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The Traders Wheel
9/5/99 by Alan Farley

Signals Within The Noise

 

Technical tools must address both numbers and emotions to locate promising trade setups. While state of the art software builds very complex buy or sell signals, most technical indicators miss important elements of the crowd behavior that ultimately drives price change. For this essential task, turn to the visual examination of recurring price and volume patterns. But don’t rely on patterns alone. Instead, combine both forms of analysis and command a highly accurate trading system.

Effective pattern analysis uncovers crowd behavior by finding positive feedback (signal) within the random price movement (noise) of stock charts. Classic formations contain response fractals that predict how volatility and price movement will evolve over time. A seasoned pattern reader can ignore mathematics (and fundamentals) when underlying price development paints a clear picture. But most traders still need to apply math-based technical indicators to confirm important observations.

Each technical indicator has its own unique fingerprint. These can be found in their repetitive patterns. In fact, many print formations very similar to price bars. For example, On Balance Volume often develops a head and shoulders formation that has great predictive value. But even the best math-based indicators contain both signal and noise. Learn their unique patterns to determine when to listen to their message and when to ignore them.

Every good analysis should validate current conditions through both forward (strength) oscillators and backward (momentum) indicators. Use popular oscillating tools, such as Relative Strength Index (RSI) and Stochastics, to identify overbought/oversold markets. Moving Averages and Moving Average Convergence-Divergence (MACD) provide the horsepower needed to look back and measure momentum change. Or just draw simple trendlines and channels in all time frames and use those instead as your momentum indicators.

Bollinger Bands offer important feedback to the short-term trader. This modern tool measures divergence between price movement and the underlying trend. It displays output by wrapping around the price bars themselves. Use these bands in conjunction with candlestick charting as a powerful swing prediction system. These lesser-known indicators reveal valuable chart landscape features and should find a place in every trader's toolbox.

Stock analysis tools can be applied equally to all time frames. Day traders should pack as much information as they can into their 5-min price charts. Very short-term Bollinger Bands effectively capture intraday support and resistance while a 5-bar Stochastics measures the oscillation of buying and selling behavior.

 

 

Alan Farley is a full-time trader and author residing in Denver, CO. He publishes The Hard Right Edge premier web site for trader education, technical analysis and trader resources featuring both Morning Trader and Traders Workshop. The site provides traders with comprehensive resources including original tactics and strategies on multi-trend technical analysis and short-term trading .

  Alan also authors on-line training technical analysis in association with independent sites. His most recent publications include the Mastering The Trade on-line workshop, Momentum: Riding The Tiger, and Time of Day. In addition to writing, he is an outstanding speaker and lecturer on short term trading strategies.

 He has been featured in Barrons, Smart Money magazine, Tech Week, MoneyCentral and TheStreet.com.

 

 

 

 
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Last modified: April 02, 2001

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