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The Complete Guide to Day Trading

The Complete Guide to Day Trading

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11/15/2013

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Here is how technical analysis is defined:

“The basic foundations or premises of technical analysis are
that a stock's current price discounts all information available in
the market, that price movements are not random, and that pat-
terns in price movements, in very many cases, tend to repeat
themselves or trend in some direction.

Therefore technical analysis involves the study of a stock's trad-
ing patterns through the use of charts, trendlines, support and
resistance levels, and many other mathematical analysis tools, in
order to predict future movements in a stock's price, and to help
identify trading opportunities.”

Source: www.daytrading.about.com

In summary, there are three main points that a technical analyst applies:

1.) Market action discounts everything. Regardless of what the
fundamentals are saying, the price you see is the price you get.

2.) The price of a given security moves in trends.

3.) The historical trading patterns of a security will tend to repeat.

All three of the points above are important, but the first is the most criti-
cal. It’s vital that you understand this point, because it’s the basis of our
approach to trading.

When you look at the price of any financial instrument as a technical
analyst, you believe that it’s the true value of the instrument as the mar-
ket sees it.

I believe in technical analysis for a couple of reasons.

Step 3: Selecting a Trading Approach

91

1.) The markets are driven by greed and fear, and not by supply and
demand. An economic report itself is meaningless: it is traders’
reactions to the report that moves the market.

Price data is more “objective.” You can interpret financial data
and economic reports any way you want, but support levels are
support levels, and a weekly high is a weekly high. It’s easier to
interpret hard facts more than financial statements, because
many times these statements might be misleading.

Example: IBM announces that it will meet the projected sales
targets, and the shares drop like a rock, because traders hoped
that IBM would exceed its goals. Another day, DELL announces
that they will meet their targets, and the shares jump up, because
traders didn’t believe that DELL would make it due to the “diffi-
cult economic environment.”

2.) It’s easier (and therefore faster) to learn technical analysis. You
can learn the basics by reading a couple of books, whereas you
need to study micro- and macro-economics to master funda-
mental analysis. And even then, you might be fooled by the mar-
ket.

An Example Of How Fundamental Analysis Can Fool You

On Friday, April 7th

, 2006, the unemployment rate for March was pub-
lished. The market expected an unemployment rate of 4.8%, and the
numbers came in better than expected.

Only 4.7%. That's good news, isn't it? The market should move up,
right?

WRONG! On that day the E-mini S&P dropped 20 points. Why?

Well, here are some comments from a news service:

"Not surprisingly, Friday’s equity trade was dictated by the March em-
ployment report. More specifically, it was the Treasury market’s reaction
to it that set the stage for stocks."

The Complete Guide to Day Trading

92

"A lack of negative surprise caused the stock market to
breathe a sigh of relief.”

"The Treasury market had a very divergent reaction to the data, and it
took the stock market down with it. For Treasury traders, the in-line data
essentially provided no evidence that the Fed will be inclined to soon end
its monetary tightening cycle."

Oops. So the stock traders thought there was good news and the market
was moving up, but the treasury trader in the other room thought the un-
employment data was bad news. So treasury instruments were rallying,
causing the stock market to drop like a rock. But don't stocks lead the
treasuries? Or do treasuries lead stocks?

The next day, another news item hit the ticker:

“Oil Prices Trading Above $69 per Barrel!”

But what does it mean? Should the stock market move up or down?

Here's a discussion I heard the next morning:

"As crude oil prices continue to plug higher, the debate over what it all
really means will begin again. The question that will be batted back &
forth: "Are sky-high oil prices indicative of a coming economic slow-
down or looming inflation?"

And more important: how will the Fed react? Will they cease increasing
interest rates or even lower the rates again? This would provide a boost
for the stock market.

Or will traders fear that there's an economic slowdown which might re-
sult in lower company earnings? This would move the market down.

As you can see, it's not the news that moves the market – it's the reaction
of the traders to the news that makes the prices jump up and down.

Step 3: Selecting a Trading Approach

93

Using a technical approach, you don’t have to twist your mind to come
up with an explanation for why the market behaves as it does. You sim-
ply believe that the factors which affect price – including fundamental,
political, and psychological factors – have all been built into the price
you see.

This means that anything which can affect the price of a financial in-
strument has already been factored into the current price by the market
participants. Technical analysts look at charts the same way a doctor
would look at x-rays: they examine the charts for information on the fu-
ture direction of the markets.

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