The most important things | In search of the alpha

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Sometimes it’s hard to know where to start. When we look at charts or go to the market for trading ideas, thousands of pieces of information compete for our attention. In this article, I’ll share an overview of some of the key technical factors that I take into account when making a transaction. I think they are the most important items on a chart.

The problem is, most of the information is, frankly, unnecessary. Much of the information overlaps and most of it will not move the markets as people expect. Unless we can focus our attention on the things that really have the power to shape the future course of prices, we are doomed to eventual failure.

Here are four things that help sort out the right potential business candidates from markets that should be avoided.

  • Presence or absence of a longer term trend
  • Short-term volatility versus long-term volatility
  • All real support and resistance levels nearby
  • Significant short-term models

Let’s look at these one at a time:

Longer term trend

The presence or absence of a trend is clearly one of the most important factors in financial markets. We are not suggesting a naïve ‘follow the trend’ approach, but knowing whether there is a trend or not will help you avoid markets that spin at random. Knowing whether you are trading in alignment or against an existing trend has important implications for the management of the trade.

Fortunately, it’s not too difficult to identify trending and non-trending markets! We can look at a chart over a longer period of time, but we can also just look at a chart and notice if the prices are going up or down, or if they are relatively stable. Here is a market with a good uptrend:

Here’s a relatively flat market that would likely offer frustrating trading for most styles:

Recent volatility in context

Volatility is just a number. This in and of itself doesn’t tell us much, but knowing whether a market has become more or less volatile recently can give us significant insight into what is to come. To a very real extent, any trade is a forecast of future volatility conditions. Here is an example of a market that has recently become much more volatile:

And here’s a market where recent volatility could dry up:

Trading this aspect of a market is not necessarily straightforward, but understanding what is likely to happen to volatility in the near future can give us some clues as to. How? ‘Or’ What this market can move – certain conditions can give us an advantage for clear moves, for prolonged moves, or sometimes tilt in favor of failure.

And here’s another nugget: A rapid change in volatility, such as new momentum from a consolidation, has a quantifiable benefit for the pursuit.

Support and resistance

I know this is an extremely unpopular opinion with much of the social media trading world, but my trading experience and quantitative testing led me to a firm conclusion: support and resistance. just don’t work the way people think. Most of the levels where people expect support and resistance don’t make sense, and you can’t trust your subjective sense of what works.

However, some levels are real and powerful. A short list of the levels we pay special attention to:

  • Highs / lows of all time
  • Annual highs / lows
  • Visible and obvious points of the graph
  • Our power levels

The action around these levels can often be revealing, and some of them (eg, 52 week highs) have clearly quantifiable trends. (Note that there are follow-up trades here as well, as some of them tend back and forth, depending on how long they’ve been hit.) When we see a market continually hitting all-time highs, it does tells us something:

Short-term models

These can be complicated as this is where everyone wants to start. The most recent traders say (quite reasonably), “Just show me patterns that tell me where the market is going to go!” The problem is, these models are more meaningful when placed in context, and each has its time and place.

Here is a list of some of the models that we find significant. Some of them cover 2-3 bars, and some are a bit bigger:

  • Flags or consolidations
  • Nested flags
  • Rapid climax of the ‘up / down’ trend
  • Antis
  • Our standard trend termination models
  • Small patterns such as NR7, ID / NR5, etc.

How to use these

The next time you look at a chart, try using this frame. It takes time and experience (for example, to understand short-term trends or inflections in volatility), but working on a quick checklist like this can probably add to what you’re already doing, and can even show you new directions for profitability.

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Editor’s Note: The bullet points for this article were chosen by the editors of Seeking Alpha.

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