Contracts for Difference

This is the second part in the Technical Analysis CD from CMC Markets, and it looks at trend analysis and the head and shoulders pattern; technical theories underlined by fibonacci price ratios; and stop loss styles and capital management.

Trendlines

Rules:

1. Declines that approach an uptrend line or price rises that approach a downtrend line are often good opportunities to initiate positions in the direction of the major trend.
2. The penetration of an uptrend line is a sell signal and the penetration of a downtrend line is a buy signal.

Head and Shoulder Patterns (HSP)

The typical HSP starts with and then consists of the following aspects.

1. A strong rally climaxing on heavy trading volumes, followed by a minor dip / retracement in relatively light volumes – this is the left shoulder
2. Then a high volume advance that penetrates higher levels above point 1, then retraces to about where the previous slips was – this higher high is the head
3. Then there is a 3rd attempt at a new high but doesn’t quite get to point 2 then it retraces – this is the right shoulder
4. Then there is a decline in price that cuts through the lows on either side of the head peak – this is called the neckline

A HSP is only confirmed once the neckline is cut.

The theory is that following a cut in the neckline, the price is projected to fall to a certain level, the magnitude of which is equal to the price distance from the peak of the head back to the neckline.

Fibonacci

Fibonacci series – 1,1,2,3,5,8,13,21,34 . . . . etc

The ratio or two consecutive numbers is 1.618 inversely is 0.618 this is usually rounded to 62% and 38%. This percentages plus 50% are used by technicians in retracement analysis.

Exponential Moving Averages (EMAs)

This is a variation of the simple moving average, the practical difference is that for an equal length average, the EMA is more responsive to the latest price observations and hugs the price closer.

The EMA weighs the more recent days as more important than those days in the distant past.

Percentage Bands

Bands mathematically define for analysts whether the price has moved too far from its moving average line. Typically short term traders use 3% bands and long term traders use 10-20% bands.

Bollinger Bands

A very similar technique to percentage bands, except instead of the fixed percentage bands either side of the price you place the bollinger bands which are 2 standard deviations above and below.

A standard deviation is a mathematical measure of volatility so the bands will expand and contract with the price volatility.

The Momentum Indicator

Measures trend acceleration of price. The indicator theoretically and usually reaches a peak just before the trend in price reaches its high and reach a bottom just before prices hit their low. As long as the oscillator keeps reading new highs it is safe to hold long positions. When the indicator does not confirm what the price is doing it indicates the trend has stopped. The momentum indicator is one that compares todays closing proice to a price selected a period of time ago.

Momentum Indicator: M = Pt – P(t-n)

Where M = Momentum
Pt = Todays closing price
P(T-n) = Closing price n days

MACD: The Moving Average Convergence Divergence

Developed by Gerald Appel it combines some of the oscilltion principles with the features of a dual moving average cross over approach.  The best buy signals are given when prices are well below the zero line (oversold) and the bar column crosses from below to above the signal line.

Directional Movement Indicator (DMI)

Welles asserts that markets trend only about 30% of the time.  This model aims to permit trades only when the market is trending.

1. Directional aspect
2. Behaviour of the ADX (ADX = degree of trendiness)

Stop Loss Styles

• Visual stops
• Trailing stops
• Times tops
• Dollar value stops