Technical Analysis

Here we help you enhance your strategy on both long-term investments and short day trading. By looking closely at concepts such as signals and price patterns, you can add more strings to your trading bow at a pace that suits you.

The following excerpt from Introduction to Technical Analysis includes explanations of key technical indicators. Account holders can access the full article from the TradeSense Databank (located under Tools) in PureDeal.

Part 28: Thursday 2 September 2010

Targets should not be taken too literally. Instead, they can be used in conjunction with the stop loss position to calculate a risk to reward ratio. The trader should look for a reasonable expectation of potential reward to be double the risk implied by the stop loss for a trade to be worth taking on. Some people say that reward should be three times the risk before the trade is accepted. In practise, that can be hard to achieve. The stop loss can be bought closer to get to the magic three, but this can often involve moving it within the normal ‘noise’ of the market and being stopped out by something without technical justification.

Example: US Light Crude Oil

Crude oil traders are looking at the potential base being formed over the last quarter of 2006. We will assume that the trader will only buy on a breakout above the base formation at $65.

Is this worth buying from a risk/reward perspective?

The reward, based on the height of the base formation is $65 minus $57.57 (the intraday low) = $7.43, giving a target of $72.43 once added to the breakout point at $65.

A reasonable stop loss would be below the potentially higher low in early December, perhaps at $61.

Buying now (at $64.09): Risk = $3.09 Reward = $72.43 - $64.09 = $8.34 Reward: Risk = 2.7

Buying at the breakout (say at $65.15) Risk = $4.15 Reward = $72.43 - $65.15 = $7.28 Reward: Risk = 1.75

So the trade can only be justified now on a reward to risk ratio, but that is only if the current chart, before the base breakout, is acceptable. Obviously, confirmation would be preferred but this always involves deteriorating reward: risk and in practice, even a 2:1 ratio is hard to achieve with full confirmation.