Most stock market traders have a favorite technical indicator.
The one that they have the most confidence in. The one that, from experience, they trust the most. Or the one that they always look at first.
For some it is the RSI. Others like the Stochastic or the MACD . Or one of the literally hundreds of other indicators that are available.
Well, I love the MACD. And the Stochastic is also a favorite.
But there is one indicator that I refer to more often than any other. However, before I tell you what it is, it is important that this discussion is placed in context.
I always stress with the traders that I mentor that the most important part of your analysis is price action.
By this I mean that the very first thing you should look at is the shape of the stock?s chart. And any patterns that you may be able to identify.
In particular, look for trends and consolidation. Candlestick reversal patterns and support and resistance levels. And be particularly aware of all time or 52-week highs or lows.
Also, be on the lookout for double tops and bottoms and triangles and head and shoulder patterns.
Because it is only in the context of the basic price action that you can make your trading decisions. And it is only from this understanding that you should begin to apply your technical indicators.
So, establish the context for your further analysis. Indeed, use this first process as a screening device.
Because, unless the chart immediately ?speaks? to you, you should eliminate the stock from any further review.
What I mean by this is that unless there is a clear reversal pattern or potential for a breakout, move on. Don?t waste time analyzing charts that have no likelihood of immediate movement.
And one of the best patterns for short-term trading is the channel. Always keep an eye out for these and when you find one, give serious consideration to trading them.
Now, let?s get back to our earlier discussion. What is the most important indicator?
Well, whilst this might surprise some of you, I believe it is volume.
You see volume is an indication of the strength of price action. A market needs high volume or increasing volume to sustain a movement in price.
So we want to see volume moving in the direction of the price. Increasing both in an uptrend and also a downtrend.
But realize that it takes more effort to push prices higher than it does to cause them to drop. So increasing volume is more significant in an uptrend than a downtrend.
If volume is diverging from the trend [going down instead of up] then we would normally not carry out any further analysis. Because the lack of volume means that there is a lower probability of price movement in the direction of the current trend.
Note however, that divergence can be an indication that a trend is about to end. So this can be an early sign of a reversal.
Another important aspect to volume that is often overlooked is in regard to retracements. Because the volume during retracements gives us a significant indication of the strength of the overall trend.
A strong uptrend should have higher volume on the upward legs of the trend and lower volume on the downward or corrective legs. Similarly in a downtrend.
Volume is best plotted below your chart as a histogram, or series of vertical lines.
And it helps to add a moving average line over the histogram to smooth the volume readings. I use a 3 day MA but you can experiment to see what works best for you.
But most importantly, always consider volume before entering a trade.
David Chandler
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The above comments are offered for educational purposes only. We are not providing you with financial advice. We are simply sharing with you what has and hasn\’t worked for us personally. If you wish to trade or invest in the stock market you should obtain advice from a registered licensed advisor.
Writen By : David Chandler