Where is the market headed? How far up or down will it go? And when will it change direction? These are the key questions for a technical analyst. In addition to charts, graphs, and mathematical formulas used in analyzing market trends, there are some fundamental concepts that apply to most of the theories used by today’s technical analysts.
John Murphy, a leader in technical analysis of futures markets, developed ten basic laws of technical trading based on his thirty years of experience. These rules are designed to help explain the general idea of technical trading to beginners and simplify the trading methodology for more experienced practitioners. These guidelines define key technical analysis tools and how to use them to identify buying and selling opportunities.
Trend Map
Study long-term charts. Start your chart analysis with monthly and weekly charts covering several years. A larger “market map” provides better visibility of the long-term market perspective. Once the long-term trend is established, analyze daily and intraday charts. A purely short-term view can often be misleading. Even if you trade only in the smallest time frame, you will achieve greater success if you trade in the same direction as the intermediate and longer-term trend.
Identify the Trend and Follow It
Market trends come in different sizes – long-term, intermediate, and short-term. First, determine which one you are going to trade and use the corresponding chart. Make sure you are trading in the direction of this trend. Buy at the bottom if the trend is up. Sell at the top if the trend is down. If you are trading on the intermediate trend, use daily and weekly charts. If you are a day trader, use daily and intra-day charts. But in any case, let the longer-term chart define the trend, and then use the shorter-term chart to choose the timing to enter the trade.
Find Its Highs and Lows
Find support and resistance levels. The best place to buy is near support levels. The best place to sell is near resistance levels. After a resistance level is broken, it usually becomes support on subsequent pullbacks. In other words, an old “high” becomes a new “low.” Similarly, when a support level is broken, it typically signals a sell on subsequent rallies – an old “low” may become a new “high.”
Measure Pullbacks
Measure corrections in percentages. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the correction of an existing trend in simple percentages. Fifty percent retracement of the prior trend is most commonly seen. The minimum retracement is usually one-third of the prior trend. The maximum retracement is usually two-thirds. Fibonacci levels of 38% and 62% should also be watched. During an uptrend, therefore, the buying point is at the 33-38% level.
Draw Trend Lines
Draw trend lines. Trend lines are one of the simplest and most effective tools. All you need is a straight line and two points on the chart. Uptrend lines are drawn along two successive lows. Downtrend lines are drawn along two successive highs. Prices will often retrace to the trend line before resuming their movement in the trend. A break of the trend line usually signals a change in the trend. A reliable trend line should touch the price at least three times. The longer the trend line, the stronger it is, and the more it has been tested, the more important it becomes.
Follow the Averages
Follow moving averages. Moving averages provide objective buy and sell signals. They will tell you that the current trend is still in effect and help confirm its change. However, moving averages will not tell you in advance that a trend change is inevitable. The combination of two moving averages is the most popular way to detect trading signals. Here are some popular combinations – 4- and 9-day moving averages, 9- and 18-day, 5- and 20-day. Signals are given when the shorter moving average crosses the longer one. Crossovers above and below the 40-day moving average also provide good trading signals. Since moving average lines are lagging indicators, they work best on developing markets.
Watch for Reversals
Monitor oscillators. They help identify overbought and oversold market conditions. While moving averages confirm a trend change, oscillators often warn us in advance that the market has risen or fallen too much and is about to reverse. Two of the most popular are Relative Strength Index (RSI) and Stochastics. Both operate on a scale from 0 to 100. For RSI, values above 70 indicate overbought conditions, while values below 30 indicate oversold conditions. Overbought and oversold levels for Stochastics are 80 and 20. Most traders use 14-day or weekly Stochastics and 9 or 14-day or weekly RSI. Oscillator divergences often warn of market reversals. These tools work best in a trading range. Weekly signals can be used as filters for daily signals. Daily signals can be used as filters for intraday charts.
Be Aware of Warning Signs
Trade using MACD. Moving Average Convergence Divergence (MACD) Indicator (developed by Gerald Appel) combines moving average crossovers into a system with overbought/oversold oscillator elements. A buy signal occurs when the faster line crosses the slower line from below and both lines are below zero. A sell signal occurs when the faster line crosses the slower line from above and both lines are above zero. Weekly signals take precedence over daily ones. The MACD histogram is built from the difference between these two lines and gives even earlier warnings of a trend change. It is called a “histogram” because vertical bars are used to show the difference between these two lines on the chart.
Trend or Not?
Use ADX. Average Directional Index (ADX) will help determine whether the market is in a trend or a range. ADX measures the strength of a trend or market direction. An increase in the ADX line indicates the presence of a strong trend. A decrease in the ADX line suggests a range and the absence of a trend. An increase in the ADX line suggests using moving averages; a decrease in ADX suggests using oscillators. By building ADX lines, a trader can determine which trading style and set of indicators are most suitable for the current market situation.
Remember About Confirmations
Incorporate volume and open interest. Volume and open interest are important confirmation indicators on the markets. Volume precedes price. It is important to ensure that higher volume occurs in the direction of the prevailing trend. In an uptrend, higher volume should be seen on days of price increases. An increase in open interest confirms that new money supports the prevailing trend. A decrease in open interest often warns that the trend is nearing its end. An uptrend should be accompanied by increasing volume and rising open interest.
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“excerpt”: “Murphy’s Laws for Profitable Trading on Financial Markets”,
“slug”: “murphys-laws-profitable-trading-financial-markets
FAQ
What are Murphy’s Laws for trading?
They are ten rules developed by John Murphy to guide technical analysis and improve trading success through trend identification and market behavior understanding.
How should traders analyze market trends?
Start with long-term charts (monthly and weekly) to identify the overall trend, then use shorter-term charts for entry timing while following the larger trend direction.
What tools are recommended for identifying market reversals?
Oscillators like RSI and Stochastics help identify overbought or oversold conditions, while MACD and ADX provide signals for trend strength and potential reversals.
