Technical Indicators and Trading Strategies

Introduction to Technical Indicators

Technical indicators help in making more accurate predictions about chart movements.
Combining candlestick charts with technical indicators provides context for trading decisions.

The Pitfalls of Over-Reliance on Indicators

Beginner traders often make the mistake of adding too many indicators to their charts, hoping for a guaranteed winning combination.
This stems from a fear of loss and the search for a "holy grail"—a perfect combination of indicators that never fails.
No combination of indicators can guarantee 100% accuracy.
Trading requires time, study, experience, and starting with appropriate risk levels.

Importance of Volume

Volume bars indicate the number of shares traded during a candlestick period.
High volume buying and light volume selling paint different pictures, providing important context.
Volume is a crucial component of candlestick charts.

Moving Averages

Moving averages display the average price of an asset over a set period.
Technical analysis and candlestick charts are universal languages applicable to various financial markets.
Shorter time frame moving averages stay closer to the current price.

Types of Moving Averages

Nine Exponential Moving Average (9 EMA):
- Typically seen as a level of support.
- As long as the price stays above it, it's considered bullish.
- Breaking below it can signal a problem.
Twenty Exponential Moving Average (20 EMA):
- Serves as a secondary level of support.
- If the 9 EMA breaks, the 20 EMA is the next level to watch.
Two Hundred Exponential Moving Average (200 EMA):
- A well-respected level of resistance on the daily chart.
- When the price is below the 200 EMA, the 200 EMA acts as resistance to the upside.
- When the price is above the 200 EMA, the 200 EMA acts as support to the downside.

Simple vs. Exponential Moving Averages

Simple Moving Average (SMA): Calculates the average price over a period of time.
Exponential Moving Average (EMA): Weights recent candles more heavily, reacts faster to price action. Most active day traders prefer it.

Formula

$EMA = (Close - Previous EMA) * (2 / (Time periods + 1)) + Previous EMA$

Practical Use of Moving Averages

Moving averages provide context and confidence in trading decisions.
They help in visualizing potential support and resistance levels.

Volume Weighted Average Price (VWAP)

VWAP is the average price of a stock, factoring in the amount of volume at each price.
It serves as an equilibrium point; prices above VWAP indicate bullish control, while prices below indicate bearish control.

Application

Traders and investors use VWAP to understand market context.
VWAP can act as resistance when the price is below it and as support when the price is above it.
Useful on intraday time frames only.
Warrior Trading (WT) Custom VWAP is used in this context.

Moving Average Convergence Divergence (MACD)

MACD is an oscillating, lagging indicator that measures the relationship between two moving averages.
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Calculation

$MACD = 12 period EMA - 26 period EMA$
Signal Line = 9 period EMA of the MACD
MACD Histogram = MACD - Signal Line

Interpretation

When moving averages diverge (move apart), the MACD swings up.
When moving averages converge (come together), the MACD swings down.
Traders use the MACD to identify potential buying and selling opportunities.

Practical Usage

Trading is generally favored when the MACD is positive.
During pullbacks the MACD should remain open to indicate continuation of the trend.

Relative Strength Index (RSI)

RSI indicates the relative strength or weakness of an asset on a scale of 0 to 100.

Levels

Below 20 (or 30) is considered oversold.
Above 70 (or 80) is considered overbought.

Usage

RSI is popular for timing trend reversals.
Useful for counter-trend traders.
Overbought conditions may indicate potential selling opportunities, while oversold conditions may suggest buying opportunities.
However, markets can remain irrational, so caution is advised.

Bollinger Bands

Bollinger Bands use a moving average and two standard deviations to create bands around the price.

Interpretation

$UpperBand = MA + (SD * 2)$
$LowerBand = MA - (SD * 2)$
Where:
MA = Moving Average
SD = Standard Deviation
99% of price action typically occurs within the two Bollinger Bands.
Prices outside the bands indicate extreme conditions.

Usage

Prices touching or exceeding the upper band may signal overbought conditions, while prices touching or falling below the lower band may indicate oversold conditions.
Combining Bollinger Bands with RSI improves confirmation of potential reversals.

Practical Application of Multiple Indicators

Using a combination of indicators helps validate trading decisions.
For example, combining candlestick patterns with moving averages and VWAP can increase confidence.

Volume Profile

Volume profile displays volume bars on the price axis, showing the prices at which the most volume occurred.
It differs from volume bars, which are organized by time.

Point of Control (POC)

The peak trading activity, indicating the price with the highest volume.
Trading above the POC is bullish; trading below is bearish.

Usage

It changes throughout the day.
Volume profile helps identify potential support and resistance levels.

Workflow

The stock should already be up 10% on the day. The most important indicator to look for is the leading percentage gainer.

Five Pillars of Stock Selection:

The type of stocks that respond the best to candlestick chart patterns and technical indicators are stocks that are already up 10% on the day,
They have five times relative volume,
There's a news event moving them higher,
Ideally, they're priced between 2 and $20,
They have a supply or number of shares available to trade of less than 10 million.

Steps

Find leading percentage gainers.
Wait for patterns to form.
Execute trades, considering level two and market depth.
The goal is obvious trades that are watched by many people.