Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
All the News You Need Is on the Chart
05/05/2011 7:00 am EST
Traders often discount how clear and powerful a picture the charts present and focus on news instead, but a look back shows that technicals alone were reliable, even the day of the infamous “flash crash.”
Nearly every time I am teaching a class on technical analysis, at least one student will ask me, "But what about the news?"
Everyone seems to want to disprove technical analysis or is so concerned about what a commentator says on TV that they forget that most of what happens in the world will be incorporated into the price action caused by the people who buy or sell stocks.
Take, for instance, the recent news of the Standard and Poor's downgrade of the US economic outlook. Many people claimed to be caught by surprise and watched in astonishment while the markets across the world dropped dramatically.
However, for those who were reading the charts, the decline in price was anticipated. The news just added to the already growing profits.
But can technical analysis help us navigate events that have never occurred before?
Prior to May 6, 2010, few investors knew anything about high-frequency trading. The now-infamous "flash crash" that sent markets reeling caught most traders and investors by surprise. Don't worry, I am not going to claim that I knew it was going to happen—it would be impossible to have known.
However, on that day, I was in the Extended Learning Track (XLT) stock trading room with Sam Seiden, and we had just told students to play the short side of the market based on technical reasons about ten minutes prior to the crash.
On May 6, 2010, the markets had already been weak intraday and had even fallen from a diamond top pattern that we identified in the XLT classes in late April.
On the day of the crash, the markets broke from a descending triangle and were continuing the morning trend after lunch. The cue for the short was a continuation of the dramatic drop from the demand and a failed hammer candle.
Typically, the target for this kind of continuation pattern is 100% of the drop. Following technical analysis would have actually allowed you to profit from the flash crash!
The reality about news is that most people are looking for a reason why something happened. We cannot simply accept that the trend was moving in the direction that it was supposed to based on the predictable fear and greed of the traders and investors.
Anything that people know or hear about the markets or economy influences their decisions to buy or sell. That buying and selling pressure can be read and evaluated on a chart. The market discounts everything!
Even the extreme events seem to fall into place and move the markets on a relatively predictable path. You just need to have the knowledge to be able to trade on that path and make it your path to success.
By Brandon Wendell, instructor, Online Trading Academy
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