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Alexander Elder - Trading For A Living | ||||
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free download links about online stock trading, forex, futures, stock investing, market, trading systems CHARTING Chartists study market action, trying to identify recurrent price patterns. Their goal is to profit from trading when patterns recur. Most chartists work with bar graphs showing high, low, and closing prices and volume. Some also watch opening prices and open interest. Point-and-figure chartists track only price changes and ignore time, volume, and open interest. Classical charting requires only a pencil and paper. It appeals to visually oriented people. Those who plot data by hand often develop a physical feel for prices. Computers speed charting at a cost of losing some of that feel. The biggest problem in charting is wishful thinking. Traders often convince themselves that a pattern is bullish or bearish depending on whether they want to buy or to sell. Early in this century Herman Rorschach, a Swiss psychiatrist, designed a test for exploring a person's mind. He dropped ink on 10 sheets of paper and folded each in half, creating a symmetrical inkblot. Most people who peer at these sheets describe what they see: parts of the anatomy, animals, buildings, and so on. In reality, there are only inkblots! Each person sees what's on his mind. Most traders use charts as a giant Rorschach test. They project their hopes, fears, and fantasies onto the charts. Brief History The first chartists in the United States appeared at the turn of the century. They included Charles Dow, the author of a famous stock market theory, and William Hamilton, who succeeded Dow as the editor of the Wall Street Journal. Dow's famous maxim was "The averages discount everything." He meant that changes in the Dow Jones Industrial and Rail Averages reflected all knowledge and hopes about the economy and the stock market. Dow never wrote a book, only the Wall Street Journal editorials. Hamilton took over the job after Dow died and struck a blow for charting when he wrote "The Turn of the Tide," an editorial following the 1929 crash. Hamilton laid out the principles of Dow theory in his book, The Stock Market Barometer. Robert Rhea, a newsletter publisher, brought the theory to its pinnacle in his 1932 book, The Dow Theory. The decade of the 1930s was the Golden Age of charting. Many innovators found themselves with time on their hands after the crash of 1929. Schabaker, Rhea, Elliott, Wyckoff, Gann, and others published their research during that decade. Their work went in two distinct directions. Some, such as Wyckoff and Schabaker, saw charts as a graphic record of supply and demand in the markets. Others, such as Elliott and Gann, searched for a perfect order in the markets—a fascinating but futile undertaking (see Section 6). In 1948, Edwards (who was a son-in-law of Schabaker) and Magee published Technical Analysis of Stock Trends. They popularized such concepts as triangles, rectangles, head-and-shoulders, and other chart formations, as well as support and resistance and trendlines. Other chartists have applied these concepts to commodities. Markets have changed a great deal since the days of Edwards and Magee. In the 1940s, daily volume of an active stock on the New York Stock Exchange was only several hundred shares, while in the 1990s it often exceeds a million. The balance of power in the stock market has shifted in favor of bulls. Early chartists wrote that stock market tops were sharp and fast, while bottoms took a long time to develop. That was true in their deflationary era, but the opposite has been true since the 1950s. Now bottoms tend to form quickly while tops tend to take longer. The Meaning of a Bar Chart Chart patterns reflect the tides of greed and fear among traders. This book focuses on daily charts, but you can apply many of its principles to other data. The rules for reading weekly, daily, hourly, or intraday charts are very similar. Each price is a momentary consensus of value of all market participants
The opening price of a daily or a weekly bar usually reflects the amateurs' opinion of value. They read morning papers, find out what happened the day before, and call their brokers with orders before going to work. Amateurs are especially active early in the day and early in the week. Traders who researched the relationship between opening and closing prices for several decades found that opening prices most often occur near the high or the low of the daily bars. Buying or selling by amateurs early in the day creates an emotional extreme from which prices recoil later in the day. In bull markets, prices often make their low for the week on Monday or Tuesday on profit taking by amateurs, then rally to a new high on Thursday or Friday. In bear markets, the high for the week is often set on Monday or Tuesday, with a new low toward the end of the week, on Thursday or Friday. The closing prices of daily and weekly bars tend to reflect the actions of professional traders. They watch the markets throughout the day, respond to changes, and become especially active near the close. Many of them take profits at that time to avoid carrying trades overnight. Professionals as a group usually trade against the amateurs. They tend to buy lower openings, sell short higher openings, and unwind their positions as the day goes on. Traders need to pay attention to the relationship between opening and closing prices. If prices closed higher than they opened, then market professionals were probably more bullish than amateurs. If prices closed lower than they opened, then market professionals were probably more bearish than amateurs. It pays to trade with the professionals and against the amateurs. The high of each bar represents the maximum power of bulls during that bar. Bulls make money when prices go up. Their buying pushes prices higher, and every uptick adds to their profits. Finally, bulls reach a point where they cannot lift prices — not even by one more tick. The high of a daily bar represents the maximum power of bulls during the day, and the high of a weekly bar marks the maximum power of bulls during the week; the high of a 5-minute bar reflects the maximum power of bulls during that 5-minute period. The highest point of a bar represents the maximum power of bulls during that bar. The low of each bar represents the maximum power of bears during that bar. Bears make money when prices go down. They keep selling short, their selling pushes prices lower, and every downtick adds to their profits. At some point they run out of either capital or enthusiasm, and prices stop falling. The low of each bar shows the maximum power of bears during that bar. The low of a daily bar marks the maximum power of bears during that day, and the low of a weekly bar identifies the maximum power of bears during that week. The closing tick of each bar reveals the outcome of a battle between bulls and bears during that bar. If prices close near the high of the daily bar, it shows that bulls won the day's battle. If prices close near the low of the day, it shows that bears won the day. Closing prices on daily charts of the futures markets are especially important. The amount of money in your account depends on them because your account equity is "marked to market" each night. The distance between the high and the low of any bar reveals the inten- sity of conflict between bulls and bears. An average bar marks a relatively cool market. A bar that is only half as long as average reveals a sleepy, disinterested market. A bar that is two times taller than average shows a boiling market where bulls and bears battle all over the field. Slippage (see Section 3) is usually lower in quiet markets. It pays to enter your trades during short or normal bars. Tall bars are good for taking profits. Trying to put on a position when the market is running is like jumping on a moving train. It is better to wait for the next one. Japanese Candlesticks Japanese rice traders began using candlestick charts some two centuries before the first chartists appeared in America. Instead of bars, these charts have rows of candles with wicks at both ends. The body of each candle represents the distance between the opening and closing prices. If the closing price is higher than the opening, the body is white. If the closing price is lower, the body is black. The tip of the upper wick represents the high of the day, and the bottom of the lower wick represents the low of the day. The Japanese consider highs and lows relatively unimportant, according to Steve Nison, author of Japanese Candlestick Charting Techniques. They focus on the relationship between opening and closing prices and on patterns that include several candles. The main advantage of a candlestick chart is its focus on the struggle between amateurs who control openings and professionals who control closings. Unfortunately, most candlestick chartists fail to use many tools of Western analysts. They ignore volume and have no trendlines or technical indicators. These gaps are being filled by modern American analysts such as Greg Morris, whose Candlepower software combines Western technical indicators with classical candlestick patterns. Market Profile This charting technique for tracking accumulation and distribution during each trading session was developed by J. Peter Steidlmayer. Market Profile requires access to real-time data—a constant flow of quotes throughout the day. It assigns one letter of the alphabet to each half-hour of trading. Each price level reached during that half-hour is marked with its own letter. As prices change, more and more letters fill the screen, creating a bell- shaped curve. When prices erupt in a trend, Market Profile reflects that by becoming elongated. Market Profile is sometimes combined with Liquidity Data Bank. It tracks intraday volume of trading by several groups—floor traders, hedgers, and off-the-floor traders. Efficient Markets, Random Walk, and Nature's Law Efficient Market theory is an academic notion that nobody can outperform the market because any price at any given moment incorporates all available information. Warren Buffet, one of the most successful investors of our century, commented: "I think it's fascinating how the ruling orthodoxy can cause a lot of people to think the earth is flat. Investing in a market where people believe in efficiency is like playing bridge with someone who's been told it doesn't do any good to look at the cards." The logical flaw of Efficient Market theory is that it equates knowledge with action. People may have knowledge, but the emotional pull of the crowd often leads them to trade irrationally. A good analyst can detect repetitive patterns of crowd behavior on his charts and exploit them. Random Walk theorists claim that market prices change at random. Of course, there is a fair amount of randomness or "noise" in the markets, just as there is randomness in any other crowd milling around. An intelligent observer can identify repetitive behavior patterns of a crowd and make sensible bets on their continuation or reversal. People have memories, they remember past prices, and their memories influence their buying and selling decisions. Memories help create support under the market and resistance above it. Random Walkers deny that memories of the past influence our behavior in the present. As Milton Friedman has pointed out, prices carry information about the availability of supply and the intensity of demand. Market participants use that information to make their buying and selling decisions. For example, consumers buy more merchandise when it is on sale and less when prices are high. Financial traders are just as capable of logical behavior as homemakers in a supermarket. When prices are low, bargain hunters step in. A shortage can lead to a buying panic, but high prices choke off demand. Nature's Law is the rallying cry of a clutch of mystics who oppose Random Walkers in the financial markets. Mystics claim that there is a perfect order in the markets, which they say move like clockwork in response to immutable natural laws. R. N. Elliott even titled his last book Nature's Law. The "perfect order" crowd gravitates to astrology and looks for links between prices and the movements of the planets. Most mystics try to hide their astrological bent, but it is easy to draw them out of a shell. Next time someone talks to you about natural order in the markets, ask him about astrology. He will probably jump at the chance to come out of the closet and talk about the stars. Those who believe in perfect order in the markets accept that tops and bottoms can be predicted far into the future. Amateurs love forecasts, and mysticism provides a great marketing gimmick. It helps sell courses, trading systems, and newsletters. Mystics, Random Walk academics, and Efficient Market theorists have one trait in common. They are equally divorced from the reality of the markets. Extremists argue with one another but they think alike. |
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expressed in action. Each price bar provides several pieces of information about the balance of power between bulls and bears (Figure 18-1).