No matter which career you choose, they all require tools to be successful. Most tools are tangible, but some are psychological, mathematical and even spiritual. As a trader and teacher, my tangible tool is a chart. Math is required to calculate my preferred market indicators, and the graphs I favor illustrate psychological and sociological behavior. As for the spiritual part, it is the euphoric feeling a trader gets when all the hard work and analysis pays off as a lucrative trade that involves minimal risk.
Basic Tools Serve a Purpose
The most valuable tool a trader must possess is a knowledge of fundamental analysis. Fundamentals drive markets. They are the forces of supply and demand, inflation, employment, sales, and earnings. Technical tools are charts that include indicators and studies. To build your own toolbox begin with the basics and purpose.
The Essentials
After researching the seemingly countless indicators and studies I concluded every tool has a use, yet they all have weaknesses as well. You do not use a hammer to cut wood, nor a saw to pound nails. Some technical tools are most effective during trends, while others are valuable signaling the end of a trend or the start of a consolidation phase.
Bar charts and trendlines were the first tools in my personal toolbox. Candlesticks eventually replaced bar charts because they illustrate momentum and often divulge a directional bias. My kit includes gauges that reveal when prices are apt to rise, fall or consolidate. Therefore, stock your box with tools that address that workload.
Though I have added a few more tools to the chest I still rely on those original ones today. Technicians build strategies by organizing data (open, high, low, close) into recognizable patterns. All the information we need to create trade signals is in the price action. In my attempts to find the ideal tools (indicators) I have found that I need just a few to keep analysis simple and logical. An overloaded chart may give conflicting signals and freeze the trader, like a deer in headlights.
Define Value
When a market is in consolidation mode, it usually forms a pattern that defines fair value. The most common patterns take the shape of flags (rectangles) or pennants (triangles). When a trend line is penetrated, it is a signal that a breakout has begun. The longer a market spends developing a horizontal pattern, the bigger the vertical move may be after violating the pennant or flag formation.
Another pre-breakout identifier is when a short-term fast-moving average (5-day exponential) and longer-term moving average (20-day simple MA) have converged for 6 to 10 days. A sharp vertical move frequently occurs when these MAs are convergent over a couple of weeks. On the other hand, when these moving averages are historically divergent for a week or 2, a consolidation phase often follows. Check out the MACD (moving average convergence divergence) indicator to add to your toolbox.
Enhance the Timing of Entry
I found the best time to enter trades is when a channel or triangle is violated after the first hour of the day or the last 30 minutes of the session. Liquidity is high during those times, thus the move higher or lower occurs because the prime-time players are typically active when volume and liquidity are peaking. Therefore, the tool I prefer to track intraday momentum and enhance entry time is a 30-minute candlestick chart.
During my career at the Chicago futures exchanges, I had many mentors who introduced me to various tools and disciplines. The tools mentioned above are the foundation for becoming a better market analyst and trader.
John Seguin
Senior Technical Analyst
Market Taker Mentoring
