The Importance of Charts and Indicators
Sam Seiden here. I began my career on the floor of the Chicago Mercantile Exchange. One of the first people I met was a fellow named Bob Dunn. He was a hockey player as well so we had plenty in common. We have remained friends for all these years. Bob did very well for himself in trading and recently, I suggested to him that he get involved with training at Online Trading Academy and he did. Students that have taken an Online Trading Academy course with him really like his unique perspective. What is unique about Bob is that he is one of the few that has mastered the indicators and oscillators and turned them in to a money machine for himself. Below is a piece he wrote that I thought would benefit Online Trading Academy readers. Enjoy… Sam Seiden – sseiden@tradingacademy.com
The realization many traders are coming to as a result from the explosion of online trading is that it is clearly not as easy as it may look. One would be surprised at how many traders know very little about technical analysis yet wonder why they don't consistently make money. We don't have to be rocket scientists to understand Technical Analysis. It actually becomes very simple once you have a routine and you stick to that same routine every single day. Trying to succeed in trading without the use of charts, indicators and oscillators is like trying to fly from Florida to Alaska without a flight plan.
Let's imagine for a moment, we're living in a perfect world and we're able to buy the lows, sell the highs with uncanny accuracy. I mean how good would that be, to sell the highs and buy the lows? There are people that do that, but they have the resources to buy all the way down and sell all the way up. I'm assuming most of us aren't traders like that and are smart enough not to add to losers. Now, let's imagine that we're living in this not so perfect world that we live in today where we can't buy the lows and sell the highs unless we get lucky. But what if, I mean just what if we could get close to the lows by say five percent and get out near the highs by say five percent, wouldn't that be almost as good? There are indicators and oscillators we could add to our charts that will help us do just that. They will help us find the better entry and exit points. They should all be on all your trading platforms and can be overlaid and added to your charts.
The one thing we'll talk about, I've been refining over the course of my twenty-five years as a professional trader on the floors of the Chicago Mercantile Exchange and the Chicago Board of Trade. I will show that it only takes a few simple steps to confirm what will amount to be a very high probability of a profitable trade. This article will describe it in a very simplified way.
Early in my career, I was editor and analyst for a daily newsletter providing market updates and trading suggestions based on my evaluation of technical support and resistance formations in conjunction with my own unique interpretation of what I maintain are some of the most valid and reliable mathematical indicators. These support and resistance numbers were generated by using my recipe of technical indicators which I feel to be the best combinations in conjunction with chart interpretations. Combining the technical information that everybody has access to, i.e. daily highs, lows, settlements, and other market data; with a series of indicators along with chart formations will provide one of the better strategies to improve our entry and exit timing while increasing our probability of making more consistent profitable trades.
Is one indicator alone or eight indicators combined the right set up for each and every one of us? While one is not enough, too many can be overwhelming and will cause us to miss our move by over-evaluating, or having what I call "Information Overload". There are many indicators and oscillators we should all know about and I will present a few of those that I feel are the easier ones to interpret and produce great results. Learning when to apply them will help us become better traders. We use these indicators and oscillators to confirm our opinion of an anticipated move but we also use them to confirm what the other indicators are saying. While no one indicator by itself is the holy grail, it will take three or four indicators and when applied the correct way they will certainly increase our profitability while helping us to manage our risk more effectively. There are some situations when one or more indicators say overbought while at the same time others may be neutral. Knowing the habits of how these indicators react under certain market conditions with different stocks, futures and commodities will allow us to be able to select the correct ones to use. This will become very easy after we see how they react over and over again in different situations. We will also begin getting more confidence in our trades when we know that they work. We all know, knowing when these trends are changing is crucial to risk management. Risk management doesn't only mean not losing any of our principal, it also means not giving back profits that we have made. We'll always give back portions of profit, that's just part of the game, but we want to give back very little.
Out of the indicators and oscillators that I use the most, I find the Relative Strength Index (RSI) will lead the way giving an overbought or oversold signal before the others do, but there are some exceptions. I will look at this as the warning as to what should happen in the near future. There are some situations though when the RSI is fairly neutral and other oscillators are overbought or oversold, that's why we are always looking at multiple indicators and oscillators. After playing with these different indicators for a while you will see some may work better than others depending on what you are trading. So after we have our basket of things to trade we will back-test these indicators to see which ones work best with our market.
Fig. 1
In figure 1 we see the RSI bounce off the oversold area giving our first signal telling us of a possible reversal. The stock continues to hold the Resistance Line which has touched five points already showing us there's strong resistance. I like to use 20 as the oversold area and 80 as the overbought area; most books say to use 30 and 70 but I find my settings take a little more risk out of the trade. Remember, not only do we want to catch the move, we want to minimize risk. Just to mention the fact that the trend line is touching more than three points is showing us there's nice resistance and every time thereafter that it touches the line just makes it even stronger. Just because the RSI is oversold is not reason enough to get long, we need the charts to give us a reason. We don't trade just to trade. We must have a reason for every trade we make. Our trading plan should now be, we have the RSI showing us this stock is oversold and a resistance trend line which is holding for multiple points, so we now have to wait for a breakout.
Fig. 2
In figure 2 we see a breakout of the resistance line with the Stochastic spiking out from well into the oversold zone to above 20. We should be buying this right above the breakout of the resistance line without any indicators. So now we have a breakout of a strong resistance line following the RSI warning from a few days earlier and confirmed by a bullish spike in the Stochastic which should now be flashing lights in our heads telling us to go long. We now have a reason to trade. But I prefer to see a breakout of a trend happen with good volume so I go to my volume indicator to look for more confirmation. All of these indicators and oscillators can be added to your charts all at once for a quick glance, they don't have to be accessed one at a time.
Fig. 3
Now in figure 3 we look at our volume indicator and see that the breakout above the resistance line is occurring with more than average volume, also confirming that the move should continue. Two days later the 7 Day moving Average crossed through the 10 Day Moving Average further confirming the continuation of the trend reversal a longer term trade. We should have been buying this as it started trading above the resistance line but the fact that it had multiple indicators all telling us the same thing stacks the odds more in our favor. As I tell the students in my classes, "We want to be the house in Vegas. The house has the odds stacked in their favor, so do we, we just have to know how to stack them."
As we can see, with the correct use of a few indicators combined with the proper placement of trend lines gives us set ups for trades that have limited risk and increased profit potential. This is such a valuable tool yet few people take the time to really learn it. So before we take that trip from Florida to Alaska, let's make sure our navigational system is all set up and ready to go.
 By Robert Dunn
Online Trading Academy Instructor
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Sam brings over 15 years experience of equities, forex, options, and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.