Profitable ETF Trading Strategies: a brief look at technical analysis
If you are a trader that uses technical analysis, or if you are just considering applying some technical techniques to enhance your investing and trading strategies, my recommendation is make sure you start with just a few tools, and understand them thoroughly, rather than flit about from tool to tool like a bee investigating flowers.
The reason for this is that most technical indicators derive from price, and thus have a lot more in common than may be immediately apparent. If you only examine them superficially, at wave top level, instead of diving deep, chances are you will not get the full value of the insights that even the simplest ones can reliably provide.
You are also more likely to have a partial understanding of many tools and when you put them together you may think you have more information about the market than you really have and may then act with more confidence than is warranted. In the case of technical analysis it is especially true that a little knowledge is very dangerous.
There are some broad categories of technical tools available to describe various dimensions of market conditions. Two of the most important are: measures of trendingness and oscillators.
Measures of strength of trend: because the market seems to have different performance characteristics when the market is trending, it is useful to have an indicator that indicates when the market or the asset trend is sufficiently strong to begin specializing in trend following strategies. These strategies include making an entry with a wide enough stop to allow the trend to fully develop, but close enough that a true change in trend will allow you to exit the position with a percentage of profits intact. In trends that are very strong, the strategy of buying on dips can definitely improve your returns.
Oscillators define periods of Overbought and Oversold, and are especially useful when the market is not trending up or down but can be considered to be in a band or a sideways trend. Authors disagree on what percentage of the time markets are found in this condition, and it is clear by visual inspection that some markets are trendier than others. However, all generally agree that the markets spend enough time in sideways conditions (or non-trending conditions) that having strategies optimized for these conditions can give you a significant edge.
For example, in a sideways market, with prices confined to a definable channel, you are looking to buy low in the channel and harvest near the top of the channel. If the market were trending though you would be inclined to buy near the top of a channel, anticipating a powerful breakout from resistance which would sweep you along to new profits.
Dr Alexander Elder is an author that I recommend for clear explanations of the purpose, construction and application of various technical analysis tools. His books are well suited for beginning traders looking to raise their understanding to the next level.