Stochastics

Celticheart Investor

A beginner's guide to trading and investing

Before I move on to other aspects of investing there are a couple more technical trading tools worth exploring.
Some of these are much more suited to the needs of the trader rather than the longer term investor but my view is, the more tools you have available to you the more you can tailor them to your needs, choosing to use any combination that suit both your needs and your investing / trading strategy.

So let's look at the "Stochastic Oscillator" which is fundamentally a technical momentum indicator that compares the closing shareprice to its range over a given period of time. The sensitivity in which this indicator compares movements in the market can be altered by adjusting the time frame or the moving average. In technical terms this oscillator is calculated using the following formula: %K = 100[(C - L14)/(H14 - L14)]

(%D = 3-period moving average of %K)  See: Moving Averages

Where C is the most recent closing sp / L14 being the lowest price paid of the previous 14 sessions and H14 being the highest price paid over the same period. Remember that this time period can be varied according to your needs.

For a more in-depth look at Stochastic oscillators see: Stochastic oscillators

Slow Stochastics will be found at the bottom of your chart. It is made up of two moving averages. The faster moving average is a blue line, the K line, while the slower moving average is the red line, the D line. These two moving averages will move between the 80 line and the 20 line. If the Stochastic is above 80, it said to be “overbought” and if it is below 20 it is said to be “oversold”.

The theory behind this indicator is that in an uptrend prices tend to close near their trading high and conversely close near their trading low during a down trend. Trading signals (buy/sell) occur when the %K crosses through a three day period moving average referred to as %D

The key with using the Stochastic indicator is, as with any indicator, only take signals in the direction of the current dominant trend i.e. if the trend is downward only take sell signals from Stochastics and if the trend is upwards only take buying signals from Stochastics.

Obviously this is a highly technical tool and should, as with all technical analysis  (TA) tools be ideally used in conjunction with other indicators for confirmation and as always without losing sight of the fundamentals of the company.

Next time:  Stop Losses

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.

Fibonacci Numbers

Celticheart Investor

A beginner's guide to trading and investing

Now this is one of my own personal favourite topics, not just because of its use as a technical analysis tool but because it absolutely fascinates me in the way that it appears so frequently in the natural world, such as in the branching of trees, the arrangement of leaves on a stem, the petals on a flower or the arrangement of a pine cone.

That of course is another blog altogether, so for now we will stick to its relevance in aiding us as a technical analysis tool.

Some think that Leonardo of Pisa (also known as Fibonacci) was the most talented western mathematician of the Middle Ages. Fibonacci is best known to us for spreading the ancient Hindu–Arabic numerical system in Europe, primarily through its publication in 1202 in his book Liber Abaci (Book of Calculation). You might want to think about why it is that, to this day, we still work mathematically from right to left in the Arabic manner. Without which we would have none of the mathematical tools available to us today, including computers which are so reliant on sequencing.

So lets look at the number sequence named after him the "Fibonacci numbers", (Also called Fib Numbers) which he did not in fact discover but simply used as an illustrative example in his book. The number sequence we now associate with Fibonacci was known to Indian mathematicians as long ago as the 6th century.

In the Fibonacci sequence of numbers, each number is the sum of the previous two numbers, starting with 0 and 1. This sequence begins 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987 and so forth.
 
The higher up in the sequence, the sum of the division of two consecutive numbers becomes closer to what Fibonacci called the Golden ratio which is approximately (1 : 1.618 or 0.618 : 1). 

e.g. 233/144 = 1.6180555 and 987/610 = 1.618033

The relevance to its use in technical analysis is that you will often find that a bullish rise will often retrace to a key Fib number and also the reverse is true,
a downtrend might correct itself and  rise to a key Fib number (not necessarily the next one in the sequence).

These are just some examples of how Fibonacci retracements in an uptrend look on the candlestick charts, along with the subsequent rises.
As with all things in charting the figures very rarely stop exactly on the fib numbers for reasons already mentioned above. The higher the number sequence the more accurate the golden ratio. 

Fibonacci numbers above all else seem to polarise opinion, with some people swearing by them and others dismissing them as nonsense. I would certainly not advocate using them as your sole means of measuring trends and directional change but, the frequency with which they appear makes me tend to take them seriously, at least as another useful technical analysis tool in your arsenal.

For a more detailed look at Fibonacci numbers check out the links below: 

http://www.tradingfives.com/articles/fibonacci_retracements.htm

http://www.maths.surrey.ac.uk/hosted-sites/R.Knott/Fibonacci/fibmaths.html

http://www.mi.sanu.ac.rs/vismath/lends/ch2.htm

Next Time: Parabolic SAR

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.

Moving averages

Celticheart Investor

A beginner's guide to trading and investing

Moving averages are not in fact a tool as such but just a smoothing out of the average share price activity to form a trend following indicator. 

They do not predict price direction as they are based on past share price so are, by definition, tracking what has already happened. Despite this delay, moving averages help smooth price action and filter out the noise. 

They also form the building blocks for many other technical indicators, such as the Bollinger bands we have already examined (the middle BB is also the EMA 20 line) and MACD (moving average convergence/divergence) which we will be looking at later on. 

The two most common types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). These moving averages can be used to identify the direction of a trend and are useful in helping to define potential support and resistance levels. It should be noted 
that it is not possible to create an EMA with out starting with an SMA.

Moving averages can be calculated over any given periods but generally 20 day and 50 day increments are used by most chartists. It is how the two periods interact that is most informative for share traders and investors alike.

Although not a strong enough indicator on its own, when the EMA 20 crosses above the EMA 50 it often signals a buy but when the EMA 20 crosses below the EMA 50 this signals a possible sell. Again I would stress that this applies in the main to traders rather than investors as often the fluctuations we are talking about are too small to consider a buy or sell unless you are trading in high volumes.

For greater accuracy in your judgements use the EMA 20/50 signals in conjunction with some of the candlestick patterns we have already covered.

I wont even begin to try and explain the formulas used to calculate the moving averages (both SMA and EMA) as, to be honest, for most small investors, what the moving averages tell us is far more important than how they were calculated. If you do want to take a more in-depth look at how they are created check out the link below:

http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:moving_averages

Next time: The MACD

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself. 
 

Bollinger Bands

Celticheart Investor

A beginner's guide to trading and investing

Having looked at some examples of candlestick charts 
it is obvious that alone they are not always conclusive enough (something which seems to sit uncomfortably with shareholders that want clear direction), which is why we use other tools to supplement these charts to help make sense of what is going on. 

This blog is not meant to be an in-depth analysis of any individual company so my apologies to those that took it that way, I was simply trying to show an example of how, sometimes, the charts do not tell us enough.

Moving on, the first additional tool that is used to complement candlesticks is referred to as "Bollinger Bands" or BBs for short, so what exactly are they?

"Bollinger Bands" is a technical analysis tool devised by John Bollinger in the early 1980s and trademarked by him in 2011.

There are in fact three bands, the upper middle and lower bands. The middle band which is a simple moving average (usually set at increments of 20) which tracks the intermediate trend and the upper and lower bands track the overall volatility of the share price. 

If the BBs are wide apart then the trading is pretty volatile but when they are close together this shows that the sp is becoming more stable. This can often help, in conjunction with the chart patterns themselves to give a more accurate indication of where the share price is going.

I believe this is a good example of how the BBs close up when market sentiment turns in favour of the share in question.

How Bollinger bands are interpreted varies depending on the individual's trading strategy.  Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger

As I said at the beginning, BBs are a great tool to use in conjunction with candelstick charting to add confirmation to trends. For a more detailed look at Bollinger bands check out the links below

http://en.wikipedia.org/wiki/Bollinger_Bands

http://www.bollingeronbollingerbands.com/chart/main.php

http://www.bollingerbands.com/

Next time:  Moving Averages

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.