The phrase “John Murphy’s technical analysis” is familiar to any trader who has ever tried to search for literature on technical analysis. Many of Murphy’s books are world-famous for their simple explanations of complex things. Every self-respecting trader has read Murphy’s “Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications” and “Intermarket Analysis”.
John Murphy has the expertise of two professions at once, as both a talented writer and an experienced trader who only stopped trading when the markets were closed. John Murphy’s books are useful for both day traders and long-term investors. His writing covers everything related to technical analysis. Indicators, support and resistance levels, trends, Elliott waves – it’s all in his books. Murphy has received several awards for his achievements. His most significant prize was awarded by IFTA, the International Federation of Technical Analysts (yes, there is such a thing!), for his outstanding contribution to the sphere of market analysis.
Murphy’s book “Technical Analysis of the Futures Markets: A Comprehensive Guide to Trading Methods and Applications” is currently considered the bible of technical analysis. It is recommended reading for anyone who is involved with trading and investment in any way.
This book, which has been translated into many languages, clearly lays out how to apply technical analysis to any areas that have charts showing price movements. In its 16 chapters, the book provides comprehensive information about market analysis and about specialized areas of analysis with a considerably large number of case studies. There isn’t a single area of technical analysis that isn’t somehow reflected on the pages of this book. The book begins with the philosophy of technical analysis. The second chapter describes the basic tenets of the Dow Theory, and from there the book transitions into charting, with detailed explanations of the pros and cons of each separate type of chart. The remaining chapters discuss trends, models of trend fractures and trend continuation, the importance of volume, moving averages – everything a trader needs to know in order to work in the markets.
John Murphy’s Laws
Murphy outlined five basic rules for successfully applying “The trend is your friend”. To start with, he recommends mapping the trend. In order to do this, you have to understand whether the current market movement is the main trend or a correction. Increasing the scale helps to identify the main trend, which is important for all types of traders.
On this gold chart (M30), we see sideways (trendless) movement.
But the next figure (H4) shows a downward trend. In this situation, it’s better to open your position at the top end in a downturn, and not work in both directions.
The next rule advises to follow the trend
On the chart below, you can use the top of the channel for the opening position in a downturn.
Murphy warns that the market always has retracements. His book recommends using classic resistance levels along with Fibonacci levels. Fibonacci levels are preferable for identifying retracements.
The author recommends drawing trend lines as frequently as possible. The more times the trend line is confirmed on the chart, the more reliable the trend is.
The chart below shows a triple confirmation of an uptrend for the USDCAD pair.
This last rule applies to using support and resistance levels. A chart normally stops showing movement once it has reached a significant level. A single point where multiple lines cluster is a good time to open a position.
The best way to work a trending market is to follow moving averages. The intersection of moving averages is an optimal place to open a position. You need to find the moving averages yourself, focusing on your own trading style.
RSI and Stochastic
To identify trend reversals, Murphy recommends using RSI and Stochastic oscillators. The indicators function in the range from 0 to 100. RSI shows overbought (greater than 70) and oversold (less than 30) conditions. For a Stochastic oscillator, overbought is over 80 and oversold is under 20. When these indicators diverge, it usually signals a market downturn, but when trading in a corridor, these indicators complement each other and point to new movement. To identify a market trend, you must use the ADX indicator. It shows whether a trend exists, and its direction.
Murphy also devotes a tremendous amount of attention to the presence of volume and open interest. These are important parameters for the futures markets. Murphy says that volume always precedes price. A large volume must have a place in the direction of the prevailing trend. If one can’t be seen, this suggests that the market trends will change soon.
Increasing open interest points to new money that is supporting the present trend.
John Murphy doesn’t limit himself to technical analysis. The book that made him popular, “Intermarket Analysis: Profiting From Global Market Relationships,” is more like a philosophical discourse on the global relationships of the world’s stock exchanges. In the book, John affirms that the market is like a melting pot where money flows from one state into another, but still stays in the same pot. The recent crisis related to falling oil prices was a powerful impetus for a new uptrend for gold, which had been falling prior to that. This is why the author encourages readers to search for relationships between things that seem to be unrelated at first glance. Consider the example of falling oil prices. Investors pulled out of oil, and they needed a reliable tool. This time it was gold, and gold prices started to increase sharply. There are many similar examples if you analyse the markets closely.
The guru himself is constantly learning, and challenges his followers to do the same.
“Technical analysis is a skill that improves with experience and study. Always be a student and keep learning.”
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NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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