Financial Markets & Financial Software The Skill-Builder for Financial Trading - Financial Training Software.
Market Variables : Direction, Momentum, Volatility, Liquidity
During any given time-frame a market can do one of three things : go up, go down, move sideways. Persistent moves in the same direction are generally referred-to as "Trends".
Up and down-moves can be fast ("impulsive") or slow ("corrective" or "drifting") in nature (or in between).
Note: The most important aspect of "Momentum" is not any absolute measurement of its value, but whether it is constant or changing. the key questions (to be answered from direct observation of the price-charts) are:
- Is the current price-move speeding up (in which case you want to stay with / get into it) or slowing down (in which case, consider taking a position against it)
- Is the current price-move faster or slower than the immediately preceding move in the opposite direction (expect the on-going trend to be in the direction of the faster of the two).
Can be low, with almost no price-swings away from and back to the underlying trend; high, with wide and erratic price-swings in both directions, or anywhere in between. Changes in volatility often signal changes in trend, often either in the form of either:
- A sharp move against the direction of the current trend, or
- a reduction in activity and size of short-term price-swings.
Can be high, with thousands of transactions being carried out on a continuous basis; or low, with only intermittent price-quote updates and transactions. In general terms technical-trading is best suited to highly liquid markets because effective transaction-costs (bid-offer spreads and commissions) are lower, and large orders can be placed without adversely affecting the market.
All of these variables are directly dependant on the actions taken (or not taken) by the participants in the market : Technical Analysis is simply the observation of those actions, as shown on price-charts.
As stated above, technical trading is predicated on the proposition that the action of the market, which is the reflection of the sum of the actions of all participants, provides clues as to the most likely future evolution of prices. The clues are, however, frequently misleading (or mis-interpreted). This leads to the necessity for any successful trading strategy to provide in advance for the "avoiding action" to be taken to minimise the damage caused by bad positions.
Technical traders/investors take important decisions (risk their own and other people's capital) on the basis of very flimsy evidence: the direction prices are moving and the type of price-action. Successful trading is based on the following basic observations:
- The current trend (up, down or flat) is more likely to persist than reverse.
- The trend will be interrupted by corrections (counter-trend price-moves).
- An accelerating price-move is likely to continue, a decelerating move is likely to reverse.
- The direction of the next significant price-swing will probably be in the same direction as the stronger of the last two.
- Minor supports / resistances to the current trend are more likely to break than hold.
- Major supports / resistances are more likely to turn the market back than break.
- Trend reversals are usually signalled by a clearly observable change in volatility (either a sharp break against the trend or its continuation at reduced momentum).
- Long-Term charts are reviewed only in order to observe major support and resistance levels.
- Medium-term charts are reviewed in order to determine both the trend and intermediate support / resistance-levels.
- Short-term charts are reviewed in order to evaluate current (and observe changes in) volatility and momentum.
Before amplifying the above statements and defining the terms used in detail, the following key points must be emphasised:
- An "Investor" attempts to profit from major market swings which last many weeks / months (or even years). In monitoring his investments, and the general population of other investments into which he might switch, he should review monthly ("long-term"), weekly ("medium-term") and daily ("short-term") charts.
- A "Position-Trader" attempts to profit from major market swings which last several days or weeks. In monitoring their trades, they also generally review monthly ("long-term"), weeky ("medium-term") and daily ("short-term") charts every day and with greater emphasis on the daily charts.
- An "Intra-day Trader" attempts to profit from major market swings which last from minutes to hours, and always closes his positions overnight (or hands them on to a colleague in the next time-zone). In monitoring his trades, he should review hourly ("long-term"), 5-minute ("medium-term") and 1-minute ("short-term") charts.
That said, since price-charts are fractal in nature (ie self-similar irrespective of the time-frame being observed), there is absolutely no difference in the methods of analysis and decision-making to be applied. It is absolutely critical to success that which of these activities is being pursued is clearly understood and the appropriate actions consistently taken. Disaster frequently overtakes those who fail to take this simple but critical decision. The cynical definition of a "Long-Term Investment" is "A trade gone sour" ! (as when a trader buys a stock at 100, watches it go to 80, and then says "That's OK, it's a .........")
Next, Trends, Highs & Lows.
Financial Markets & Financial Software. The Skill-Builder for Financial Trading - Financial Training Software.