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Updated: June 4, 2011 20:13 IST

Cut the clutter in stock charts

D. Murali
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Do not become a victim of ‘analysis paralysis,’ cautions Balkrishna M. Sadekar in ‘How to Make Money Trading with Candlestick Charts’ (www.visionbooksindia.com). There are over a hundred technical indicators which traders use for deciphering the way a stock is heading, and traders can also program their own indicators and back-test the same on different stocks, the author explains.

“They can then tweak the parameters which define the indicators and try to make them as accurate as possible. Technical traders take great pride doing these exercises. However, many a time traders face the ‘analysis paralysis’ phenomenon. They have too many indicators and oscillators on the chart. This crowds the price action of the signal leading to indecision.”

Reminding that your goal as a trader is to identify the best possible support and resistance levels for the stock and act accordingly, the author warns that if you have five different moving averages, Fibonacci re-tracement levels, support-resistance lines, along with stochastics, MACD (moving average convergence-divergence), RSI (relative strength index), volume, on balance volume, and a few other oscillators set up on the chart, it can be very confusing. “Let the chart be clear. Pick your favourite oscillator, a couple of moving averages and your trend lines,” he urges, therefore.

A more compelling reason to keep things simple is that the different oscillators can show ‘oversold’ and ‘overbought’ conditions at different times. For instance, one oscillator might suggest that the stock is still heading down while another might suggest it has bottom-ed, Sadekar notes. “This again will lead to indecision on the part of traders as they will not be confident about the direction of the trade.”

Swim with the current

A section titled ‘The trend is your friend’ exhorts traders to trade only in the direction of the trend. What this means – for starters – is that, if a stock is trending up, you should only buy on candlestick buy signals, and sell out on sell signals; and not short sell on a sell signal. In the opposite, if a stock is trending down, then short sell on a candlestick sell signal and buy back on a buy signal; and do not buy long, the author instructs.

Likening the market to a flowing river, he adds that if the river is flowing upstream you should swim upstream, using the strength of the current to your advantage, rather than swimming downstream against the current. “So, too, with the markets. In an up trending stock, always buy on a candlestick buy signal. You can sell out when a sell signal appears to protect your profits. But shorting the stock is not advisable because the weight of the market is against you. When the stock breaks the trend line, a new dynamic is generated. Use the candlestick signals to short the stock at the right time.”

On the common dilemma that traders face about how to handle earnings reports, the author’s counsel is to avoid taking a position before the results are out. Adding that, as a candlestick trader, you can watch what candle formations occur after the earnings news is released and then take a decision to go long or short, he says that similar fundamental news – such as a drug approval decision, a huge contract decision, takeover speculation – should be treated the same way. “Always keep in mind that you are a trader, not a gambler. Any trading situation in which a news outcome can completely disrupt your rationale for entering a position should be avoided.”

Educative addition to the technical traders’ shelf.

**

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