Practical Technical Analysis (2006) Chapter 7
Chapter 7 - Trending and Ranging Market
Psychology of Trend
"When a stock moves up, are there more buyers than sellers?"
- When bulls feel optimistic, they don't mind paying extra.
- Bears feel tense in an uptrend, they agree to sell at only a higher price.
- The stronger the feeling, the sharper the rally.
- Rally ends only when many bulls lose their enthusiasm.
- Bullish uptrend
- Each rally reaches a higher high than preceding rally and each decline stops at a higher level than the preceding decline.
- Successive higher highs, higher lows.
- When price slides, bears feel optimistic. Sell short at lower prices.
- Bulls are fearful and agree to buy only at discount.
- Bears feel like winners, they continue to sell at lower prices.
- Downtrend ends when bearss start feeling cautious and refuse to sell at lower prices.
- Bearish downtrend
- Each successive rally fails to penetrate the high point of the previous rally. Each decline terminates at a lower point than the preceding decline.
- Successive lower highs and lower lows.
- Bulls and bears are equally strong or weak.
- When bulls manage to push prices up, bears sell short into the rally.
- Bargain hunters step in and break the decline.
- Bears cover short, their buying fuel minor rally.
- Cycle repeats until either side (bull or bear) decide to take charge.
- Ranging market
- Prices go nowhere.
- Markets spend more time in trading range than trends because aimlessness is more common among people than purposeful action.
How to identify trend and range
- No single magic method
- Identify trends and trading ranges is one of the hardest tasks in technical analysis.
- Confluence of many methods
- If they confirm, go for it.
- If they contradict, pass it.
Checklists for Trending or Ranging Market
|1.||Patterns||Highs and lows and irregularities|
|2.||Trend lines||Trend line connecting recent highs and lows. Slope of last trend line identifies current trend|
|3.||Moving averages||Exponential moving averages e.g. 20, 100, 200 periods|
|4.||Indicators||Suitable for trending markets|
|5.||Double screen||Refer to higher timeframe|
Following a strong trend, the trend may reverse or change to a range.
How about these patterns? Are they trend change signals?
- Identify trends and trading ranges is one of the hardest tasks in TA.
- Trends and trading ranges clearly stand out on old charts.
- The past is fixed and easy to analyse.
- Future is fluid and uncertain.
- Shout when it is a trend market.
- Probably it is the middle or end of a trend.
- Nobody rings a bell when a trend dissolves into a trading range.
- Different tactics when trading in trends and in trading ranges.
- Trending market: many hearts needed. When you go long on uptrend or sell short on downtrend, buckle your seat belt and hang on as the trend continues.
- Ranging market: Nimble. Buy low sell high.
Trade or Wait?
Trending up → the market is so high, it is about to fall?
Trending down → the market will fall some more, let's wait?
Ranging market → let's wait for breakout of this range, buy upon breakout, but is it a false breakout?
- Money management
- How much are you willing to lose?
- Therefore determine your stop loss.
- Wider stop loss in a trending market.
- Emotional control
- Stick to your rules.
- Start with a few stocks that you know.
- If unsure, pass. The market is always there for you.
Can oscillators help?
- Indicators can contradict one another; some work best in trending markets, some in ranging markets.
- Beginners will
- Start off with indicators - that's the easiest.
- Have only one indicator.
- Or often have too many indicators.
- 3 main types of indicators
- Trend following: moving averages, MACD, OBV, A/D etc.
- Oscillators (help identify turning points): Stochastic, RSI, Momentum etc.
- Miscellaneous indicators