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Trader's Corner

For the Birds

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Dictionaries define the phrase "for the birds" as an idiom that means that something is useless or worthless. Lately, even those of us who love technical analysis have sometimes felt with disgust that it's for the birds.

Annotated Daily Chart of IWM:

The IWM is the IShare Russell 2000 Index, one many employ for their RUT-related trades.

When studying charts such as this one, it's clear that the action must be scrambling intraday charts, and it is. That's often where the disgust with technical analysis begins. Intraday setups are often and often brutally reversed. All the technicals, including breadth indicators, can be in favor of an intraday trade, only to reverse and leave traders with gains that evaporated seemingly instantaneously.

It's tempting under such circumstances to chuck out technical analysis. Although some talented and lucky scalpers can benefit wildly from action such as this, traders with sound account and trade management practices may be hurting, punished for their good management skills. They're repeatedly whipsawed out of trades that were entered on solid trade setups or trade setups that certainly appeared solid at the time.

Such action might prompt some traders to decide that since so many reversals are occurring, they should just hold onto their trades gone wrong. A reversal is bound to come, some reason, and will soon put them right again. Or if not, they prefer to suffer one big loss rather than go through whipsaw after whipsaw that amounts to the same thing.

Big mistake.

Traders will of course find times that ignoring a stop and hoping for a reversal works in their favor, at least minimizing losses if not producing gains. I've heard from a few in recent weeks who were delivered such reprieves. They were grateful. They should not have been.

Those traders were terribly unlucky.

Why unlucky? They were rewarded for bad trading practices. Such practices will eventually decimate their accounts if not changed.

Let's take a second look at that IWM chart and see if technical analysis is really for the birds, if traders should chuck out technical analysis and sound account and trade-management practices, too. Let's start with a look at the candles, with candlestick theory being a valid technical analysis study in my opinion and those of many others.

Annotated Daily Chart of the IWM:

Indecision mixed with emotion-based trading: that's not a mix that's predictive of solid gains for traders, except those with deep pockets, well able to endure the whipsaws or to hang on through those whipsaws. Technical analysis of this chart signals loudly and clearly that retail traders need to exercise caution. Front-month options will be suffer theta-related (time) decay all the while this whipsawing action is going on. They'll suffer vega-related (volatility) decay when those indecision days arrive and volatility measures drop.

Adding in other technical analysis indicators provided other clues to traders. They alerted traders when their profit-protecting plans needed to be updated. They alerted other traders when a countertrend entry might be attempted, when logical stops were nearby. Sometimes those warnings weren't needed and new trades were stopped, but the function of technical analysis is to allow planning time, not to offer a crystal-ball prediction.

Annotated Daily Chart of the IWM:

The wild chop also alerted traders that the IWM was in a period of disorganization and that they should watch for it to settle into some kind of tradable formation. Such formations would allow traders to make more reasoned decisions.

Annotated Daily Chart of the IWM:

Technical analysis can't predict when that channel will be broken or even the direction in which it will be broken, but it can do many other things. As noted earlier, technical analysis can alert traders to places where their trades might be in trouble and profit- or stop-losses should be updated. Such plans can help avoid that deer-in-the-headlights paralysis when prices reverse. Technical analysis can allow traders to make reasoned what-if or just-in-case plans.

Technical analysis does not offer crystal-ball predictions. More importantly, in my opinion, even the most rudimentary technical analysis--a glance at a candlestick chart to notice the size of the candles and the pattern of those candles--can immediately identify a disorganized market, one signaling all but the most experienced and well-heeled traders to exercise caution.

Traders should note that this article was written midday Friday, August 01, 2008. By the close of that day, the IWM might have broken through that channel to the downside or bounced up toward the 200-sma again. The charts presented here are up-to-date only through midday.

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