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5 Technical Trading Rules Explained

| December 28, 2021 | By

The modern marketplace is a dynamic, ever-changing environment. Traders practicing fundamental and technical analysis meet every business day with a single goal in mind: to make money! 

At this point, you may be asking, “What is technical analysis?” Well, here’s a working technical analysis definition: Technical analysis is the study of an asset’s past and present price action. It is used to project future market behavior and build technical trading rules. 

In this blog article, we’ll break down five price-based rules and explain technical analysis with examples.

1. Make Friends with the Trend

A trend is a directional move in price, typically identified via a set technical chart. Typically, traders qualify trends as being a series of periodic higher highs (bullish) or lower lows (bearish). It’s a cliché, but the old saying “the trend is your friend” is among the most popular basic trading rules in existence for a reason.

For active traders, market technicals are ideal for spotting trends and implementing trend-based strategies. However, no matter your technical trading methodology, there are two essential rules to live by when dealing with trends:

  • Favorable market entry is with the trend
  • Going against the trend is a high-risk proposition

It’s a point of fact that trend-following is one of the trading practices in which technical analysis is applied. And, although it is an elementary concept, always remember that “the trend is your friend!”

2. Don’t Ignore Fibonacci Numbers

Fibonacci numbers are integers that represent the sum of two preceding, sequential numbers. Based on the “golden ratio,” Fibonacci numbers are the basis for many methods and tools used in technical analysis and technical trading. Fibonacci expansions, spirals, and retracements are examples of golden ratio indicators frequently utilized in both long- and short-term technical analysis.

If you’ve ever listened in on a squawk box or a technical traders com link, then you’re probably familiar with slang such as “pullbacks,” “retracements,” or “fibbys.” These are terms used to reference Fibonacci retracements, an exceedingly popular tool in trading technical analysis. In practice, fibbys measure the percentage of a retracement or pullback from a periodic extreme. Many rule-based trading systems are based on the Fibonacci retracement sequence: 

  • 38.2%
  • 50%
  • 61.8%
  • 78%

Fibonacci retracements may be used to define market entry/exit as well as to align profit targets and stop losses. The levels most commonly scrutinized by active traders are 38.2 percent and 61.8 percent.

3. Understand the Concepts of Support And Resistance

The second or third chapter in any book titled Trading Indicators Explained would most likely deal with the concepts of support and resistance. Simply put, a support or resistance level is a price point that may (or may not) restrict price action. A resistance level restricts bullish price action; support restricts bearish price action.  

Price levels where technical trading indicators such as moving averages or Fibonacci retracements fall are potential areas of support and resistance. These levels often act as self-fulfilling prophecies: If enough traders respect the same ones, they function as barriers for price extension or launch points for new trends.

After determining the location of support and resistance, integrating them into a trading strategy is relatively simple:

  • Enter orders to the long (buy) from support
  • Enter orders to the short (sell) from resistance

In the past, support and resistance day trading rules explained how a trader could profit from constricting price action in the short term. Many of these lessons still hold true today. Although many market participants swear by trend-following, there’s also money to be made with consolidation or reversal strategies.

4. Don’t Count on Long-Lasting Trends

Nothing lasts forever, and all trends eventually end. These two facts are essential stock, futures, or forex technical analysis basics. As applied to technical trading trend-following strategies, they are most certainly true.

Spotting the end of a trend is a fine art. One way of addressing this task is to determine when a market becomes “overbought” or “oversold.” This may be accomplished through the use of a group of technical tools known as oscillators. 

Two of the most common oscillators are stochastics and the relative strength index (RSI). Both assign a numeric value from 0-100 to the periodic price action of a security. A high reading shows that a market is becoming overbought, and a low reading suggests it is becoming oversold. Values that approach the extremes are signals of trend exhaustion and a possible market reversal.

5. Get Comfortable with Multiple Time Frame Analysis

Prolonged trends or consolidating price action can be placed into the proper context by observing monthly, weekly, daily, and intraday charts. A long-to-short progression is a key part of conducting astute multi-time frame analysis: 

  • Identify the macro market state by using longer-term pricing charts
  • Establish current trading conditions via shorter-term or intraday charts

Futures market newbies often waste time asking, “What is most common time frame for day trading?” Although there’s no steadfast rule, it is critical to remember that longer time frames are more relevant to market behavior than shorter ones. For day trading, a market’s true state is best determined by a weekly or daily chart. After the market’s condition is established, you may use intraday charts (hour, minute, tick) to fine-tune entry and exit points.

Getting Started with Technical Trading

It’s no small feat to develop a live market technical trading plan. In fact, becoming a competent market technician takes time, effort, and dedication. From becoming familiar with technical trading terms to conducting real-time analysis, a technician’s education never stops. 

So which is the best technical analysis strategy? The answer to that question depends on your resources, aptitude, and goals. To learn more, contact one of our StoneX brokers today.

This blog was originally published on June 5, 2018, and has been updated for accuracy and comprehensiveness.

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