Technical Analysis 101

Technical Analysis 101

Technical Analysis 101

 

One of the requisite fundamentals of any trader who seeks to trade options short-term is technical analysis. There is just no way around it; “TA” has to be learned and it has to be learned well. Many approaches to it exist, and often several methods will be combined for the most probable trade entries and exits. Regardless, that is the point. Analyzing technical trade setups is the way to have more data-informed trade theses. Everything on a chart is a visual representation of data, at the end of the day, the trader who can interpret patterns and probabilities from that data will have a greater chance of profitability. At BlackBoxStocks, we offer a robust and free education program to our members and one of the classes taught is an overview of technical analysis. It is taught by one of our most popular traders and moderators, Kang, and this article will outline how he teaches the class.

Let’s get into it.

The class attempts to give a fundamental basis for technical analysis to options traders with a learning mindset… It approaches short-term trading from a technically oriented point of view. It serves as a review of basic patterns and concepts such as support and resistance. It is always a good idea to know where you will exit to the upside and the downside before you enter a trade. There simply isn’t a way to do this if you are not adept at the basics of technical analysis. Finding opportunities in price action and trends doesn’t happen overnight. But the more you study, learn, and apply technical analysis, the more frequently you will be able to confidently buy and sell at pattern points on a chart. For basic terms and ideas, the class suggests the resource of Investopedia as a good resource.

 

SUPPORT AND RESISTANCE

The class isn’t designed to teach people how to trade individual tickers or discuss the various personalities of different instruments. It is geared toward gaining a more solid foothold in technical analysis. The first step in that is understanding that drawing patterns and trends is not enough by itself. You must be able to map out areas of support and resistance. Too often newer traders will enter into trades unaware of an upcoming zone of support or resistance. This can, and often does, result in buying at resistance or selling at support. Perhaps XYZ ticker is trading at $88 with some clear resistance at $89.80, right under the psychological level of the next whole tens number. If the trader going long at $88 is unaware of this resistance, she could go long at that point and watch in dismay as price action hits the sub-90 resistance and falls back down. This can lead to averaging down and other issues, and quite often when this happens there was clear resistance on the chart that the trader simply was unaware of. Conversely, a trader may be looking to sell his lot of XYZ with the current price of $77. If there is a grouping of likely solid support just below the $75 level, it would be disheartening to sell right at support and then watch price action continue to climb once you have realized the loss.

Support and resistance are areas where price action is likely to react especially during short-term intraday trades. The first step is to bring up the daily chart. Mark any areas that show price action bouncing. These levels are strongest when it reacts with the most price action, so a combination of wicks and candle bodies can be used. In other words, the more times a horizontal line touches groups of candles at the same price level the stronger the support or resistance will be. Some short-term daytraders might tend to ignore the daily chart, but this is a mistake. Important long-term levels can only be seen on the daily or larger.

Then bring up the four-hour chart of the ticker at hand. Look for other areas of support or resistance that were not obvious on the daily. Each time frame will highlight different areas of price action. Then Kang does the same thing on the hourly chart. Remember the older a line is, the stronger the support or resistance will be. A four-hour level is stronger than the hourly, etc. Then check the 30 minute as well as the 15 minute charts as well. The less you know a particular ticker, the more important it is to have these levels mapped out on the charts. Remember, it is useful to map levels on the following timeframes: daily, four hour, hourly, 30 minute, and 15 minute.

 

CHART PATTERNS

Remember that the type of trading this discusses is short-term intraday. These trades may last anywhere from less than a minute to a few hours. Keeping this in mind, when the levels are set, pull up the one-minute chart. It is on the one-minute chart that it is most helpful to identify technical chart patterns as well as to trade, as taught in our technical analysis 101 class.

One great aspect of the class is that it is taught live. Attendees can submit questions for the instructor to answer in real-time. Classes are also recorded so members can view the videos at any time according to their own schedule.

Avoiding fake-outs is a significant issue when technically day trading. If you only trade patterns without using support and resistance levels, patterns can suggest a move that might work well in a vacuum. However, if a strong level of support or resistance is clear on a longer-term chart, the stronger element will win out and invalidate the chart pattern on the lower time frame chart. The class discusses this in terms of a bull pennant. Some traders might hear “bull pennant,” and get ready to go long. Patterns either confirm or invalidate, and the quest is to raise your win percentage. There are a few resources traders can use to keep from getting faked out.

The first thing needed is a deep knowledge of the different patterns they trade. It is easy to confuse a bull pennant for a double bottom, but it is easy to keep these separate if you know the definitions. Chart patterns are more complex than some new traders realize, and it is imperative that traders understand the difference between patterns, how to identify them, and what types of move they suggest.

Beyond basic pattern knowledge, intraday technical traders need disciplined patience. Technical traders must wait for pattern confirmation. Too many traders attempt to front-run an emerging pattern only to see the pattern not form, price action go the opposite way, and lose money.

The way to not get faked out with patterns that invalidate instead of confirm is to have solid areas of support and resistance mapped out on the above-mentioned timeframes. These lines will largely disappear on the one-minute chart; however, they are still there. When price action approaches one of them, you will see it on the one-minute chart. This way, a bounce off a long-term support or resistance will not surprise you. What it comes down to is that strong support and resistance increase your chances of profitability.

 

VOLUME IS KING

Once one has support, resistance, and patterns identified on a chart, the waiting game begins. One of the main things you are waiting for is high relative volume. Waiting for a pattern to confirm during price action consolidation, you need to know what to look for. Every move has varying levels of strength. The judge of strength is volume. Volume is one of the most important aspects of technical analysis.

If a pattern break is accompanied by significant relative volume, there is less chance of a fake out. If volume does not accompany the break, it is likely not highly reliable.

Identify the pattern. Confirm areas of support and resistance. Wait for pattern confirmation with volume. Never buy contracts in areas of consolidation. This is where patience comes in. Wait for confirmation with volume; this is paramount. Many strategies rely on confirmation. One of our most popular BlackBoxStocks alerts is the Opening Range Breakout. It is a perfect example of the necessity of patience. The way we teach this strategy is that once price action breaks the opening range, the best entry is after it retests the entry level and bounces. When the price action overtakes the previous high of day with volume, this is a high-probability entry for a short-term scalp. Additionally, the opening range breakout strategy relies on compelling volume. If the volume isn’t there, the breakout isn’t reliable. The same goes for just about any pattern breakout or breakdown confirmation. Patience, confirmation, volume…can’t be repeated enough.

 

RISK-REWARD ANALYSIS

Next, you need to do a risk-reward analysis. This is an often overlooked part of the process, and that is unfortunate. It is not difficult if you have a grasp of charting support and resistance. To do a risk-reward analysis, look at the price you intend to enter at and then the price of the next likely support or resistance. Resistance might be close or very far away. This comes with experience, but depending on the ticker a one or two dollar move in the underlying might not affect the contract price much. In that case, it doesn’t make sense to enter a trade a few dollars below a resistance point. You would want more room for the underlying price to increase before running into resistance. This risk-reward analysis can help you skip trades with a low degree of decent profitability. If you get stuck in a sideways trade, you might be tempted to hold on longer hoping for price action to go your way. And, without a doubt, you should never rely on hope. Rely on support and resistance, pattern recognition, patience, and risk-reward analysis. The most successful and experienced traders like to take trades with generous risk-reward. There needs to be compelling reasons to put your capital at risk in the market.

 

DYNAMIC SUPPORT

34 and 89 In addition to static support and resistance plotted on charts, it is also useful to utilize dynamic resistance in the forms of various moving averages. Our class mentions both the 34 EMA and the 89 EMA and how they can serve as dynamic support and resistance. Dynamic refers to the fact that it will shift and change throughout the trading day. To use an EMA as support or resistance, simply apply them to your chart and see if price action tends to respect the EMA line. Many traders in the BlackBoxStocks community use the 34 EMA as dynamic support. The idea is that it can act as support throughout a trading session with price action bouncing repeatedly off it. If this is the case, then the 34 can serve as an exit trigger if price action breaches it. It can work on the upside or the downside and on all time frames. It is imperative to learn your chosen individual tickers and which EMAs they tend to respect. The 34 and the 89 EMAs tend to work well on many tickers when using three minute candles. Using dynamic support and resistance in addition to static support and resistance can reveal powerful methods to plan entries and exits.

 

BOTTOM STUDIES

There are dozens, if not hundreds, of available bottom studies. These are the indicators that show up along the bottom of your charting software when they are activated. New traders tend to use a lot of them, and over time most people reduce that down to one or two or do away with them altogether. However, they can be powerful tools to spot momentum for trading. The class mentions the MACD , RSI, and TTM Squeeze studies. They are used to see how much momentum is left in a move. Even if an entry looks good regarding support and resistance, patterns, and dynamic resistance, if a MACD or RSI type bottom study is bottoming out, there may be waning energy in that move and it might be best to wait. The amount of momentum present in current price action and volume can help inform a trader when to sell perhaps a third or a half of a profitable position instead of the full position.

 

TAKEAWAY

At the end of the day, technical traders use all sorts of indicators and combinations of strategies. The approach discussed here emphasizes the importance of chart patterns, multi-timeframe charted support and resistance, volume, dynamic support and resistance, and bottom studies. This is a solid basis of technical analysis that can yield positive results when combined with proper risk-reward analysis and position sizing, healthy trading psychology, and disciplined entrance and exit criteria. Read that last sentence a few times because there is a lot there to unpack, but if those things are under control you will be well on your way to being a profitable trader.

Make no mistake, all of these things take time and it is with perseverance, discipline, patience, and practice that they can combine to yield results.