What Are Technical Trading Tactics?
Technical analysis (TA) is the study of price action itself presented in a chart format. Although the basic assumption of future price movements being dependent on past price movement is never certain, many traders use TA as their primary means of making tactical buy and sell decisions.
Using Daily Moving Average
The daily moving average is a popular technical indicator. Since it represents a “rolling” average of price over a specific period, traders can apply various tactics to them.
Most traders use moving averages as a visual way to identify the trend. If it is trending higher, they focus on buying. If it is trending lower, they focus on selling.
Short-term traders will use shorter periods to generate more frequent trading signals. The goal here is to make many small profits that will accumulate into larger gains overtime.
Longer-term traders will prefer longer periods to stay in trends for longer durations. Their objective is to make fewer trades and ride out the trends for bigger gains.
Of course, neither of these will work without a sound money and risk management plan to keep losses under control.
Some traders use moving averages as a mean reversion trade. In other words, if price extends too far up or down away from its average price, the assumption is price will start to retrace back to the average.
While this approach to trading can be very profitable, it is best suited for more experienced traders with a strong discipline in place to keep risk under control as they bet against the trend.
The most popular moving averages are the 20, 50, and 200-day periods. As a general guideline, traders want to be Long when price is above all three and the 20-day is trending up over the 50-day, and the 50-day is trending above the 200-day. Vice versa for Short positions.
Some traders will adjust their position size based on where price lies in relation to the moving averages. If price slides between the 20-day and 50-day moving averages, position size is reduced to half. If it falls between the 50-day and 200-day, the position is reduced to a quarter. Below the 200-day ma, the position is exited.
Broken Trendlines
Another popular technical analysis method is to look for broken trendlines to identify a change in the trend.
The assumption is the prevailing buyers or sellers that created the trend have exhausted their positions and allowed for a shift in the supply-demand relationship. Downtrends will be broken with a rise in price making a series of Higher Highs. Uptrends will be broken with a drop in price making a series of Lower Lows.
If you can develop a reliable method of determining when a trend has truly been broken, this tactic can be very effective. Some general tips to consider include:
- Make sure volume spikes above average upon breaking through a trendline. The more volume the better as it suggests a significant shift in ownership is happening.
- Support/Resistance Levels. The common saying is “old support becomes new resistance; and old resistance becomes new support.” It is not uncommon to see a mild pullback pattern develop after a broken trendline occurs on heavy volume. Monitor prior support and resistance for potential low-risk entry points.
- Multiple Timeframe Analysis. Most traders don’t rely on just one chart to make their decisions. By analyzing both the short- and long-term charts, traders can make a better determination of whether the trend is changing or not. The more timeframes that show a change in trend, the stronger that change is.
Short-Term MA Crossing Long-Term MA
Another technical trading tactic is looking at moving averages of differing duration and deciding to buy or sell based upon the interaction of the two lines.
When the shorter of the two averages moves above the longer one, a buy signal is generated. A sell signal triggers when the opposite happens.
While this is an excellent way of making sure to be trading with the trend, realize that the different in length of the moving averages can have a significant impact on trade results due to the lag. For less lag and more momentum, the intervals should be closer together. The wider apart they are, the more likely price is already extended away from their means and likely to reverse by the time the crossover occurs.
For example, by the time a 20-day and 50-day ma crossover, price could be ready to reverse if it is extended too far from their intersection. However, a 10-day and a 5-day ma are more likely to be in the middle of a momentum change to jump aboard the trend.
Summary
In this article, we barely scratched the surface of the numerous ways to trade using technical analysis. However, the key to success with any trading approach will always come down to being disciplined to a plan and proper risk management once in the trade.
No approach to trading is going to work 100% of the time. In fact, most traders should assume a 50/50 probability on all their trades, therefore recognizing the only way to be successful is to consistently maximize their winners and keep their losses small.
