How to set technical analysis variables for long and short trades on short-term and long-term trades
Today, many investors and analysts use advanced graphical and technical analysis as well as indicators to monitor their investments. However, before starting venturing into this nontrivial world, it is worth going back to the basics. Prices go up if there are more buyers than sellers, and they go down when sellers exceed buyers. Technically speaking, when we have a consistent demand curve exceeding supply, prices move up, forming an up-trend line; therefore, indicating higher future prices. When supply exceeds demand, we get a downward trend line, reflecting future lower prices as illustrated in the following figure 1 and 2, respectively.
Figure 1: Up-trend Figure 2: Down-trend
In sum, technical analysis may be used as a trading tool to forecast future trends and prices, while focusing on patterns within stock charts to forecast future pricing and volume trends.
Followers of technical analysis typically believe that charts reflect all the information that is publicly known about a particular security.
Hence, repeated future chart patterns emerge.
The following image shows some of the main patterns, allowing for opportunity trades buy/sell.
Usually, Long-term traders give greater emphasis to fundamentals, and short-term traders to technicals. However, the type of analysis one chooses depends on the overall trading strategy. But make no mistake about it, both forms of analysis are important for successful trading, and ignoring either potentially overlooks valuable information because the intended duration of an investment trade may change; hence, employing both forms of analysis might be the best approach, especially on long-term trading.
Technical factors may dictate the ideal entry or exit price. Setting up technical analysis variables for trading opportunities may become very complex because there are many variables in technical trading that one must grasp. However, most of the professional traders keep it simple, focusing on five main variables: Trend (slope up/down), Volume, Momentum, MACD, and Scholastic/RSI to predict future trade range movement.
Trend: the general direction of a market or an asset’s price. In technical analysis, trends are identified by trend lines price action that highlight when the price is making higher swing highs and higher swing lows for an uptrend (figure 1), or lower swing lows and lower swing highs for a downtrend (figure 2).
Volume: an important technical analysis tool to learn and understand how to apply to price movements. Volume increases every time a buyer and seller transact their security. Volume has two major premises: When prices rise or fall, an increase
in volume acts as confirmation that the rise or fall in price is real and that the price movement had strength. When prices rise or fall and there is a decrease in volume, then this might be interpreted as being a weak price move, because the price move had very little strength and interest from traders. The chart below of Gold futures shows a strong trend being confirmed by a strong increase in volume:
Momentum: In technical analysis, momentum is considered an oscillator and is used to help identify trend lines.
MACD: Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the number of periods of the Exponential Moving Average (EMA) from the number of periods of the EMA(exponential moving average).
Scholastic/RSI: Both the relative strength index (RSI) and stochastic oscillator are price momentum oscillators that are used to forecast market trends. Despite their similar objectives, they have very different underlying theories and methods. The stochastic oscillator is predicated on the assumption that closing prices should close near the same direction as the current trend. The RSI tracks overbought and oversold levels by measuring the velocity of price movements. More analysts use the RSI over the stochastic oscillator, but both are well-known and reputable technical indicators.
The first thing we must do before setting the indicator variables is to select the type of graph. There is Line, Bar, Candlestick, Renko, and Point and Figure charts. The most recommended chart is the Candlestick chart, which contains open, high, low and close values for each time period you want to display. The hollow or filled portion of the candlestick is called “the body”. The long thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” and “tails”). The high is marked by the top of the upper shadow and the low
by the bottom of the lower shadow. If the stock closes higher than its opening price, a hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price as shown in figure 5.
Finally, we are ready to set up and indentify trading opportunities as the following figure 6 illustrates. After selecting the candlestick chart type, the next variables to select are Momentum, MACD, and Scholastic/RSI. Setting the time period on these variables depend on the trading strategy: very short-term (day trading), Short-term (1-month to 1-week), Long term (<12 months or >1year). Let’s assume we want to trade Short-term the currency pair EUR/USD. We would set Momentum at 14 days periods, MACD (26,12), which is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. Finally, we set Scholastic/RSI (14), day period.
For day trading in all other securities rather than Forex, I would suggest to keep Scholastic/RSI (14), which means closing price data from the past 14 periods (15m, 30m, 1h, 4h, etc) will be used to calculate RSI. For Momentum and in Forex most traders set it for 40 periods.
Having all of the technical indicators set-up, in figure 6 candlestick bar chart indicates a neutral slope in the moving averages prices during the four periods to a slightly negative slope (adding all the high/low prices for the four periods). This means the EUR/USD is fairly priced for the period, which does not mean, there is not an opportunity trade. In fact, the Bollinger band indicates an opportunity trade for the last period, ranging from 217.5 to 107.5 EUR/USD. Further, in the fourth starting period, we notice there is a strong positive slope, meaning future higher prices, which is confirmed by a Cup and Tea formation. Is this the right time to buy or selling for profit taking?
In this example, EUR/USD Momentum is close to 0.01. If the price crosses above the 0 line, the price is starting to gain momentum. A drop below the 0 line shows the price is losing momentum. This is a contrary indicator, meaning we should sell it when the momentum is equal or above 0.01, and buy it below -0.01.
In the MACD graph if price is making a high while the MACD line is declining (called “negative divergence” or “bearish divergence”), this could indicate that price could fall. If price is making a new low while the MACD line is increasing (called “positive divergence” or “bullish divergence”), this could indicate that price could rise. Therefore, in this example, we should buy it below -0.004 and sell it above 0.004 or for less risk taker traders above 0.002.
Finally, the Scholastic/RSI is one of the most important parameters as a technical analysis tool to trigger a buy/sell signal.
Rule of thumb for a Day Trading with the RSI Long Day Trade when the 14-period RSI is below 30 means it is oversold. For Short Day Trade 14-period when RSI is above 70 is overbought. In this example the Scholastic/RSI is at 100, indicating an extreme over-bought condition, suggesting is time to take profits or placing a Short position. In order to increase the probability of a successful trade all these indicators: Trend (slope up/down), Volume, Momentum, MACD, and Scholastic/RSI must be correlated. However, the way you may set such parameters should be adjusted to each trader risk tolerance or style of trading, while keeping in mind technical analysis is a much more powerful toll for a successful trade when used in connection with fundamental analysis.
Until next article, wishing all of you successful and wealthy trading!
Data and information is provided for informational purposes only, and is not intended for trading purposes. Neither the writer nor its data providers shall be liable for any errors or delays in the content, or for any actions taken in reliance thereon.