When I bought my first house, I had no tools to repair or make anything. I was far from a handyman and my father knew it. After we settled in, my dad showed up with gifts that every homeowner should have. Those essential tools were duct tape, WD-40, a couple of screwdrivers, pliers, an electric drill and a hammer. He said I could fix most problems and build shelves with these essential tools. As time passed my toolbox grew, but after 30-plus years of home ownership I still use those original tools more than any others.

Traders Need Tools Too

Every professional trader I ever worked with or for, has a “toolbox.” The tools of the trade are either fundamental (forces of supply and demand) or technical (charts and indicators). Trading toolboxes are often overloaded with rarely used and unreliable technical indicators. To build your own technical tool kit begin with the basics.

The Essentials

After researching the seemingly countless indicators and studies I concluded every tool has a use. Some work best during trends; others are most effective timing the end of a trend or the start of a consolidation phase.

Bar charts and trendlines were the first technicals in my personal toolbox. Candlesticks eventually replaced bar charts because they illustrate momentum and often divulge a directional bias. My kit includes gauges that reveal when prices are apt to rise, fall and consolidate. Therefore, stock your box with tools that address that workload.

Though I have added a few more tools to the chest I still rely on those original tools today. Technicians build strategies by organizing data (open, high, low, close) into recognizable patterns. All the information we need to create trade signals is in the price action. In my attempts to find the perfect tools (indicators), I’ve learned that I need just a few to keep analysis simple and logical.

Use tools that do the following…

Define value

When a market is in consolidation mode, it usually forms a pattern that defines fair value. The most common patterns take the shape of flags (rectangles) or pennants (triangles). These trendlines are often used to determine if a breakout or trend has started. Fair value can also be defined when short-term moving average (5-day) and longer-term moving average (20-day) are similar. A sharp vertical move frequently occurs when these MAs change little over a couple of weeks.

Determine momentum

Momentum is the move from fair value, so it is dependent on the first tool. Consecutive closes above/below a flag or pennant indicate that bulls/bears have taken control of momentum.

Timing entry

This indicator is used to determine if trend potential is high or low. Average True Range (ATR) is perfect for this job. For example, if day ranges over 5 sessions dip below the average, odds increase for a vertical move or onset of a trend. To take directional positions, scan for channels and triangles with below average ranges and volume.

ATRs can also be used to signify when a market is overbought/oversold. We will save that for another lesson.

Every trader needs tools. Building strategies requires the essentials: logic and market generated information.

John Seguin, Market Taker Mentoring