How to Make Order Out of Market Chaos
When I was a kid, I was a bit sloppy. My mom was always on me to clean up my room.
In college, I was no better. Living with three other guys didn’t exactly turn me into a neat freak. Our house probably should have been condemned.
But as I’ve gotten older, I’ve come to crave order in my life. So much so that I was shocked when I heard myself pleading with my daughter to please clean up after herself to keep the house looking nice.
Nowhere is that desire for order in my life more apparent than in my trading. Maybe it started at the beginning of my career as an assistant on a trading desk, back when I couldn’t make any sense of the numbers dancing across my screen, clueless as to how traders decided when to buy and sell.
I needed some way to create order out of all of those numbers and symbols.
Now when I trade, I use technical analysis.
Technical analysis – the use of stock charts to analyze the markets and individual stocks to inform buy and sell decisions – is great for creating a trading plan.
As I always say, technical analysis is not a crystal ball. But it does help you increase the chances of being right and, just as importantly, minimize your losses when you’re wrong.
Everyone’s trading style is different, and there are lots of technical analysis tools that fit any individual’s preferred method.
As a long-term investor, I’m a value investor. I like to buy beaten-up stocks (with dividends) and watch them bounce back over time.
So it’s no surprise that, as a trader, I do the same thing – just with a much shorter time horizon.
With the goal of entering a trade at a discount, I may buy a stock that’s predominantly moving up a trend line and yet has momentarily returned to support – the price level at which a stock’s downtrend reverses.
For example, if I were interested in buying Tesla (Nasdaq: TSLA), I would wait until the stock returned to the trend line (the orange line), which is acting as support.
If the stock never returns to the trend line, I will miss the trade, which I’m fine with.
But if the stock’s price returns to the support line, I will pull the trigger for two reasons…
The first reason is if the stock proceeds to drop below the support line, that signals to me that I’m wrong and enables me to quickly exit the trade with minimized losses. The second reason is if I’m right, the stock will bounce from support – likely to new highs – and I will have bought the stock much cheaper than it will be going for in the future.
There are other tools that help me fine-tune the timing of my trades. Some of my favorites are stochastic momentum indicators. I’ve been using them for more than 20 years, ever since I spent a day with the inventor of the stochastic oscillator, George Lane, who walked me through how stochastics work.
Stochastic indicators often show a range of 20 to 80. When their readings top 80, a stock is overbought. When they dip under 20, a stock is oversold.
I use stochastics to wait for an oversold reading that’s turning higher, like the one shown in the bottom panel of this chart of Microsoft (Nasdaq: MSFT).
You can see that Microsoft had been in a downtrend but also that every time the stock’s stochastics readings in the bottom panel fell below 20, the stochastic line responded by turning higher, after which the stock rose.
Now, I don’t buy every stock whose stochastics have fallen below 20 and are turning around, but I do combine attractive stochastic readings with other analysis, like support, resistance and other indicators.
I wouldn’t be a successful trader – or even have a career in the markets – if I hadn’t come across technical analysis nearly 25 years ago. It has helped me better understand the movement of markets and stocks, and, most importantly, it has helped me develop a plan for each trade so that I’m not flying blind, crossing my fingers and hoping for a good outcome.
I strongly encourage you to explore technical analysis to see how it can help your trading results.
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