader should also be aware that the overall long term market tendency is for stocks to trade higher each day. As such, even while the market is in a downtrend, quite a few trading days will close to the upside. During the current down move, nearly 40% of the trading days have closed to the upside. If a daytrader can recognize that even bear markets will pause for a breather, they will recognize significant opportunities to profit after these brief pauses when the market resumes its downtrend.

Day traders should also consider trading other vehicles besides individual stocks during bear markets. This is due to the fact that it costs the trader extra to short a stock, since they must first borrow the shares from their broker, and pay interest on those shares, in order to sell the stock short. Therefore, day traders should consider trading stock index futures, or ETFs that rise when the market falls. It is important that traders consider the cost of their trades, not just whether they make a profit or loss.

While it is definitely possible to trade profitably during bear markets, there are significant pitfalls. For many novice day traders, it may just be a good idea to sit on the sidelines and observe the market action so that they are prepared for the next bear market downturn when it comes along.

Go to the article »
04. Jun, 2011