Technical analysis has added a new level of understanding to my trading.
However, my frustration with many introductory books and webinars is that the chart examples shown are always picture-perfect examples indicating what the author/presenter would have done given the information we now know about the subsequent price movement. Of course the chart would make a lot of sense at that point. However, never discount the fact that in live trading, pattern formations or price breakouts do not always develop in such a straight-forward manner.
When I first started technical analysis, I was given the advice to do a lot of back-testing on charts. I spent copious amounts of time back-testing - looking for rectangles, triangles, uptrends, downtrends, and Elliott Waves. To these charts, I added MACD, RSI, Stochastics, Fibonacci, and moving averages. I even spent time analysing price movements of certain currency pairs immediately following a news announcement. Whilst back-testing provides good practice on spotting chart patterns, it is also important to forward-test.
In real-time trading, with so many emotions at play and prices bouncing back and forth as if they're on a trampoline, future price movement is not always going to end up looking like the charts that you've back-tested.
This is why I started a trading journal to keep track of my real-time trades. My trading journal helps me to not only look at past price action, but focus on how I feel price will move in the near future. I always take a screenshot of the chart on a trade I'm about to do and jot down notes on why I'm doing the trade, as well as the entry, limit, and stop levels. After the trade is over, I do a trade review and write down any new trading insights gained from the trade.
Lately, I have started integrating different technical approaches for different markets.
The more I trade forex, the more I realise that the previous five or six candles are actually the most important ones to base your trade on. These candles provide an indication of current trader sentiment. In a highly volatile market like forex, current trader sentiment matters more than anything else. How traders are positioning themselves in the short term is usually reflected on these five or six candles. On forex trades, I like to use these candles as indicators of where I should put my stop. I try my best to look for trades where I can place stops of less than 30 pips, although this is not always feasible. By doing this, I am able to capitalise on quick momentum moves. If momentum stalls, the loss is much easier to recover.
When I first started trading, I always felt that using such a small stop ends up working against you. However, now that I've have some market experience, I realise that this is part of being a selective and discerning trader. There are definitely trade setups that enable you to trade on a 30 pip stop. Do not be afraid of using a small stop because keeping your stops tight will enable you to survive in this market. Do be cautious if you're trading on a variable spread platform, though. If the spreads are wide, you need to be very, very cautious.
On equities, I prefer to look at fundamentals such as P/E ratio, EPS, book value per share, and dividend yield. I basically use the Warren Buffett/Carl Icahn method, which stipulates that if a stock is below its book value, then it's safe to buy - although I also own stocks that have negative EPS. These were purchased before I really started studying investment strategies in great detail. In this type of market, it would be smarter to buy the bonds of companies with negative EPS if they have a good asset base rather than hold their stocks. With a bond, at least you have a stronger claim on the underlying assets of the company.
Lately, I have also started adding technical analysis to my 'active cash' stock trading. Active cash is the part of my portfolio that I try to actively trade by implementing profit-taking with marginal ROI, which enables me to grow this cash yet keep some liquidity. In 2006, I made a good double digit return by implementing this strategy. However, in 2007, the cash became inactive due to unrealised losses. I had to consider these positions as part of my longer term portfolio at that point.
Nonetheless, I have been trading my active cash strategy once again as I've discovered a key success factor to this strategy. Timing is critical if you're implementing a strategy that is similar to active cash, which is what many hedge fund managers are using.
To get timing more accurate, I like to look at the short-term DJIA chart first. If there are indications of DJIA momentum picking up, I know that it's potentially a good time to buy. If DJIA indications are bearish, I stay out of the market.
Looking at the DJIA chart is so important during this time. The buy low and sell high mentality is not prevailing at the moment. People will be looking to take smaller short term profits in favour of keeping liquidity. Hedge funds and mutual funds need to build up their capital levels again and I suspect that taking smaller short term profits day in and day out is how they're doing it. Once the Troubled Asset Relief Program bailout starts working through the system and more capital flows through the market again, we can possibly expect profit-taking to be more measured and dignified.
Disclaimer: Do your own homework. Do not in any way take this to be investment advice. You are responsible for your own portfolio.
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