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Which Technical Analysis Method Will Work Best for You?

      What is the best way to trade? Which technical analysis method should you use? How can you know which techniques will work best for you?

      Everyone wants to know if there is one particular technical analysis method that works better than the others. It's a great question, because a simple answer could save a lot of time and effort.

      Unfortunately, there is no simple answer. Nobody can tell you which technical analysis method will work best for you. Only you can make that determination. Here's why:

      In The Little Book of Market Wizards, author Jack Schwager wrote the following:

      Traders must find a methodology that fits their own beliefs and talents. A sound methodology that is very successful for one trader can be a poor fit and a losing strategy for another trader.

      How can that be? How is it possible that a trading strategy can work for one person and not another?

      In that same book, Schwager interviewed a hedge fund manager named Colm O'Shea, who elaborated on this concept:

      If I try to teach you what I do, you will fail because you are not me. If you hang around me, you will observe what I do, and you may pick up some good habits. But there are a lot of things you will want to do differently. A good friend of mine, who sat next to me for several years, is now managing lots of money at another hedge fund and doing very well. But he is not the same as me. What he learned was not to become me. He became something else. He became him.

      As a trader, you need to become you. How can you accomplish this? Study the various techniques in this book with an open mind. Consider that any of them may or may not work for you. Most likely, one or more of these concepts will resonate with you. Begin your search there.

      Once you have found something that makes sense to you, apply it to your personal trading style, which will continue to evolve over time. Gain as much experience as you can, while taking as little risk as possible. After the initial excitement wears off, traders normally become less frantic and more patient. Circumstances change, people mature, and you'll find that your trading style will evolve with experience. The initial thrill of trading is gradually replaced with a calm focus.

      This is important, because if you're highly excited while placing trades, you're much more likely to make a serious mistake. How would you feel about being the passenger in a vehicle whose driver is extremely emotional and excited? Or, would you want to glance up from an operating table and notice that the doctor who is about to perform surgery on you is very animated or agitated?

      My trading styles have been documented in the books Forex Patterns and Probabilities and The Ed Ponsi Forex Playbook. Those styles are geared toward currency trading, but many traders have adapted them to stocks and commodities as well. However, as Mr. Schwager and Mr. O'Shea point out, there is no promise that a technique that works for one person will also work for another.

      There's a good chance you will find something in this book that resonates with you. Just as important, you need to determine which techniques are incompatible with your personality. Read through the different methods, examine the charts, and sort through the various concepts presented in the following pages. At the very least you'll be able to eliminate some methods, and that's a start.

      CHAPTER 2

      The Language of Trading

      In trading, large sums of money can be lost due to confusion caused by the use of imprecise language. That's why it's important to use appropriate terminology. The proper use of the following expressions removes ambiguity because they describe trading activity in precise terms.

      This precise language may seem unnecessary to the untrained novice. However, to the experienced trader, who may have lost money on a trade or has witnessed a good trade get “busted” due to confusion caused by imprecise terminology, this is more than mere semantics.

      Trading terminology can be confusing at times and often seems unnecessarily complicated. However, there are a few expressions that are critical to your understanding of both technical analysis and trading in general. Certain terms allow traders to express a concise thought in one or two syllables.

      Trading errors can be expensive, and often there are tremendous sums of money on the line, so it's important that every party involved in the trade understands exactly what is taking place.

      First, we will briefly discuss three important terms – “long,” “short,” and “flat.” What do these terms mean?

      Long– When a trader expresses an intention to go long, he or she is placing a trade that will only become profitable if the price increases. The trader wants the price to rise; if it falls, the trader loses.

      Context: John is long ABC because he likes their new line of products.

      Short– When a trader expresses an intention to sell short, he or she is placing a trade that will only become profitable if the price declines. The trader wants the price to fall; if it rises, the trader loses.

      Context: Jane shorted XYZ just before earnings; she thinks the company might be in trouble.

      The obvious question is, why don't traders simply say, “I'm going to buy stock XYZ” instead of “I'm going to go long XYZ”? In this case, the word “buy” is an imprecise term. In the world of trading, the term “buy” could mean two different things.

      A trader might buy XYZ because he or she believes the price will rise. Or, a trader might buy XYZ because he or she is currently short shares of that stock. Those are two very different situations. A trader who is short a stock must buy shares if he or she wishes to exit or “cover” the short position.

      Similarly, why don't traders simply say “I'm selling ABC” instead of “I'm shorting ABC”? A trader who is selling ABC might already own the shares. Perhaps this individual wishes to sell in order to exit the trade.

      It's also possible that this person may wish to sell ABC short. However, there can be no confusion if a trader states that he or she is “short ABC.” This trader will turn a profit if stock ABC falls, and will lose money if ABC rises.

      Flat —The trader is neither long nor short. This trader has current position in the market.

      The act of being flat can indicate the mere absence of a trade, but it can also represent a strategic decision. This is particularly true of short-term traders, who may wish to avoid the volatility associated with an economic report, an election, or a speech given by a central bank official. Often, such traders wait for the event to pass and then reassess the situation before reentering the market.

      Context: John entered the weekend flat because he's going away on vacation.

      There is additional terminology that is important to understand as it relates to trading. Here are some supplementary key terms:

      Position– If a trader invests in XYZ in anticipation of making a profit, that trader has established a “position” in XYZ. A position can be long or short, and may involve any trading instrument – stocks, bonds, currencies, options, and so on.

      One position can be used as a “hedge” against another position. This means the trader is using one position to protect or provide insurance against a potential negative move in another position.

      Most hedge funds are capable of taking long and short positions simultaneously. Mutual funds and institutional traders have demonstrated a tendency to build positions over a period of weeks or months, while individual traders tend to enter and exit positions more freely.

      Any position that is still in effect is referred to as an “open position”; after the trader exits that position, it is referred to as a “closed position.” A position can be entered all at once, or it can be built over a series of trades.

      For example, some traders prefer to initiate a position with a small trade and then add to it if the price moves in their favor. Others maintain a long-term “core” position in a stock, commodity, or currency while

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