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The technical analyst has many tools at their disposal which are either directly, or indirectly, derived from the stock price. The technical analyst uses these indicators to aid their decision about when to enter, or exit a trade, based upon which type of opportunity they are trying to exploit. For the technical analyst, there are three main types of trading opportunity:

1. Trend trading;
2. Break-out trading; and
3. Reversal trading.

Trend trading is the most common and most intuitive approach to market trading. The idea of trend trading is to enter a trade during a well established uptrend, riding on the back of rising prices, and close out before the trend comes to an end. Trend trading is not about trying to capture all of the uptrend, but rather a sizeable portion. The philosophy of trend trading is best remembered using the following analogy:
When eating dinner, it’s better to have many small portions and be satisfied, than to try and fit all of it in one mouthful and choke.

Trend trading works better in markets which are actually trending. Although obvious, traders can often try to apply trading techniques which are not suited to the current trading environment and market sentiment. Entering positions based on trend trading signals in a non-trending or slightly bearish market will be destined for failure. As a rule of thumb, if a stock is trading below its 150-day moving average, then the stock is more than likely in a long-term downtrend state. If it is below its 21-day moving average, then the stock is more than likely in a short-term downtrend state. As a trend trader, it is preferable that price action is above both the 21-day and 150-day moving averages.

A concept often overlooked by traders is market support. In order to confirm that a stock is trending strongly, and with the backing of the market, entry signals must occur on relatively heavy volume. In fact, in general, all upward price movements within the trend should be accompanied by heavy volume. This can be quantified using the 50-day volume moving average, as well as the 5-day moving average. It is preferable to have the volume of stock traded for a particular company above its 50-day moving average, as well as the 5-day moving average above the 50-day moving average.

Types of indicators commonly utilised in trading trends are:

• ADX;
• On Balance Volume (OBV);
• Multiple Moving Averages (MMAs);
• Relative Strength index (RSI); and
• Price Oscillator.

A break-out trade develops after a stock has experienced a pause in trending activity (i.e. periods of consolidation, accumulation, or other similar non-trending price activity). When the price breaks away from this period of non-trending activity, the opportunity arises for a break-out trade. As a general rule, the longer the inaction time (the time where a stock price flat-lines), the larger the reaction (the greater the change in price when the period of inactivity expires). Break-out trades are a favourite amongst those who are able to recognise the opportunity, as they present high-probability trades at a low risk.

Types of indicators commonly utilised in trading break-outs are:

• Bollinger bands;
• OBV;
• Moving Average Convergence -Divergence (MACD); and
• Stochastic Oscillator.

Reversal trades may appear similar to break-out trades, however, this are fundamental differences. In a break-out trade, price activity stalls temporarily, before exploding in a particular direction. Reversal trades, as the name suggests, involve a complete reversal from one trend direction to the opposite. That is, price action reverses the trend direction without a period of consolidation, accumulation, or any obvious period of non trending activity. Reversals occur most commonly after there has been a sharp downward rally in price action – in a blind panic the market brutally drives prices downwards only to realise that in the process the stock has become drastically undervalued. This presents the opportunity to purchase a stock at a greatly discounted price and the market behaves accordingly.

This trading opportunity presents the most amount of risk, but can also produce the largest amount of gain for the alert trader. Traders looking for these opportunities must be wary of the “dead cat bounce”, where stocks can rebound after a significant low point giving the indication of a reversal trade, only to suddenly run out of momentum and continue the downwards plummet. Market support needs to be monitored carefully for this type of trade.

Types of indicators commonly utilised in trading break-outs are:

• Trend lines;
• OBV;
• Count-back entry;
• Bollinger bands;
• RSI; and
• Stochastic Oscillator.

Given that trend trading is the most basic form of strategy available to the technical analyst, it is often recommended that this form be undertaken for new traders to the market. Once confidence has been built and the trader has become successful using this type of trade, surveying for break-out trades can follow. Reversal trading presents the most difficulty, and should be undertaken last.

About 19 Articles
Arjunsinghania is a Business & Marketing tips author of several publications of Trading and experiences in life. he is a regular contributor to online article sites on the topics of Seminar & Conferences allover the world.

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