April 28, 2017

Trading Systems Owe Their Existence to Statistics and Technical Analysis

Guest contribution provided by ForexTraders.

Technical Analysis is a term that is bandied about in the investment world as a most useful tool, but investors that are not analytically inclined typically pass over learning that much about the topic.  Books and articles alike seem directed to the geek-side of the brain, and once again, most readers will tune out before the first page is read.  Technical jargon is the name of the game, but a general overview is all that is really needed to use these invaluable trading tools.

For those active souls that prefer security, commodity or forex market trading and who “dumb down” when “TA” is mentioned, today’s software tools will do most all of the work for you.  There is no need to have expensive calculators that perform mind-numbing operations.  However, it is best to understand how the calculations are performed in order to understand their constraints and the impact that selected variables may have on the signals provided.

There has been a great deal of attention paid to the run up in both soft and hard commodities in today’s markets.  Gold has set new records, but prices for soft items like cotton or corn have gone through the roof.  The following chart presents the results for a new ETF that focuses on corn futures:

Click image to enlarge:

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There are no less than seven technical indicators presented within this one chart.  In case you did not identify them, here is a list:

1)    Candlestick Formations

2)    20-Day Moving Average

3)    50-Day Moving Average

4)    Bollinger Bands

5)    Commodity Channel Index (CCI)

6)    Relative Strength Index (RSI)

7)    Moving Average Convergence-Divergence (MACD)

Each of these indicators displays a wealth of information, especially when viewed over a number of trading periods (1-day periods in this case), and involves a number of computations, some based on statistics, to generate signals for the trader.  For example, the Bollinger Bands, the two blue lines that border the candlesticks, are a statistical presentation of prior pricing trends.  In this case, the dotted line is a 20-day simple moving average, and the blue lines are placed at two standard deviations of the last ten days of pricing information.

Bollinger Bands can send a “Buy” signal when the lower band is penetrated and a “Sell” signal when the upper boundary is crossed.  As you may also notice, the bands widen and constrict, much like an accordion.  A tightening of the bands is generally indicative of an imminent expanding, a type of leading indicator signal of a trend reversal.  Always remember that the objective of a trader is to identify a new trend early, confirm its voracity, apply a planned approach for market entry, aim to protect against downside risk, and then let your winner run.

The last three items listed are specialized indicators that are designed to suggest an optimum point for entering a position, and then an optimum point for closing the position.  Since indicators can be wrong, it is generally helpful to have confirmation from another indicator. Technical analysis is by no means perfect.  That goal was never the intent, but TA, although based on previous price action with no guarantee of future results, does provide a level of consistency and an advantage for the trader.  Experience helps to improve interpretive skills over time.

Investing for the long term requires talent, but trading in active markets involves high risk and puts a high premium on specialized training. Plenty of forex and stock options trading strategies exist to assist you in both fundamental and technical factors.  There are also many forex news articles out there to aid a “must have” step-by-step trading plan.  The best ones utilize technical analysis for entry and exit signals while also setting risk control stop-loss orders based on consistent analytics