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.

Relative Strength Index (RSI)

Celticheart Investor

A beginner's guide to trading and investing

The relative strength index (RSI) is another technical analysis tool created by the renowned J. Welles Wilder who, surprisingly enough started out as a Mechanical Engineer by profession.

He was also a keen investor in real estate and, after just seven years quit working as an engineer to concentrate on real estate full time. It was only after he sold out to his business partner that he started to focus on research and trading, concentrating mainly on silver futures.

He is best known for having developed several technical analysis tools that are now regarded as "core indicators" in trading, such as "Average Gain / Average Loss" and one which we have already covered Parabolic SAR

The RSI is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period. It's prime function is to compare the amount of recent gains to recent losses to try and identify when the stock has been overbought or oversold and is calculated using the following formula: RSI = 100 - 100/(1 + RS*)

I have extracted a concise description of how RSI works from Wikipedia (with thanks) as it explains it far more succinctly than I could:
How the Relative Strength Index (RSI) works.

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

"The RSI is regarded as a momentum oscillator, measuring the velocity and momentum of directional price movements. Momentum is the rate of the rise or fall in price. The RSI computes momentum as the ratio of higher closes to lower closes: stocks which have had more or stronger positive changes have a higher RSI than stocks which have had more or stronger negative changes.
The RSI is most typically used on a 14 day timeframe, measured on a scale from 0 to 100, with high and low levels marked at 70 and 30, respectively. Shorter or longer timeframes are used for alternately shorter or longer outlooks. More extreme high and low levels—80 and 20, or 90 and 10—occur less frequently but indicate stronger momentum."  (Quote courtesy of Wikipedia)





For a more in-depth look at RSI check out the link below:

http://www.investopedia.com/terms/r/rsi.asp#axzz2HC5UYARm

Next time:  An overview of charting

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.

Reading the Signs

Celticheart Investor

A beginner's guide to trading and investing

Interpreting candlestick charts might seem complex at first but as with all things, the more you understand the easier it gets. There are many elements that can be applied to charting (Stochastics, Bollinger bands often called BBs, Parabolics, Fibonacci numbers and MACD) but for now we will focus only on the candlesticks themselves and look at the others an element at a time. Trying to understand them all at once would only add to the confusion.

To recognise what the candlesticks mean we have to look at the patterns they form. It is by seeing repeating patterns that we come to understand the likely course that trading will follow. Basically all candlestick charts are mapping is sentiment; whether or not the market is positive, negative or neutral and more importantly which way the trend is going to shift.

To start with there are a only a few basic elements you need to worry about, as I mentioned earlier the basic structure of the bar is as shown here on the left with a main body in solid or white and wicks at top and bottom. These are frequently also shown as red and blue or green.

You don't really need to worry about what they are called only to recognise the shapes and the patterns they will form part of in your candlestick chart. It does help to know their names though so that you understand what others are referring to.

So lets look at some basic indicators and what they mean. Candlesticks come in three basic types; Bullish (buyers are dominant), Bearish (Sellers are dominant) and if they are Neutral (Neither buyers nor sellers are dominant).  

If the pattern is bullish then the likelyhood is the share price will either stay as 

it is or rise, if it is bearish then there is a chance the share price will drop and 

of course if it is neutral the price will not change.

The trick is to try and anticipate the change of direction or sentiment before it happens or at least recognise the start of that change. These are some basic patterns that will help you identify that change. 

Some are stronger signals than others but I would always say not to take one signal alone as a certainty, look for conformation signals to back it up.

Below is an example of such a change in direction from earlier today on MAGP showing a shift in sentiment from bearish to bullish.

The chart on the right was based on 1 hour increments but the same principles can apply on a daily, weekly or monthly basis too. The hammer followed by the long red bar was a sign that this share was being oversold and would probably reverse upwards but it was not until two hours later with the doji formed that it was confirmed.

Before we look at more complex patterns it is probably wise to look at simple reversal signals based on as few as 2 or 3 candlesticks. To start with stick to daily chart comparissons although later on you might want to look more frequently on fast moving shares. These are of course just a selection, there are many others to look for.

Below you will see examples of all three types, Bullish, Bearish and Neutral. Some signals are stronger than others but we will come back to that later on. Don't be too focused on the colour as it is not as important as the size of the main body and its relationship with its neighbours.

I have already referred to this book in a previous blog but for me it is an accessible introduction to understanding the basic fundamentals of analysing candlestick charts.

http://www.amazon.co.uk/Candlestick-Charts-introduction-candlestick-char ts/dp/1905641745/ref=sr_1_1?ie=UTF8&qid=1352029161&sr=8-1 

Next time:  How the Candlesticks are formed

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.

Technical Analysis

Celticheart Investor

A beginner's guide to trading and investing

As I mentioned in my last blog technical analysis is the name  given to a whole host of analytical tools that can be used to examine and identify buying and selling trends in a company's share.


We do not appreciate just how lucky we are, having so many tools available to us on line, often free of charge. Although these tools lend themselves best to traders who are looking to buy and sell shares on a relatively short term basis 
it is my view that there is also a lot of valuable information that can be learned by the mid to long term investor too.

The logical place to start looking at these tools is with charts, these can be linear or candlestick depending on your preference. For me the candlestick charts are infinitely easier to interpret which is why I lean towards them.

Before I go any further I would like to stress that I am not an expert in charting, simply an enthusiastic user of charts who is, as they say, "learning as I go".

My intention with, what will be through necessity, a series of blogs, is to show you the tools that are available to you, explain what it is they are capable of showing and point you in the right direction to get more in depth tuition.

Hopefully, by taking this approach I too will learn through the process, to start with I would like to give you an overview on candlestick charts.

Candlestick Charts

The origin of these charts goes back to the 17th century, in contrast similar charts did not appear in the United States until the 19th century. They were originally used in the trading of rice, the most important commodity in Japan 
at the time but ultimately became used in establishing trading patterns for Gold, Silver and other commodities.

Strangely enough, the main factor that these charts track is not profit or loss but simply market sentiment or emotional responses to the markets.

Amazingly the Western world did not really embrace these "Candlestick" charts until the 1980's when the spread of PCs really started to take off and made access to information so much more readily available.

The principles of Candlestick charts are pretty much the same as bar charts 
and are relatively simple to understand. Every bar has 3 key elements, the real body (solid or open), the top shadow / wick and the bottom shadow / wick. 

Increments can be set as minutes, hours, days or months but for now we will just look at them on a daily basis.


The real body represents the bulk of the day's trading with the top shadow being the highest price of the day and   the bottom shadow representing the lowest price.

If the day closes up on the day's opening share price then the body will be open, but if the sp closes down the body will be solid. These days the bars are frequently shown as red (down) and green or blue (up) but the principle is the same.

The next thing to understand is the size of the body which represents volume   of trades, in a way the colour of the bar tells us less than the size of the bar because if the bar is very small it shows that there was no real dominance between buys and sells and if the bar is replaced by a single line (A Doji) this shows complete indecision in the market which can indicate a change of direction.


Doji comes in several types, including, 3rd from left,
the distinctive "Dragonfly Doji" and 4th from left, the Gravestone Doji"

We will deal with the significance of each of these doji in future blogs but for now will leave you with  a word of advice, don't get emotionally attached to doji, they are fickle little creatures at the best of times.
 

There are many books around about Candlestick charting but for me one of the best books I have found which will give you an, easy to understand, introduction to charting is "Candlestick Charts by Clive Lambert.

http://www.amazon.co.uk/Candlestick-Charts-introduction-candlestick-charts/dp/1905641745/ref=sr_1_1?ie=UTF8&qid=1352029161&sr=8-1 

Next time:  Recognising patterns

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.