The monthly S&P500 Emini futures candlestick chart has not had a pullback in 14 months. This has...
How to Use "Crayon Drawings" to Make Money Trading (Part 1)
07/26/2010 10:53 am EST
Those of you who have been following my writings for some time may have noticed I have been showing more stock charts lately. In fact, there was a time when I rarely—if ever—showed a stock chart, let alone an actual trade in a stock. People new to my Web sites often e-mail me asking if the methodologies I use in my trading work for stocks, and that usually reminds me that I have to teach more about the history of many of the methods I use, since they were invented to trade stocks in the decade before the (prior?) Great Depression.
But there are three reasons I have been showing more stock charts:
- More people have the fates of their stock holdings on their minds these days and are finally beginning to take control of their own investment portfolios—or at least beginning to monitor the success or failure of their financial advisors.
- I had the honor of being asked to teach three elementary school's gifted fourth and fifth grade students how to use technical analysis; in my mind, this will probably the single greatest professional honor I am ever accorded. Given the current economic problems in most states, these programs will likely be shut down this coming school year, though I am working with two well-known universities to help me provide these programs, free of charge, to any elementary or middle school that would like to offer the programs. As you can imagine, I am currently creating lots of long-only stock charts and technical analysis material for this program. I have yet to get an exchange, a trading-focused magazine, or even a national brokerage firm interested in sponsorship, but I'll do the program for those schools that are interested, even if I have to have my own firm provide the funds and materials.
- I have a 12-year old son that was in the stock trading program last year, and of course, he was well aware that I began my trading career at about his age, when my brother, an active commodity trader living in Miami, was impressed with my charting ability. My brother had me paper trade for about six months, helped get me a better education (from Dr. Alan Andrews and the Coral Gables Group) one summer, and then funded me by allowing me to trade in his own account, with a $2,000 maximum stop loss. My son knocked on my trading room door not too long ago and asked for the same opportunity. He's been helping with my hand charting for years and can use most computer charting packages much better than I can. I would be a hypocrite if I didn't afford him the same opportunity. Now that I have a financial interest, I watch individual stocks much closer!
I thought it might be interesting to see one of my son's current open positions and his thoughts behind the trade. Remember, I teach him trading basics and solid money management, but I do not show him trades, nor do I wave him off of trades I think might be losers. The most important part of this exercise is that he can show both himself and me that he can trade, and also decide if he likes trading enough to consider it as a profession. The rules are simple: He must have a trading plan written down before any trade is taken, he has a maximum amount he can risk per trade (and he set it, not me), he has a maximum amount he will risk at any one time (and he set it, not me), and he has a “kill switch,” an amount that closes down his trading account (a $2,000 total drawdown from the opening balance of the account—I set that!).
Sean uses what I call “crayon drawing,” or crayon trading—no special or fancy technical analysis tools. He draws in simple market structure, which by its nature, should keep his trades and his stop losses and profit targets close to areas where the “whales,” or large traders, are leaving their orders. Once you can read the whale tracks, I believe the market becomes much easier to read and trade. Let's look at a chart and I'll show you what I mean:
This is a chart of Burger King (BKC) shown using daily open/high/low/close bars. I do not let the students in my class use anything other than simple bar charts, because other styles hide market structure, and so many of the techniques I teach them are based on simple price and market structure.
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Crayon drawing involves drawing simple, easily recognizable lines to try to identify market structure. If you identify where the whales may have left their buy and sell orders and draw these simple lines over and over again, market structure becomes easier and easier to identify. So, let me break out a crayon and mark up this same chart with some simple lines!
There's nothing magical about drawing in the highest high and the lowest low on a chart, but all analysis must begin somewhere, so we always begin there. Then I teach students to literally get up from their chair and take a step or two back from their computer monitors, and after looking away from the screen for ten or 20 seconds, look back at the chart in front of them and see what catches their eye right away. Is this always the most important thing on the chart when they are done doing their analysis? No, but it leads them down a visual path and helps unlock their minds to what is right in front of them. People of any age are generally visual in nature, and once they begin that process, the visual path is open and ready to be used.
Now, remember those were my charts, not Sean's charts. Let's take a look at his style of chart, with fewer lines and less annotations:
Many traders have their charts filled with lagging indicators (moving averages, CCI, RSI, MACD, etc.), but this method simply identifies the market structure that price has left. By identifying market structure, you have identified where the whales may play well in advance of price reaching those areas. That means this method is built entirely on leading indicators. I'd much rather trade knowing in advance where the market structure shows me buyers or sellers are likely to emerge than rely on lagging indicators, which will get me into moves well after they have started.
More tomorrow in Part 2…By Tim Morge of MarketGeometry.com
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