A Short Course in Technical Trading / Edition 1

by Perry J. Kaufman

Overview

Learn to trade using technical analysis, market indicators, simple portfolio analysis, generally successful trading techniques, and common sense with this straightforward, accessible book. Essentially a course in making money, A Short Course in Technical Trading teaches proven long- and short-term trading techniques (with an emphasis on short-term), covering basic indicators and how you can best use them to your advantage.

The book includes a trading game so you can trade along with the lessons, posing likely problems that you'll encounter once trading begins. As trading becomes more complicated, so do the problems..

You'll get a running start as a trader with usage tips on the most popular trading tools. A Short Course in Technical Trading is unlike any other book on the market and is available at a convenient low price.

Product Details

ISBN-13:	9780471268482
Publisher:	Wiley
Publication date:	06/25/2003
Series:	Wiley Trading , #161
Pages:	336
Product dimensions:	7.01(w) x 10.06(h) x 0.89(d)

About the Author

PERRY J. KAUFMAN is a leading expert in trading systems and the developer of successful investment programs for over thirty years. He is actively involved in the practical analysis needed to support international investment management. Kaufman is the author of Trading Systems and Methods, 3rd Edition (Wiley) as well as eight other books. He has published numerous articles in Technical Analysis of Stocks & Commodities, Futures Industry, and Futures magazine. This book is the result of a graduate course taught at Baruch College in the Spring of 2002. Mr. Kaufman can be reached at [e-mail].

Read an Excerpt

A Short Course in Technical Trading

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By Perry J. Kaufman

John Wiley & Sons

Copyright © 2003

Perry J. Kaufman
All right reserved.


ISBN: 0-471-26848-8

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Chapter One

Timing Is
Everything

This course is about how to trade, not how to hold a position. It's about being
on the right side of the hill. It will teach you when to buy, when to sell, and
how to take losses before they affect your net worth.

There are some basic market truths that everyone needs to know before
trading. One of the most important things to learn is that things change.
Because things change, you need to ground yourself with trading facts. After
all, you are going to be immersed in stock prices, interest rates, and the barrage
of information that floods the news. You will need to know some of the
terms used in trading and in analyzing price patterns. You'll also want to
know what works and what doesn't work-mostly what works-and why.
For the answer to this last question, you will need to work your way through
the lessons. By the end of this course, you will understand why a technical
approach to trading makes sense.

THE MARKET CHANGES

The stock market is evolving. It is not the same as it was 10 years ago, or even
5 years ago. That's good news for those of youstarting now because you
won't be burdened by unnecessary and incorrect ideas about the way the
market should act. Consider the obvious things that have changed:

The equipment is faster.

The people who are trading are more knowledgeable.

More people are using the markets-there is more competition.

Exchanges are becoming electronic.

A lot of the order entry is computerized.

Commissions are so low that they no longer force you to hold a trade for
a long time just to break even.

Improved communications technology has caused globalization.

New trading vehicles, such as trusts, Fed funds rates, single stock
futures, and derivatives have changed the way institutions and individuals
use the markets

Everyone reacts to news faster than ever before.

We've discovered recently that the recommendations of stock analysts
often were biased.

How could prices move in the same way now, when the basic structure of the
market is in constant change?

The importance of these changes is that what was successful trading in
the past is unlikely to work as well today-if at all. During the 1990s we saw
an unprecedented bull market trend in stocks that stretched around most of
the world. That was followed by an equally dramatic, highly volatile drop in
prices and an erratic sideways price period. In Figure 1.1a, we see the S&P
500 index from 1993 through 1997, and in Figure 1.1b, Microsoft from late
1995 through 1997. The trends are remarkable. During the last three years of
that period, the S&P 500 gained 50 percent, and Microsoft gained 260 percent.

We see how quickly these markets can change in Figure 1.2. The S&P
(Figure 2.1a) loses 50 percent of its value during 2000 and 2001, with very
sharp drops and mild rallies. Microsoft (Figure 1-2b) loses half of its value,
changing to an erratic, volatile sideways pattern before dropping half its
value in one month. As if global warming affected the markets, we are seeing
one extreme after another.

HOLDING ON FOR THE BIG PROFIT

Of course, you can still profit from a buy-and-hold approach, given enough
time. You also can profit from a sustained policy of the Federal Reserve to
lower interest rates and stimulate growth-a plan that can last two years or
more and create trends in everything from stocks to real estate and art. But when
you hold a position for a long time, you are exposed to more price fluctuations
and more risk. With the exception of the mid-1990s, there haven't been many
periods of high profitability for investors and long-term traders.

Beginning in 1999 anyone holding equity positions found out that the
stock market doesn't just keep going up. It's been three years of downward,
sideways, and volatile price movement; trying to keep losses to a minimum
isn't easy. Investors are now looking at the market with the eye of the trader,
trying to hold a position when it's doing the right thing and getting out when
it's not. There's nothing wrong with that approach. In fact, there's a lot that's
right with it.

EXTRA BENEFITS OF TRADING

When you actively trade a stock or a futures contract, you are not holding a
position all of the time. That's very important because stocks spend a lot of
time doing nothing, or doing the wrong thing. To offset these sometimes
prolonged periods of aggravation or boredom, we get an occasional price
shock, such as September 11, 2001, the U.S. invasion of Kuwait, a presidential
election, or a surprise interest rate increase by the Federal Reserve. A price
shock causes an unpredictable, large jump in prices.

Note that the term unpredictable means that you can't plan to make a
profit, no matter how clever you are. When you are always in the market, you
will always be tossed around by price shocks, most of them small, a few of
them very big. We're going to spend some time throughout this course looking
back at price shocks. They are the rare random events that cause the
greatest losses among traders. The longer you trade, the more you'll see price
shocks. You don't ever want to make the mistake of thinking that it was
skill that netted a big profit from a price shock. It was luck. Next time, or
the time after, you won't be lucky. It's a 50-50 chance.

WHAT IS TECHNICAL TRADING?

Technical trading is the process of making trading decisions based on clear,
objective, predetermined rules. Those rules apply only to price data, volume,
and for futures markets, open interest. You could include other economic
data, such as unemployment and the Consumer Price Index (CPI), but that's
not necessary and we won't do it here. Besides, it's not clear that using all
these facts will improve our profits.

The techniques used in technical trading include trendlines, moving averages,
chart patterns, and a few indicators based on simple mathematical formulas.
None of it is complicated, but it takes practice to do it right.

Some people call this systematic trading. The way to be sure that the
indicators are done correctly is to enter them into a spreadsheet, or program
them into a software trading program that helps us get results quickly. Charting
and pattern recognition remain special skills, but ones that are not very
difficult to master.

CHOOSING THE SYSTEMATIC WAY

It is not a choice between "which is better," investing based on fundamentals
or technical trading. They are two very different methods chosen for completely
different reasons.

The fundamental investor may be looking for a cheap price or good
value on a piece of merchandise with the idea of holding it until it returns to
value, or appreciates in value. You don't want to overpay for real estate or
stocks because it cuts into your returns.

The systematic trader is foremost a trader. A trader doesn't hold a position
based on value, but decides whether the price is relatively too high or
too low, whether it is in a long-term or short-term trend, extremely volatile
or quiet. For each of these technical qualities, the systematic trader has a
clear rule to follow. The rules are based on common sense and then tested
using historical data to be sure they actually work. We will learn how a
spreadsheet or special computer program may be used to validate the rules.
You will find that many of the rules that are based on charting methods have
been handed down from one generation to another.

TECHNICAL TRADING AND VALUE

A technical trader may also be influenced by fundamentals. A long-term
trend follower-one who buys a stock when the trend is rising-is really
tracking the increase in the value of the stock in an objective way. If Mrs.
Hathaway was long Cinergy (a public utility) in 1997 based on a 100-day
trend, she would be taking advantage of the Fed policy of lowering rates
even though the reason for rising prices might not be important to her, and
she may not have seen the close relationship between Cinergy's stock price
and interest rates.

The fast systematic trader could even profit if the stock or futures market
were above value. He or she could be in a trade for a few hours or a few
days. The value of a stock isn't very important for a fast trader, only its
volatility and short-term direction. Even when stocks were trending higher,
as they were in 1997, the impact of the long-term trend on a one-day trade
was very small. You could buy or sell and still return a profit. Value, or fundamental
information, is of minor importance for short-term traders.

We choose systematic trading because

It provides discipline.

We can backtest (check the rules using historic prices) to see if the
trades would have been profitable.

We have confidence by knowing what results to expect both risk and
return.

We can monitor current performance to decide if the method is still
working as we expected.

USING A METHOD WE UNDERSTAND

By using trading rules based on prices, we are going to avoid some important
problems. For example,

We don't know how to find out if a stock is undervalued. In fact, we're
not sure that the experts can find the right value. We've found out the
hard way that those who try to assess value may not have all the facts.

We don't need to watch a stock price drop by 90 percent before being
told by an expert that its value has changed.

We are concerned that news, opinions of others, or just a bad day can
change the opinion of a fundamental or value trader.

We don't know if using fundamentals can produce consistent profits.

We will let the market tell us that prices are rising or falling and not rely
on the advice of broker. A trend follower needs a Yogi Berra type of philosophy:
"It's not going up until it's going up!"

What's the Downside to Technical Trading?

Every method has its problems. To use systematic trading, you also need to
know what can go wrong.

You can't find a method that works.

You may take a position opposite to what is being said on CNBC.

It may seem stupid to take another long position after just posting two
losses in a row.

It started working great, but now something's gone wrong.

The risk is too high.

Each one of these problems has a reasonable solution. The purpose of this
course is to show you some of the methods that are most likely to work, and
help you get comfortable with their good and bad parts. If you can't find a
simple method that works, you won't find a complicated one.

WHAT ARE THE OTHER GUYS DOING?

Let's take a few minutes to look at how man.y fundamental traders decide on
what stock to buy, and when they will enter and exit the position.

How Do We Normally Decide to Buy a Stock?

We make a qualitative decision: Is it a good company?

Is it profitable? Has it paid dividends regularly? Is the stock rising? Does
it have a lot of debt? Is the P/E ratio high or low? In other words, is the
company a good value?

Is the company healthy? Is it in good strong hands? Is the management
competent? Is there a large employee turnover? Are salaries reasonable?

Is the company likely to be competitive in the future?

Add to these concerns some new questions, such as: Does the CEO have
a sensible exit package? Are there any accounting irregularities?

All of these questions and answers are important. They try to reach the vital
areas that determine whether a company is sound and likely to remain that
way. The problem is whether you can get answers to these questions, and
whether those answers are reliable. Even when they appear to be answered,
what is your level of confidence in a decision based on so many complex
issues?

Reliability of Information

Let's look at the most outrageous event of the past 10 years-the collapse of
Enron. Briefly, Enron was a powerhouse in energy trading. It had assets in
the form of a pipeline, and a large trading "book" in electricity. It was thought
of as innovative and highly successful, a business model for the future. It was
a substantial component of the S&P.

We see now that much of that was done with mirrors. It appears that
Enron had off-balance-sheet deals that were not reflected in their numbers,
and the company was said to have generated artificial trades to make it
appear that their trading volume was higher. Enron closed out trades before
producing its monthly risk report, and then reset them the next day. The
company did everything it could to inflate the Enron stock price and with
the apparent blessing of their accountants. With the full benefit of hindsight,
how reliable is the information that we use to base our value decisions?

Pro Forma Results-What Are They?

Amazon.com has made an art of publishing pro forma company performance.
What is that? It's not the net earnings of the company, or its profitability.
It's a statement of "what company earnings would be if ...," where
"if" can be

If we didn't need to write off a one-time loss due to a mistake in starting
a new product

If we didn't need to pay out debt that was obligated when we began the
company

If we didn't have to pay our employees a salary

The problem is that pro forma results can be anything, as long as you explain
what you've done. As remarkable as it seems, the stock price will rally after
good pro form results-why would a pro forma report be anything but good?

What Happens When Public Confidence Changes?

Returning to Enron, we need to remember how fast public confidence
eroded. In Figure 1.3 we see the stock quickly drop from $30 to nothing in the
final days, but Enron prices had peaked a year earlier. Even before the off-balance-sheet
transactions became public and problems became obvious,
prices had declined from $90 to $60. What is most upsetting is that the major
brokerage firms did not issue a sell signal until Enron was in the throws of
death, a decline of nearly 90 percent of the stock price.

How Would You Have Done?

Look at Figure 1.3 again. During all of 2000 and the first part of 2001, Enron
held above $60, peaking at $90. In early 2001 it dropped from about $70 to
$60, then to $50 within a few weeks. That was an unprecedented decline,
leaving prices well off the highs by 40 percent. Traditional thinking declares
a bear market when prices decline 20 percent. At least we need to recognize
that something has changed. Why would the price drop 40 percent unless
there was a problem?

HOW DO YOU DECIDE THAT YOU
SHOULD NO LONGER OWN THE STOCK?

The decision to sell a stock is at least as important as the one to buy.

Continues...

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Excerpted from A Short Course in Technical Trading
by Perry J. Kaufman
Copyright © 2003 by Perry J. Kaufman.
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Preface vii

Acknowledgments ix

1. Timing Is Everything 1

2. Charting the Trend 18

3. Breakout Trends 36

4. Calculating the Trend 51

5. The Trading Game 78

6. Channels and Bands 91

7. Event-Driven Trends 107

8. Controlling the Risk of a Trade 118

9. One-Day Chart Patterns and Reversals 130

10. Continuation Patterns 145

11. Top and Bottom Formations 153

12. Retracements, Reversals, Fibonacci Numbers, and Gann 167

13. Volume, Breadth, and Open Interest 180

14. Momentum and MACD 199

15. Overbought/Oversold Indicators and Double Smoothing 213

16. Managing Your Entry and Exit 235

17. Volatility and Portfolio Management 243

18. Dow Theory 262

Review Questions 275

Answers to Chapter Questions 287

Review Answers 307

Index 317