ESSENTIALS. ESSENTIALS of Technical Analysis for Financial Markets. James Chen. Praise for ESSENTIALS OF TECHNICAL ANALYSIS FOR FINANCIAL MARKETS

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Chen Investments & Securities Praise for ESSENTIALS OF TECHNICAL ANALYSIS FOR FINANCIAL MARKETS Wiley s Essentials Series promises need-to-have fundamentals for professionals.

, founder/president of Elliott Wave International, Publisher of The Elliott Wave Theorist Trend trading technical analysis is the most important lesson for all investors and Essentials of Technical

Michael Covel, author of Trend Following and The Complete TurtleTrader Think of this as financial market technical analysis 101 A valuable resource for traders at all skill levels, Essentials of

1 Chen Investments & Securities Praise for ESSENTIALS OF TECHNICAL ANALYSIS FOR FINANCIAL MARKETS Wiley s Essentials Series promises need-to-have fundamentals for professionals. With James Chen s new book, it now delivers some need-to-have technicals as well. Robert Prechter, Jr., founder/president of Elliott Wave International, Publisher of The Elliott Wave Theorist Trend trading technical analysis is the most important lesson for all investors and Essentials of Technical Analysis for Financial Markets is a great start. If you choose to ignore technical analysis, I guarantee a lifetime of very difficult money-making. Michael Covel, author of Trend Following and The Complete TurtleTrader Think of this as financial market technical analysis 101 A valuable resource for traders at all skill levels, Essentials of Technical Analysis for Financial Markets equips you with the knowledge you need to analyze any major financial market. This accessible guide to the art and science of technical analysis points you to a wealth of essential methods for identifying potentially high-probability trading opportunities. Focusing on the key information you ll need as a trader or investor, author and leading technical strategist James Chen helps you take on any financial market effectively, manage risk, and target profitability. Take a look inside this indispensable book for world-class guidance on: How you can pursue profit in the financial markets using technical analysis Principles of price action analysis and trading Charts including bars, candlesticks, and point and figure The key concept of trend Support and resistance Making the most of financial drawing tools, chart patterns, indicators, and other essential elements of technical analysis Top technical trading strategies, risk control techniques, and money management concepts Need the ultimate quick-start guide to technical analysis in the financial markets? Essentials of Technical Analysis for Financial Markets explains it all in a way that helps you hit the ground running and take your financial destiny into your own hands. JAMES CHEN, CTA, CMT, is Chief Technical Strategist at FX Solutions, a global leader in foreign exchange trading. An expert on technical analysis and financial market trading, he is also a registered Commodity Trading Advisor (CTA) and a Chartered Market Technician (CMT). Mr. Chen contributes daily and intraday technical analysis to key financial media, is a frequent speaker at trading seminars, and has authored numerous articles on trading strategies and technical analysis in major financial publications. His previous book, Essentials of Foreign Exchange Trading (Wiley), has become an industry-standard guide for currency traders. $39.95 USA /$47.95 CAN ESSENTIALS of Technical Analysis for Financial Markets A serious, workmanlike book, a terrific introduction to technical analysis. Chen offers beginners a clear sample of methods and techniques from which a reader may choose in what Dr. Alexander Elder, author of Trading for a Living to specialize. ESSENTIALS of Technical Analysis for Financial Markets Discover how technical analysis can dramatically improve your potential for success in trading and investing Understand the essential tools and methods of technical analysis to trade in any major financial market, including stocks, bonds, futures, and forex Explore the specific strategies technical traders use to make trading decisions and stack the odds in their own favor James Chen ISBN: PMS 2766C PMS 123C GLOSSY

3 ESSENTIALS of Technical Analysis for Financial Markets

4 ESSENTIALS SERIES The Essentials Series was created for busy business advisory and corporate professionals. The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core business areas. Each book provides need-to-have fundamentals for those professionals who must: Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope Manage a new functional area Brush up on new developments in their area of responsibility Add more value to their company or clients Other books in this series include: Essentials of Accounts Payable, Mary S. Schaeffer Essentials of Balanced Scorecard, Mohan Nair Essentials of Business Ethics, Denis Collins Essentials of Business Process Outsourcing, Thomas N. Duening and Rick L. Click Essentials of Capacity Management, Reginald Tomas Yu-Lee Essentials of Cash Flow, H.A. Schaeffer, Jr. Essentials of Corporate Fraud, Tracy L. Coenen Essentials of Corporate Governance, Sanjay Anand Essentials of Corporate Performance Measurement, George T. Friedlob, Lydia L.F. Schleifer, and Franklin J. Plewa, Jr. Essentials of Cost Management, Joe and Catherine Stenzel Essentials of Credit, Collections, and Accounts Receivable, Mary S. Schaeffer Essentials of CRM: A Guide to Customer Relationship Management, Bryan Bergeron Essentials of Enterprise Compliance, Susan D. Conway and Mara E. Conway Essentials of Financial Analysis, George T. Friedlob and Lydia L. F. Schleifer Essentials of Financial Risk Management, Karen A. Horcher Essentials of Foreign Exchange Trading, James Chen Essentials of Licensing Intellectual Property, Paul J. Lerner and Alexander I. Poltorak Essentials of Knowledge Management, Bryan Bergeron Essentials of Managing Corporate Cash, Michele Allman-Ward and James Sagner Essentials of Managing Treasury, Karen A. Horcher Essentials of Patents, Andy Gibbs and Bob DeMatteis Essentials of Payroll Management and Accounting, Steven M. Bragg Essentials of Sarbanes-Oxley, Sanjay Anand Essentials of Shared Services, Bryan Bergeron Essentials of Supply Chain Management, Michael Hugos Essentials of Trademarks and Unfair Competition, Dana Shilling Essentials of XBRL, Bryan Bergeron For more information on any of the above titles, please visit

5 ESSENTIALS of Technical Analysis for Financial Markets James Chen John Wiley & Sons, Inc.

6 Copyright # 2010 by James Chen. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) , fax (978) , or on the web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) , fax (201) , or online at Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) , outside the United States at (317) or fax (317) Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at Library of Congress Cataloging-in-Publication Data: Chen, James, Essentials of technical analysis for financial markets / James Chen. p. cm. (Essentials series) Includes index. ISBN (pbk.) 1. Investment analysis. I. Title. HG4529.C dc ISBN Printed in the United States of America

7 To my parents, my wife, my children, and technical analysts everywhere

9 Contents Preface Acknowledgments xiii xvii 1 Introduction to Technical Analysis: Pursuing Profit in the Financial Markets 1 What Is Technical Analysis? 2 Technical versus Fundamental 2 Methods 5 What to Expect 5 Summary 9 2 The Story of Technical Analysis: From the Japanese Rice Markets to Dow Theory to Automated Trading 11 The Beginning: Japanese Rice Markets 12 Dow Theory 14 Charting 17 Elliott Wave 18 W. D. Gann 20 Indicators 20 vii

10 Contents Trend Followers 22 Market Technicians Association 23 Technical Analysis Today 23 Summary 24 3 The Power of Technical Analysis: Principles of Price Action 27 Introduction to Price Action Concepts 28 Components of Price Action 29 Summary 32 4 The Basics of Technical Analysis: Bars, Candlesticks, Lines, and Point and Figure 33 Bars and Candlesticks 34 Line Charts 37 Point-and-Figure Charts 38 Summary 40 5 The Heart of Technical Analysis: Uptrends and Downtrends 41 Introduction to Trend 42 Effect of Time Frames on Trend Determination 50 Parallel Trend Channels 52 Trend Lines 54 Summary 55 6 The Soul of Technical Analysis: Support and Resistance 57 Introduction to Support and Resistance 58 viii

11 Contents Support Becomes Resistance Becomes Support 60 Summary 64 7 Primary Drawing Tools: Trend Lines, Trend Channels, and Horizontal Support and Resistance 65 Introduction to Drawing Tools 66 Static Support and Resistance 67 Dynamic Support and Resistance 72 Horizontal Support and Resistance Lines 78 Trend Lines 81 Parallel Trend Channels 87 Summary 89 8 Chart Patterns: Bar Shapes and Candlestick Formations 91 Introduction to Chart Patterns 91 Continuation Bar Patterns 93 Reversal Bar Patterns 102 Gaps 106 Candlestick Patterns 110 Single-Candle Patterns 111 Multiple-Candle Patterns 116 Summary The World of Moving Averages 119 Introduction to Moving Averages 119 Moving Average Crossovers 123 Moving Averages as Support and Resistance 131 Summary 134 ix

12 Contents 10 Key Technical Indicators and Oscillators 135 Introduction to Indicators and Oscillators 135 Key Indicators 139 Key Oscillators 148 Summary Fibonacci and Elliott Wave 161 Fibonacci Theory and Methods 161 Elliott Wave Theory 170 Summary Point-and-Figure Charting 177 Introduction to Point and Figure 177 Point-and-Figure Patterns 181 Point-and-Figure Price Targets 188 Summary Volume 193 Introduction to Volume 193 On-Balance Volume 196 Tick Volume 198 Summary Technical Trading Strategies: Practical Applications 201 Introduction to Technical Trading Strategies 202 Moving Average Crossovers 203 Breakout Trading 212 Trend Trading 224 x

13 Contents Range Trading 238 Price-Oscillator Divergences 244 Oscillator Trading 249 Fibonacci Trading 254 Positive Expectancy 256 Summary Risk Control and Money Management 261 Introduction to Risk Control and Money Management 262 Stop-Losses 263 Reward:Risk Ratio 266 Maximum Allowable Loss 269 Multiple Fractional Positions 271 Diversification 273 Summary 273 Index 277 xi

15 Preface The practice of technical analysis has grown at a remarkably rapid pace in the last few decades. Traders, investors, and analysts involved in all of the various financial markets have increasingly turned to the principles of technical analysis both to interpret as well as to act on market price behavior. These practitioners recognize that technical analysis provides a concrete, logical, and effective approach to tackling any major financial market. In addition, the development of new methods and techniques within the realm of technical analysis has been equally rapid. Whether it is the latest and greatest technical indicator or a fresh and innovative way to denote support and resistance, technical analysis has generally progressed in a swift, continuous manner since its inception. Many of these new developments have contributed substantially to the further evolution of the field. Consequently, innumerable specialties and subspecialties have developed within the discipline of technical analysis. In my years as an analyst and trader, however, I have deliberately refrained from having my primary focus progress onto excessively complex or esoteric concepts within the field. As a result, many have asked me why I xiii

For more information on any of the above titles, please visit

For more information on any of the above titles, please visit ESSENTIALS of XBRL Financial Reporting in the 21st Century Bryan Bergeron John Wiley & Sons, Inc. ESSENTIALS of XBRL Essentials Series The Essentials Series was created for busy business advisory and