Another guest post from one of my trading challenge students…I don’t use these tools, but they do exist and many traders use them so it’s better to know what they are than not know!
For reference, these are the 5 best penny stock patterns I care about
Here’s the guest post from one of my students:
There are so many technical analysis tools out there and it is very easy to get overwhelmed. At least some of the tools are complex in their underlying math, but easy to use. When using technical analysis to control buying and selling bereft from fundamental analysis try to keep the time scale smaller. Holding on too long can open you up to something unexpected.
Simple Moving Average
The simple moving average (SMA) gives you the daily average of the last x number of days. Using the 20-day, 50-day, and 200-day time periods are common. That provides three different levels of time information. The SMAs are typically used to provide support and resistance areas, and the crosses are treated as signals to buy, sell, or cover as the case may be. There are variations on the moving averages, but the simple ones suffice for what most people need them for. They are also effective to confirm another signal. Most indicators can be used together to present stronger evidence. Just be aware that some indicators use similar information so they are likely to arrive at the same conclusions.
The MACD (Moving Average Convergence/Divergence) is an example of an indicator using similar data to the SMA, though with different calculations resulting from it. This indicator is pretty versatile and the lines can be used along with the bars. For the lines when the fast line crosses over the slow line it can be treated as an early signal. Waiting for the bars to confirm the trend might work as well, but a lot of gains could be left on the table. The bars flip when the lines cross, but looking at the line can give you an earlier confirmation. If the slope on the crossing line looks sharp, then that is a strong signal. The goal is always to get fast moving gains and move on if you are short-term trading. The cross of the bars from below the baseline to above can be fast moving because it might be a correction or the opening of a reversal.
Relative Strength Index
The Relative Strength Index (RSI) is tricky in its math. It compares gains to losses and then charts whichever is greater and the magnitude of that. So an RSI that is climbing up rapidly means that the stock’s gains are rapidly outpacing its losses on a daily bases for the time period chosen. The most common time period is 14-days. So 10 scattered days of 10% gains, with 4 scattered days of small 1% losses would mean a sharp rise in the RSI. RSI is measured on a scale of 0-100 and 30 and 70 are used as oversold and overbought lines respectively. Above 70 is overbought, and below 30 is oversold. A lot of people actually treat the lines are breakout indicators, which tends to work. Breaking into 70 can be a sign that the stock is starting an upward breakout. It can also indicate that a stock is overbought, which seems like divergent signals so it would be good to use another indicator in conjunction. The RSI seems better suited to judging the strength of a move. With a trend it can tell you if the trend is strong or weak. Weak trends can turn badly at any time. Strong trends generally throw off some signals before turning.
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The parabolic SAR is something popular in foreign exchange circles, but has great utility in stocks that have clear trends. Generally, stocks tend to flatten out more often than foreign exchange and during periods of little movement the parabolic SAR is a confusing nightmare. Going into what makes the parabolic SAR would be too dense and unnecessary. It amounts to a little dot below or above a candle. If the dot is below the candle that is an upward trend, and vice versa. The interesting thing about the parabolic SAR is that it treats trends like they are subject to time decay. While this is not absolutely true like in options, when a trend starts getting long in the tooth it will at least correct for a while even if is going to continue. So the parabolic SAR requires that the pace of gains grow, because if they stay the same or start gaining less per day then the trend is fizzling out. The same holds true for a decline. The daily decline has to intensify otherwise the trend could change. As soon as the dot flips to the upside close the corresponding position. It might not be time to flip to the other side, because the parabolic SAR is utterly useless when there is no trend.
Your Own Lines and Experience
Technical indicators are great, but not discount the usefulness of your own perception. This includes chart patterns and just hunches in general. If you see a pattern you have seen before then you might draw your own lines on the chart and see if the pattern will play out that way. Chart patterns that people study are the most common, but they do not cover everything. Sometimes a stock will have five peaks instead of a double peak. It is rare, but it can happen. Any veteran will tell you that after spending years staring at one stock they have an intuition about how a stock trades. In general, they might see more into certain movements than others. So sometimes indicators might not give you the strongest signal, but your experience tells you that something is up.
Do not discount your own experience. Technical analysis is trying to judge the future based on information from the past, and your experience counts as information from the past. It might not seem like a technical analysis tool, but it is important not to get stuck into the information that exists in books. The written information is good and usually accurate but over-reliance makes you ignore the unexpected or the little known. Not all stocks trade exactly the same so your experience with a specific stock might tell you more than cookie cutter signals from indicators.