2 minute read.
Part 6 excerpted from lesson 7.10 of the upcoming Trade Like a Pro ver.10 course.
Professionals reduce Technical Analysis to four basic questions. They ask the questions every day to better understand the context of the market. The Professional asks these four important questions of every bar on the chart. Endowments trade weekly or monthly charts. Hedge funds trade daily, minute, or second charts.
A Professional must have the answers to these four questions, before taking any trade. No action without understanding. Fundamental Analysis asks questions about financial data before determining what to buy. Technical Analysis asks four questions before determining how and when to buy.
I remember a young broker in my office who became enamoured with Robert Prechter and the Elliott Wave Principle. He carried the book around like a religious text. Every page included highlighted text. His notes filled the margins. Different coloured ink underlines indicated important passages. He disregarded all other analysis as being unimportant and a waste of time. He and his clients failed to survive the 1987 crash and he left the business. He failed to ask the four most important questions.
Just as those who rely on fundamental analysis alone are wrong at the extremes, where it is most important to be right, those who rely on technical analysis often become fixated on an aspect that worked in the past. By failing to consider the context, strength, and probability they fail at the crucial moment.
The first question helps Professionals understand the historical context they work within. By asking, “What has the market done?” we look backwards to gain perspective. No matter what time frame a Professional trades looking back twenty-bars clarifies the context. A longer lookback may be helpful, but a 20-bar look-back is necessary. A Professional trading daily or intraday looks to the left to better understand today.
The second question helps Professionals understand what is happening in its current context. By asking, “What is the market trying to do?” we look forward to potential targets or magnets in the structure of the market. A previous high or measured move may be a target for the bulls. A previous low or high volume point of control may be a magnet for the bears to find support. Knowing support and resistance exits below and above the market allows the Professional to understand what the market is trying to do.
Strength of the Market
The third question helps Professionals see buying and selling pressure. By asking, “How good a job is the market doing?” we identify the strength of the market. The tug-of-war between the bulls and bears shows on the charts. Size, direction, quantity, along with wicks and tails reveal the potential change in control before it occurs. We cannot predict, but expectation allows Professionals to prepare for uncertainty.
The fourth and last question helps Professionals execute on time. By asking, “What’s more likely to happen from here?” we include probability in our decision process, protecting us from the negative impact of randomly entering into uncertainty. The Professional is no longer at the mercy of negative volatility, and manages the trade with confidence.
These four important questions asked before any trade, increase the Professional’s success and can do the same for you.
Trade Like a Pro – Part 7: The Binary Decision Process
Coming in September
Trade Like a Pro ver.10 course launches September 14th. Endorsed by CSI for all financial advisors. Early Bird Registration begins in July.