Contracts for Difference

This CD took a lot more concentration than the last one, particularily since I’ve never really done any technical analysis before.  I think do the post in 3 parts since there’s so much to get my head around, and it may be a bit disjointed as it’s a brain dump.

The first section, the Mechanics of technical analysis starts off by discussing the basic types of charts including the bar chart, Japanese candlestick, line and point and figure charts.  Time frames are also very important to be aware of, and a good trade will use a combination of timeframes.

Some practical rules for finding support and resistance:

• Times tested
• Volume spent
• Recent trading
• Round numbers

1. Take a profit – as price approaches a support a short seller would take profits and conversely as price approaches a resistance long traders should have a tendancy to take profits
2. Place by orders near and above a defined support, and place sell orders near and under resistance levels
3. Establish a new position on a break of a level
4. Stop loss setting – use a breach of a level to limit your losses
5. Once broken, they reverse roles

Once you have worked out the basic trends of price and the important support and resistance levels you are able to start sketching out a plan.

Key patterns to look for:

• Rectangle
• Double top
• Triple top
• Triple bottom

Some of the basic technical analysis theories include the following:

The Moving Average

This is the basis of trend following systems.  Buy and sell signals are simple, ie when price closes above the simple moving average you have a buy signal and if the price closes below the single moving average you have a sell signal.

The Double Moving Average

Rather than use the price in the case of the simple moving average as the trigger to buy or sell, DMA uses a faster moving average as the trigger.  This technique lags the market and theoretically misses more of a profitable move but it has fewer false signals.

The Triple Moving Average

It is three double moving averages used in combination.  eg 5-15-30 or 5-13-34 are popular combinations.  The only time you are allow to buy under this system is when your fastest average is above you 2nd which is above your 3rd average.

RSI: The Relative Strength Indicator

This theory was developed by J.Welles Wilder Jr in the 1970s.  The RSI measures the strength of a market price by monitoring changes in its closing price.

RSI = 100/(100-21 + RS)

Where RS = Avg of x days up closes / Avg of x days down closes
Normally x = 14 days

RSI is a number that fluctuates between 0 and 100, horizontal lines at 30 and 70 define oversold and overbought readings.  Buy signals occur when RSI reading drops below the 30 RSI level and then crosses back above it.  Conversely sell signals occur when the RSI reading moves over the 70 RSI level and then crosses back under.

Note: you don’t sell when the RSI gets overbought, but when the RSI reading exits the overbought zone.

RSI is best for stable or ranging markets, it’s not as good for trending markets.

Stochastic Oscillators

These were popularised by George Lan in the early 1970s, and are based on the concept that the latest closing prices tend to cluster at the high end of recent price ranges in an uptrend and at the low end of ranges in a downtrend.

%K = 100 x (Cn – Ln) / (Hn – Ln)

Where:

%K = George Lane’s Stochastic Indicator
Cn = The latest close
Hn = The highest high of the past n days
Ln = The lowest low of the past n days
n = normally 14 days

This method uses the same 30 / 70 oversold and overbought zones as above.