Technical analysis often plays a large part in the determination to enter or exit stock trades in the short and intermediate term. It can also play a part in determining entry and exit of long option trades (buying calls or puts). What about using technical analysis in determining entries and exits of more complex options strategies such as vertical spreads, calendar spreads, aktieanalys iron condors and diagonal spreads? In this article, I want to specifically address the use of technical analysis in advanced options trading.
The problem with technical analysis
Even the best market technicians can only tell you what is likely to happen. This isn't the fault of technical analysis (TA for short) or in the practitioners of it. It is simply a fact that must be reckoned with. TA is much more like checking the direction of the wind than a predictor of which way it will blow tomorrow.
While TA may be able to tell you what is likely to occur or what is going on at the moment, it can't tell you your probability of success in a trade. There has been some work to quantify the accuracy of different technical indicators, particularly in the area of chart patterns, but that still doesn't help with the analysis of the trade itself.
One other danger of technical analysis is the temptation to pile on a bunch of indicators in the hope that it will somehow give us additional insight or edge in trading. I'm not saying the employment of stochastics, MACD, Bollinger bands and the like aren't important but their use in the overall trading strategy must be understood.
Technical analysis must also be correlated to a timeframe to be effective. In other words, you must know the timeframe you are working in. Is it short term (days), very short term (intra-day), medium term (weeks) or long term (months). To be effective, you must understand the timeframes involved in the options trade and ensure that technical analysis is done for the same timeframes.
Don't get me wrong, I'm not against using TA for advanced options trading. In fact I'm a firm believer and practitioner of it. However, it is important to realize the limitations as well the benefits and uses. In fact, let's take a look at some of the benefits.
The benefits of technical analysis
Technical analysis can be used to time an entry or trigger an exit. I often use basic support and resistance levels to do just that. In fact, I believe the combination of TA to time an entry combined with probability analysis for choosing my position actually improves my overall success. Also, when I have a clear support or resistance level that can be used as an indicator that my initial analysis was wrong, I often exit a trade earlier keeping more of my money for another trade.
One other area of TA I find beneficial is in determining overall market outlook. Remembering that timeframe is important, I often use TA to determine what the medium term trend is. This can help me determine what kinds of trade strategies to best employ over the coming weeks.
I'm sure there are other very successful options traders who have found additional uses for TA. In fact, I'm sure there are as many ways to incorporate technical analysis as there are strategies to use them on. That's what makes trading so interesting. In fact, networking with other successful traders can be an important factor in determining your own trading style.
Knowing how and when to use technical analysis
Ultimately, the determination of how and when to use technical analysis is up to the trader and the trading plan(s) they are using. Understanding the limitations as well as the benefits of technical analysis is a great start. From there, experiment with different approaches using some form of paper trading until a clear strategy emerges.
It's best to start with basic support and resistance analysis. Keep it simple. Use only the indicators that you are comfortable with and that help in making basic trading decisions. Ultimately though, you as a trader must make that decision to enter or exit the trade based on your evaluation of all the factors.