Investors Guide2

8/6/2019 Investors Guide2

1/11The Investors Guide to Trading from Charts and Using Level 2 1

The Investor's Guide to

Technical Analysis andUsing Level 2

Digital LookBrought to you by

www.DigitalLook.com



Contents

Basic Technical Analysis

Everything is discounted in the price | Page 4

A simple sell strategy, but remember:

Money Management Risk/Reward/Discipline | Page 5

A Buy and Sell reversal strategy:

Keep it Simple Stupid - KISS | Page 6

Using Level 2 to inuence trading decisions

What is Level 2? | Page 7

Research Plus

The new research platform from Digital Look | Page 10

One investor website stands out.

Digital Look now oers a new premium service - Research Plus

Combining Real Time streaming data with expert insight into the market.Using Digital Look.coms

research and analysis tools, private investors like you can now make more informed investments from

the research.



Michael Hewson has 20 years of market experience as a trader and technical analyst. He has lectured at

business schools and holds a CFTe from the International Federation of Technical Analysts.

Trading from charts is a popular method used by traders and private investors to nd trends and new

stocks to research and analyse. Michael takes you through some of the most commonly used strategies

that people employ to nd potentially winning trades.

Level 2 gives you real-time access to the stock market order book. It gives you a view of streaming prices

as trades are placed and enables you to make an informed decision on how you think these trades will

aect the price.

Michael will explain how to read Level 2 order books, what to view and how you can use this information

to help support your trading strategies. Please note that this is an introductory guide only. Digital Look

regularly oers a wide-range of seminars covering, in much greater detail, all of the main topics touched

on within this guide. These include seminars given by Michael on topics including Technical Analysis and

Level 2: Market-Open Breakfast Briengs.

At Digital Look, we see it as our mission to inform private investors about all aspects of investing from

providing award-winning data and research tools to alternative investment devices.

Digital Look provides a new premium service called Research Plus. This service combines Real Time

streaming data from the UK with current exclusive news stories. Our experts here are dedicated to

providing in-depth information through market analysis columns which is available exclusively to

Research Plus subscribers.

Written by Digital Looks Technical Analyst Michael Hewson, the Investors

Guide to Technical Analysis and Using Level 2 provides you with

explanations of some of the tools and strategies that successful traders and

investors use.

About this guide

About Digital Look



This is how the technical approach can work.

Market forces dictate price supply and demand. Price is driven by people just like you and me who succumb to the

same human emotions of hope, greed and fear as anyone else.

Seeing where previous highs and lows have occurred in the past and how the market has behaved when at these

levels can give clues as to what might happen next. Traders can formulate a number of strategies using what if

scenarios.

If we look carefully at the chart above we can immediately see that there seems to be considerable resistance to

the market going higher above 6750.

Based on this information we can see that the market doesnt seem to have the impetus to move above this

particular level. As such, we can deduce that being long (buying) at these sorts of levels is probably too expensive,

and that we can probably buy at cheaper levels later. We are not concerned with the whys or hows it is simply

enough that there appears to be a barrier at this level.

We can also consider short-selling the market at these high levels around 6700 as historically it looks good value to

do so.

Figure 1 - FTSE 100

Basic Technical Analysis:Everything is discounted in the price1

Dow Theory

One of the key tenets of the technical approach is to evaluate the past. Dow Theory works on the premise

that history repeats itself and that market price action discounts everything.

Looking at past price action on an asset can give clues as to how the price will behave in the future. Human

behaviour can, to a certain extent, be predictable given a certain set of circumstances.

Resistance line

Support and

resistance levels

Horizontal support and

resistance levels are the most

basic indicators of technical

analysis. A support level is an

area below the current price

where buying power overtakes

selling power. A resistance

level is the exact opposite.



A simple sell strategy:Money Management Risk/Reward/Discipline

Money management is a key element to a traders overall protability. The urge to take a prot as soon as you seeit sees many a trader end up losing money in the long run.

Why is that you may well ask? Well, traders tend to run their stop losses until they are executed but they dont do

the same thing when they are making a prot.

Traders often see a small prot and they take it. If you work on the basis that you are right on 50% of trades

executed, then you will never make any money.

When putting on a trade I always think, based on worst case scenario how much money am I prepared to lose

on this trade? Starting at 1 a point a 100 loss would allow me a 100 point move against my position before I get

stopped out. If it is 100 Im prepared to lose then I should be looking to make between 200 and 300 prot. Thatwould then mean I need a 200-300 point move in my favour. This way, based on a 50% success rate I would be

making money.

For every element of risk, I should be looking to make at least double that on the prot side. Its all about

maintaining discipline when things are going well, as well as when they are going badly. And make no mistake

they will go badly from time to time.

Another way to lose money is the setting of unrealistic stop loss and prot levels on unsuitable markets. A 100

point stop loss on EURUSD for example is quite realistic, but totally useless on something like a penny share. Use

the price ranges of the last few days, and months, as a benchmark when setting stop loss levels.

Figure 2 - FTSE 100

2

Lines & Candlesticks

A simple line chart usually shows the closing price for an instrument. A more powerful chart can be drawn

using candlesticks which will show both open and closing price. The wicks also indicate the trading range.

Unlike bar charts, candles are colour coded in a certain way; a (white/blue/green) candle represents a higherclosing relative to the opening of the particular period (an up candle). A red or black candle represents a

lower closing relative to the opening of a particular period (a down candle).



In the example above I have drawn a resistance line through 6754 on the FTSE100. On a risk/reward basis going

short (sell) the FTSE is the sensible way to trade when the price is near these levels. There are a number of reasons

for adopting this strategy.

1. The market has held below it a number of times.

2. Because of the resistance level the potential downside is clearly dened a move above 6750 negates your

strategy and you can stop the position out.

3. The potential prot can be calculated by looking at previous reactions o these highs.4. If you put a 100 point stop loss on your position then at the very least you should be looking to make 200

points and more.

Looking at the previous reactions o the 6750 highs this is easily achievable. The red arrow indicates any potential

loss and the blue arrow your potential prot. As you can see that shows an acceptable reward/risk ratio of over 2:1.

If history repeats itself, and the unexpected always happens, how incapable must Man be of

learning from experience.- George Bernard Shaw



To begin with dont overcomplicate your analysis with complex oscillators, moving averages, smoothingtechniques you probably wont understand them and they can sometimes give contradictory signals which

result in cluttered thinking and a paralysis of indecision.

The questions you have to ask are:

a) Is it trending Yes/No?

b) What is the direction of the trend - Up, Down or sideways?

1. Up look to buy it,

2. Down look to sell it,

3. Sideways do nothing

Next, look for support and resistance areas, trend lines and make a decision.

In the above example we have a classic example of keeping your analysis simple. We have a candle chart of the

FTSE100 and two lines on it a simple horizontal support and resistance line and a simple trend line. However

from these two lines we were presented with at least 5 dierent trading opportunities. All would have been

buying opportunities with only one of them failing. In each case except one, a buy order with a stop loss below the

sloping trend line would have yielded a prot.

In the rst instance we had both trend line and horizontal line support which would have reinforced our buying

strategy. Where the buying strategy failed a simple stop out and a reverse of position would have negated any loss

made in the initial trade as the market dropped rapidly once the trend line broke.

As you can see from the above example we have devised a simple strategy that can be applied to any type of chart

and timeframe the rules are as equally valid whether you are looking at a daily chart or an hourly chart.

Figure 4 - FTSE 100

Buying Opportunity 4

failed, however a stop

loss and reversal of

position would have

turned this trade

around and ensured a

prot.

A Buy and Sell reversal strategy:Keep it Simple Stupid - KISS3

Be fearful when everyone is greedy. Be greedy when everyone is fearful.- Warren Buett



Before looking at how we can use Level 2 to trade we have to understand what it is that we are looking at.

The data is streaming live prices there is no need to refresh the screen. There are 2 types of order book SETS

(order driven) and SEAQ (quote driven). The SETS order book matches buy and sell orders from Market Makers or

Brokers on a price/time priority on an electronic basis. On SEAQ all buys and sells go through a Market Maker orBroker who acts as an intermediary. Order book statistics are displayed at the bottom of the window (A).

Theyellow strip (B) shows how many Market Makers are quoting the best bid price (2), the best oer price (4), and

the number of shares they will trade on the bid side (11,590), the oer side (46,200), the best bid price (119.05p),

and the best oer price (119.10p).

The Buy Orders column (C) on the left hand side shows the prices at which Market Makers are prepared to buy

stock from you. This is the price that you can sell at.

In this case the best price is 119.05p and there are 2 orders here totalling a quantity of stock up to 11590 at this

price.

The next best price is 119.00p and there are 11 orders totalling 50426 shares. The green indicates that new shares

have been added to the total order sizes.

The Sell Orders column (D) on the right hand side shows the prices at which the Market Makers are prepared to

sell stock to you. This is the price that you can buy at.

Using Level 2 to inuence trading decisionsWhat is Level 2?

Figure 5 - Level 2

G

HC

A

E F

D

B

4Level 2 data is far more comprehensive than Level 1 data. It gives access to all the information presented by

Level 1 data, and also displays the full depth of the market which is essential for an active investor. It also

helps investors to gain a better understanding of the current trends in a security and which technical factors

may be inuencing the price.



In this case, the cheapest oer is at 119.10p and there are 4 orders here totalling a quantity of stock up to 46,200.

The next best oer is at 119.15p and there are 3 orders totalling 20,200 shares. The red indicates that part of the

order at that price point has either been deleted or executed.

This is only part of the story; as you also need to look at the order book statistics for an idea of how the market is

positioned. Note that there are 121 (E) buy orders totalling nearly 5.9 million shares and 192 (F) sell orders totalling

nearly 9.2 millions shares.

So what does that tell you?In simple terms because there is a higher concentration of sellers than buyers with a day high of 120.90 (G) and a

day low of 117.65 (H), a strategy of selling into rallies (i.e. short-selling when prices rise) would be sensible as you

could reason that the market looks overly long and prices might fall.

However, look what happens when I change the order book to display only orders within 5% of the touch price (I).

Suddenly there is more buying interest than selling interest.

From showing a large interest to sell in the previous screenshot there are now 4.7m shares on the bid side, and

only 2.9m shares on the oer, so from the market looking overly long it now appears to look overly short.

One of the favourite tricks that market makers like to pull is to put large orders well away from the touch price togive the impression of a lopsided order book, when they want the market to go the other way.

Based on this information, there appears to be greater interest to buy near to the touch price than there is to sell,

so you might actually expect prices to rise.

To learn more about Level 2, Digital Look hold monthly webinars on how to interpret Level 2.

Figure 6 - Level 2

I VWAP is a trading acronym

for Volume-Weighted Average

Price, the ratio of the value

traded to total volume tradedover a particular time horizon

or for a particular number of

shares

Charting and Level 2 are essential tools for the serious trader. Using charting can give important clues about

the long and short term supply and demand of a particular asset, while Level 2 oers important clues aboutthe distribution of buy and sell orders at dierent price points as the market moves up and down. Level 2 is

particularly useful in highlighting the short term distribution of supply and demand, while charting oers

insight into the historical price curve and its key levels.



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PLUS exclusive Technical Analysis insight

from our expert Michael Hewson.

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Use strategy screens built by our experts or

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Streaming charts

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Real Time Data and ToolsView unlimited real time streaming data including:

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Streaming portfolio prices

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11/11

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Copyright Digital Look Ltd 2008. All rights reserved.

To reproduce any part of this guide or for additional copies, please [email protected]

Inside you'll discover:

Basic Technical Analysis

A simple sell strategy: Risk/Reward/DisciplineA Buy and Sell reversal strategy

How to read Level 2 order books

How to use Level 2 order books to inuence trading decisions

Digital Look events

We run a regular series of London seminars in addition to online webinars which you can attend from

home regardless of your location. Our events range from small, focused seminars where you will haveaccess to a trading platform and a tutor to work with you to put real strategies into practice, to large

lectures with well known industry experts. Our comprehensive range of seminars covers everything

you need to gradually learn about the markets, improve your condence, learn new techniques and

strategies and go on to become a successful investor.

Events include:

See the Market Open with Level 2

Introduction to Technical Analysis

Advanced Technical Analysis

For more information please go to: www.DigitalLook.com/events

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Investors Guide2