Today I want to spend some time on looking at the basics of chart evaluation. Any time we look at a chart, we should focus on identifying several things. Just like the price action on the charts will often times follow a pattern, our evaluation of the charts should follow a pattern also. Of course, you may look at things in addition to what I mention, just make sure you have a pattern for what you look at. In the past, we have talked about daily and weekly routines that we should go through in order to be more efficient in our trading. This same concept is true when we are looking to evaluate a chart. It should be a step-by-step process that we go through every time we look at a chart.

So, with that in mind, there are a few things that I want you to consider when reviewing a chart. The first thing is how to start. My suggestion would be to start with a blank chart, just like a painter would view a canvas before beginning to paint. Looking at the chart with just the price bar or candles will give us a clear picture of what the price action looks like. We can see the longer-term movement, the intermediate movement, as well at the current movement. This price action is the key to everything in trading. Often times we get bogged down with indicators that hide the true intentions of the charts. So the first thing is to get a general idea of where you see the price moving without anything on the chart except the price.

The next thing we should look at is how to identify the overall trend of the price. We can do this several ways, but the simplest way is to look at the patterns that the price is making. Are the highs getting higher or lower? Are the lows getting higher or lower? As you identify this pattern of highs and lows, you will begin to see the trends forming as up or down. Lower lows and lower highs suggest a pattern of trending down, while higher highs and lows will suggest a pattern of trending up. Another way to identify the trend is to place a simple moving average on the chart and look at the direction it is moving. You may use something like a 40 period SMA and if it is moving up, then the trend is up, or if it is moving down, the trend is down. By identifying the trend, we can know the direction we should be trading. It does not tell us when to trade, just the direction.

After the trend, we will want to look for where the support and resistance levels are located. This can be done as horizontal or diagonal lines drawn on the chart. Typically, you will look at the highs and lows of price action and draw lines to show where the price may begin to have a hard time moving. By knowing this, you can know the best places to enter and exit your trades.

By knowing the price action, trend, and support and resistance levels, we can get a clearer picture for the direction price may want to move. After this, we can then look for our setup conditions in order to actually enter the trade as a buy or sell. Take some time to review your process of evaluating charts and make sure you can do it effectively.

An observation that I have made over the past few months is that there seems to be more and more traders that are interested in trading options in their IRA accounts than in the past, and, based on the recent IRS ruling around IRA Rollovers, this trend may continue, and even increase. The IRS has always mandated limits to what investments can and cannot be used within the scope of IRA accounts. They state that traders cannot sell short in an IRA account and trading options in IRAs is very limited. What is allowed in an IRA account is buying puts instead of selling a security short. Buying puts allows the IRA account to enjoy a drop in the price of a security that they could not otherwise participate in due to the selling short restriction. This strategy is no secret and has been used for many years, but it appears to me as though interest in this strategy has increased recently as people become more and more aware of how much money they will actually need during their retirement years, versus what they have now.

IRA accounts have always had restrictions placed on them with an interesting and controversial new restriction just added. The IRS produces IRS Publication 590, which is thought to be the Bible of IRA rules; this is its own guide to the tax rules around IRAs. In a recent US Tax Court ruling, involving rollovers of IRAs, they ruled in direct conflict of IRS Publication 590, meaning that they are changing the rules as they go along and as they see fit to do so. The actual ruling, and the circumstances around it, will have little impact on many IRA accounts, and even less impact on others, but that isn’t the point; the point is that they can change the rules, seemingly, at will to whatever works for them at the time.

The specific issue was around how many rollovers can be done per year by any given person. They have mandated in IRS Publication 590 that only one rollover per 12-month period, per account could be done. So, previously, if a person had multiple IRA accounts they could do multiple rollovers; however, they have now ruled that only one rollover per 12-month period can be done, per person. This ruling is largely aimed at people that roll over their IRAs to borrow money out of them retuning it just before the 60-day deadline with money from the rollover of another IRA. People that do not do this will be unaffected, but the point still remains that this is a ruling that is in direct conflict with their own rules. This leads to the obvious question of what other rules do they have around taxes in general, not just IRA accounts, that they will contradict on a whim and how do we actually know which of their rules they will acknowledge and abide by, and which ones will they change or rule against when it suits them?

If you are a creative investor or trader who likes to use a variety of investments and strategies in your IRA accounts, you may consider applying them as much as possible, while you still can, since it isn’t out of the question that you may no longer be able to use your current strategy at some point in the future. You may also consider having a backup plan if the types of strategies that you like to use become “off limits” for IRAs at some point in the future. The interesting thing is that their recent violation of their own rules doesn’t really seem that beneficial to them. If a person rolled over IRA dollars consecutive times, paying back the most recent rollover with new rollover dollars, this would not create a taxable event or fees that the IRS would collect. With their new restriction, people will no longer be able to do this, meaning that the IRA will be kept where it is, which still doesn’t produce any revenue for them. The ruling was odd and clearly illustrates how much control they actually have over what we all think of as “our own money”.

If you have been following the markets for any time, you have likely heard the saying “buy low, sell high”. The question is, do we really understand what it is trying to say? Well, if we can apply this to our trading, it can be a big help in understanding when to buy and sell. Of course, the terms “low” and “high” can be relative, so we need to make sure we use them correctly. Just because we think something is low doesn’t mean it cannot go lower or if we think it is high that it cannot go higher. In fact, sometimes we may be buying high and selling higher or selling low and buying back lower. Now this might seem like a lot of confusing words, but the idea is that when we look at a chart, we need to make sure we know the best places to enter our trades.

As we begin to understand this concept, we will see that the market moves in patterns or cycles and, if we can identify them, we will be able to see the best opportunities to buy or sell. Price patterns generally use the concept of buy low, sell high. If you look at a triangle pattern on a chart, you will see that it will give us an entry signal to long or short as the price breaks up or down through the triangle support or resistance lines. This is an example of buying high on the break of resistance, with the anticipation of selling at an even higher price, or selling low on a break below support, with the anticipation of buying back at an even lower price.

Cycles in price action will give us a more traditional look at buying low and selling high. As the price swings from high to low, we can often anticipate when the next swing is getting ready to occur. This does not mean we are trying to find the perfect low or high on the swing, but it does give us an idea of when a reverse of the cycle may be getting ready to happen.

One exercise you can try is to begin looking at the chart without any indicators. Then, as you begin to see price cycles develop, look to paper trade your entry. Do not look for anything other than trying to identify when the price is getting ready to go through the next cycle. If you look at the chart and it looks like the price is coming to the bottom of the cycle, then look to enter a long position as price begins to cycle back up, or if the cycle is moving up to the top, look for the price to begin to cycle back down to take a short.

By doing this, you will gain a greater understanding of how price action works and you will better understand the statement to buy low and sell high. Take some time to practice this on both longer and shorter time frames and you will see how well it can work.

Today we are going to spend a few minutes discussing the importance of price action in our trading. As useful as trading indicators are, without the ability to read the price actions, we can, often times, get fooled by them. Because of this, we really need to be able to use price action to help confirm what we are seeing when our trading indicators try to tell us something. Many times, new traders will become excited as they see what an indicator can do for them. This excitement will often times lead to disappointment as they realize that an indicator may not be as good as it first seemed. Because of this, it is important to know how to read the price action associated with the chart and indicator.

Price action can be used to confirm the action seen on the chart with the indicator. This means that we should have some price action component to our entry rules, along with the indicators that we are using. This could be something as simple as waiting for the price to close after the indicators say to buy or sell. It could also be something as detailed as looking for multiple candles forming major price patterns to help you will the confirmation. Regardless of what you are using, it is important to look at the price action to confirm what your indicators are showing you.

Price action tells us what the market participants are thinking at the time we are evaluating the trade. If the candles are big, then there is likely to be lots of interest in the price moving up or down. If the candles are small then the interest in moving the price is small. Big price movements are suggesting a continuation of the price in the direction of the big price move. Small price moves often indicate that the price is getting ready to change.

As we look at the price action in relationship to the areas of support and resistance, we can gain even more insight into what might happen. For example, if the price has moved up to a level of resistance and we begin to see small candles or price action, it may indicate that the price is ready to reverse. This is even a stronger likelihood if we see reversal patterns forming such as double tops. On the other hand, if we are near resistance and see a large candle move up above the resistance and close above it, we need to consider that as a strong bullish sign because it is breaking out of the resistance area.

Of course there are no guarantees that big or small price action will lead to what we think should happen, but it does give us the added information that things are moving and doing what the indicators might be suggesting. Take some time to review how you use price action in your trading rules and make sure you know how they work within your set of trading rules.

One of the hardest things for a new trader to learn is discipline. There are three main elements or keys that can help to control your emotions and find more success in your trading:

1. Find a good system and follow it. Notice, that I said a good system not a perfect system. Traders are often looking for the next best or greatest thing, and sometimes are hoping for a “perfect” system of trading. This is an easy trap to fall into because of all the marketing hype out there. Even the very best systems are not perfect and are going to have losses. This is just a fact of life, but if your system has been back-tested and works relatively well in a variety of market conditions; the best thing you can do is to stick with it! Don’t fall for the system that promises easy profits, because over time that system is just an illusion. We can often get into the mindset of the always looking for something better and ignores the fundamental trading rules that will give us good results over time.

2. Get a good routine and follow it. Consistency is the key here. What I mean by that is that you should treat trading as a profession and not just a hobby. In order to have a good routine, you should understand and decide what you are going to trade, or in other words specialize in a few things and get very good at those and leave the rest to someone else to do. Also, when you trade is very important and is also heavily influenced by the markets you trade. For example if you trade Forex you may have more flexibility to trade at different times, than if you trade stocks or options who have specific exchange trading times. Also, where you trade is important, you should set up a concussive place to trade, be organized, and free of distractions that might inhibit your trading. The overall message here is to take your routine seriously like if it was your only source of income and be very consistent with what, when and where you trade.

3. The third key to controlling your emotions is to use consistent risk management. If we risk too much on any one specific trade or if we risk too much of our account on too many trades at one time, it is easy to let our emotions get out of control, because we may have too much anxiety to make rational decisions. This may well bring fear of losing in to your trading and can cause you to make significant trading errors. The way to control this is to make sure that you use stop loss orders and that your make sure that your position sizing is appropriate to the size of account you have. You should limit your risk to 1 percent per trade and no more that 3 percent overall at any one given time. This will allow you to sleep good at night even if you have some trades go against you.

Being a successful trader largely comes down to controlling your emotions by being more disciplined. Following a good system, a good routine, and good risk management will help to accomplish this.