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Mastering Short-Term Trading

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    Mastering Short-Term Trading


    Short-term trading can be very lucrative, but also risky. It can last for as little as a few minutes to as long as several days. To succeed at this strategy, traders must understand the risks and the rewards of each trade. They must not only know how to spot good short-term opportunities, but also must be able to protect themselves from unforeseen events. In this article, we'll examine the basics of spotting good short-term trades and show you how to profit from them.

    The Fundamentals of Short-Term Trading

    Several basic concepts must be understood and mastered for successful short-term trading. These fundamentals can mean the difference between a loss and a profitable trade. Let's take a look at these vital principles.

    Recognizing Potential Candidates

    Recognizing the right possible trade will mean that you know the difference between a good potential situation and the ones to avoid. Too often, investors get caught up in the moment and believe that if they watch the evening news and read the financial pages they will be on top of what's happening in the markets. The truth is, by the time we hear about it, the markets are already reacting. So, some basic steps must be followed to find the right trades at the right times.

    Step 1: Watch the Moving Averages

    A moving average is the average price of a stock over a specific period of time. The most common time frames are 15, 20, 30, 50, 100 and 200 days. The overall idea is to show whether a stock is trending upward or downward. Generally, a good candidate will have an increasing moving average that is sloping upward. If you are looking for a good short, you want to find an area where the moving average is flattening out or declining. (To learn more, read Moving Averages.)

    Step 2: Understand Overall Cycles or Patterns

    Generally, the markets trade in cycles, which makes it important to watch the calendar at particular times. Since 1950, most of the stock markets gains have occurred in the November to April time frame, while during the May to October period, the averages have been relatively static. Cycles can be used to traders' advantage to determine good times to enter into long or short positions. (For more insight, see Understanding Cycles - The Key To Market Timing.)

    Step 3: Get a Sense of Market Trends

    If the trend is negative, you might consider shorting and do very little buying. If the trend is positive, you may want to consider buying with very little shorting. The reason for this is that when the overall market trend is against you, the odds of having a successful trade drop even more. (For related reading, check out Short- Intermediate- and Long-Term Trends.)

    Following some of these basic steps will give you an understanding of how and when to spot some of the right potential trades.

    Controlling Risk

    Controlling risk is one of the most important aspects of trading successfully. Short-term trading involves risk, so it is essential to minimize risk and maximize return. This requires the use of sell stops or buy stops as protection from market reversals. (For background reading, see The Stop-Loss Order - Make Sure You Use It.)

    A sell stop is a sell order to sell a stock once it reaches a predetermined price. Once this price is reached, it becomes an order to sell at the market price. A buy stop is the opposite. It is used in a short when the stock rises to a particular price and it becomes a buy order.

    Both of these are designed to limit your downside. As a general rule in short term trading, you want to set your sell stop or buy stop within 10-15% of where you bought the stock or initiated the short. The basic idea here is to keep the losses manageable so that the gains can always be considerably more than any losses you may incur.

    Technical Analysis

    There is an old saying on Wall Street: "never fight the tape". Whether most admit it or not, the markets are always looking forward and pricing in what is happening. This means that everything we know about earnings, the management and other factors is already priced into the stock. Staying ahead of everyone else requires that you use technical analysis to understand what is going on.

    Technical analysis is a process of evaluating and studying the stock or markets using previous prices and patterns to predict what will happen in the future. In short-term trading, this is an important tool to help you understand how to make profits while others are unsure. Below we will uncover some of the various tools and techniques of technical analysis. (For more insight, see Basics Of Technical Analysis.)

    Buy and Sell Indicators

    Several indicators are used to determine the right time to buy and sell. Two of the more popular ones include the relative strength index (RSI) and the stochastic oscillator.

    The RSI compares the inside strength or weakness of a stock. Generally, a reading of 70 indicates a topping pattern, while a reading below 30 shows that the stock has been oversold. (Learn more about this indicator in Getting To Know Oscillators: Relative Strength Index.)

    The stochastic oscillator is used to decide whether a stock is expensive or cheap based on the stock's closing price range over a period of time. You will see a reading of 80 if the stock is overbought (expensive); when the stock is oversold (inexpensive), you will see a reading of 20.

    RSI and stochastics can be used as stock-picking tools, but you must use them in conjunction with other tools to spot the best opportunities.


    Another tool that can help you find good short-term trading opportunities are patterns. A pattern is a change in direction up or down in the price of stock and reflects changing expectations. Patterns can develop over several days, months or years. While no two patterns are the same, they are very close and can be used to predict price movements.

    Several important patterns to watch for include:

    Head-and-Shoulders Patterns: The head and shoulders is considered one of the most reliable patterns. This is considered to be a reversal pattern when a stock is topping out. (For additional insight, see Analyzing Chart Patterns: Head and Shoulders.)

    Triangles: A triangle is when the range between the highs and lows narrows. These occur when prices are bottoming or topping out. As the prices narrow, this will signify that the stock could break out to the up- or downside in a violent fashion. (For more, read Triangles: A Short Study In Continuation Patterns.)

    Double Tops: A double top occurs when prices rise to a certain point on heavy volume and then retreat. You will then see a retest of that point on decreased volume. At this point, a decline will take place and the stock will head lower.

    Double Bottoms: A double bottom is when prices will fall to a certain point on heavy volume. They will then rise and fall back to the original level on lower volume. Unable to break the low point, prices will then start to rise. (To learn about tops and bottoms in FX trading, see The Memory Of Price.)


    Short-term trading uses many methods and tools to make money, however, you must know how to apply the tools to achieve success using this type of strategy. If you can do this, you will be able to make money in both bull and bear markets while keeping your losses at a minimum and your profits at a maximum. This is the key to mastering short-term trading.
    Quran 2:32. "Glory be to ALLAH, we have no knowledge except what You have taught us. Verily, it is You, the All-Knower, the All-Wise."



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    John Murphy's Ten Laws of Technical Trading


    StockCharts.com's Chief Technical Analyst, John Murphy, is a very popular author, columnist, and speaker on the subject of Technical Analysis. John's "Ten Laws of Technical Trading" is the best guide available anywhere for people who are new to the field of charting. I urge you to print out this page and refer to it often. If you find this information useful, consider subscribing to StockCharts.com which will allow you to read John's latest market commentary.

    Which way is the market moving? How far up or down will it go? And when will it go the other way? These are the basic concerns of the technical analyst. Behind the charts and graphs and mathematical formulas used to analyze market trends are some basic concepts that apply to most of the theories employed by today's technical analysts.

    John Murphy, StockCharts.com's Chief Technical Analyst, has drawn upon his thirty years of experience in the field to develop ten basic laws of technical trading: rules that are designed to help explain the whole idea of technical trading for the beginner and to streamline the trading methodology for the more experienced practitioner. These precepts define the key tools of technical analysis and how to use them to identify buying and selling opportunities.

    Before joining StockCharts, John was the technical analyst for CNBC-TV for seven years on the popular show Tech Talk, and has authored three best-selling books on the subject: Technical Analysis of the Financial Markets, Trading with Intermarket Analysis and The Visual Investor.

    His most recent book demonstrates the essential visual elements of technical analysis. The fundamentals of John's approach to technical analysis illustrate that it is more important to determine where a market is going (up or down) rather than the why behind it.

    The following are John's ten most important rules of technical trading:

    Map the Trends
    Spot the Trend and Go With It
    Find the Low and High of It
    Know How Far to Backtrack
    Draw the Line
    Follow That Average
    Learn the Turns
    Know the Warning Signs
    Trend or Not a Trend?
    Know the Confirming Signs

    1. Map the Trends

    Study long-term charts. Begin a chart analysis with monthly and weekly charts spanning several years. A larger scale map of the market provides more visibility and a better long-term perspective on a market. Once the long-term has been established, then consult daily and intra-day charts. A short-term market view alone can often be deceptive. Even if you only trade the very short term, you will do better if you're trading in the same direction as the intermediate and longer term trends.

    2. Spot the Trend and Go With It

    Determine the trend and follow it. Market trends come in many sizes – long-term, intermediate-term and short-term. First, determine which one you're going to trade and use the appropriate chart. Make sure you trade in the direction of that trend. Buy dips if the trend is up. Sell rallies if the trend is down. If you're trading the intermediate trend, use daily and weekly charts. If you're day trading, use daily and intra-day charts. But in each case, let the longer range chart determine the trend, and then use the shorter term chart for timing.

    3. Find the Low and High of It

    Find support and resistance levels. The best place to buy a market is near support levels. That support is usually a previous reaction low. The best place to sell a market is near resistance levels. Resistance is usually a previous peak. After a resistance peak has been broken, it will usually provide support on subsequent pullbacks. In other words, the old "high" becomes the new low. In the same way, when a support level has been broken, it will usually produce selling on subsequent rallies – the old "low" can become the new "high."

    4. Know How Far to Backtrack

    Measure percentage retracements. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the corrections in an existing trend in simple percentages. A fifty percent retracement of a prior trend is most common. A minimum retracement is usually one-third of the prior trend. The maximum retracement is usually two-thirds. Fibonacci retracements of 38% and 62% are also worth watching. During a pullback in an uptrend, therefore, initial buy points are in the 33-38% retracement area.

    5. Draw the Line

    Draw trend lines. Trend lines are one of the simplest and most effective charting tools. All you need is a straight edge and two points on the chart. Up trend lines are drawn along two successive lows. Down trend lines are drawn along two successive peaks. Prices will often pull back to trend lines before resuming their trend. The breaking of trend lines usually signals a change in trend. A valid trend line should be touched at least three times. The longer a trend line has been in effect, and the more times it has been tested, the more important it becomes.

    6. Follow that Average

    Follow moving averages. Moving averages provide objective buy and sell signals. They tell you if existing trend is still in motion and help confirm a trend change. Moving averages do not tell you in advance, however, that a trend change is imminent. A combination chart of two moving averages is the most popular way of finding trading signals. Some popular futures combinations are 4- and 9-day moving averages, 9- and 18-day, 5- and 20-day. Signals are given when the shorter average line crosses the longer. Price crossings above and below a 40-day moving average also provide good trading signals. Since moving average chart lines are trend-following indicators, they work best in a trending market.

    7. Learn the Turns

    Track oscillators. Oscillators help identify overbought and oversold markets. While moving averages offer confirmation of a market trend change, oscillators often help warn us in advance that a market has rallied or fallen too far and will soon turn. Two of the most popular are the Relative Strength Index (RSI) and Stochastics. They both work on a scale of 0 to 100. With the RSI, readings over 70 are overbought while readings below 30 are oversold. The overbought and oversold values for Stochastics are 80 and 20. Most traders use 14-days or weeks for stochastics and either 9 or 14 days or weeks for RSI. Oscillator divergences often warn of market turns. These tools work best in a trading market range. Weekly signals can be used as filters on daily signals. Daily signals can be used as filters for intra-day charts.

    8. Know the Warning Signs

    Trade MACD. The Moving Average Convergence Divergence (MACD) indicator (developed by Gerald Appel) combines a moving average crossover system with the overbought/oversold elements of an oscillator. A buy signal occurs when the faster line crosses above the slower and both lines are below zero. A sell signal takes place when the faster line crosses below the slower from above the zero line. Weekly signals take precedence over daily signals. An MACD histogram plots the difference between the two lines and gives even earlier warnings of trend changes. It's called a "histogram" because vertical bars are used to show the difference between the two lines on the chart.

    9. Trend or Not a Trend

    Use ADX. The Average Directional Movement Index (ADX) line helps determine whether a market is in a trending or a trading phase. It measures the degree of trend or direction in the market. A rising ADX line suggests the presence of a strong trend. A falling ADX line suggests the presence of a trading market and the absence of a trend. A rising ADX line favors moving averages; a falling ADX favors oscillators. By plotting the direction of the ADX line, the trader is able to determine which trading style and which set of indicators are most suitable for the current market environment.

    10. Know the Confirming Signs

    Include volume and open interest. Volume and open interest are important confirming indicators in futures markets. Volume precedes price. It's important to ensure that heavier volume is taking place in the direction of the prevailing trend. In an uptrend, heavier volume should be seen on up days. Rising open interest confirms that new money is supporting the prevailing trend. Declining open interest is often a warning that the trend is near completion. A solid price uptrend should be accompanied by rising volume and rising open interest.


    Technical analysis is a skill that improves with experience and study. Always be a student and keep learning.

    - John Murphy

    Definitions: Leonardo Fibonacci was a thirteenth century mathematician who "rediscovered" a precise and almost constant relationship between Hindu-Arabic numbers in a sequence (1,1,2,3,5,8,13,21,34,55,89,144,etc. to infinity). The sum of any two consecutive numbers in this sequence equals the next higher number. After the first four, the ratio of any number in the sequence to its next higher number approaches .618. That ratio was known to the ancient Greek and Egyptian mathematicians as the "Golden Mean" which had critical applications in art, architecture and in nature.

    Stochastics - an oscillator popularized by George Lane in an article on the subject which appeared in 1984. It is based on the observation that as prices increase, closing prices tend to be closer to the upper end of the price range; conversely, in down trends, closing prices tend to be near the lower end of the range. Stochastics has slightly wider overbought and oversold boundaries than the RSI and is therefore a more volatile indicator. The term "stochastic" refers to the location of a current futures price in relation to its range over a set period of time (usually 14 days).
    Quran 2:32. "Glory be to ALLAH, we have no knowledge except what You have taught us. Verily, it is You, the All-Knower, the All-Wise."



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    Direct-access brokerages vs. online retail brokerages


    Speedy execution: It allows very fast execution, measured in terms of milliseconds.

    Cost reduction: Transaction costs are lower for trade executed with a direct-access brokerage. Transaction costs are generally per share (ex. 0.004$ per share) whereas retail brokerage firms charge on a per transaction basis (ex. 5$ per trade).

    Slippage: Slippage is controlled at a minimal. Also it has a higher chance to execute at a better price when the market suddenly moves rapidly.

    Control over order routing: With most direct-access firms, a trader may choose to send his orders to any specific market maker, specialist, or electronic communication network.

    Liquidity rebates: Traditional online brokerages usually have a simple and flat commission fee per trade because they sell order flows. Direct-access brokerages do not sell order flows and get rebates They earn money from serving their customers. An active trader can gain what traditional online brokerages gain.


    Volume requirement: Some firms charge inactivity fees if a minimum monthly trading volume has not been met. For example Interactive Brokers charges a 10 USD per month inactivity fee on accounts generating less than 10 USD a month in commissions. Many firms will deduct transaction fees and commission paid each month from that month's inactivity fee. Hence an activity fee often serves as a minimum monthly commission which is paid to the brokerage. However, not all direct-access brokerages have minimum monthly trading volume requirements.

    Knowledge: New and inexperienced traders may find it difficult to become familiar with direct-access trading. Knowledge is required when dealing with something like making trade decisions & order routing.
    Quran 2:32. "Glory be to ALLAH, we have no knowledge except what You have taught us. Verily, it is You, the All-Knower, the All-Wise."



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    Thank you for this information. I wonder if any of the experienced traders on this forum would be willing to mentor me, a novice trader. I have already read up a few books on trading and just need a little guidance before I can start trading. I would really appreciate all the help. Thank you so much.

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