Murphy's Ten Laws
of Technical Trading
John J. Murphy is StockCharts.com's
Chief Technical Analyst, a former technical analyst for CNBC, and
author of the classic book Technical
Analysis of the Financial Markets. Renowned for his
leadership in inter-market technical analysis, John has
distilled more than 35 years of market experience into just ten
If you are new to trading, this is a great place to start. Read,
learn, and memorize these laws so that they will seamlessly
become a part of your future trading. If you are already
trading, now is the time to reassess your trading system against
the backdrop of these laws. Since they provide the conceptual
framework of technical analysis regardless of the specific
indicators used, they can help you identify weaknesses in your
overall approach and push you to greater profitability.
Without further ado, here are the ten laws...
Map the Trends
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
Spot the Trend and Go With It
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.
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.”
Know How Far to Backtrack
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 50% 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 38.2% and 61.8% are also worth watching. During
a pullback in an uptrend, therefore, initial buy points are in
the 33-38% retracement area.
Draw the Line
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.
Follow that Average
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
Learn the Turns
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
Know the Warning Signs
The Moving Average Convergence Divergence (MACD) indicator
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.
Trend or Not a Trend
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.
Know the Confirming Signs
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.
Keep at it. Technical analysis
is a skill that improves with experience and study. Always be a
student and keep learning.
Be sure to integrate
these laws into your trading.
your own swing trading system here.