The Evolution Of My Charting Process
Yogi Berra once said, "When you come to the fork in the road, take it!". For me this fork was essentially fundamental or technical analysis. Do I want to study for the CFA and learn about companies? Or do I want to study for the CMT and learn about the stocks and the market? It seemed like an easy decision at the time but little did I know how important that decision would eventually become and how much it would impact my life and career path.
Half way through John Murphy's Technical Analysis of Financial Markets I thought I was the next Paul Tudor Jones. I was day trading options based on MACD crossovers like there was no tomorrow. Needless to say, I quickly learned that I had a lot more to learn....
The good news was that I didn't have much money so how much could I lose? Veterans in this business will tell you that the money you lose trading early on is your tuition. You don't learn this stuff in school. You have to go out and figure it out on your own. That costs time and money. That is your tuition. I truly believe this to be the case and would tell that to anyone new to trading and investing in publicly traded and liquid markets.
Fast forward to 2008 and I have now finished the curriculum for all 3 levels of the CMT program as suggested by the Market Technicians Association. It didn't matter that I passed all 3 levels, I already thought that I knew everything there was to know about the market. Well, wrong again. I needed a few bull and bear market cycles to really get a solid footing on the fact that I don't know anything at all. No one does. The market is going to do what it wants and it doesn't care what any of us think, especially me. It's the old Socrates quote: "I know one thing: that I know nothing".
So now that I've figured out that I can't tell you what will happen next and no one else can either, it's been an evolution of a process. I can't predict the future, but I'm willing to bet that the evolution of my process is not yet complete. It's something that I will continue to adjust as time goes by, hopefully for several decades to come.
My timeframe is simple: I look out weeks and months. I'm not a day-trader and I'm not one of these people who make up reasons for single-day moves just because my boss tells me I have to. I wish just once someone would come out and say on TV or on one of these sites, "The Dow is up today because the buyers are being more aggressive than the sellers". Or, "Oil is down today and we don't know why". So me personally, I use a more intermediate-term time horizon. Not long-term and not too short-term either. This makes it the easiest way to manage risk.
I use candlestick charts for my every day charting. Once a week I go through the 400 charts in my arsenal with just bars. No moving averages or momentum or anything else on the chart - just bars. You'd be surprised how much you can see when you simply get everything the hell out of the way. Amazing I know. For ratio analysis I use line charts. This helps with the day to day or week to week changes in a ratio. Remember that not everything opens up at the same time. So if you're using candlesticks or bar charts for ratios, you're going to have bad data all the time. Most of the time really.
For momentum I use a 14-period Relative Strength Index, or RSI as the cool kids call it. I don't change my RSI periods and I don't smooth them out like other do. Not that there is anything wrong with that, it's just that 14-periods works for me. Also, when I say "periods", I mean daily and weekly. So if I'm looking at a chart with weekly candles I'm using a 14-week RSI. If we're analyzing a daily chart, I'm using a 14-day RSI.
Smoothing Mechanisms: I only use a 200 period simple moving average. This is for both daily and weekly timeframes (like in momentum). For my timeframe a 50 period moving average is too noisy. It doesn't help, just hurts. Also, I don't use moving averages for support and resistance purposes as I see being done so frequently. This is an invisible line, as far as I'm concerned, with no supply and demand history whatsoever. Therefore I use the smoothing mechanism to help with trend recognition. Is it an upward sloping 200 day? downward sloping? Or is it flat? I hate when prices are near flat 200 period moving averages (see here: Price Near Flat 200 Day = Headaches).
I don't look at volume on stockcharts. Sorry Charlie Dow. This is sacrilegious in come circles but I'm here to make money, not agree with my nerdy technician friends. Charlie Dow wrote down his Dow Theory Tenets in the late 1800s well before there were derivative markets. I think that volume can be seen elsewhere, not just in stock charts. If someone really wants in, are they going to buy the common? Or are they going to use options leverage? It depends. So the point is we don't know. So I look at volume just to make sure it's a liquid enough market for me to participate in, but that's it. It's not a confirmation of any kind for me, just more noise.
I think you guys get the idea. There are other tools that I use like Sentiment and Correlation analysis to supplement all of the price activity across markets. But in terms of my chart by chart work, this is my process and it is as a result of many failures and successes over a lot of years. It's not perfect and it's always a work in progress. I think you need to be a fool to think your process has been perfected. I got over that ego thing many years ago.
The market has taught me, the hard way, to check my ego at the door and always remember that none of us know anything. It doesn't matter how loud they get on TV or how many blog posts they write about a subject, or how long they've been the Chief Strategist *of fill in the blank* sell side shop, they don't know any more than you do about what will happen tomorrow or next year. This is a fact. So it all boils down to how well you manage risk. Remember, it's not about being right, it's about making money. Don't forget that.