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Algorithmic Trading: the Basic Concepts

What is Algorithmic Trading?

Algorithmic trading, or algo-trading, refers to trading which uses computer programming to place orders.

The trading is carried out on computers which are set up to follow an algorithm when placing trades. In other words, the computer follows a previously composed set of commands. These commands can be based on anything you want: price, quantity, timing, etc.

The advantages of algorithmic trading are numerous. The profit that this kind of trading makes and the speed and frequency that it does it in is incomparable to a human trader. Besides that, there’s no human emotion that can influence trading decisions, which makes the process more systematic. Also, the market is more liquid with algorithmic trading as well.algorithmic trading

Example: You want to set the following instructions – purchase 50 stock shares just after the 50-day moving average* surpasses the 200-day moving average. And you also want to sell stock shares when the 50-day moving average falls below the 200-day average.

*A moving average is a median of your previous data points which identifies trends by smoothing out regular, day-to-day movement of the price.

And now you can program the computer to follow these instructions. The program can control the stock price and moving averages. And not just that – the program can arrange buy and sell orders following your set of rules.

Now you don’t have to spend hours placing orders manually; you don’t even have to keep an eye on live graphs and prices. Algorithmic trading does it all for you. It sees the opportunity and doesn’t ever miss it.

In the rest of the article, we’ll address the many advantages of algo-trading, as well as some common strategies revolving it. Then we’ll also mention some of its technical requirements.

Algorithmic Trading Advantages

  • Algo-trading works with the best prices on the market.
  • Algo-trading’s order placement is accurate and fast. That’s why you can choose any level, and the computer will perform at that level successfully.
  • Algorithmic trades are perfectly timed, so it can avoid any possible price variations.
  • Algo-trading has discounted transaction costs.
  • With algo-trading, you can automatically check multiple market situations.
  • You can prevent any manually-made mistakes when placing orders.
  • You can backtest your trading strategy on both real-time and historical data that are available to you.
  • There’s no human psychological influence when it comes to trading decisions, so there is less chance of making a mistake, also.

Another key point is that high-frequency trading is the most used rendition of algorithmic trading today. What it does is follow the previously programmed instructions and place a multitude of orders at a fast speed, on multiple market conditions at the same time. The goal is to capitalize as much as possible.

Algorithmic trading is beneficial for various types of investing and trading. Here’s a few of them:

  • Mid-term to long-term investing and buy-side firms (insurance companies and pension funds). These investors can buy a huge number of stocks and not worry about their huge investments affecting the stock prices.
  • Sell-side participants and short-term traders. Speculators, market makers and arbitrageurs all profit from algorithmic trading and its automatic trading. Sellers also benefit from the market liquidity.
  • Systematic traders. Hedge funds, trend followers and pair traders** profit from algo-trading big time. By programming their own instructions and letting the computer trade automatically, they gain speed and efficiency.

** Pair trading is a trading strategy that is market-neutral. It uses a set of correlated instruments (two stocks, or ETFs, for example) and then matches a short position to a long position.

In short, algorithmic trading uses a more efficient trading approach and thus beats human trader’s methods that are based on sheer intuition.

The Strategies of Algorithmic Trading

We use strategies to recognize a profitable opportunity that will improve earnings or bring fewer costs.

These are the most popular strategies regarding algorithmic trading:

  • Trend-following strategies.

These strategies usually follow trends when it comes to price movements, average movements, channel breakouts, etc. Trend-following strategies are the simplest to program because there are no price predictions or forecasts involved. Predictions are way more difficult to implement. The trend-following strategy is pretty straightforward – trades are executed by following trends, which is basically the easiest instruction for an algorithm to pull off.

The previously mentioned example (with 200-day and 50-day moving averages) is a typical example of a trend-following strategy.

Arbitrage is the price difference when you are purchasing a dual stock in one market at a low cost and at the same time selling it in another market at a higher cost. You can do the same thing with stocks and futures instruments. Arbitrage is popular with algorithmic trading, as arranging the orders with it is much easier, and thus the effectiveness is much higher, too.Algorithmic Trading Math

  • Index fund rebalancing.

When it comes to index funds, there are rebalancing periods in order to match the holdings with their benchmark indices. When it comes to algorithmic traders, this is a great opportunity to capitalize. Right before index fund rebalancing, there are trades that offer anywhere from 20 up to 80 basis points (revolving around the quantity of stocks in the fund). We use algorithmic trading here to initiate trades at the best speed and price.

  • Mathematical models.

Mathematical models in algorithmic trading present a variety of options to choose from. An example of this is the delta-neutral strategy. This is a strategy that has many positions with negative and positive deltas. Delta is a ratio that shows the price variation of assets and compares it to the price variation in its derivative. In the end, the total delta of assets has to be zero.

  • Mean reversion.

Mean reversion (or trading range) strategy considers the fluctuation of prices as a temporary occurrence. Eventually, the price goes back to its mean (average). And then it will fluctuate again. That’s why it’s important to ascertain a price range. Then, after setting an algorithm, there can be an instruction for automatic order placement when the asset prices go beyond or below their price range.

  • Volume-weighted average price.

The VWAP strategy divides a big order into smaller parts by using historical volume profiles that are stock specific. The main goal of this strategy is to end up with a price that is similar to the VWAP.

  • Time-weighted average price.

The TWAP strategy also divides a big order into smaller parts. But with TWAP strategy, it uses evenly distributed time slots from the start to the end. The goal is to reduce the influence of the market and keep the price as similar as possible to the average cost, from the start to the end.

  • Percentage of volume.

This strategy includes an algorithm that sends partial orders based on the previously set participation ratio as well as the traded volume of the market. That occurs before the order is filled completely.

There’s another strategy related to this one – the ‘steps’ strategy. This strategy follows the percentage of volume that has been previously defined by users to send orders. And, once the stock price comes to the already set levels, it increases or decreases the participation rate.

  • Implementation shortfall.

The goal of this strategy is to reduce the order execution costs as much as possible. This can be done by trading in the real-time market. Doing so would certainly lead to fewer expenses in general. Not to mention the opportunity cost that comes with delayed execution. This strategy increases and decreases the participation rate based on the movement of the price and whether it’s favorable or not.

  • Other strategies and algorithms.

Besides the algorithms that we listed previously, which are all conventional, there are more than a few algorithms that work a bit differently. For example, there are ‘sniffing’ algorithms, which are set to detect algorithms that are found on the buy-side of large orders. These are mostly used by those who make the sell-side markets in order to help them recognize opportunities for large orders and thereby fill them at the highest price. This type of situation clearly shows the countless benefits of using technology and how using it can simply make you a front-runner.

Algorithmic Trading Technical Requirements

Actually integrating the algorithm into a computer is the very last step of the process, together with backtesting***. The real concern is how to convert the strategy you chose to a computerized process that can access a trading account and place orders.

*** Backtesting refers to the testing of an algorithm on past stock markets data. It should provide you with a clear picture of the algorithm’s performance, so you can know whether it’s actually profitable.

Firstly, here’s a list of things you need:

  • Programming skills, a hired professional programmer or a pre-made software that you can buy. Obviously, you need these in order to implement the algorithm into the computer.
  • Access to trading accounts (so you can place orders), and good internet connection
  • Market data feed access. The algorithm uses these to scout for order opportunities.
  • After you’re done computerizing the process, you need to test it.
  • Historical data. You need this for backtesting, as we mentioned earlier.

Example: RDS or Royal Dutch Shell is listed on both the London and the Amsterdam stock exchange market. Suppose you want to make an algorithm that will detect arbitrage opportunities.

Here’s where things get more complicated:

– Amsterdam stock exchange uses euros, whereas the London stock exchange trades in pounds.

– There’s an hour time difference; thus the Amsterdam exchange starts an hour before the London exchange. In the meantime, the trading happens at the same time in both exchange markets. But in the final hour, only the London market is trading.Algorithmic Trading Strategies

The question is: Is it possible to implement arbitrage trading on the RDS stock, but in different currencies?

The basic necessities for this kind of strategy are:

  • A program with the ability to interpret current market prices
  • Price feed for both the London and Amsterdam stock exchanges
  • A foreign exchange feed for the British pound and euro conversion
  • Ability to place orders to the proper exchange
  • And again, data for backtesting

The programmed computer has to be able to do this:

  • Read the Royal Dutch Shell stock incoming prices from both markets
  • Convert the prices (from pound to euro and vice versa) using the current exchange rates
  • Identify a good opportunity for placing orders (for instance, if there’s a large price difference).
  • When there’s an opportunity, place a buy order on the exchange with lower prices and place a sell order on the exchange with higher prices.

And finally, you have a program that will do all the work for you.

Although this may be true, don’t forget that there are other traders who are probably doing the same thing. So, in order to really shine, your strategy has to be better. That requires a lot of experience and knowledge. The program is there to simply make it easier for you.

Also, algorithmic trading isn’t all that easy to take up and manage. Even though the algorithm can work fast and seamlessly, you still need to keep an eye on it. Especially when it comes to price fluctuations.

In addition, there are risks, as with any other machine, too. For instance, a system failure or a connection problem can occur. And there’s always a chance that the algorithm was programmed poorly. If there’s a coding mistake, the program is basically useless.

Final Thoughts

A computerized trading process can certainly be effective. However, it has to be executed perfectly and tested many times. Only then can you use the program safely. But even after all that, you still have to monitor it for potential mistakes.

Become a Better Technical Trader by Following These Ten Laws

We asked a professional analyst to tell us what are the secrets of technical trading. These ten laws are what will help you become better at trading as long as you follow them to the letter. Thanks to the Day Trade Review team for providing some of these insights.

There are a lot of questions a trader has during each trading day. Is the market on the move? How significant is the move? Which way is it going? When will it reverse? And, if you are a technical trader, you will want to get answers to those questions. You will utilize the graphs, charts, and various formulas to try and predict the future. And, behind all of those, there are fundamental ideas and rules that apply to technical analysis.

Technical trader

So, we have asked the expert to explain what we should consider before going into trades. And, with many years of experience behind him, he has given us ten essential tips to improve our game. Any beginner who wants to try their hand in technical trading would be wise to abide by these. If you are here looking for tips, treat these ten tips as laws of trading. They will help you understand the idea of technical trading as a whole. And, if you already have some experience in this field, make sure to go through them, as they can help streamline your methodology.

By going through these tips, you will be able to define the tools you require for analysis, and you will learn how to properly use the tools at hand to find opportunities for beneficial trades. So, without further ado, these are the top ten laws for technical traders:

10. Study Long-Term Charts

You should start your chart analysis off with weekly and monthly charts that span several years. You want to have more visibility and accurate perspective on a market to predict its movement. And that is why creating a large scale map is beneficial. You want to map the trends and use that knowledge to turn a profit. So, once you establish the long-term map, go on and consult shorter term charts. Some people prefer to stick to the short-term view alone. However, that can be tricky. So, even if you consider yourself to be a short-term trader, it would be wise to understand the long-term trends beforehand. Intraday charts can otherwise be very deceiving.

9. Follow the Trends You Spot

Trading is not a spectator sport; once you determine a trend, go with it. Of course, make sure to classify the trend correctly. Trends, as such, can be short, intermediate, or long-term. So, once you know which type the one you are using is, you can determine the appropriate chart. If the trend you are following is intermediate, you should focus on weekly and daily charts. Otherwise, if you are a day trader, you can utilize the intraday charts too. Just make sure to use the long-range charts to map the trend. Daily charts are there to help you perfect your timing and maximize your gains. With the knowledge of the trend, you will be able to trade in the direction the trend is going. If the trend is going up, you can use it to buy dips. And, if it is going down, you can sell rallies.become better technical trader

8. Identify the Resistance and Support Levels For the Trend.

As we all know, finding the high points and the low points of a stock’s price movement is crucial to traders. You want to buy when it is nearing the support levels. You can usually determine the support level by finding the low of the previous market reaction. And, if you want to sell, you should do so when a market is nearing its resistance levels. Determine the resistance by identifying the previous peak. However, this is not always the case. Both the peak and the low can be broken during a stock movement. If the stock breaks the peak, that peak will become the new support level for future pullbacks. And, if it breaks the low, it will become the new resistance level for following rallies.

7. Understand Retracement Percentages

One of the things you have to know is how far you will backtrack. Whether a market is going up or down, it will face corrections along the way. One way to quickly measure these corrections is by using percentages. And, with those percentage numbers, you should figure out how big of a retracement you are facing right now. It is very common for a trend to retrace fifty percent. Usually, a retracement won’t be smaller than 33% or bigger than 66%. You can use this information to determine your buying or selling points in trends. So, if there is an uptrend that is going through a pullback, your initial entry point is in the retracement area of 33-38%.

6. Use Drawing Tools

Being able to have a visual representation is very useful. So, you should make sure to draw trend lines as you do your analysis. And it is very simple to do so. If there is an uptrend, identify two successive lows and draw along them. And, do the reverse for down trends by drawing along successive peaks. While the prices will go up and down through time, they will usually hit the trend line and go back to their original course. If prices actually break the trend lines, that can be a signal indicating a change in trend. To confirm you have a valid trend line, you should be able to identify at least three “touches.” And, of course, the more tests it goes through, the more important a trend line is.

5. Follow the Moving Average

If you want to have objective buy and sell signals, you will do well to follow moving averages. With them, you will be able to see if the trends are changing, or remaining the same. Just bear in mind that they won’t be able to tell you that in advance. The most popular method includes combining two moving averages to find trading signals. Use one shorter and one longer average line (most commonly, 9 and 18- day lines). And, once the shorter line crosses the longer one, the signal is formed.

4.  Utilize Oscillators

If you are new, you will learn to love indicators of all kinds. And oscillators are there to help you find markets that are being overbought or oversold. That means that, with oscillators, you can get a warning when a market moves too far in a certain direction and will probably turn. Two of the most used oscillators right now are the RSI (Relative Strength Index) and the Stochastic. These simple indicators can help you up your game significantly. If the readings of RSI, for example, show over 70, the market is overbought, or, if they are under 30, the market is oversold. With Stochastic, the limit numbers are 20 and 80.

3. Utilize MACD

This indicator works by combining the moving average system with the elements of an oscillator. It is a bit more complex, but it is also beneficial once you master it. In essence, a  sell signal occurs when both lines are above zero, and a faster line crosses below the slower one. Conversely, a buy signal takes place when both lines are under zero, and the faster line passes above the slower line. Bear in mind that weekly signals are stronger than daily ones.

2. Confirm the Existence of a Trend With the ADX Indicator

You can use the ADX indicator to confirm a trending phase. This index helps by measuring the strength of a trend or the direction in a market. If the ADX line is rising, that is a sign of a powerful trend. Alternatively, if it is falling, it is a sign of a trading market, instead of a trend. This indicator will help you determine which other indicators to use in the market. If the ADX line is rising, you should opt for moving averages, and, if it is falling, consider going with oscillators instead.

1. Volume Precedes Price

This tip represents one of the most important rules of trading. After all, volume is one of the most important confirmation indicators when it comes to trends. You should follow the volume even during confirmed trends. During up days, you should see heavier volume. That would confirm that the funds are coming in to support the trend. If the volume is declining, you should take it as a warning that the trend might be ending. Following the volume can help you avoid entering an uptrend right before it ends.

Bonus Tip: Keep Going

Using technical analysis to trade is not easy. The more you use it, the better you will become.

Day Trading Computer – Setting Everything Up

In every business undertaking, equipment is essential. That being said, day trading is no exception. As you are searching for day trading equipment, I suppose you are familiar with the server farms that automated trading firms in Connecticut and New York use. Keep reading, and you will learn about all the basics regarding the equipment you’ll need to start day trading.Day Trading Computer

How to Get Started with Day Trading?

Apart from a good technique or approach to day trading, you will need the following things:

Computers

Profiting from extremely fast moves at times is what makes day trading. You will sometimes find yourself in a trade for less than 10 seconds. So, you will need a day trading computer with a fast processor. It has to be able to handle the speed at which you need to act. Consider at least a Pentium 4 with a minimum of 40 GB hard drive and 1 GB of RAM.

Note that buying a dual-core processor doesn’t have to mean that your computer will work faster. If your trading application doesn’t support dual-core processors, you can’t really make the most of them. An AMD dual-core processor that runs at 2 GHz won’t help with Tradestation. That is because Tradestation hasn’t been designed to take advantage of dual-core processors yet. Thus, you would be better off with a single core processor in this case. Make sure that you understand how your trading platform functions before you go computer shopping.

Don’t forget to use a surge protector to keep your equipment safe!

MonitorsMonitor for trader

Some people enjoy having multiple monitors, as that allows them to track different stocks and technical indicators simultaneously. But, it is just a personal preference. Some traders need a dozen of monitors while others simply use a laptop. If you want a multi-monitor setup for your day trading computer, you will have to buy a video card as well. You need the card because it allows multiple monitor setup. Matrox and ATI offer solid video cards that cost between $250 and $500. Be sure to do your research and check eBay prices too. You can get great discounts online.

Try browsing numerous websites (for example, digital tigers) to learn what you actually need. You don’t have to necessarily buy from them, but you can make the most of their content. Find a fully functional setup online, and it will give you a piece of mind. However, keep in mind that these setups are rather pricey.

Finally, your monitors should have good resolution. Also, it is a good idea to keep the brightness low in order to preserve your eyes. If you set your monitor up properly, you won’t have any trouble in the future. Take your time and avoid a potential headache in the long run.

Internet Connection

You will need a cable modem connection at least. Since trading is extremely fast, your data has to be even faster. In this case, more is more. Verizon’s FIOS has the best connection with the highest speed. However, not everyone can get it at the moment.

Here are some golden rules to follow regarding internet connection:

  1. No Library Trading – These networks aren’t secure enough, and they often go down.
  2. No Starbucks – Coffee shops are great for enjoying your coffee, but don’t show everyone what a cool trader you are. People will comment and ask you numerous questions.
  3. No 3G – 3G is for smartphones and kids playing games. A trading professional shouldn’t use 3G; your connection speed should be at a decent level.

Data Feed

With day trading, a real-time data feed is required. So, you will have to buy a real-time subscription from your broker. Be aware that whenever you require a real-time data from exchanges, you will have to pay an additional fee. Also, to view the Level 2 information, you will have to pay another additional fee. A real-time news feed is expensive; prepare to pay around $100 a month for it.

Backups

Every trader dreads of his computer crashing while he is trading. So, it is vital that you have a backup laptop or PC which will have an appropriate trading software installed. This way, you can easily switch setups if your day trading computer fails you.

It is equally important to have an internet connection backup. Unfortunately, internet connections sometimes go down. If that happens in the middle of a trading session, it’s even worse. Bad internet connection could cost you a lot. A serious day trader should have the option of a dual internet connection. You should be able to instantly switch between two connections in the case of a network failure. It’s better to be safe than sorry.

Software

Keep the software on your trading computer to a minimum. Your system resources shouldn’t be taken up by a third party software that has no relations to trading. It is enough to have a trading software, MS Office, and an anti-virus software. You won’t really need anything else.

Conclusion

Think carefully about your day trading command center, and treat it with respect. Your computer shouldn’t lock up at 9:30 breakout when the time and sales window goes crazy. Also, switching between multiple windows and screens might be too much for a laptop. Don’t try to save money on your equipment. You have to spend more at the beginning in order to have a shot at success.

A Beginner’s Guide to High-Frequency Trading

The popularity of high-frequency trading has been on the rise lately, partially because of “Flash Boys,” a new book by Michael Lewis. In this article, we will explain (in layman’s terms) what high-frequency trading is, how it works, and why small investors can benefit from it.

The first step will be to imagine a market with a number of small, individual investors. After that, we will see how large institutional investors can affect the market. The third step is to examine high-frequency trading, and after that, we will explain how it affects small investors.

Let’s imagine a regular stock. Its price is somewhat stable, and there is a multitude of small trades. Some traders have gained a bit of profit from it, but now they believe its price is a bit high. Others saw the results and decided to invest in it.High-Frequency Trading

Some traders have been keeping an eye on it, and now, they finally have enough money to invest in it. Meanwhile, others are perfectly happy with it (they already own it), but they are in desperate need of cash. So, overall, the stock’s price seems steady, and there are many buy and sell orders coming.

But, what if some of the small investors were actually large institutional traders? They take the same actions – they buy and sell – but the quantity is different. A pension fund or a large mutual fund might make an order, but it will buy a million shares instead of a hundred. Likewise, they also sell big when they decide to remove certain stocks from their portfolios.

During the day, the large investors make orders, thus creating a lumpy pattern. But, in that case, we cannot notice a certain trend. Instead, the market goes either up or down, depending on the institutional order moves. It will require quite a bit of time to get the price back to the underlying trend line.

So, who are HF traders? They are people who are trying to profit from price fluctuations, which are caused by large institutional investors. As soon as a mutual fund sells 1,000,000 shares, the price of the stock plummets. When that happens, HFTs jump at the opportunity. They want to buy the shares at a low price and sell them later when they regain their normal price.

If, however, a pension fund purchases 2,000,000 shares, those same traders will want to short-sell the stock. Thus, they might be able to profit from the sale.

High-Frequency TradingShort selling is a technique that requires you to ask a stockbroker to borrow the shares. Then, you can sell them and later purchase the stock so that you can give back the shares to the stockbroker.

So, to understand HFTs, you must remember one thing. When the price surpasses a trend, the HTF will sell. Meanwhile, if it goes below it, that trader will consider buying. If they are successful at it, there aren’t many deviations. In any case, if there are some blips, they are usually short-lived and small.  Thus, the HFTs can combat price volatility and fluctuations.

Even though this explanation is rather simple, it’s vital to know that there is more to it than meets the eye. For starters, HFTs are quite common, and if you are not fast enough, some other trader will profit from an opportunity you missed.

In addition, they cannot just follow one particular stock. Nowadays, HFTs are crunching an incredible amount of data about stocks, futures, options, bonds, and commodities. But, they cannot let themselves be caught by surprise. Thus, it’s crucial to evaluate every blip correctly, and they also have to be fast. If there’s a downward trend in the whole stock market, the trader would have to buy a multitude of various stocks – and then watch the prices plummet even further.

In the past, it was easier to trade like this. The HFTs had to be fast in order to capture all the trades. However, today there is far more competition. But, they aren’t competing against institutional or individual investors. They are actually trying to beat other HFTs.

So, how does this all impact small investors? Well, there’s always a chance you’ll be unlucky. You can place a buy or sell order, and it can go either way. It may be a downward deviation or even an upward blip. But, are you really going to risk it? Probably not. You would want to take advantage of the underlying trend price.

Furthermore, you have to consider the bid-ask spread. When there’s too much volatility regarding the stock price, the spread will be wider. The “bid” is the price investors are going to sell shares at. Meanwhile, the “ask” is the opposite – the price they have to pay for the shares.

HFTs are there to narrow that spread. They do that by giving protection to the market makers and letting them hold their positions. Hence, without them, your trading costs would rise or stay the same. Instead, they get lower.

Yes, high-frequency trading could be interpreted as mysterious and secretive. But, you cannot say that it’s all bad. Without it, the market wouldn’t be as efficient as it is, and small investors (those who trade whenever they want during the day) would probably fail.

Nevertheless, there’s no need to feel sorry for them. After all, HFTs have made a lot more money than you.

How Important Is the Dow Theory for Day Traders?

The Dow Theory is a theory of technical market analysis. Concepts of the Dow Theory are considered one of the most valuable in the field. Every certified school or course in technical analysis includes most of the Dow Theory in their curriculum.

Not just that – many traders that didn’t even take the course can make use of the Dow Theory. Learning the principles of this theory will help both day traders and swing traders better understand the movement of the market. In other words, understanding the Dow Theory and all of its principles will certainly improve your knowledge and trading skills.

Even though this theory dates way back to the 19th century, it’s still widely used today. Many other theories, like Andrews’ or Waves’ theories, follow the Dow Theory’s basic concepts. Anyone who knows anything about technical analysis also knows the significance of this theory.Dow Theory for Day Traders

The Dow (Jones) Theory

Again, the Dow Theory is a trading concept conceived by Charles H. Dow, an American journalist and founder of the ‘Dow Jones & Company’ financial firm. The ‘Jones’ part refers to the statistician and co-founder of the company who also took part in the development of Charles Dow’s concepts. Initially, it consisted of 255 editorials. Dow himself didn’t actually create and name the theory. After Dow’s death, Rea, Schaefer, and Hamilton gathered the editorials, formed the theory and named it after Dow.

Even though it’s more than 100 years old, this is the theory that technical analysts use and swear by today.

Now we will address the main principles of the Dow Theory.

The Six Principles of the Dow Theory

  1. The market discounts everything.

The first principle states what we already know – that market manifests all of its elements in the security’s price. All there is to know about the market is manifested (for example, outcome expectations like stock earnings). 

  1. There are three market trends.

These three market trends are primary, secondary and minor trends.

Also, there are uptrends and downtrends. Dow defined uptrend as a price with constantly rising peaks and downtrend as the opposite, a price which is constantly falling and has low peaks.

The three market trends differ in duration and have different timelines. The primary trend is usually a year or so, whereas the secondary trend lasts from a couple of weeks to a couple of months and the minor trend is only a few weeks.

Dow himself stated that it’s important to acknowledge the primary trend since it directly affects the secondary and minor. In addition, you should know that these trends persist until there’s a reversal. But, that’s another postulate that we’ll discuss a bit later.

Dow’s second principle, in particular, resembles the Elliott Wave Theory. There are correlations that prove this.Dow Theory

  1. There are three primary market phases.

Now, the previously mentioned trends aside, there are three mandatory phases that all trends go through: the accumulation, the public participation, and the distribution phase.

Accumulation phase is mostly utilized by more shrewd investors. This phase is when they take the opportunity to gather the stocks. It typically ensues at the end of a downtrend and when it seems that the security is awful for the stocks. In this phase, the market usually ranges sideways. For those who are more experienced, the accumulation phase is the best one. Since the downtrend is still at play, stocks are still at a huge discount, and most bad things that come with the downtrend have already retreated. This phase is also the most difficult one since it’s pretty hard to keep track of. Most of the times the downtrend hasn’t ended yet, so you kind of have to make a pause before that happens.

In the public participation phase is the time when the new trend is arising and growing in popularity with the public and, more importantly, technical analysts. The progress of the price is swift, and it quickly gets lifted by the public who buys into the rally. During this phase, all the negative connotations with the stock are slowly going away. The public participation phase is often the longest of the three and has the most intense price movement.

For those who are familiar with the Elliott Wave Theory, this principle is related to the Wave 3 – the strongest and one of the most impulsive waves.

The final phase, which is the distribution phase, is the high point of the market. In this phase, the events have already become popular among the public. That is when money managers take the opportunity to get rid of their stock before the public realizes that a trend reversal is coming. Unaware, they still keep buying stocks, which raises or lowers

the stock prices.

  1. Averages have to confirm each other.

Dow and his partner invented two indices, which we’ll need for this principle. These two indices are DJIA (Dow Jones Industrial Average) and DJTA (Dow Jones Transportation Average).

The 4th principle states that the two averages (Dow Jones Industrial Average and Dow Jones Transportation Average) must proportionately rise together and drop together. So, for example, if some sort of industry evolves and produces more goods, the transportation industry will grow with it too. If we look at a chart, the divergence (the difference) of the two lines should be minimal. When one average goes to a new high or low, the other one should do so, too. These two averages are certainly never going to go together identically, but they should still noticeably confirm each other.

This principle was the basis of the convergence and divergence concept in technical analysis, an occurrence of turning points in prices. That happens when the security price doesn’t confirm to an indicator or oscillator.

  1. Volume has to confirm the trend.

Dow considered volume to be the second most important factor besides the price.

This principle states that volume has to rise and fall with the movement of the price. Also, a decreasing volume indicates that there’s a trend reversal coming soon.

Volume is definitely one of the integral concepts of technical analysis. Furthermore, it’s important for other aspects of the analysis as well, such as charts. And we all know how essential charts are for trading. 

  1. A trend persists until there’s a confirmed reversal.

This principle was already mentioned a couple of times, but now is the time to fully address it.

According to Dow, a trend is continuous, and it will not stop moving until an external influence comes along.

Interestingly, this principle resembles Newton’s action-reaction principle in physics.

And not just that –  technical analysts use it in many other methods too, such as the Pitchfork method.

Buy and Sell Signals of the Dow Theory

Since the publishing of the Dow Theory, a lot of studies have been conducted in order to test its principles. The first to publicly display the results of the study was A. Cowles in 1934. His results showed that the Dow Theory, in comparison with conventional portfolios, offered lower returns.

On the other hand, many other experts in the field rejected Cowles’ study. They deemed his work inadequate.

Website thedowtheory.com has been tracking the buy and sell signals of the Dow Theory. And from 1953 to today, the method has generated 11,4% return, beating the buy and hold portfolio, which generated 10,6%.

Here’s a summary of the Dow Theory signals:

  • A secondary reaction interrupts the primary trend. It typically lasts a few weeks to a few months.
  • When it comes to the bull market, a secondary reaction usually precedes a pullback. That means that there should be a leap of at least 3% in either the Dow Jones Industrial Average or the Dow Jones Transportation Average.
  • After the said pullback, both averages either rise above the pullback in the bear market or drop below the pullback in the bull market. Based on whether it’s a drop or a rise, this movement is classified as a buy or sell signal.
  • When there’s a sell signal and the market reverses, and both averages reach new highs and lows on the buy, then the sell signal is confirmed.

The Dow Theory method is mostly intended for long-term strategic trading, so many day traders think they don’t really have much use of it. Although this may be true, and the method was made for long-term trading, the Dow Theory’s concept can surely be a useful method for day traders, too. Where it could be the most useful is with the swing failure strategy on an intraday.

We’ll explain a bit more about the significance of the Dow theory for day traders in the next part.

How Important is the Dow Theory for Day Traders?

Even though the Dow Theory isn’t specifically created for day traders, nor it is adapted for them, its fundamental concepts apply to anyone who works with technical analysis. It perfectly sums up all the important points of technical analysis. And this is something that anyone in trading, not just day traders, could definitely find useful.Day Trading

Trends

Trends are surely the key elements of trading. Knowing if the market is in an uptrend or downtrend (or sideways) is basically the first and foremost step. All the other indicators revolve around the concept of trends. Also, if you want to know which way the primary market is going, you need to look at a visual representation of trends. Once again, almost everything in trading depends on trends.

Closing prices

Right after trends, closing prices are the next most important aspect of trading. Besides being significant for the market analysis, they are also vital for building other technical indicators. Even though high, low and open prices are also commonly used, closing prices are better as technical indicators in market trading. They are very indicative of the market itself than high and low prices when it comes to the price movement perspective.

Volume

Volume is an aspect that is certainly most relevant for day traders. They mostly use it to confirm the supply and demand levels, as well as support and resistance levels. And not just that – volume movement can also confirm new highs and lows.

Just like the 5th principle of the Dow Theory says, the volume is one of the key components of the market for day stock traders.

Convergence and Divergence

The concept of convergence and divergence is yet another concept that the Dow Theory has shed light on. In Dow Theory, this concept refers to the differences and similarities between the Dow Jones Transportation Average and the Dow Jones Industrial Average. However, today it is widely used and adapted for many different day trading systems.

The most convenient way to acknowledge divergence is to compare the closing security prices with an oscillator. The oscillator itself is constructed based on the security price. If the oscillator doesn’t succeed in confirming the prices’ highs and lows, then this incidence is divergence. Divergence then actually signals a shift in price direction that ought to come soon.

A Guide To Selecting The Best Trading Platform For You

As long as there is a decent number of traders out there, you’ll always have multiple ways of approaching trading. Also, there are many different ways of setting the trading environment. It’s quite evident that numerous technological advancements are currently underway. These technological advancements have likely left their mark on the online broker system and trading as well. Now, you have online brokers who constantly provide and reinvent efficient trading tools for the clients. Some of these tools refer to market research, streaming prices, news services, and charting capabilities. Just because you can’t find a specific service in your broker’s list of services, doesn’t mean that you can’t find it elsewhere.

Trading Platform

Before entering the trading world and making your computer into a trading platform, you’ll have to know which methods to use. There are two main methods for efficient trading tools and service delivery. The first one regards the use of your internet browser to input and deliver orders and general information. The second one refers to the use of a standalone software that communicates with your broker.

The use of integrated trading platforms is closely tied to certain brokers. Many brokers give you the ability to choose between their separate programs for software and web trading systems.

The approach that matches your requirements best depends solely on how you intend to trade. Other determiners include cost considerations as well as how strong your computer is.

A Short Summary Of Web Browser Trading Features

New traders will start out with a small volume of trade. That means that you won’t make many trades within a single day, and your holding position will be measured. A browser trading environment can aid you in that regard as it offers helpful features.

The way systems are integrated depends on how well your broker integrates them. That is achievable in two ways. Either via an automatic fill-in order screen or a manual information input. There’s also a possibility that certain brokers will provide order reports.WebTrader platform

Pros:

Trading via a browser is available to anyone who has a computer with an internet connection. Windows operating system probably gets the most attention. However, the users of Macintosh and Linux systems get equal support. A good thing about the web browser trading platform is that your broker offers a lot of information to the clients. Hence, there is no restriction on the amount of information. That depends on your trading volume or the size of your account. As mentioned, if brokers don’t provide certain information, you can definitely find it somewhere else.

Cons:

If we compare web browser trading to integrated software trading, we can clearly see the difference in speed. The speed is often affected by having to constantly manage your account information on your own.

Another possible downside comes in the form of interrupted internet session. That is a potential problem which is caused by a longer period of inactivity. In addition, certain configurations require that you use certain browsers.

What Does Software (Integrated) Trading Mean? 

As opposed to trading that uses a browser, software trading is oriented towards the more active traders. Therefore, this platform can function without a browser because it’s a standalone program. You use it simply by downloading the said program and installing it on your computer. In return, you get a more efficient approach to trading.

Platforms such as these allow for basket trading. Such trading allows you to enter multiple orders at the same time. Furthermore, you can use some of the available strategies. They will give you access to contingent orders. Contingent orders mean that one executed order can immediately cancel the other one. Moreover, another thing that sets software trading apart is the alert system. That means that you can receive a text message or an e-mail alert from your broker.

Pros:

First of all, software trading is incomparably faster, and it offers user-friendly access to the traders. Secondly, there are some platform tools that monitor and test your strategy efficiency.

Cons:

Firstly, these platforms are rather pricey, and they usually use a monthly subscription business model. Secondly, you will need to have a high-end computer.  Strong computers are necessary in order to get the maximum of what the platform offers.

Points To Consider When Selecting A Trading Platform 

Always think about how you’ll benefit from a platform. To ensure that you select what’s right for you, you will want to look for these features in trading tools. Search for tools that have text or e-mail notifications, stock trading support, watchlists, and trading strategies. For analysis, look for tools with sale report, charting, and sector analysis. Finally, for account managing, look for portfolio, order status, and account balancing management features.

 

 

 

Top 5 Free Chart Websites for Traders

Technical analysis can be tricky to do, especially if the investor performing it doesn’t have access to an excellent charting service. So, using the best available websites can be a game-changing resource for new traders.

That is why we have decided to create the list of top five free websites. Our top criteria were the ease of use, the cleanliness of the service, and the professional scalability.

5. TradingView.com

This website offers a very clean way of observing stock charts. The community of the site also has the ability to provide their own analysis. They do so through the annotation system on each chart. Even without the community feedback, this website offers chats that go into detail, and their pay-to-use services are very affordable. You can also pay for real-time data updates.tradingview

4. StockCharts.com

StockCharts definitely deserves a place on this list. It is very easy to use and presents the data very cleanly while the overall scalability is very impressive. In fact, financial bloggers around the world swear by this website. As a free user, you will be able to access various tools and analyze any chart you want. You can also subscribe to their services to receive access to historical charting and more tools.

3. Yahoo Finance

Yahoo offers one of the best free charting services you could access. It is simple to use; the charting is clear and regular investors use it all the time. This service is also the one to turn to if you are looking for quotes, news, new research, etc. In essence, it is very similar to the next entry on our list.

2. Google FinanceGoogle Finance

Google Finance is a charting solution that offers clean service for investors who want to use it. Two of the most popular features of this service are the ability to follow critical events for every day, and the ability to analyze historical performance of a stock. The use of this service is very simple. You can even compare multiple charts and indices via the overlay function.

1. FINVIZ.com

And, in the first place, we have our favorite site for stock screening – FINVIZ. Their charts are very clean and  easy to read. However, they got the first place thanks to their technical analysis overlays that are active by default.

Trend Trading Through Four Basic Indicators

There are several possible ways of extracting profit from trends. That is what all trend traders essentially do. Risk management and psychology of trading are basic factors which are not affected by indicators that much. That means that you can’t rely only on indicators to maintain a successful trend trade. However, some indicators stood out from the rest as being more efficient. The primary focus of this article will be to give you a general sense of how you should use each of these indicators. How you use and tweak them depends entirely on what you decide.

Moving Averages

What exactly are moving averages? They are a means of smoothing out the price data by integrating a flowing line. This line stands for an average price over a specific period of time. The time frame usually dictates which moving average the trader decides to use. Some of the most popular choices for investors and trend followers include the 50-day, 100-day, and 200-day simple moving average.

The utilization of the moving average is achievable in several ways. Firstly, you should take a look at the moving average angle. The price is ranging (instead of trading) if the angle remains horizontal over a period of time. An uptrend is preceded by an angled-up angle. An important thing to understand about moving averages is that they just show the price status. They don’t predict anything.Trend Trading

Another way of moving average utilization is a crossover. To ensure utilization, you’ll have to plot a 50-day and 200-day moving average on the chart. A buy signal will occur once 50-day crosses above 200-day. Moreover, a selling signal happens once it goes below. You can easily alter the specific time frames in a way that they match your preferences.

As far as prices are concerned, once they cross above the moving average, they become buy signals. If they drop below the moving average, they become sell signals. The price is more liable to change which is why there’s a potential for false signal occurrence.

Moving averages can directly influence the price by providing supportive or resistant factors to it.

Moving Average Convergence Divergence (MACD)

This is an indicator that’s constantly changing. It can be seen as a momentum or a trend-following indicator. A useful piece of advice when dealing with MACD is to pay attention to which side of zero are MACD lines located. The trend is up if they are above zero, and it’s down if they are below. When the MACD goes above zero value, it causes buy signals to appear. On the other hand, once it drops below it, the sell signals occur.

Additional buy and sell signals can be provided by a single line crossover, considering that a MACD has two relevant lines (fast and slow). Quite similar to previous examples, a buy signal occurs once the fast line goes above the slow one. A sell signal appears once the complete opposite of that happens (a fast line crosses below the slow one).

Relative Strength Index (RSI)

Relative Strength Index is referred to as an oscillator. However, it provides a bit different information due to its movement being between a zero and 100. The information that it provides is not the same as the one from MACD.

A simple way of interpreting what RSI shows is by following the indicator values. If it shows a value above 70, it means that the price has acquired the overbought status. When it’s below 30, the price is oversold. If an uptrend is good, the price can extend even beyond 70 while downtrends revolve around 30. Take into consideration, however, that these levels are not always accurate.Relative Strength Index

There is an alternative though, which is to purchase an oversold condition once you notice that the trend is up. Additionally, you will have to place a trade next to an overbought condition that is currently in a downtrend.

Concerning the signals, a buy signal can appear once the RSI goes under the value of 50. What that means is that the price has a pullback. Once it ends, the trader makes a purchase which resumes the trend. Typically, RSI does not reach the value of 30 in an uptrend, which is why people use the 50 level.

Once the trend is down, there is a possibility of short trade signals occurring. That happens when RSI reaches above 50 and back.

OBV (On-Balance Volume)

What OBV does is collect information and integrate it into an indicator which is represented by a single line. It measures buying and selling pressure by monitoring the volume. It adds the volume on up days and subtracts it on down days.

Since volume is something that should confirm a trend, the OBV should always go along with a price. Therefore, a rising OBV goes with a rising price while a falling OBV goes with a falling price.

If there’s a mismatch between the OBV and a price, the price is likely to follow the OBV’s values. In case the OBV is rising while the price is falling, it could mean that the price has already reached the bottom. The price reaches the top when the complete opposite happens.

The Bottom Line

There are several ways in which indicators can simplify the whole process. They can warn you of reversals and provide trend signals. Furthermore, you can use them along with any time frame and adjust them to your liking. You can combine various indicator strategies or even think of some other ways to implement them. If there is an indicator that is to your liking, take some time to look it up and test it out.

What are Charts?

Simply put, charts are visual representations of a security’s index or price over a certain period of time. All securities with price data over an interval of time can be employed to make a chart for a survey.

The vertical axis (y-axis) on the chart stands for the price scale. The horizontal axis (x-axis) stands for the timescale. Prices are plotted from left to right over the x-axis. The newest plot is at the furthermost right.

Chart Types

In order to analyze price movements, technical analysts use a wide variety of charts. Here are the main three types:

  1. Line Charts
  2. Bar Charts
  3. Candlestick Charts

Line ChartsLine Charts

We typically use the line chart to get the “big picture” view of price movements. We form the line chart by joining the closing prices over a defined time frame. Some traders and investors think that the closing level is more important than the open, high or low. When we pay attention only to the close, we can ignore intraday swings. These days, line charts are commonly seen together with mutual fund charts. That is because they only have closing prices and no intraday movement.

Bar Charts

This type is probably the most popular charting method. It can show the opening, low, high, and closing price of a specific security on a specific day. That can provide a better sense of how the stock traded for the duration of the day or its day-to-day volatility.Bar Charts

The low, high, open, and close have to form the price plot for every single period of a bar chart. The bottom and top of the vertical bar represent the high and low. The open and close are shown on the vertical line by a horizontal dash. The dash that is located on the left side of the vertical bar illustrates the opening price on a bar chart. Conversely, the dash on the right represents the close. The main difference between a line chart and an Open, High, Low, and Close (OHLC) chart is that the latter chart can show volatility.

Candlestick Charts

Candlestick ChartsThe third usual chart type is the Candlestick. Being similar to an OHLC chart, but also being able to present the information on a specific day’s trading in an easier and quicker-to-read format, this chart is many traders’ favorite.

They are similar to OHLC charts; they provide the same information, just not in the same format. A horizontal line which points out the open and close is used to construct the candlestick. A vertical box is what we get when we connect these two lines to make the candlestick “body.” There’s a single vertical line above the box, in the middle; it shows the high. And there’s another single vertical line in the middle, below the box; it shows the low, and it is called “shadows” or “wicks.” Another difference is the color of the body or whether it is filled or not. Usually, if the close is higher than the open, the body is left hollow (green or white) to point out an up day in that day’s price action. The body is closed if the close is lower than the open, to point out a down day.

Conclusion

There is a variety of charts available to us; one is not necessarily better than the other. We may use the same data to create a chart, but the way it is interpreted and presented will definitely vary. Each chart has its own advantages and disadvantages. Luckily, we can choose whichever we want or even use multiple types for analysis. It depends on our investing style and personal preferences.

What Exactly is Technical Analysis?

In essence, technical analysis is a technique used to find certain patterns in stock prices. Trading professionals who use the technique believe that stock prices follow a historical pattern. Technical analysts use the technique to identify and study these patterns in an effort to predict future stock price changes.Technical Analysis

Now, you shouldn’t confuse the term with fundamental analysis. Fundamental analysis actually involves studying certain characteristics of a single company, in order to estimate its market value. On the other hand, the technical analysis only looks at the price changes in the market. Now, let’s take a look at some of the main principles of technical analysis.

Technical Analysis Principles

·       The Market Discounts Everything

Some industry experts have criticized technical analysis before because it ignores the aforementioned fundamental factors and focuses on price movements in the market. However, technical analysts have a counter-argument based on the famous Efficient Market Hypothesis.

This hypothesis states that the price of a certain stock already reflects everything that affected the company, including fundamental factors. Furthermore, technical analysts think that every factor, from market psychology to company’s fundamentals, is already priced into the company’s stock.

That means that studying every factor separately before making an investment is basically useless. Therefore, you only need to analyze the price movements before making an investment decision.

·       Price Changes in Trends

According to technical analysts, stock prices move in clearly visible trends. Prices also have a tendency to stay on a particular trend. Prices usually move in short- and long-term trends. Until something breaks the trend line, the trend is considered intact.Technical Analysis Stock

Once the trend is established, stock prices are far more likely to continue a past trend than move unpredictably. A vast majority of technical analysts base their strategies on this assumption. Technical analysts follow market trends and trade their stocks accordingly.

·       The History is Bound to Repeat Itself

As we all know, history tends to repeat itself. Price movements also have a repetitive nature. Most experts attribute this to market psychology, which has a tendency to be very predictable based on basic emotions such as excitement and fear.

A technical analyst uses chart patterns to analyze market psychology and subsequent market movements in order to grasp current trends. While some of these chart patterns have been used for more than a century at this point, they are still relevant because they illustrate repetitive price patterns.

Final Words

Although technical analysis may sound overly-complicated at first, in essence, it’s a simple study of supply and demand. If you want to become a successful investor, you need to understand both the advantages and disadvantages of technical analysis.

Remember, technical analysis is done by ordinary humans – it’s not an exact science – which means it’s not perfect. Moreover, technical analysis is just one of the many approaches to studying stocks. When you’re considering what stocks to buy or sell, use an approach you’re the most comfortable with.