Top 10 rules of technical trading by John Murphy

Where will the market move? Will it soar or plunge? When will the trend reverse? These are the key questions asked by technical strategist John Murphy.

John Murphy is a legendary trader with the over 13 years’ experience. He developed 10 major rules of technical analysis based on his experience. The rules apply to a wide audience of traders – both novice and pros.

For reference, John Murphy worked as technical analyst for CNBC TV channel. He hosted a popular Tech Talk show for 7 years. Murphy also is the author of Technical Analysis of the Financial Markets, Intermarket Analysis, and The Visual Investor, well-recognized best-sellers. His most recent work covers the so-called visual aspects of technical analysis.

Rule No.1 Map the trend

First and foremost, examine long-term charts. Start with the weekly, monthly and yearly charts. The bigger time-frame you choose, the better long-term perspective will be seen. Having recognized the downtrend, study the daily and intraday charts. The analysis of one short-term movement can mislead you. The rule applies for successful traders working with short-term time frame. It will help them to make weighted trend-following decisions.

Rule No.2 Find trend and follow it

Long-term, short-term and intermediate-term - these are the trend types. Make your choice and work with the relevant chart. Make sure that you follow the right trend. In case the trend is up, buy on the dips. If the trend is down, sell rallies. As for the intermediate trend, use daily and weekly charts. Day traders are advised to use daily and intraday charts. This way or another let the longer trend reveal itself.

Rule No.3 Look for highs and lows

At first, find support and resistance levels. The best level to buy is near the support level, for sell deals the resistance level works perfectly. After the resistance level is breached, it becomes a new support level at possible pullbacks. Similarly, when the support level is broken, it becomes the resistance level.

Rule No.4 Be cautious calculating rebounds

The correction is measured as percentage. Market corrections that go whether up or down, usually retrace the most part of the lost trend.  This can be measured as percentage. Commonly, 50% retracement of the previous trend is seen, rarely – 30%. Two thirds is the maximum price rebound. Besides, it is useful to monitor Fibonacci figures. In other words, during an uptrend, the buy point will be consolidated near 33-38%.

Rule No.5 Mind the trend lines

Make it a routine to draw trend lines. What is a trend line? It is a helpful and quite simple tool consisting of a straight line and two dots. The uptrend lines are plotted by two consecutive lows, and downtrend – by two consecutive highs. Prices pull back to trend lines amid the market rebound. When the trend line is broken, it flags trend reversal. The most accurate trend line is the one that touched the lowest level at least 3 times. The longer the line is, the stronger and more important it is.

Rule No. 6 Adhere to MAs

Keep in mind that the moving averages point to the reliable buy and sell signals and show the trend strength confirming its change. However, they cannot predict a reversal in advance. Anyway, combination of two moving averages is the right way to determine trading signals. The most popular ones are combinations of 4- and 9-day MAs, 9- and 18-day, 5- and 20-day. The moment when the shortest line is crossed by the longest one is the signal. A good signal is the price crossing above or below 40-day MA. The indicator works best of all on the forming markets.

Rule No. 7 Investigate reversals

Oscillators should be carefully monitored. They will help you to quickly determine both the oversold and oversold level. If the MAs identify the trend change, oscillators can predict the reversal. The Relative Strength Index or the RSI and Stochastics are the most popular oscillators which work in the range from 0 to 100. RSI above 70 threshold means overbought area, while 30 – oversold. Relative to Stochastics overbought and oversold areas equal to 80 and 20. The lion’s share of the market players prefer 14-day or weekly Stochastics and 9 or 14-day or weekly RSI. Any divergences in oscillators can mean a bellwether of a trend change. These indicators work smoothly in a trading range. Weekly signals can serve as filters for daily signals and the daily ones – for intraday charts.

Rule No.8 Do not ignore signs

Use MACD. The indicator comprises two MAs in one system with overbought/oversold elements of the oscillator. If you have noticed that the quickest line crosses the slower one from the bottom up nearing at the 0 level, this is the buy signal. Sell when the quick line crosses the slow one from above and above the 0. Note that the daily signals are less accurate than the weekly ones.

MACD histogram is based on the difference between the two lines and shows the trend change. It is known as histogram as it is plotted by the vertical lines.

Rule No.9 Trend or not a trend?

Pay attention to the ADX indicator. It can show whether the market is in trading or trending phase. The indicator can also measure the trend and market movement. A rising line signifies a strong trend, while low line shows its absence. In the first case they use the MAs, in the second one – oscillators. The ADX indicator will help you to choose a trading style and any extra indicators most suitable for the current market situation.

Rule No. 10 Signal confirmation does matter!

The volume and open interest are important indicators of signal confirmation. A change in volume supersedes a price change. Make sure that the biggest volume follows the trend. Amid the uptrend, the bigger volume can be found during greater movement. Stronger open interest means that new money supports the prevailing trend. If interest is fading, the trend will end soon. A growing volume and interest are noted at the uptrend.

John Murphy’s rules are aimed at making technical trading clearer. Try not learning from your own mistakes, but use experience of professional traders.

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