Useless. Too elementary. These are the comments I've received from a few Augen-addicted technical analysts when they hear me recommend an old text to newbie traders who ask for an introduction to technical analysis. That old text is Stikky Stock Charts
. Those heaping the scorn on that little tome don't realize that some traders want or need help with drawing and recognizing important trendlines and support and resistance zones. Do they really have to know how to recognize a three-inside-down candlestick reversal pattern in order to trade?
Should any of us really scorn the importance of simple technical analysis? Perhaps we sometimes make it sound too difficult. There's something to be said for simple techniques.
For example, one of the patterns taught in the Stikky book is a double top pattern. A double top begins, the book suggests, when a trending-higher price chart "first fails to match the last high." Some texts would extend that first condition to charts where prices roughly match or only slightly exceed the first high. The formation is confirmed only when price "drops lower than the valley between the two highs."
Imagine that a few weeks ago, you were doing a scan for higher-than-normal volume and Kroger (KR) appears on that scan. What you notice when you pull up the chart is that on the intraday chart, KR hit a 24.03 high on 9/13 and pulled back sharply. Sellers were evidently waiting. A few days later, as you're running scans, it's back at 24.03, and it begins to slide down again.
It hasn't fulfilled all the requirements of a double-top. However, based on the strength of the selling the last time KR tested 24.03, you don't wait for that confirmation and you buy a bear put spread (+1 OCT 24 put/-1 OCT 23 put) for $0.40. You have a maximum loss of $40.00 plus commissions. You have a maximum gain of $60.00 minus commissions, although you'd likely never collect that entire maximum gain. In the real world, you're probably looking at a roughly equal risk/reward here, with a $40.00 gain probably about the most you could expect unless you wanted to carry the trade right into expiration.
KR pulls back nicely, but then starts speeding upward again before it ever confirms the double top.
Ten-Day, 60-Minute Chart for Kroger, as of September 19:
Uh-oh. KR reached a high of $24.04, a cent above that "double top" formation. The Stikky format is to show some simple graphs and explanations and then set up a sample situation like this and ask a few "what would you do questions." Let's do that, too.
What would you do here? You could tell yourself that you'd based this trade on the supposition that KR was going to form a double top. The formation of a higher high disproved your original premise. You could elect to get out of the trade, selling your debit spread for a very small loss.
You could determine that since you weren't going to lose any more than your initial investment and you still had the opportunity to make $40-60, you would treat this as a set-and-go trade and hold on.
You could switch to a bullish trade, supposing that KR, once it violated that double-top formation, would just keep going higher.
These are decisions that ought to have been made before the trade was ever entered. Typically, it's wise, if the trade is entered on one supposition and that supposition is proven to be wrong, to exit the trade. With this setup, I would have given KR just a little more room, as I don't think we should always be a stickler for literal "to the penny" amounts. However, the point is that using a simple Stikky strategy, the trader should have been able to look at the premise upon which the trade was entered and immediately set the stop to exit the trade once that premise was proven wrong, probably at a few to five cents above the previous high, if it had been the trader's intention to exit the trade once that premise was proven wrong.
In this case, the risk was not large if the trader was a little lazy about following a plan, but what if the trader had elected to spend $20,000 on long KR puts, not put spreads, and KR had closed a day at something like $24.08, gapped up the next morning and just kept going? The author of Stikky warns, "If you learn only one thing today, make it this: when a trade turns sour, get out" (162).
What if the trader's original tactic was to find several equal risk/equal reward trades of the type originally discussed, set them and let them go? Perhaps this trader works fulltime and isn't able to attend to trades moment-by-moment, and therefore uses this technique to enter the market each month. Then that trader's original premise hasn't yet been violated, and as long as more trades are profitable than not, that trader and that trader's account survive.
What about switching trades, switching from bearish to bullish? That's not usually a great idea unless your entire trading strategy is built on trading bearish if an underlying is beneath a key moving average or other trigger or bullish if above. You better have backtested such a strategy first to prove that it works, too, as I'm not at all certain that it does. I can't take the whipsaws, the frequent small losses, so it's not a strategy I could advise on either way. Instead, many people who switch sides when their original premise is proven wrong are traders who just lost money and are determined to win it back from the market. I would usually advise waiting at least a day to reevaluate the situation before I elected to change sides. Trying to wrest anything from the markets out of a vengeful frame of mind doesn't usually lead to the clearest thinking.
In the KR case, the trader might have been on edge about that double-top formation when KR edged a cent higher, but KR did eventually drop to test the confirmation level of the double top. It did not, however, continue dropping but instead started climbing again. The debit spread trader would have been able to collect a profit on that KR debit spread, if perhaps not a big one, if that trader was watching for possible support at the confirmation level and got out when KR started higher again.
Sometimes, simple technical analysis and simple trades can be investigated. A trader might specialize in watching a particular stock, recognizing the patterns that stock tends to form. I used to watch one that regularly settled into 40-point wide bands for months at a time. It might occasionally rise or slip below that band's resistance or support, but then it just tended to settle into another 40-point band. Using Stikky or other charting books' techniques to recognize a rectangular band would have allowed traders to draw support and resistance, and "buy low and sell high." The Stikky warning for traders to get out when the trade sours would have kept losses small in such a trade. It would have warned them to exit the trade when the expected bounce from support doesn't occur in a stock normally trading in a wide rectangular band, for example.
Sometimes a trader might specialize in a certain chart formation rather than a particular stock. That trader might look for stocks bouncing from a particular moving average, for example. As always, test any new approach, backtesting if possible. Enter new trades with small amounts until you're sure they work for you. Know the premise under which you're entering a trade, and plan--before you enter--the point at which you'll know that your original premise is wrong. Be prepared to exit if you're proven wrong.
You do have to follow those precepts to manage risk. You don't have to make the trade or its triggers too difficult. You really don't have to recognize a three-inside-down candlestick reversal pattern or be able to quote Augen in order to trade.