CHAPTER 6

Technical Trading
Security Timing Tactics

echnical analysis examines the supply‐and‐demand data as explained by

T variables. Technical analysis can be used for forecasting, and if included
in conjunction with fundamental analysis, you can have an especially reward-
ing day‐trading enterprise. The big investment traders draw on both of these
methods of stock selection, often called the top‐down approach.When you are 41
looking at the bigger concept and making use of fundamentals, you are op-
erating with a security‐selection approach. When you make use of stock charts,
you are applying a security‐timing strategy. When I was on the trading floor,
I never really looked at technicals or fundamentals; I just traded on im-
plied volatility, paper order flow, and the supply‐versus‐demand curve for
these options. I recently realized how valuable this tool can be and I have
combined this with my OCRRBTT and HIMCRRBTT Trading Plans in order
to make myself the best trader possible. I’ve had three proprietary trading
plans in my arsenal for 11 years; I’ve been consistently tweaking them to
improve their efficiency and keep them up-to-date.
The chart of a stock and its option represents an image of the secu-
rities price as well as volume over time. The most useful graph is the
bar chart. You can probably find a securities bar graph on your current
day‐trading software or even at any of the commercially available sites
on the Internet.
Some trading programs allow you to request price charts and sketch
trend‐lines right on the graph.When this software application is available,
it is frequently possible for you to position your cursor precisely at the

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 position you intend to make a purchase or sell order. This helps you
visualize where your buys and sells are on the chart. I day‐trade futures
as well as make trades in equity options and stock. Every futures product
trades better on a different interval. For example, Silver, Gold, and Oil
move fast and usually with the trend, so I might want to trade these
futures on a fast 1‐ or 5‐minute bar. Futures such as the Dow and S&P
500 move much slower, so I want to widen my 5‐minute bar to a 15‐ or
30‐minute bar.
Price charts can be changeable with regard to the timeframe they include.
To make sure you get a complete background viewpoint you could look at a
weekly graph or chart, which shows the securities closing prices at weekend.
These weekly charts frequently show historical prices of 52 weeks and
greater, and are beneficial to obtaining a point of view of the price history
of the security. For day‐trading purposes you may wish to change to hourly
and then 15‐minute charts, in order to get an up‐close look at the direction
of the security in a shorter time period.
When I trade all of my equity positions in my account, I go through a
couple of different graphs. I always look to see how the chart compares to
the Ichimoku Kinko Hyo Cloud. I first look at the daily chart for options and
42 then often I can expand it to a weekly chart or even a monthly chart. I am
a trend trader; I want to trade with the trend. For earnings I might care if
TECHNICAL TRADING

MSFT is channeling higher on the weekly chart, if it is beneath the Ichimoku

Kinko Hyo Cloud on the daily chart.
If the stock is in a bear channel, then I often do not take bullish trades
even if the unusual options activity supports these trades. Also, if on the
daily chart of a stock is making higher highs and higher lows and I see bearish
activity, I believe this trade will often be made as protection for a long stock
position as opposed to a bearish trade. I use the charts to help indicate to me
that I am making the right choice when making or not making a trade. This
concept will be further covered later in the book.
Bar charts show the closing, the highest, and the lowest price of the
session. They also include the volume of the security during that session.
Volume is a good indicator when you are looking for support and resistance
levels and breakout activity. Often volume can help find breakout to the
upside or when a short squeeze might have ended too high. Just as I watch
the volume of the unusual options activity it is important to watch the
volume of a stock on days after earnings, breakout days, and huge movement
days. Is it possible that there might be a massive short squeeze selloff or a
liquidation from a big hedge fund?
■ Support and Resistance Levels

Patterns appear in a bar chart over time and each pattern offers different types
of information. Support and resistance patterns show traders the psychology
of a security’s price. When you draw a line at the average bottom price and
top price you come up with the support and resistance of the security. The
top line is called the resistance level or resistance line. A breakout is when the
security moves above the resistance level. When a breakout is reached, there
will be added excitement in that security, and if the breakout is reached with
above‐average volume, this indicates the formation of a new trend. It is said
that what is resistance becomes support. This means that if a stock breaks through
resistance to the upside with higher volume, then if the stock sees any selling
pressure in the future, the level that was a hard level to break is often where
buyers will come into the market, thus making it a support level.
The support is the bottom line, and when the security gets to this point,
traders will sell out of the security. If there is a lot of volume at the support
or resistance, this means that there are a lot of traders using this as entry and
exit points. When a security travels past its support or resistance point with a
lot of volume, it is thought to be a good breakout. The point of the breakout
is called a pivot point, and is often followed by a test of the breakout, a time 43
when the market rethinks the breakout and the security falls in price. There is

TECHNICAL TRADING
often much activity when a security reaches a support or resistance level, be-
cause stock and options traders all over the world have drawn the same lines.
Many of them have come to the same conclusions as to where those important
levels are and they are ready to react when a level is reached. Support to the
downside also becomes resistance.Thus, if a stock is breaking lower and moves
through the support level with heavy volume, then many times this level will
become resistance. That means if the stock pops back up to this level, where
there used to be buyers there will now be sellers.
An ascending triangle or descending triangle is revealed when you draw a line
along the top supports and along the resistances. If the lines make a wedge shape,
then there is a good chance that there will be a breakout in that direction. If a
stock is making lower lows and lower highs in an ascending triangle, most likely
it will have a breakout to the downside, as the stock looks very weak.

■ What Is a Gap?

A gap occurs if the trading of a security opens above or below the close of
the session before; this is often due to the market’s reaction to overnight
 news. Then there are two things that are important: a half‐gap and a full‐
gap fill. Let’s say that XYZ is traded between $29 and $31 on Monday.
On Tuesday, the stock gaps higher to $32. (This is above yesterday’s high,
hence the gap.) Most of the time there will be buyers in the market at
half the level of yesterday’s high and the open, at $31.50. Then there will
be even more buyers at $31, testing the full gap. Just as support becomes
resistance, yesterday’s high will now act as support and even more buyers
should enter the market.

■ Dow Theory

Dow theory is used to plot the future movement of a security using the
Dow Jones Industrial 30 and the Dow Jones Transportation averages as
baselines. There are hourly, daily, and weekly movements in the stock
market. The shorter the time period, the faster the movement. When the
hourly chart crosses the daily chart and is in the same direction as the
weekly chart then the Dow Jones Transportation averages report the same
trend. This theory has been around for many years and is still employed by
many technical analysts.
44
TECHNICAL TRADING

■ Elliott Wave Theory

Elliott Wave theory employs past information of a security’s movement

to predict future direction. The basis of this theory is that securities in
the market have five distinct steps, and these steps form three separate
waves. Once all five parts of the wave have worked their way through,
a top (or bottom) of the stock will be tested. When a top or bottom is
reached, this also marks the beginning of a fresh trend.
There are flaws to the theory, and they are similar to the flaws of the
Dow theory, as there is no distinct separation of the different steps,
and it is often difficult to determine a step’s number in relation to the
others; that is, you might be thinking a step is number four in a series
when in actuality it is number three or even number two. It can be
difficult to decipher the elements of the Elliott Wave accurately. This
should not, however, prevent you from determining for yourself its
value, as many professional traders rely on its indicators in their trad-
ing strategies.
■ Moving Averages

Don’t be too concerned with your calculation of some of the indicators.

Indicators such as a 200‐day moving average can be easily drawn with some
of the software programs that are available. I look at 20‐, 50‐, 100‐, 150‐,
and 200‐day moving averages. If the stock is trading above all moving aver-
ages, it is bullish. These moving averages act as magnets that stocks like to
test to in order to find buyers or sellers in the market. If the stock is trading
above all moving averages except the 20‐day moving average, this means
that the longer‐term averages are higher, but the short‐term trend is lower.
Once an indicator is drawn on a chart, the chart can be saved and refreshed
at each trading session. The moving average is just the average price where
the stock closed in 20 straight trading days, and 50, and 100. This does not
take into consideration how much it moves intraday and the volume at dif-
ferent price levels.

■ Fifty-Day Moving Average

Another useful chart to look at is a security 50‐day moving average. The

measure of a security’s rate of movement is called its momentum, and is 45
measured by a security’s moving average deviation.This number is calculated

TECHNICAL TRADING
by dividing the security’s closing price by its ten‐week moving average.
Many professional day traders use this method to analyze securities that
have a tendency to be very volatile. This indicator can help you determine
when a new trend is in play, and when a security is overbought (too high) or
oversold (too low.) Ten‐week or 50‐day moving averages are also useful in
gaining a longer‐term perspective.

■ Forty-Week Moving Average

Many technicians refer to a securities price in relation to its 40‐week moving

average. The 40‐week moving average number for a security is figured by tak-
ing the security’s ending price for the previous 40 weeks and dividing by 40.
The next week would be added to the initial number, and the first week of the
group would be dropped. The result is a 40‐week moving average and has the
effect of smoothing the picture of the securities closing prices. The 40‐week
moving average is also known as a 200‐day moving average (200 DMA).
 Then there is the golden cross, where the 50‐day moving average crosses
the 200‐day moving average. If the 50 DMA is under the 200 DMA and
crosses it to the upside, it is extremely bullish. The opposite is true if the
50 DMA crosses the 200 DMA to the downside.

■ Magnets and Targets

It does not matter where the stock is trading; there are always magnets and
targets. The price level to which a stock is attracted or propelled to can
be known as a magnet. Support, resistance, moving averages, and previous
highs and lows all act as magnets as a stock will often move to that level in
order to attract new buyers or sellers coming into the market. Then there
are targets, which act as Fibonacci levels (or “Fib” levels) and measured‐move
targets in technical analysis. If a stock is trading between $30 and $35 for an
extended period of time and breaks to the upside on heavy volume, then it has
a measured‐move target to $40. We get this from $35 – $30 = $5 + $35 =
$40. Also, as we talked about a half‐gap, if a stock is trading between $50
and $100 for a couple of years and is currently trading $85, it might need to
test the Fib level of 50 percent to $75 to attract new buyers in the market.
46
TECHNICAL TRADING

■ The Stochastic

Another useful indicator is a security’s stochastic. This is the measure-

ment in percentage terms of the price velocity of an individual security or
market index as compared to a range set by a market analyst. The higher the
percentage of the stochastic, the closer that security’s price is in relation to
the preset range. A stochastic of 0 percent would indicate it is at the bottom,
while a stochastic of 100 percent would indicate that the security or index
was at the top of the range.

■ Other Charts, Technical Indicators,

and Money Supply
The popular periodical Investor’s Business Daily (www.investors.com) pub-
lishes the relative strength number for securities. The relative strength of a
security is designed to measure the security’s relative price change in the
year prior and compares it to all other securities. A relative strength number
of 80 and above is considered exceptional.
■ Japanese Candlestick Charts

Japanese candlestick charts are read much like bar charts. The main
difference is that Japanese candlestick charts offer more information
than ordinary bar charts. The high and low for the day and the opening
and closing price of the day are shown. Also, there is a difference in the
charts for when the end-of-the-day price is lower than the beginning‐of‐
the‐day price, and vice versa. In part due to the many inputs required to
formulate Japanese candlesticks, there is something of a consensus among
professional traders that these charts are inherently too complicated for
serious use.

■ Disadvantages to Moving Averages

Moving averages work very well on a broad scale, but they fail to account
for how much the stock moves during the day. For example if XYZ is
$30 and trades down to $25 with heavy volume, then the stock spikes to
$35 prior to closing at $30, then the moving average would merely show
two days that the stock settled at $30. It does not take into consider-
ation how much volume traded at $25 and how much volume at $30. This 47
would be very important information, so that is why I use the “Cloud,”

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discussed next.

■ The Ichimoku Cloud

This is my favorite indicator and I take many of my equity options trades off
indicators from the Ichimoku Cloud on the daily chart. I also use this indi-
cator in much of my day trading. It is a time‐weighted moving average and
keeps me on the right side of the trend. A chart is used in technical analysis
that shows support and resistance and momentum and trend directions for
a security or investment. It is designed to provide relevant information at a
glance using moving averages (tenkan‐sen and kijun‐sen, in Japanese) to show
bullish and bearish crossover points. The “clouds” (kumo) are formed be-
tween spans of the average of the tenkan‐sen and kijun‐sen plotted six months
ahead (senkou span A), and of the midpoint of the 52‐week high and low
(senkou span B) plotted six months ahead. I am in general a trend trader, so
I want to make sure I stay on the side of big money and big paper. I could
write a whole book about the Ichimoku Cloud, but basically I want to buy
 above the Cloud and sell below it. If I bought above the Cloud, I would have
a stop under the Cloud or where the trend has now flipped to the downside.
The Cloud takes advantage of time and volume trading at different levels to
keep a trader in the direction of the trend. The Ichimoku Cloud has many
different aspects and setting it up to chart properly depends on product and
timeframe.

■ Summary

Do I use all of these technical trading tools? No, but I include them in my
trading plan so I have the most complete trading repertoire possible. It’s like
being one of the best hitters in major league baseball, but not being able to
hit a curve ball. Eventually, pitchers will realize that you cannot hit a curve
ball and soon they will only throw curves to you. Throughout my 11‐year
career, I have made some bad trades, but I have made many more good
trades. I have to realize that technical analysis is a tool that I need to combine
with all my other tools in order to be the most complete trader I can be.
If you find a charting system, ratio, or indicator too complicated, too
difficult, or too hard to understand, feel free to switch to a chart system or
48 indicator you feel comfortable with. Options trading is difficult enough, and
you shouldn’t feel obligated to complicate it further.
TECHNICAL TRADING

Questions
1. Traders on the trading floor never really look at the when they are
trading options.
a. Technical indicators
b. Fundamental indicators
c. Implied volatility
d. Paper order flow
e. a and b
2. Changing the timing of your bar chart from a 5‐minute bar to a bar
with different futures products, such as from Gold futures to S&P futures,
can help you trade with the trend.
a. 5‐second bar
b. 1‐minute bar
c. 30‐minute bar
d. None of the above; don’t change the time of your bar.
Questions (Continued)
3. Bar charts show the price including the period’s closing, highest, and
the price during the time period.
a. Average
b. Ending
c. Lowest
d. None of the above
4. Volume is a good indicator when you are looking for:
a. Support levels
b. Resistance levels
c. Unusual options activity
d. All of the above
5. It is very important to watch the volume of stock on days after .
a. Earnings
b. Breakout days
c. Large percentage movement days
d. Important news days
e. All of the above
6. Which of the following is obviously not one of Andrew Keene’s trading
plans?
a. OCRRBTT Trading Plan 49
b. HIMCRBBTT Trading Plan

TECHNICAL TRADING
c. Non-Blowout Trading Plan
d. Jiminy CRICKET Trading Plan
7. Dow theory combines hourly, daily, and weekly movements in the market
with the .
a. S&P 500
b. Dow Jones 30
c. Dow Jones Transportation Average
d. b and c
e. All of the above
8. Moving averages can be effective indicators when they .
a. Stand alone as information
b. Are combined for information
c. Are combined with different timeframes
d. All of the above