From the November 01, 2011 issue of Futures Magazine • Subscribe!

The basics of reading charts

Drawing a trendline is easy. Simply begin by drawing a line connecting two or more market tops or market bottoms. The more times a market touches that line, the more significant that level is as either support or resistance. Basic trendlines can serve as a building block for a range trade or breakout trade.

In addition to hand-drawn trendlines, most charting packages include a number of indicators to help you define trends. One of the simplest and easiest to understand is moving averages. These are a lagging indicator that display average prices from a previous given number of bars. These help show the strength of the trend, eliminate some of the noise in the market and often are used as a signal for entering or exiting a trade. Technical traders often will use two moving averages of different durations. A simple strategy signals an entry when the faster (shorter-term) moving average crosses the slower (longer-term) moving average. A trade is signaled in the direction of the cross. "The trend(line) is your friend" shows how the 10-day moving average crossing the 20-day moving average would have signaled, albeit a little tardy, several successful trades. This approach usually is used with additional filters to improve results.

Traders like to experiment with different time intervals but the concept is the same; the faster moving average crossing the slower moving average is an indication of momentum. The time horizon of your trades should determine what time intervals you look at. If you are trying to determine changes in a long-term trend, you might look at 50- and 100-day moving averages. In choppy market conditions there could be many crosses of 10 and 20-period moving average (see "A matter of time," below). There are different types of moving averages. Our examples show simple moving averages, but some traders prefer to use exponential or volume-weighted moving averages. An exponential moving average gives more weight to recent data in calculating the average.

Besides identifying trends, charts also make finding support and resistance levels more accessible. Like identifying trends, detecting support and resistance also can be done from a visual standpoint or with the help of indicators. "Past highs and lows, especially when they occur around a round number, become magnets or targets," Rockefeller says.

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