Last week, we looked at 3 Major Strategies that can help you garner maximum profits in the stock market today.
This week, before we illustrate to you the exact rules of the strategy that we have proposed as part of our line of articles on Stock Market Strategies you read every monday, it is important for you to understand the indicators and charts that are commonly used in the trading process.
In addition, we shall also explain to you how, why and where these charts and indicators are used.
The first step, before we set the stage for executing a strategy, is to choose the timeframe in which you wish to work.
In the present context, the strategy that we have illustrated in this book is a day trading strategy.
Now, you need to choose a chart that can help you see the intraday trading details.
You possess three options in this regard and you can choose any one of the options available to you.
As the name suggests, the time-based charts work on the basis of the specified time intervals.
For instance, if you specify the time interval as 5 minutes, then you will see a new spike, bar or value indicator after every 5 minutes have lapsed.
When charting pricing action, the data presented by these charts has been found to be inadequate.
In addition, these charts also suffer from many other disadvantages, which cannot be compromised upon.
This type of a chart is also called tick-based chart in light of the fact that it relies on the number of ticks or trades that have occurred in the market before a spike or bar is raised on the chart displayed to you.
As a result, when the market is active, you will see a busier chart.
However, as the market slows down, you will notice that the chart has also slowed down significantly.
This chart is considered a better alternative when compared to time-based charts.
However, the next chart is assumed to be the best chart out of the three.
These charts are popularly called range bars for the reason that a bar or spike is created on the chart whenever the range value, which has been specified as the threshold value, is exceeded.
So, if the threshold value is 2 points, then whenever the prices rise by more than 2 points, a spike or bar can be seen on the chart.
Although, you can use the strategy mentioned in this book with any of the charts illustrated above, the use of volatility-based charts is recommended.
Within the scope of this book, we will cover three indicators, which are as follows:
Bollinger bands consist of three lines namely, upper Bollinger band, centerline and lower Bollinger band.
The centre line indicates the moving average while the upper/lower bands indicate a standard deviation above/lower than the moving average.
Regardless of the software you use, you will need to specify two things to plot Bollinger bands – number of bars to be considered for calculating the moving average and standard deviation value.
For the strategy that we are using in this book, you will need to use these values as 12 and 2 respectively.
Moreover, you can omit the centrebline, as you just need the upper and lower Bollinger bands.
Moving Average Convergence and Divergence (MACD)
There are three components of the second indicator on our list – MACD.
The difference between the slow moving and the fast moving averages is called MACD.
The exponential moving average of MACD is referred to as the signal line.
The difference MACD and signal line is represented by the histogram.
When the value of MACD is above signal line, the histogram value is above zero.
However, when MACD is lower than signal line, the histogram value is lesser than 0.
The zero indicator of the histogram is called the zero line and the histogram keeps oscillating above and below the zero line.
For our strategy, we will keep the values as follows:
Slow Moving Average = 26
Fast Moving Average = 12
Signal Line = 9
It is also a good strategy to color the chart on the basis of the MACD value to improve the readability and user understanding.
If the MACD value is higher than signal line, the bar should be colored in green.
This green bar shall indicate bull market situation.
However, if the MACD value is lower than the signal line, then the bar must be colored in red and this shall indicate a bear market condition.
This is an optional step.
However, it is still a good idea to help you read charts better and more effectively.
It is also important to mention here that MACD green bar alone cannot be an enough parameter to give you an entry signal.
However, it is certainly a signal for you to start looking for options and long trade opportunities.
On the contrary, when the bar is red or MACD is below signal line, it is time for you to start looking for selling opportunities.
Relative Strength Index (RSI)
The RSI, created by Welles Wilder, is an optional indicator for you to use as far as the strategy illustrated in this book is concerned.
However, the use of the same will certainly be beneficial in helping you identify strong trends as and when they appear.
The RSI indicator can be seen as an oscillator that measures and weighs the weaknesses and strengths of the market and in terms of values, the indicator keeps oscillating between the numeric values, 0 and 100.
If the number is closer to the lower end, the market can be assumed to be weak while a higher number indicates a stronger market.
In order to plot this chart, you just need to give a parameter, which indicates the number of bars that the system must analyze to determine the relative strength/weakness of the market.
For the strategy specified in this book, this value must be kept at 7.
Just like the MACD, the RSI indicator values can also be color-coded.
For RSI values lesser than 30, the triangles above the bar must be red in color.
However, if the value of RSI is greater than 70, the same triangles must appear green in color.
Again, the use of color-coding is optional and you can do just as well without it.
However, the use of color-coding makes it a touch simpler to assess and identify trends.
Since, we’ve familiarised ourselves with various charting techniques available to us in the market, next week, we’ll take a quick look at a concise group of effective strategies for trading stocks.
So, read on at www.stockmarketsignals.com