Saturday, January 12, 2008

Thoughts on Technical Trading

I consider myself to be primarily a technical trader. By that I mean I make my trading entry and exit decisions based on what I see on price and volume charts and with the use of some favorite indicators. I do not mean to suggest that I completely ignore fundamentals because I don't. However, fundamentals give me little information about when to enter and, even more importantly in my view, when to exit a position. As has often been said, fundamentals can tell us what to buy, but give us little information on when to buy it. Technicals, on the other hand can provide the "when" of a trade.

I have heard the argument that technical traders just expect history to repeat itself and while history may, indeed, repeat itself at times, that is not the primary reason for my use of technicals in the decision making process. The old cliche that traders need to cut losses and let profits run in order to succeed is axiomatic. Unfortunately, most unsuccessful traders do just the opposite; they cut their profits and let their losses run. My best guess is that they do things "bass akwards" because they simply don't know how and when to either cut losses or let profits run. I have reached the conclusion for myself that technical analysis is a very effective way to achieve the goal of cutting losses before they get out of hand and of staying in a play without prematurely cutting profits. Appropriate use of lines on a chart will at least remove the danger of making entries and exits on the basis of emotion and achieving that goal can vastly improve the average retail trader's chances of attaining profitability. In my view, while the line on a chart may be an artificial device it can create the discipline necessary to successful trading.

I recently received an email from a subscriber to one of my paid services who said that I had not set an exit or a target in the alert I sent about one of my trades. What I had written in the alert was that I was using the uptrend line as my exit. I had purchased the stock as it bounced up off an uptrend line so I had set an exit -- a violation of the uptrend line -- whenever that might occur. As long as the stock kept going up, the trend line would go up and as long as the stock remained above the trend line, I would continue to make money. If the stock suddenly turned down and broke through the trend line, I would exit, thereby cutting my loss. I wrote the subscriber and told him that I did not set targets because a target can result in getting out too early. If we set a target and get out when it is hit, what is to say that the stock price may just continue going on past the target? If we exit when the target is hit, we may have just cut our profits. If, on the other hand, we continue the use of the trend line, we would not exit until the trend line is violated and, in that case, the stock is no longer in the same trend so we have let our profits run until the trend we are using has ended.

When I write that I do not use a target as explained above, I do not mean to indicate that I am unaware of support and resistance levels. If I am in a bullish play and the stock price is approaching a resistance, that may well be a good reason to tighten a stop on the theory that the stock may turn back down at the previous resistance, but if it goes on through and continues up, that is fine with me and I have not taken myself out prematurely.

I have just used the trend line as an example of a way to use technical analysis. There are many methods used by technicians to determine entries and exits. Years ago, I gave a talk where I demonstrated the use of moving averages as a way to enter and exit positions. Much like a trend line, one could enter a bullish position on a bounce up off a moving average and exit on a break below that same moving average. One could use a MACD reversal, for example, from negative to positive as an entry and the opposite as the exit. The methods are legion. Before using any, however, the trader should study and practice the device he is considering and only when he determines that it fits his personal requirements should he incorporate it into his personal business trading plan.

by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved

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Anonymous said...

Bill, thanks so much for the review on exit points. I have been getting out of my positions too soon. This month I bought BDGR at .02 and sold a couple of days later at .025. I was happy with the 25% gain, but BDGR continued to almost .10. I'm rewriting my exit plan.


Anonymous said...

I am still in the learning process and am a "technical trader". I use support and resistance and trendlines for entry and exit. My question is what indicators are more "important", horizantal support and resistance at previous swing highs and lows or uptrending and downtrending trendlines? Also, can you direct me to some good resources on technical trading?

Bill Kraft, said...

Thanks for writing, Tom. Glad to hear you are reviewing your exit plan. Review of all parts of one's trading plan is an important ingredient to success in my estimation. Keep up the good work.

Bill Kraft, said...

Dear spmdpm,

I don't know that I can say that one type of support is more "important" than another. Much depends on the individual's trading plan. Price supports and resistances (the horizontal ones) can give a good idea for entries and exits for certain strategies such as the often very lucrative iron condors or spreads while trend supports or resistances can provide very helpful information for directional trades. I would suggest you take a look at my new book, "Trade Your Way to Wealth," to see how some of these strategies interrelate to technical analysis. Martin Pring's "Technical Analysis Explained" is a very detailed work on technicals alone. Thanks for writing.