About This Book 1

Foolish Assumptions 3

Icons Used in This Book 3

Beyond the Book 4

Where to Go from Here 4

Part 1: Getting Started with Technical Analysis 5

Chapter 1: Introducing Technical Analysis 7

Stepping Up to Science 9

Unpacking Lingo 10

Buy-and-Hold Is Bunk 11

Recognizing Who Uses Technical Analysis 13

Remembering the Trend Is Your Friend 13

Charting your path 14

Picking a time frame 14

Viewing the Scope of Technical Analysis 15

Charting 16

Market timing 16

Trend-following 16

Technical analysis 16

Algorithmic trading 17

Why Technical Analysis Works and What Can Go Wrong 20

Setting new rules 21

Controlling losses to protect gains 21

Why Technical Analysis Gets a Bad Rap 22

Beating the Market Is Hard Work 23

Finding Order 24

What You Need to Get Started 25

Chapter 2: Tapping into the Wisdom of the Crowd 27

Securities Are Not Socks 28

The eBay Model of Supply and Demand 30

Securities have their own economics 30

Creating demand from scratch 31

Identifying Crowd Behavior 32

Defining Normal 33

Reverting to the mean 33

Trading mean reversion 34

Breaking Normal 35

Going against the grain: Retracements 36

Recognizing why retracements happen 37

Accepting When the Crowd Is Extreme 40

Avoiding stampedes 41

Lesser devilry — playing games with traders’ heads 42

Chapter 3: Trade What You See: Market Sentiment 43

The Origin of Market Sentiment 44

Thinking Outside the Chart: Defending Sentiment 47

Monitoring investors: The bull/bear ratio 47

Following the money: Breadth indicators 47

Viewing volatility: The VIX 48

New and improved sentiment indicators 48

Getting the Lowdown on Volume 49

Tracking on-balance volume 50

Refining volume indicators 50

Leading the way with spikes 51

Getting a two-for-the price-of-one coupon 52

Blindsiding Yourself 52

Understanding confirmation bias and anchoring 53

Being aware of potential errors 54

Thinking Scientifically 55

Humility: Conditions and contingencies 55

Sample size 56

Chapter 4: Gaining Critical Advantage from Indicators 59

Overcoming Noise 60

Distinguishing between noise and an Event 61

Knowing where noise comes from 61

Noise from inside the market 62

Indicators Give You the Edge 62

Classifying indicators 63

Understanding what indicators identify 64

Choosing your trading style 64

Examining How Indicators Work 66

Finding relevant time frames 66

Heeding indicator signals 67

Establishing Benchmark Levels 69

Choosing Indicators 70

Examining Indicators in Detail 71

Constructing a backtest 71

The other top metrics 73

Fixing the indicator 73

Evaluating the risks of backtesting 74

Chapter 5: Managing the Trade 75

Finding Your Risk Profile 76

What’s your ratio? 76

Introducing positive expectancy 76

Measuring the trade 77

Considering your stake 77

Adhering to the no-guru rule 78

Building Trading Rules 78

Creating your trading plan with four easy rules 79

Combining indicators with trading rules 79

Trading styles 80

Knowing How Much Is Enough 81

Using the First Line of Defense: Stop-Loss Orders 81

Mental stops are hogwash 82

Sorting out the types of stops 83

Chapter 6: Taming Uncertainty: How to Use Technical Analysis 87

Numbers Are Better than Words 87

Distinguishing between feeling and thinking 88

Realizing cognitive psychology is useful to technical trading 88

Between a rock and a hard place 90

Introducing Positive Expectancy 91

Measuring the trade 92

Considering your stake 92

Adopting the Technical Mindset 94

Chapter 7: Slicing the Pie 95

Adjusting Positions 96

Scaling in 96

Scaling out 97

What Is Asset Allocation? 97

Tharp method 98

Vince method 98

Chapter 8: Using AI in Technical Analysis-Based Trading 101

Exploring the Wonders of Perfect Memory 102

Reviewing the Drawbacks of Using AI 103

Not knowing what to ask 103

Incomplete training 104

Cost 105

Picking an AI Program 105

Getting Acquainted with AI Tools 106

Part 2: Building Indicators From the Ground Up 109

Chapter 9: Reading Basic Bars: How to Pounce on Opportunities 111

Building Basic Bars 112

Reality in a nutshell 112

Setting the tone: The opening price 114

Summarizing sentiment: The closing price 115

Going up: The high 117

Getting to the bottom of it: The low 119

Putting It All Together: Using Bars to Identify Trends 119

Identifying an uptrend 120

Pinpointing a downtrend 121

Overcoming Murky Bar Waters 121

Paying heed to bar series 122

Knowing when bar reading doesn’t work 122

Framing Your Bars 123

Using daily data 124

Zooming out to a higher time frame 124

Zooming in to a shorter time frame 125

Applying Bar Reading in Real Time 128

Chapter 10: Special Bars: An Early Warning System 129

Finding Clues to Trader Sentiment 129

Tick and bar placement 130

Williams three-bar system 130

Trading range 131

Identifying Common Special Bars 132

Closing on a high note 132

Spending the day inside 133

Getting outside for the day 133

Finding the close at the open 133

Decoding Spikes 133

Getting Gaps 135

Pinpointing a gap 135

Using gaps to your advantage 137

Filling the Gap 141

Using the Trading Range as a Tool 142

Paying attention to a changing range 142

Determining the meaning of a range change 143

Looking at the average trading range 144

Chapter 11: Redrawing the Price Bar: Japanese Candlesticks 149

Appreciating the Candlestick Advantage 150

Dissecting the Anatomy of a Candlestick 150

Drawing the real body 151

Doing without a real body: The doji 152

Catching the shadow 152

Sizing Up Emotions 155

Identifying Special Emotional Extreme Candlestick Patterns 157

Interpreting candlestick patterns 157

Turning to reversal patterns 159

Bearish engulfing candlestick 159

Shooting star 159

Continuation patterns 159

Combining Candlesticks with Other Indicators 161

Trading on Candlesticks Alone 163

Part 3: Finding Patterns 165

Chapter 12: Seeing Patterns 167

Introducing Patterns 168

Using imagination 168

Coloring inside the lines 170

Cozying Up to Continuation Patterns 170

Ascending and descending triangles 170

Dead-cat bounce 171

Cup and handle 172

Recognizing Classic Reversal Patterns 173

Double bottom 173

Double tops 175

The ultimate triple top: Head-and-shoulders 176

Evaluating the Measured Move 177

Taking dictation from the pattern 177

Resuming the trend after retracement 179

Measuring from the gap 179

Current-day warning 179

Chapter 13: Drawing Trendlines 181

Looking Closely at a Price Chart 182

Following the Rules with Rule-Based Trendlines 182

Drawing support and resistance lines 182

Using the support line to enter and exit 183

Noting breakouts and false breakouts 184

Using resistance to enter and exit 185

Being aware of the 1-2-3 Rule 187

Playing games with support and resistance lines 188

Do Prices Pivot? 189

Drawing Internal Trendlines 191

Rules for drawing a linear regression 191

Identifying trendedness 192

Using the linear regression 194

Chapter 14: Transforming Channels into Forecasts 197

Diving into Channel-Drawing Basics 197

The swing bar problem 198

Drawing channels by hand 198

Benefitting from channels 200

Delving into the drawbacks of channels 201

Channeling to make gains and avoid losses 201

Riding the Regression Range 201

Introducing the standard deviation 202

Drawing a linear regression channel 202

Confirming hand-drawn channels 204

Sizing up the special features of the linear regression channel 204

Discovering the drawbacks of linear regression channels 205

Dealing with Breakouts 206

Distinguishing between false breakouts and the real thing 207

Putting breakouts into context 210

Part 4: Dynamic Analysis 213

Chapter 15: Using Dynamic Lines 215

Introducing the Simple Moving Average 216

Starting with the crossover rule 217

Using the moving average level rule 219

Dealing with limitations 220

Comparing moving average rules with Donchian rules 223

Magic moving average numbers 223

Adjusting the Moving Average 224

Weighted and exponential moving averages 225

Adaptive moving averages 225

Wild and woolly moving averages 226

Choosing a moving average type 226

Using Multiple Moving Averages 227

Putting two moving averages into play 228

Trying the three-way approach 229

Throw them all at the wall and see what sticks 230

Delving into Moving Average Convergence and Divergence 231

Calculating convergence and divergence 232

Creating a decision tool 233

Interpreting the MACD 234

Chapter 16: Measuring Momentum 237

Doing the Math: Calculating Momentum 238

Simple momentum 239

Using the rate-of-change method 240

Pondering the Trickier Aspects of Momentum 242

Smoothing price changes 242

Filtering momentum 243

Applying Momentum 244

Discovering divergence 244

Confirming trend indicators 245

Determining the Relative Strength Index (RSI) 245

Calculating the RSI 246

Picturing RSI 247

Filtering RSI 249

Using the Rest of the Price Bar: The Stochastic Oscillator 250

Step 1: Putting a number to the fast stochastic %K 250

Step 2: Refining %K with %D 252

Fiddling with the stochastic oscillator on the chart 252

Chapter 17: Estimating Volatility 255

Catching a Slippery Concept 256

How volatility arises 257

Low volatility with trending 257

Low volatility without trending 258

High volatility with trending 258

High volatility without trending 258

Measuring Volatility 259

Tracking the maximum move 259

Considering the standard deviation 260

Using the average true range indicator 260

Applying Volatility Measures: Bollinger Bands 262

Applying Stops with Average True Range Bands 263

Chapter 18: Ignoring Time to Create Better Timing 267

Focusing on Tick Bars: In the Spirit of Ignoring Time 268

Narrowing the Focus to the Move Itself: The Constant Range Bar 269

Defining a constant range bar 269

Identifying what criteria are needed 270

Catching the Big Kahuna: Point-and-Figure Charts 270

Visualizing What’s Important 271

Putting each move into a column 271

Dealing with box size 273

Applying Patterns 274

Support and resistance 274

Double and triple tops and bottoms 275

Projecting Prices after a Breakout 276

Using vertical price projection 276

Applying horizontal projection 277

Combining P&F Techniques with Other Indicators 278

Chapter 19: Combining Techniques 279

Adding a New Indicator: Introducing Complexity 280

Choosing primary and secondary indicators 281

Inserting unexpected validators 281

Studying a classic combination 282

Sailing into Outer Space 286

The Conquistador 286

Wave with relative strength 287

Enhancing gains with selective timing 288

Trading with Limited Expectancy: Semi-System, Setup, and Guerilla Trading 288

Semi-system “discretionary” trading 289

Solving the squaring problem — setups 290

Guerrilla trading 293

Chapter 20: Judging Cycles and Waves 295

Defining a Cycle and a Wave 295

Starting with economics 297

Combining market metrics with cycles 298

Moving on to magic numbers 299

Using cycles 299

Cycling with Supply and Demand: The Pragmatic Mr Wyckoff 300

Finding Universal Harmony: Hurst’s Magic Numbers 301

Looking to the Moon and the Stars 302

Examining the lunar cycle 302

Adding more celestial bodies 303

Including the sun 303

Figuring out what’s (maybe) wrong with astronomy cycle theories 303

Following the Earth’s Axis: Seasonality and Calendar Effects 304

Differentiating between seasonality and calendar effects 304

The most well-known calendar effects 304

Examining Big-Picture Cycle Theories 305

Shining a Spotlight on the Magnificent Mr Gann 306

Applying core Gann concepts 306

Celebrating Gann’s 50 percent retracement rule 307

Embracing the Most Popular Wave Idea: The Elliott Wave 308

Looking closer at the Elliott Wave 309

Validating retracements 310

Chapter 21: The Mind-Blowing Ichimoku 313

Taking a Closer Look at Ichimoku 313

Defining ichimoku and its characteristics 314

Eyeing ichimoku’s differences with conventional technical analysis 314

Adapting to new core concepts 315

Building a cloud: Starting with moving averages 316

Grasping Why Analysts Rely on Ichimoku and Why You Can 319

Using Ichimoku in Your Analysis 321

Venturing inside the cloud 321

Changing time frames 321

Trading with Ichimoku 322

Part 5: the Part of Tens 325

Chapter 22: Ten Secrets of the Top Technical Traders 327

Appreciate Probability 328

Recordkeeping Matters 328

The Trend Is Your Friend 328

Entries Count as Much as Exits 329

Stops Aren’t Optional 329

Treat Trading as a Business 330

Eat Your Spinach 330

Technical Stuff Never Goes Out of Date 331

Diversify 331

Swallow Hard and Accept Some Math 332

Chapter 23: Ten Rules for Working with Indicators 333

Don’t Jump the Gun 333

Defeat Your Math Gremlins 334

Embrace Patterns 334

Use Support and Resistance 335

Follow the Breakout Principle 335

Watch for Convergence and Divergence 335

Backtest or Practice-Trade Honestly 336

Accept That Your Indicators Will Fail 337

Get Over the Idea of Secret Indicators 337

Open Your Mind 338

Appendix: Additional Resources 339

Index 345