TSC Technical Forum: Getting Started and Picking Your Indicators

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Welcome to this week's edition of TSC's Technical Forum. If you would like to send a question, just email it to

technicalforum@thestreet.com -- and make sure you include your full name. There are lots of great questions this week, so let's jump right in!

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How Much Is Enough?

I have recently gotten interested in using technical analysis and charts in determining sector mutual fund rotation. I presently use 20- and 40-day exponential moving averages, RSI, and daily and weekly MACD and stochastics. Would you please address my following questions: 1. Are the indicators I am using appropriate for my purpose? 2. How many indicators are needed to give "reliable" signals? 3. Which technical indicators historically have been the most reliable? 4. How many indicators should agree to have some validity? 5. Although weekly signals are more important than daily, is it necessary that they both agree? I use weekly as a filter on daily. -- Tony DiVincenti

Tony,

You're heading down the slippery path of analysis paralysis. I know, because

I've

been down that path! With that in mind, let me address your questions:

1. Tough to say without knowing your time frame. Are you charting sector funds like you chart a stock? Judging from your use of 20- and 40-day moving averages, your time frame appears to be 7 to 10 days, and if so, your indicators are fine ... just too many.

2. If you're confident and consistent ... and use good money management: ONE. If you're looking for indicators to give you complete answers: A zillion isn't enough.

3. Volume and a price movement out of congestion. A 50-day moving average is also okay.

4. See No. 2. The better you get, the fewer indicators you'll need.

5. Again, it depends on your time frame. But, yes, I generally like the next-level time frame (i.e., weekly if you trade with daily charts; daily if you trade intraday) to agree.

Start With a Solid Game Plan

I'm convinced I want to pursue becoming a day trader! I love the market, I love the challenge, but let's face it, it's about making a living -- and a good one, I hope! Here's just the beginning of my challenges: Question 1: How do I get started? The technical stuff and computers don't intimidate me a bit. But I don't know where to begin. Like uncovering the timely "Buys" soon enough -- by the time I see the stock, it exploded a day or two before. I'm left sitting there looking at some chart, saying, "If I only knew yesterday!" I think with my personality I'm looking for a quick play approach to this thing. Where do I start? Question 2: I have some basic charting and technical analysis software, Window on Wall Street. It seems to have the basics for my newbie knowledge level. However, I am finding that the stocks I catch mentioned here on TSC don't often fit the "Green Light" scenario my software and indicators are recommending. Yet, I've seen some of the stocks go right through the roof. So, how do you know when to believe what you see on the chart, what you read in the news or, better yet, when you're looking at the stock sloping to the moon. Are the indicators too late or ineffective for these quick breakouts. I wanna do this! But without loosing my butt in the process. Point me in the right direction. -- Ken Anderson

Ken,

You're enthusiastic, so that's a positive. However, I'm going to have to give you a question surcharge -- only one to a customer! Okay, your answers:

How to get started:

Before you run out and get any equipment, come up with a game plan. Are you trading on the news, or on technical analysis? Both can work, and both have their pros and cons. After you've thought this through thoroughly, get a real-time data feed. Don't sign up for an eternity; one month will do. Then "paper trade." Look at the quotes or your charts, and write down when you'd buy and sell. When you get good -- really good -- try it for another week. Then, and only then, open an account. But start small. Real money is ALWAYS harder than paper trading.

Indicators:

You'll have to develop what works for you. I love breakouts, because I believe in them and they make psychological sense. Others hate them and won't use them. It doesn't matter, though, because YOU have to trade with what's comfortable for you.

But first you have to build your base of knowledge to know what to choose from. See my Dec. 22

reading list. And keep reading my column, as I'm going through many of the same things as you'll be getting to. And then practice. Don't be in a hurry to make money. That'll come, but only if you're prepared and have a solid game plan.

Looking for Swingers

I have had success with "swing failures" (on the downside). Is there a program that will alert me to this situation so I don't have to peruse hundreds of charts on a daily basis? -- Robert Jackson

Robert,

I'm going to assume your "swing failure" is a failure to break out on the upside and instead the company breaks through support. If so, you can probably program this in software like

TradeStation

or

MetaStock

. The other way is to limit the stocks you look at by volume and/or price, and scroll through each one.

Also, as tedious as it is sometimes, looking at a lot of charts each day is extremely helpful for keeping in touch with the market and becoming familiar with your select group of stocks.

Don't Touch That 401(k) Money!

I'm just beginning to explore TA, and want to know whether it will help me with what I want to do. Most of my investment money is in a 401(k). I can use the phone to switch funds each day. I have to call by 3:30 p.m. in order to switch my funds for the following day. One of the funds is an S&P 500 index fund and another is an insurance contract fund. If I could just be in the S&P 500 fund on a uptick and move my money to the insurance contract fund when the S&P 500 is headed down, I could greatly increase my return. I can make these daily changes commission-free, and because it's a 401(k), I don't have to worry about taxes. Would I be wasting my time with TA? -- Allen Faircloth

Allen,

One word: YIKES! First of all, trading the S&P is a minefield. Trading on upticks or downticks is a minefield surrounded by bombs. Sure, technical analysis can help, but you'd have to be a good, committed day trader for this to work. Second, it's your 401(k) money! And, I assume that's part of your nest egg, so don't mess with it. If you want to trade, set up a separate account. Leave your 401(k) in some kind of stock fund and ignore it until you're ready to retire.

Where to Go When a Stock Is Low

I'm new to

TSC

, and I think you're articles are great. How do you analyze stocks that have broken through their 52-week low? It seems like there is no data to help you analyze support levels. Is this not more the realm of fundamental analysis (i.e., based on future earnings, p/e ratios, etc)? -- Steve Kim

Steve,

Thanks for the nice words. I look at these kinds of stocks two ways:

Go short if the breakdown occurred out of good congestion and on heavy volume. A lot of people try to come in and scoop these stocks up, thinking they have a bargain. But 80% of the time they drop further.

If it's not a good short candidate, and I really like the stock (that's where the fundamental stuff comes in), I might wait until it develops a good bottom and then jump in on the long side if it looks like it wants to go back up. Take a look at the chart of

Boston Chicken

(BOST)

, for example. Not a recommendation, but if the company's fundamentals improve, and it ever gets my order right at the drive-through, it's a potential long.

Arcane, but Germane

I really enjoy your series on trading. You mentioned Townsend Analytics and some other arcane-sounding indicators (e.g., Level II foofraws and so forth.) Also, you mentioned you paid higher commissions than the discount trading houses like Ameritrade. Without giving away any personal information you don't want to reveal, what are reasonable commissions to pay? And what is the name of the firm you trade with? -- Roger Mann

Roger,

Level II Nasdaq refers to the ability to see where all the market makers for a particular stock have their bid and ask quotes. You can also see the minimum volume they are willing to buy and sell at each price. Arcane? Yes. But, also helpful if you know what to look for.

Per my recent columns, I'm using

AB Watley

for day trading. The company charges about $25 per trade for OTC, $30 per trade for big board. High, but you make it up with flexibility, speed and the ability to buy and sell within the spread. At least that's the theory.

More Cooper Questions

Thank you for the excellent series on the Jeff Cooper day trading method. My question is this: If many people follow this method, and they all place orders 1/8 above or 1/8 below the previous day's opening and close respectively, are they all going to get lousy executions? Especially on the short side? -- Nicholas Shao

Nicholas,

The only time that this method is a problem is with thinly traded stocks. If you're trading just about any large-cap, it shouldn't be a concern. Regarding the short side, the same thinking applies, although I have a difficult time getting a good fill because of that silly uptick rule.

Ignorance Is TA Bliss

In last week's TA Forum, a gentleman by the name of Grant Cooke mentioned Bollinger/volatility bands and ADX? What are these things? My apologies for my ignorance. -- Janice Clayton

Janice,

You're not ignorant. In fact, the LESS you know about indicators, the better trader you'll probably be. Bollinger bands are named after the planet Bollinger, which they revolve around. Okay, a little levity. Seriously, the bands are named after technician John Bollinger, and there a two of them: an upper and a lower band. These bands are number of standard deviations above and below the moving average of the stock. (The number is determined by the user; the default on many systems is two, but it can vary.) The theory is that as the stock price approaches the edges of the bands, it gives an overbought or oversold signal.

ADX is an indicator that tells you if a stock is trending and also the quality of the trend. It does not, however, tell you the direction of the trend.

Every once in awhile, I'll look at ADX. Bollinger bands, never.

Coming Attractions

Have more questions for Gary B. Smith? Put them straight to him when he chats on Yahoo! Finance on Tuesday, Feb. 24, at 5 p.m. EST (2 p.m. PST). For more information and to register for this chat (it's FREE), click

here. If you haven't already registered for a Yahoo! chat, please try to arrive a little early to do so.

Gary B. Smith is a freelance sportswriter who trades for his own account from his Connecticut home using technical analysis. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. His column, Technician's Take, appears every Monday. His Q&A column, TSC Technical Forum, appears every Saturday.