Best Thread The Basics of Trading

Hi all

Techcherry has asked me (well I offered) to do a step-by-step guide on how trade.

BEFORE I START: I want to point out that this is NOT going to be a Holy-Grail, and you will be disappointed if you think it is.

Also, don't invest your money based on anything I say. Remember it is your own money on the table and not mine!!

Thirdly and most importantly. Anything you learn within this thread must not be used against me in any Trade2Win competition!!!! I want to win occasionally.

Ok, now the legal stuff is out of the way. I would like to say that there is no right or wrong answers in the market. The important thing is that we share our views, and all learn together.

If at any point I miss out something, or I haven't explained something clearly enough, then please post a question. A Chinese saying says

A man who asks a foolish question is foolish for a minute, a man who doesn't ask a question will remain foolish for a life-time

Click to expand...

...and this is something I really want to embrace.

Ok let's start with the basics of Support, Resistance and Trendlines. This really is the core basics of trading, and in my view is the foundation of a trading strategy. We will move onto indicators in time, but first

How Candlesticks are constructed.

There are 3 types of bars that can be used for charting. A line chart (which connects the closing prices), a bar chart and a candlestick chart.

A bar or candlestick chart will show the high, low, open and close for a set period (so on a daily chart, one bar represents one day). The high and low data is very important, so a line chart is no good for that.

There is no real difference between a bar or candlestick chart – they both show the same data so it’s personal preference – but I prefer to use candlesticks.



The above just shows how a bar or candle is created. The up candles have light or hollow "bodies", where as down candles have dark or filled "bodies"


Ok onto the technical stuff, Support, Resistance and Trendlines

Support:

Support is a level on a price chart, that price hits and finds a large amount of buyers, and hence the price starts to rise again



On the chart above of Cadbury’s you can see that every time price hit 399 / 400, it found enough buyers to force the price up.

Resistance:

Resistance is the level at which a price chart struggles to break above. When price hits a resistance level, the number of sellers is strong (as they know that the next move is down), and it takes a lot of buying pressure to get it above this level.



In the above chart you can see that there was a large number of sellers at 423, which was too strong for the buyers to push through.

Trendlines:

Trendlines are made by connecting 3 or more points along the same line. They either connect the tops of the highs together or the bottoms of the lows. Trendlines work because everyone sees them and know that the next time price hits that level, a reversal should happen, so they either rush to buy or sell depending if it is an uptrend or downtrend.



On this chart I have connected the highs together to create the straight line (or trendline). This is a downtrend because the trendline is pointing down (simple really)




On this chart I have connected the lows together, and as the lows are rising, it is in an uptrend.

….and that’s pretty much the foundation to trading. I know it sounds simple (and many of you would all ready know this), but it works and that is the main thing.


Ok, enough of me talking. Take a look at the chart for Anglo American, which has the symbol or ticker AAL.

We’ll look at the Daily chart (so every candle represents one day), and look at it over the last 6 months, and I would like you to draw in any support, resistance and trendlines you can see that you think are relevant. Remember there is no right or wrong to this.

For those of you who haven’t got a charting package, you can use the charts on www.advfn.com It’s free to sign up, and they do have a good service.

The link for the chart in advfn ishttp://www.advfn.com/cmn/chrt/chrt_...0&ind1_2=&ind2_2=&ind_type3=0&ind1_3=&ind2_3= To draw trendlines onto the chart you will need to load it up onto a charting package. To do this have a look at this link, which goes through and shows how to post charts onto Trade2Win. http://www.trade2win.co.uk/boards/showthread.php?s=&threadid=4624
To draw the trendlines. Once the chart is on the paint package, you can draw lines and then save the image, complete with trendlines, ready to be posted.

It would be great if you could post a chart into this thread, and give some reasons why you’ve decided to draw the lines you did. To take it a step further, could you please write down what you would do based on the chart. So either buy now, sell now, stand to one side, buy at X price or sell at X price, and we’ll see how the chart progresses over the days and weeks to come.

Well that’s part one done, and I look forward to seeing your interpretation of the Anglo American chart.

first attempt...

Hi f...tsuie!!!

Very good, simple and approchable, if any day you decide to quit in the trading world I'm sure you have a future in teaching...
1. the big black line its theneral trend which I believe its a upwards...
2. the red one which is after the resistence point the reverssal efect a big & fast fall in the price share, which I believe will see for the next few days continuing...

This is my first interpretation, please correct me ...

I don't know why when I attached my .gif image doesn't come on to the screen...

Hello everybody,

This is my first post on the T2W boards. I have never traded a share in my life, not directly anyway, but I find the whole topic of trading addictive reading.

This is my first attempt at technical analysis so feel free to laugh

AAL has been steadily moving upwards for the past six months, therefore I would wait and see if it dips below 862 and buy it on the way up at 862. I would then hope to hold it for 2 weeks and sell at 950 (which is a little lower than my resistance level).

From everything I have read about trading I believe it pays not to be too greedy and pick a realistic target to sell at before buying. Hence I would sell at 950 and be v. happy with ~10% profit.

What worries me about my analysis is it treats the share price movements as clockwork. Surely this is often not the case?

FTSE Beater are you willing to say what your analysis is? I would really appreciate it, especially if you analysis is totally different to mine.

Regards
Paul.

Hi Paul,

You are right of course, all trades are not clockwork.

In fact probably only a small percentage are. This game is all about mathematics. You need to make more than you lose just to cover costs.

It is therefor essential that losers are small and winners are relatively large.

In the case of AAL it is showing a steady five month uptrend. Personally if I were to buy, my protective stop would be around 820p. I also wouldn't be adverse to getting in around the current level of 875p, but my initial target price would be around 1080p

Therefor my risk is 55 points and my profit target 205 points. Therefor from a textbook prospective a viable trade as the risk/reward ratio is better than 3:1.

I would certainly be looking at tomorrow though for a better entry to improve this still further.

JonnyT

To JonnyT.

I am very interesed in your explanation of Risk Reward ratio,I am trying to learn how to use it in my trading.I liked the way you set it out with the AAL example.Can you give me some more examples with other chart patterns. I have picked up the cup and handle one from this site and would like to see others.
I know the theory 3to 1 etc .

Hi Paul102

Yep, I'll put up my analysis in a day or 2 (so everyone can have a laugh ). I want to give as many people as possible the chance to share their analysis first.

The next thing I was going to talk about is the risk / reward factor and money management side of trading, but JonnyT, if you want to start a new thread on risk / reward that would be great.

Difficult situation at the moment, with IRAQ and the Blix report.
without that I would wait for a clear candlestick to print and enter long, looking to 940 for my exit,
at the same time watching how the ftsie100 is acting as this share follows it quite closely.

Hi FTSE Beater

Would be great if you gave an explanation of the risk/reward ratio as I have been giving this some thought since JonnyT mentioned it.

As I see it, the previous lesson explains one way of calculating the reward. The risk is determined by where you place your stop and knowing where to place your stop is possibly lesson 3 But I guess your stop position has to be based upon the volatility of the stock you are trading. Obviously you cannot just place your stop anywhere that makes your risk/reward ratio look good because then you run the unmanaged risk of your stop being triggered and losing money.


Regards,

Paul

Risk Reward Ratio

Hi All,

I hope that you dont mind me contributing to this discussion. For risk reward ratio another factor that is critically important is "Percentage of successful trades"

For example
1) If you have a trading system or method that gives you a 50% success rate and

2) You get a 2:1 reward to risk (ie. for every trade you win you make 4 points whereas for every trade you lose you lose 2 points) and

3) You trade the FTSE 100 future at £10 per point

Then, on average, for every 10 trades you make you will have the following scenario

(10 trades) x (50%win) x (4 points x £10) - (10 trades) x (50% lose) x (2 points x £10) = £100 profit

But if your percentage of successful trades drops by just 10% to 40% the picture changes as follows:

(10 trades) x (40%win) x (4 points x £10) - (10 trades) x (60% lose) x (2 points x £10) = £40 profit

A very different picture and if your percentage of successful trades drops to 30% then this would change to a loss of £20

This is why I think that backtesting systems over a long period is important as it will give you a more accurate percentage of successful trades that you can expect to achieve and as such adjust your targetted reward to risk ratio.

Just a thought


Paul

Bill G
Thanks Bill I am looking for some chart examples like the one you posted to get the hang of risk reward entry to trade.Your chart shows a pull back to 870 with a risk of 50 points to 820 and a reward of 70 points. Have I got it correct ?.
What do you mean by candlestick to print.?

Fluke
Are you referring to the support of 820 set at 11 Dec? I think a more genuine support would be 853 as shown by the P&F chart .
920 would be my resistance.
The clear candle is a long open bull type candle `print` (showing up on the chart)
Hope this is a bit more clear.
Bill

Bill G
Thanks for reply.I am trying to learn the art of opening a trade using the risk reward ratio I have read about on this site.I will try to explain what im after.Im using Sharescope EOD charts and want to open a trade after the chart has reversed down from an upward move .Lets say its come back 70% of the up move and I am looking to trade at this point. This would put the price 30% above a double bottom,therefore could i undarstand going long would give me a 30% risk (to a double bottom) and a 70% reward back up again to the previouse resistance. Am I correct in saying this will give 70% reward and 30% risk.
Hope this makes sense

AAL Chart

Hi all

Well this is my analysis of it.



The main thing that everyone picked up on was the long term trendline from early August to mid December and on onwards. The trendline / resistance was less obvious, but still valid if price reaches that point.

If I was looking solely at the chart (and I had no idea of what was happening in the world), then I would have looked for a bounce off the trendline, with a stop just below the trendline. The target would be the sloping trendline at the top of the chart.

Would I have traded this? - No. The only reason is that at the moment the markets are very unsteady and going long in this market carries a high risk. In calmer times I would have taken the trade.


Hi Techcherry. Well done on spotting the long-term trendline. I'm not sure that 930 is a valid resistance point. Mainly because the price went either side of that line without stopping. The only other thing I would say is that the red down trendline, I would only draw on a 60 minute chart. End of day charts, should represent longer term movements, but that would have been a great downtrend on a 60 minute chart.


Hi Paul102. I loved the way that you kept the chart simple, which is a good thing, as it focuses the mind on what’s important. The top trendline that you’ve drawn did get pierced in December, but the later test of the trendline in January held strong so that is a good trendline and well spotted. I probably wouldn’t want to see 862 broken, but if the price pierces 862 and then quickly reverses, then yes that would make a good entry.


Hi Bill G. The award for the most colourful chart goes to you – I didn’t know that Sharescope’s colours went that bright . Anyway, I like the resistance point at 940, that makes for a good target if it can get that high. I presume the dotted lines, are the partial trend lines that Sharescope draws in. I can never get those things to work, I find them too subjective and unreliable at best, but it does show how well it has been trending over the last 6 months.


Hi Fluke. Yes you are correct with regards the risk and reward calculations. I will hopefully later on this week be posting a thread on risk / reward and how it all fits in.


Thanks to everyone who has posted their charts, and if anyone still wants to post there thoughts on the AAL chart, please feel free.

fingers crossed (I think I CRACKED it)

Hello everybody, particularly Paul and Jonny T

I think your Risk/Reward calculation is a bit misleading. The obvious inference is that you can improve the ratio by either reducing your stop loss or increasing your target price. Either of these could result in disaster. A better way of looking at risk and reward is to include some assessment of the probability of the SL being breached and of the target being reached.

For example, you might conclude that, based on the figures you mentioned, the probability of 820p being breached was 20%, but increasing the SL to 850 would increase the probability to 50%. Similarly, it seems logical to assume that the higher you set your target price, the lower the probability of achieving that figure. At the price quoted by Paul (862p) you might assess that the probability of reaching 900p was 75%, but that would decline as the target price increased. You might conclude that the probability of reaching 1080 within a reasonable timescale was only 35%. This would give (for want of a better term) a Probability Ratio of 35/25 or 1.4.

In the figures I have given, the Probability Ratio for a target price of 900p with a SL of 820 (ie a small, quick profit) would be 3.75. If the SL was reduced to 850 the Probability Ratio would give a negative for a target of 1080 and a ratio of 1.5 for a target of 900p.

This approach gives a more realistic assessment of the risk involved, but does require an estimate of probability for the target and SL.

I put this suggestion forward for discussion.


John

Hi John,

Surely this depends on timescale?

I wasn't looking at a day or swing trade, more an intermediate trade.

I stand bu my guns.

As Bush is saying to Saddam

Hello JonnyT

Time is definitely another factor but maybe we're talking at cross purposes. My post was trying to introduce a method which gave a realistic estimate of the probability of a trade succeeding.

Your calculation seemed to imply, especially to someone without experience, that the probability of success in the trade is about 73% - and if you're getting that sort of success rate, can I shadow you? Mine implies a success rate of about 40%.

I've no doubt that your experience tells you the true probability of success and the Risk/Reward ratio as you define it is a useful tool, but it doesn't show the overall risk of a trade. Trader 333's post also introduces some caution by highlighting the percentage of successful trades.

John

PS - I lived in Ruddington until middle of last year. Small world - just what is the probability of that?

Hi John,

Very small world!

I agree the RR may fool a complete novice, but I'm sure I never meant to suggest or infer a 73% success rate.

JonnyT