When I purchased my first house, I had no tools to repair or build 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, WD40, a couple of screwdrivers, plyers, 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.

             

Every trader I worked with or for had 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.

Essentials

After researching and utilizing seemingly countless indicators and studies I concluded every tool is useful, but they all have weaknesses as well. 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 essentials when I began to fill my toolbox in the 1980s. Eventually candlesticks replaced bar charts because they illustrate trend strength and a directional bias.

Furthermore, some candles reveal when a trend is near an end. My toolkit includes intraday indicators that reveal when prices are apt to rise, fall or consolidate. I use short-term indicators to enhance the timing of entering a trend early. One of my favorite intraday directional indicators is to enter a long position if a market extends higher after the first hour of the day or go short if a new low is made after the first hour of the session. Stock your box with tools that address a short-term workload. Explore exponential moving averages for this task.

All the information we need to create trade strategies is in the price action. In my attempts to determine the ideal tools (indicators), I found it best to keep the analytics simple and logical.

Trendlines 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). When these trendlines are violated, it is often the onset of a breakout. Fair value can also be defined when the short-term moving average (five-day) and longer-term moving average (20-day) are similar over time. A sharp vertical move frequently occurs after these MAs converge over a couple of weeks. Explore MACD for timing breakouts.

Trend Strength

Profits increase as the market trends in your favor, so we need a tool that monitors trend strength. If long, I will hold a position overnight if the low was made in the first hour of the day, there is an extension higher after the first 60 minutes and the close of the session is in the upper quadrant of the day range. A short position is to be held overnight if the high of the day was made in the first 60 minutes, there is an extension lower after the forst hour and the close is in the lower quadrant of the day range. A long body candle with little to no wicks illustrates this phenomenon. Explore RSI as a tool to gauge strength of trend.

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

John Seguin, Market Taker Mentoring