10 Commandments in Technical Analysis: Heed Them to Succeed in Trading!


Growing up in the 1980s, I found myself fascinated with the idea of becoming a high-stake, high-finance trader like the character of Gordon Gecko in the 1987 movie Wall Street. At the time, it seemed to me that traders led the perfect life: nice suits, hot women, fast cars, and tons of money. I was in college when Wall Street came out; I was then majoring in Economics and thinking of a career in banking and finance.

Immediately after college, I was offered a job at a multinational investment company. I was part of the sales team, and we were tasked to solicit accounts for investments in commodities trading. The research department trained us in both fundamental and technical analyses. Fundamental analysis is the method of evaluating the value of an investment by studying qualitative and quantitative factors, such as financial statements, economic indicators, industry trends, and company management. Technical analysis is the method of using statistics, charts, and other tools to identify investor behavioral patterns and trends to forecast activity.

After two quarters of hitting sales quota, management promoted me as section manager, which meant I could trade my accounts assuming I get licensed. I passed the SEC (i.e., Securities and Exchange Commission) licensure exams for traders, and my dream of becoming Gordon Gecko was becoming reality. Little did I know that the dream would eventually become a nightmare.

My first trade was in coffee. It was not a volatile commodity. Philippines only exported 3% of its production to the world market, volume of trading was not heavy, and it had been playing near current lows. There appeared to be more upside to coffee. For several weeks, coffee was range trading. Losses or gains on paper were not significant to justify any decision to cut my position.

And then it happened. The coffee market crashed.

The second trade was in sugar. The market had been on a bullish trend. Moreover, there were reports that Brazil’s unpredictable weather was damaging its production of sugar, and prices of world sugar or Sugar No. 11 was projected to soar. Brazil is one of the world’s leading producers of sugar. The volume of trading in sugar was heavier than that in coffee. Liquidating adverse positions should be easy.

And then it happened again. The sugar market crashed!

These losses were a reality check. Every Monday morning, the entire sales department conducted a market review, and for the most part, I presided over it. My background in Economics made news reports and data for market analysis easy to understand and to interpret. In theory, you invest in securities with strong fundamentals. It should be as simple as that, but it wasn’t.

“The problem with commodity trading is its thin volume; it’s easy to get in but it’s difficult to get out. Just because you post an offer to sell doesn’t mean you’re guaranteed a buyer. In the end, it’s still about supply and demand.”

That’s how I rationalized my losses. So when foreign exchange was included, I was elated because currencies move fast. You can’t argue the amount of money that is traded every day. But the same thing happened. I placed a client’s money on British Pound because nonfarm payroll data on the United States was expected to be below targets. It was but the US Dollar soared, and the British Pound crashed. I kept losing client investments even though the plans were based on solid fundamentals.

Shortly after the British Pound disaster, my department manager introduced me to an industry colleague of hers. His name was Andrew, and he was the vice president of another trading house. In addition, he was reputed to be one of the best traders in the industry. We were having coffee, and he asked me how I approached trading.

After I poured out my frustrations, Andrew smiled and said, “Fundamentals don’t work in trading.”

He explained that the news that comes out has already been digested by investors. The trend has been determined by the market, and the focus shifts to positioning, which is a function of investor behavior. The key to market positioning lies in understanding market psychology, and this is what technical analysis is all about.

I made a deal with Andrew. I would move my team and our accounts to him if I became his understudy in technical analysis.

That partnership was the start of my second lease on life as a trader. And I would never lose in the market again!

Andrew gave me his “10 Commandments” in using technical analysis for designing trading strategies.

 10 Commandments in Using Technical Analysis

1. Remove all biases

Andrew advised me to read news reports only for the purpose of presenting to clients. Technical analysis is a separate and distinct discipline from fundamental analysis. You must not be influenced by the news.

2. Follow the rules strictly

The guidelines for technical analysis are very strict and should not be violated. Otherwise, the reading will be flawed.

3. Identify market structure

The key to succeeding in trading is to determine the overall trend of the market. Clues on where the market wants to go can be seen with technical trading technique charts, which seemed like an amalgamation of points, lines, and shapes.

4. Identify entry points

Once you’ve identified market structure and your market position, you can now calculate your possible entry points. Having three to four possible entry points would be best to ensure that you can enter the market.

5. Identify profit objectives

If you are correct in determining the correct position, calculating your pricing targets for profit with near accuracy is possible via technical analysis.

6. Identify cut loss targets

At the same time, determining pricing targets is also possible if the market’s position is contrary to yours. Make sure to cut losses to absolute minimum.

7. Look for all possibilities

In technical analysis, the popular saying is, “Eliminate all the possibilities; what will be left is the truth.”

8. Always have an alternate reading

Technical analysis isn’t a crystal ball. The possibility of making wrong call exists especially if you have not removed all your biases. Therefore, you should always have an alternate reading so you can reverse your position if needed.

9. Keep your trading plan simple

You can use several technical trading techniques. But stick to those that have been proved effective.

10. Once you have placed your position, walk away!

If you have done all you could to develop the best trading plan for your client, then there is nothing more you can do once you place in your order. The last thing you want is to second-guess your primary trading plan.

Andrew introduced me to his three primary tools for technical analysis.

Three Primary Tools for Technical Analysis

1. Elliott Wave Theory.

This method was developed by Ralph N. Elliott and popularized by Robert Prechter. Elliott Wave Theory asserts that market behavior can be determined by analyzing the movement of “waves” within channels. Waves that move in a pattern of 5s are identified as the trend, whereas those that move in 3s are merely corrective. Elliott Wave is used to identify market structure, and students of this approach have to strictly follow its guidelines.

2. Fibonacci Ratios

Italian mathematician Leonardo Fibonacci believed that all things of consequence are governed by the golden ratio. In technical analysis, these ratios are calculated at 0.236, 0.385, 0.50, 0.618, and 1 = 1. Further extrapolated, the ratios can expand to 1.236, 1.382, and 1.618. In conjunction with Elliott Wave Theory, Fibonacci Ratios are used to determine profit objectives and cut loss points.

3. Relative Strength Index

RSI is used to determine if the market is approaching overbought levels, namely, above 80%, or oversold levels, namely, below 20%. By itself, RSI is not a reliable tool for technical trading. But with Elliott Wave and Fibonacci Ratios, RSI becomes a near accurate strategy for identifying the perfect entry or exit points. The key is to look for divergent signals, namely, RSI points below 20% that continued to rise while pricing continues to drop, and convergent signals, namely, RSI points above 80% that continue to drop while market prices continue to rise.

I approached learning technical analysis like an athlete preparing for competition. Every morning, Andrew’s secretary had several charts printed on my table. Before I could even have my first coffee of the day, I had to do the following:

  1. Establish at least three probable market structures using Elliott Wave Theory
  2. Calculate three profit objectives and one cut loss point using Fibonacci Ratios
  3. Identify potential entry points using RSI
  4. Present an alternate reading
  5. Run a mock trade

Once these were all done, I would discuss my analysis with Andrew. He never once countered or objected my readings, and he only pointed out possible violations in the rules of Elliott Wave Theory and in the computation of Fibonacci Ratios. Not once did we discuss news reports. After a month, Andrew pronounced me “fit to trade.”

The first account that I traded using purely technical analysis was the client whose money I lost in the British Pound. He had to infuse more money to bring his account back to minimum. Andrew wanted to prove a point that with technical analysis you have nothing to fear in the market. He told me to trade the client again in the British Pound!

I drew up the trading plan and discussed it with Andrew. This time, the charts were indicating a selling movement. But fundamentals pointed to a strong European economy and a weak US Dollar. Andrew and I were the only ones who chose to sell the British Pound. We put in the order to sell, and I could not hide my anxiety. I simply could not handle losing again. It was nearing Christmas, and there was “midnight madness” in Ayala.

“Go shopping with your girlfriend. Don’t bother with the market. Call me up after 11:00 pm; by then the market would have digested the news,” Andrew said, smiling, which gave me some comfort.

I called up the office at 11:10 pm, and I remember hearing so much screaming and yelling. Andrew took my call in his office.

“Set up a meeting with your client first thing Monday morning. His money has nearly tripled in value. Enjoy your shopping. Everyone here who bought the British Pound is dead.”

I could not believe it. I drove to the office and saw how much the British Pound had fallen. We got the correct position, and my client was earning 400%!

Every single account I traded with Andrew made money; a 100% return was considered low. I remember receiving a call from a client, saying he was able to buy a new car after trading with me. The British Pound client used the proceeds to expand his business and to pay for his son’s college education in the US. Technical analysis saved my soul; it exorcised the demons from my losses in fundamental trading.

And that was the problem with leveraged trading in foreign exchange at the time. Without going into details, we realized that the industry operated more like a casino than an exchange. The “house” doesn’t like it if you keep winning. I heard rumblings in the office about Andrew’s uncertain future. I understood the concept but could not reconcile the principle: “Why was having profitable clients bad for business?” We were after all getting referrals and additional investments.

Andrew resigned within the first quarter of the year. One of the few good men in the industry resigned due to pressure. I was ostracized because of my association with Andrew. I knew the writing was on the wall when I had to fight tooth and nail to pull out all of my accounts. It wasn’t until a client threatened the company with TV coverage that the accounts were finally released. Once again, I found myself disillusioned not by the market but because of the industry. I resigned before the end of the year.

Technical analysis works when approached strategically and with purpose. Trading is a zero-sum game, that is, when one party wins, another party loses. The market is a battlefield where investors can get scratched, critically injured, die or walk away with the spoils of war. Using fundamental analysis to trade is like joining the field of battle armed with plastic knife from your fast-food take out order. Technical analysis gives you the Big Guns that you need to win the war. Just like any discipline, its success depends on the individual who wields it. Once you’ve developed your set of technical trading tools and adopted their principles, you will never forget it.

Do I still read the news and keep myself abreast of market updates? Of course, in my line of work, which is BPO, I have to be informed with developments here and in the international markets. But whenever I see adverse movements in the US Dollar, I never refer to the news. Instead, I review the US Dollar technical charts I get on a weekly basis from a local brokerage firm.

So at least twice a month, I go through the entire process again.

Elliott Wave for market structure, Fibonacci Ratios for profit objectives, and RSI for dollar selling levels.

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