Overall approach to technical analysis
By Warrick Selzer
1. Top down global to share: The Top Down approach involves focusing first on the global “picture” then onto a country and then onto sectors & ultimately onto analysing the INDIVIDUAL shares. We do this by using the Price Relative indicator and comparing it between global indices to see which global indices are strong and which are weak. We follow this process by then taking the strongest indices and drilling down to discover which are the best performing sectors within the strongest indices. The final step is to compare, by price performance over the same time, which top 3 stocks within the strongest 3 sectors should be considered to trade or invest. Period is significant with a focus of at least end of day time frames for swing trading positions with 3-day chart time frames for medium term and weekly time frames (charts) to be used for longer term investments.
FIG. 1 Picture of Shanghai Index vs JSE and DAX vs JSE in Price Performance
(click on image to enlarge)
2. Setting up of graphs :Graphs should be set up in such a way as to enable analysis of price & time (normal graph), incorporate moving averages ( suggest 10 & 20 & 50 day exponential and 89 day simple moving averages), technical indicators (such as a MACD or Stochastic). Price Relative should be analysed at a sector to market and share to sector level.
3. Long term & short term technicals: Long term technical's should be analysed first to establish the long term trend (bull, bear or sideways/trading markets). Once the long term trend has been analysed then the short term technical indicators should be analysed.
4. Chart patterns: It is important to analyse the pattern recognitions before using detailed indicators. Identify chart patterns & in particular whether you have rising bottoms & rising tops (bullish) or falling bottoms & falling tops (bearish). Other significant chart patterns would be head and shoulders, double-tops & Evening stars for bearish reversals and reverse head and shoulders, double bottoms & Morning stars for bullish reversals for example.
5. TSAR the “king” of patterns: Trend (T), support (S) and (A) resistance (TSAR) lines are a very powerful form of technical analysis. When listening to the Bloomberg or CNBC channels there is often discussion about trend lines or critical support or resistance lines. A book such as “Getting Started” in Chart Patterns by Thomas .N. Bulkowski is suggested for improving your expertise on these chart patterns. As the market repeats itself there are very often levels that are revisited as resistance and support.
FIG. 2 Picture of JSE GOLD sector with TSAR levels of support & resistance
(click on image to enlarge)
6. Trend lines: are established by connecting the peaks or valleys along the trend. There are 3 different types of trend lines being external, internal & curved. Internal trend lines connect the body of the candles; external trend lines connect the wick of the candle. Curved trend lines
are curved trends that could be connected using either the body of the candle or the wick. Trend lines are more reliable the longer they are, the more points on the trend line and the more sustainable the angle of the trend (a 30 to 24 degree slope is ideal).
7. Support & Resistance (SAR) lines: are areas where price stalls over a small range of prices. A support line is where large buying pressure stops a decline. A resistance line is where large selling pressure ends a rise in prices. SAR are usually horizontal & often at round numbers. They are very often repeated with some historical point of reference as they operate as powerful psychological levels of turning points or breaking points. Pay attention to these levels especially when combined with different time frames such as daily and weekly charts.
8. Retesting of TSAR lines: On a break of a TSAR line in a very high percent of cases the share comes back to the TSAR line to retest. Never buy on gaps as gaps mostly close. Wait for the retest of the TSAR lines to confirm a break & then buy as close to the TSAR line as possible with confirmation on an intraday candle. The TSAR line should then be used as the stop loss level.
9. Trading using the TSAR patterns: Try to buy when going long or sell when going short on trend, support or resistance lines (TSAR). The TSAR lines should then become your stop loss level to minimise losses or just above or below them respectively. Use other confirmations such as Morning or Evening Star candle patterns, bearish or bullish engulfing to confirm with a break of the moving averages.
10. Volume: is an important “independent” indicator from price & time. Rising prices & rising volumes followed by “pull backs” on falling volume are positive. Rising volumes & falling prices are negative followed by rises on falling volume. Big volumes on a sideways volatile range often
indicate a top or bottom of a market.
11. Candle stick patterns: are vital to successful trading and important in determining changes in market direction. It is recommended that you become an expert in candlesticks by buying & studying a book such as “Steve Nison: The Candlestick course”. It is suggested that you analyse the daily candle sticks followed by intraday candles in order to execute. A useful technique is to use the 30 minute candle & look for confirmation with the 15 & 60 minute candles. Often a positive day's candle is followed by a “gap” up the following day. It is useful to draw your candle sticks at 4.30 pm and prepare to buy just before the market closes.
12. Moving averages: Moving averages are lagging indicators & so have their limitations especially in volatile markets as they tend to work better in trending markets. In volatile markets the combination of moving averages & stop losses can lead to “whip lash”! The 10 & 20 & 50 exponential and 89 simple moving averages are useful to add to your graphs. When a combination of moving averages cross over each other within a day or two of each other it makes for a fairly good confirmation of a change of trend.
13. Make sure you apply a stop loss strategy: We tend to refer to exponential moving averages over 50 days and 89 days as general stop loss levels depending on our time frame of holding the position. See the example of Didata below if you doubt the reasoning behind having a stop loss strategy.
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The above graph of Dimension Data (Didata), a SA IT company, is a valuable lesson to all investors that you should not try and “bottom pick” & that you should always apply a stop loss. Didata went from R1 to R70 & then back to R1 over a period of less than 10 years!