SFO Magazine - Technical Foundations
The following article is from the SFO Magazine, February 2012 issue.
While a gut feeling is not necessarily a bad thing, I would not recommend using that as your sole reason for pulling the trigger on a trade.
Many novice traders base their trades on their gut feeling. It is important to hone in on timing the trade using technical analysis to set logical entry and exit parameters. Understanding some of the most fundamental price formations can change your interpretation of when to enter a trade with defined risk and reward.
TREND
First and foremost, understand the trend. You will have greater odds of success if you follow the trend. The most simplistic definition of a bull market is a price pattern of higher highs and higher lows. The most simplistic definition of a bear market is a pattern of lower lows and lower highs.
Once the trend is violated, we view this as a market divergence and a sign that the trend may be changing. However, market divergence in and of itself does not warrant entering a trade.
PATTERNS
Once you understand the trend, study consolidation patterns, also known as continuation patterns, such as triangles.
The odds are in favor of the market trend continuing in the same direction prior to consolidating. When a market breaks out of a sideways consolidation pattern, a reasonable price target would be an equivalent price movement as the widest distance of the triangle. Since consolidation breakouts can fail, it is recommended to use a divergence level to define your risk on a trade.
This simplistic view can be applied to any time interval, depending on your trading style and risk tolerance.
If you are a day trader, you likely will use a time interval of less than 15 minutes. If you are a position trader, you likely will use a daily bar.
Donna Heidkamp is president of RJO Futures. Improve your understanding of the markets and develop timely trade ideas with a defined risk by watching technical webinars at www.rjomrt.com or www.rjofutures.com/research/rjomrt.php.
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