Let us sort out the most popular and effective ones.
Moving average is a price-over-time analyse method used for smoothing the price chard by findig the average over a specific number of periods. There are different types of moving average - simple, cumulative and weighted. Average is used to determine trends. Simple moving average (SMA) is calculated from the given periods: to calculate the SMA over 5 periods one should sum up the prices at each period and divide by five.
The more periods are used to calculate the average the larger the scale. If we take an hour’s period and take 1-period SMA we get the average per hour. If we take a 24-period SMA we get the average per day. To determine a trend we nead at least two averages. That’s a simple tactic: when the average of the smaller period outgorws the average of the larger period it means an upward trend is starting and vice versa for a downward trend.
Trading classics John Murphy, Bill M. Williams, Ton DeMark and Larry Williams used different periods for SMA calculations. They determined trend beginnings and ends at the intersection of two or more averages.
Upward trend and moving averages 5-34
The difficulty is that the more mentors and gurus there are the more different period variations for averages for trend determining they give. There are dosens of indicators used by thousands of traders. These indicators also include personal enhancements to classic methods. If the averages show trends why so many variations? SMA method is good when there is an upward or downward trend. It is useless in the flat. The variations were designed to solve this problem.
As it is known 60% of trade is in the flat. And whereas average is useless in the flat average-based indicators lead to loss when a sideways trend starts. There is no point in improving an initially faulty instrument. Averages show the trend but they don’t show its strength. And it is very important to be able to determine the beginning and the end of a sideways trend if one wants to use averages to avoid losing all the profit in the flat.
Trendlines and trend channels
128 years ago Charles Dow, an American journalist, founded The Wall Street Journal. The journal published his analitics price analisis emerged from. An American who didn’t get a proper school education built up a theory of trends and construed the Dow-Jones Industrial Average Index. According to Dow theory in an upward trend every peak will be higher than the preceeding one and every valley lower than the preceeding one in a downward trend.
Charles dow specified three phases of a tendency:
Accumulation (distribution in a downward trend) phase. That’s when the investors “in the know” trade against the market.It doesn’t give a dramatic change in price as those well-informed are few.
Public participation phase. When the trend has shown signs of reverse that would be a signal to traders who get involved in the trade and make the upward or downward movement steeper.
Exsess (panic in a downward trend) phase. That’s when the last buyers (or sellers) enter the market hoping to get some profit on the trade.
Trend channels are made based on the Dow theory to determine price movement borders.
Classic trend channel (source - FxPro.by)
The idea is that the price movements use the channel border as support and resistance levels. When the price breaks through the channel border in theory it should mean a reverse in trend. The tactic seams easy enough, the breakthrough is visually seen. The difficulty is that the price happens to leave the channel borders at rebound times as well. The classics’ opinions on this problem differ. John Murphy suggests using one’s own experience. Robert R. Prechter recommends building channels based on a larger scale taking no less than a daily period. Jack D. Schwager advises to build new channels each time, Eric Nyman advises to wait for the reverse to be confirmed. So there is no unified solution to the problem. The choice is left to the individual trader.
False trade channel breakthrough
In the third decade of XX century Ralph Elliott, an American financier introduced a wave theory. He made a successfull accountant career but at the age of 58 retired due to health issues. In order to keep himself busy he began to study stock market price models. After five years of studies he formulated his wave theory principles. The idea was that the wave pattern repeats itself regardless of the time scale. Each price model has a larger scale equivalent although the amplitude may vary. The principle became base to theory of fractals formulated 40 years later.
Elliott specified two types of price movements: impluse - waves 1, 3, 5, A, C and correctional - waves 2, B.
According to the theory the 5-wave model has constant characteristics: the second wave is smaller than the first, the third is the longest among the five, the fourth doesnt enter the first wave range. The full cycle consists of 8 waves - 5 impulse waves and 3 correction waves. In theory the cycle repeats itself and after the correction there comes a larger scale third wave that also consists of 5 waves.
The full cycle
The wave theory principles are simple but Benoit Mandelbrot, the author of fractal geometry, considered that market assessments based on them subjective. And he was right: the theory doesn’t give definitive wave measuring instruments that would show equal results for different traders. That is why it’s difficult to calculate this strategy success rate and the trade outcome.
That was before Bill Williams, the author of trading chaos concept introduced rules for wave definition. Williams construed an indicator based on moving averages and called it Awesome Oscillator (AO). The indicator helps to acheive greater objectivity in defining waves. The first wave is at the intersection of 0 and the first histogram the third wave histogram is higher than the first wave, divergence on the five. With the help of these principles Bill managed to increase his deposit 19-fold in a year and a half.
Wave definition by means of Awesome Oscillator
The rules help to find waves at any scale. But there is no instrument that would tell the 5-wave from an a-b-c correctional model. And we could get the picture shown below:
Situations where the rules don’t work
Bill Williams did not give a solution to this problem. That is why the trading model is a 50/50 gain/loss.
The price at the stock market is formed by supply and demand. Take Bitcoin for example. When it was released there were very few people who were interested in having it. A year later when people started to find it interesting the price started to rise. MtGox hack in 2014 undermined the trust in cryptocurrencies and the demand for bitcoin fell. The news affected those who did not understand the core of the problem because the bitcoin security was Ok. Due to bitcoin demand this year the price has risen up to $20 000.
Practicing trader and a number of books’ author Eric Nyman (born 1969 in Novosibirsk, at present - a powerful figure in the Urkaine stock exchange) wrote:
«Increase in volume shows increasing interest towards the asset. This is a signal of possibility of trend reverse upward. And on the contrary volume decrease shows decreasing interest and that will lead to correction or trend reverse downward».
Nyman suggests marking volume peaks. They could be signals for trend reversal.
Alexander Elder, author of the international bestseller «Trading for a living: Psychology, Trading tactics, Money management» wrote in his book:
«Volume reflects the activity of traders and investors. If you compare volumes of two markets, you’ll see which is more active or liquid. Whenever prices move about half of the traders are hurting.When prices rise, bears are in pain, and when prices fall, bulls suffer. Losers who give up on their trades propel trends. A trend that moves on steady volume is likely to persist. It shows that new losers are replacing those who washed out».
Elder believes that volume drops lead to trend reversal whereas new price and volume peaks with a high possibillity will lead to trend persistance.
Volumes is a wide field, but some information is impossible to verify. In the first place traders tend to buy cheap and sell at higher price. As an instrument they use a formed graph. How should one know if the volume change is instigated by the market sentiments and or by a major player who attempts to manipulate the market? Examples of this occured. Positive cryptocurrency news at the trend peak generated high demand and that made the situation favourable for large volume closures.
Before making a desicion on a deal traders analyse charts. Patterns help determining the market sentiments and predicting the price change. There are two types of patterns.
Flags, pennants and wedges are continuation signals for opening deals in the current trade.
Head and shoulders, double and treble top and bottom, diamond, prick and Murphy’s saucer are reversal signals for closing the current deals and opening deals against the current trend
The problem with these patterns is that the analyses based on them is even more subjective. The classics don’t provide presice category criteria for these patterns. That’s why an inexperienced trader may mistake a false reversal signal for a head and shoulders reversal signal for instance.
A Head and shoulders reversal pattern
A false reversal
The described above strategies are the basics without which it is better not to trade for the loss would be imminent. Discoveries of trading classics provide a more comprehensive understanding of the market. But in order to trade steadily one neads to solve problems answeres to which weren’t given by the classics. It is impossible to find a popular method that would be working equally well for everyone.
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