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How
to Read a Chart & Act Effectively
Introduction
This is a guide
that tells you, in simple understandable language, how to choose
the right charts, read them correctly, and act effectively in the
market from what you see on them. Probably most of you have taken
a course or studied the use of charts in the past. This should add
to that knowledge.
Recommendation
There are several
good charting packages available free. Netdania is what I use.
Using charts
effectively
The default
number of periods on these charts is 300. This is a good starting
point;
Hourly chart
that’s about 12 days of data.
15 minute chart its 3 days of data.
5-minute chart it’s slightly more than 24 hours of data.
You can create multiple "tabs" or "layouts"
so that it’s easy to quickly switch between charts or sets
of charts.
What to look
at first
1. Glance at
hourly chart to see the big picture. Note significant support and
resistance levels within 2% of today’s opening rate.
2. Study the
15 minute chart in great detail noting the following:
Prevailing trend
Current price in relation to the 60 period simple moving average.
High and low since GMT 00:00
Tops and bottoms during full 3 day time period.
How to use the
information gathered so far
1. Determine
the big picture (for intraday trading).
Glancing at
the hourly chart will give you the big picture – up or down.
If it’s not clear immediately then you’re in a trading
range. Lets assume the trend is down.
2. Determine
if the 15 minute chart confirms the downtrend indicated by big picture:
Current price
on 15-minute chart should be below 60 period moving average and
the moving average line should be sloping down. If this is so then
you have established the direction of the prevailing trend to be
down.
There are always
two trends – a prevailing (major) trend and a minor trend.
The minor trend is a reversal of the main trend, which lasts for
a short period of time. Minor trends are clearly spotted on 5-minute
charts.
3. Determine
the current trend (major or minor) from the 5 minute chart:
Current price
on 5-minute chart is below 60 period moving average and the moving
average line is sloping downward – major trend.
Current price
on 5-minute chart is above 60 period moving average and the moving
average line is sloping upward – minor trend.
How to trade
the information gathered so far
At this point
you know the following:
Direction of the prevailing trend.
Whether we are currently trading in the direction of the prevailing
(major) trend or experiencing a minor trend (reaction to major trend).
Possible trade
scenarios:
1) Lets assume
prevailing (major) trend is down and we are in a minor up-trend.
Strategy would be to sell when the current price on 5-minute chart
falls below the 60 period moving average and the 60 period moving
average line is sloping downward. Why? Because the prevailing trend
is reasserting itself and the next move is likely to be down. Is
there more we can do? Yes. Look for further confirmation. For example,
if the minor trend had stalled for a while and the lows of the past
half hour or hour are very close to the 5 minute moving average
then selling just below the lows of the past half hour is a better
place to enter the market then just below the moving average line.
2) Lets assume
prevailing (major) trend is down and 5-minute chart confirms downtrend.
Strategy would be to wait for a minor (up trend) trend to appear
and reverse before entering the market. The reason for this is that
the move is too “mature” at this point and a correction
is likely. Since you trade with tight stops you will be stopped
out on a reaction. Exception: If market trades through today’s
low and/ or low of past three days (these levels will be apparent
on the 15 minute chart) further quick downward price action is likely
and a short position would be correct.
3) A better
strategy assuming prevailing trend down, 5-minute chart down, and
just above days lows is to BUY with a tight stop below the day’s
low. Your risk is limited and defined and the technical condition
(overdone?) is in your favor. Confirmation would be if today’s
low was a bit higher than yesterday’s low and the price action
indicated a very short-term trading range (1 minute chart) just
above today’s low. The thinking here is that buyers are not
waiting for a break of today’s or yesterday’s low to buy
cheaper; they are concerned they may not see the level.
4) Generally
speaking, the safest place to buy is after a sustained significant
decline when the bottoms are getting higher. Preferably these bottoms
will be hours apart. By the third or forth higher bottom it is clear
a bottom is in place and an up-move is coming. As in the example
above your risk is limited and defined – a low lower than the
last low.
5) The reverse
is true in major up-trends.
Other chart
ideas
There are always two trends to consider – a major trend and
a minor trend. The minor trend is a reversal of the major trend,
which generally lasts for a short period of time.
Buying above old tops and selling below old bottoms can be excellent
entry levels; assuming the move is not overly mature and a nearby
reaction unlikely.
When a strong up move is occurring the market should make both higher
tops and higher bottoms. The reverse is true for down moves- lower
bottoms and lower tops.
Reactions (minor reversals) are smaller when a strong move is occurring.
As the reactions begin to increase that is a clear warning signal
that the move is losing momentum. When the last reaction exceeds
the prior reaction you can assume the trend has changed, at least
temporarily.
Higher bottoms always indicate strength, and an up move usually
starts from the third or fourth higher bottom. Reverse this rule
in a rising market; lower tops…
You will always make the most money by following the major trend
although to say you will never trade against the trend means that
you will miss a lot of opportunities to make big profits. The rule
is: When you are trading against the trend wait until you have a
definite indication of a selling or buying point near the top or
bottom, where you can place a close stop loss order (risk small
amount of capital). The profit target can be a short-term gain to
nearby resistance or more.
Consider the normal or average daily range, average price change
from open to high and average price change from open to low, in
determining your intra-day price targets.
Do not overlook the fact that it requires time for a market to get
ready at the bottom before it advances and for selling pressure
to work it’s way through at top before a decline. Smaller loses
and sideways trading are a sign the trend may be waning in a downtrend.
Smaller gains and sideways trading in an up trend.
Fourth time at bottom or top is crucial; next phase of move will
soon become clear… be ready.
Oftentimes, when an important support or resistance level is broken
a quick move occurs followed by a reaction back to or slightly above
support or below resistance. This is a great opportunity to play
the break on the “rebound”. Your stop can be super tight.
For example, EURUSD important resistance 1.0840 is broken and a
quick move to 1.0860, followed by a decline to 1.0835. Buy with
a 1.0820 stop. The move back down is natural and takes nothing away
from the importance of the breakout. However, EURUSD should not
decline significantly below the breakout (breakout 1.0840; EURUSD
should not go below 1.0825.
After a prolonged up move when a top has been made there is usually
a trading range, followed by a sharp decline. After that, a secondary
reaction back near the old highs often occurs. This is because the
market gets ahead of itself and a short squeeze occurs. Selling
near the old top with a stop above the old top is the safest place
to sell.
The third lower top is also a great place to sell.
The same is true in reverse for down moves.
Be careful not to buy near top or sell near bottom within trading
ranges. Wait for breakaway (huge profit potential) or play the range.
Whether the market is very active or in a trading range, all indications
are more accurate and trustworthier when the market is actively
trading.
Limitations
of charts
Scheduled economic
announcements that are complete surprises render nearby short-term
support and resistance levels meaningless because the basis (all
available information) has changed significantly, requiring a price
adjustment to reflect the new information. Other support and resistance
levels within the normal daily trading range remain valid. For example,
on Friday the unemployment number missed the mark by roughly 120,000
jobs. That’s a huge disparity and rendered all nearby resistance
levels in the EURUSD meaningless. However, resistance level 200
points or more from the day’s opening were still meaningful
because they represented resistance to a big up move on a given
day.
Unscheduled
or unexpected statements by government officials may render all
charts points on a short-term chart meaningless, depending upon
the severity of what was said or implied. For example, when Treasury
Secretary John Snow hinted that the U.S. had abandoned its strong
U.S. dollar policy.
By Jimmy Young
EURUSDTrader
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