John Murphy is a famous and popular publisher, article writer, and public speaker in technical analysis sector. Murphy has an article named “10 laws of technical trading”, which is a collection of his advice for amateur traders. In fact, these laws have been collected and shaped over several years. In this article we are going to explain these 10 John Murphy’s laws. These rules are useful in cryptocurrency market or any other financial markets.
John Murphy’s laws; Introduction
Beyond graphical charts and mathematical formulas, which are used to analyze the market trend, there are some basic concepts that are useful and suitable for most technical analysis theories. John Murphy designed and published some laws over 30 years, which not only could help amateurs to understand the general idea of trading, but also made it easier for professionals to identify their trading strategies. The basis of Murphy’s approach in technical analysis is where the price wants to go, not the reason behind the price movements.
1- Map the trend
Study the market trend in long term. Begin it by analyzing the chart on weekly and monthly basis as well as know the market trend over several years. In fact, by doing so, you will have a clearer and better perspective of market. Once the main market movements established, then begin to analyze the market in short-term period. Even if you are willing to trade in short-term period, it is better to be at the same direction of the main market movement in long-term period.
2- Detect the trend and go with it
Market trends cover various time frames. It consists of long-term periods to mid-term and finally short-term period. Know these time frames and use the most suitable one. If you are using the mid-term period, it would be better to follow the weekly or daily trend. On the other hand, if using the short-term period, use daily, hourly or even minutely chart. In any case, in order to use any trading strategy, it requires to identify the main market trend in long-term period.
3- Find tops and bottoms
Find resistance and support levels in price charts. In order to take a long position (buy), it would be better the price stay close to the support levels. On the other hand, resistance levels are the best in order to place a short position (sell). If the price breaks the resistance level, this level becomes a support level for a pullback. The same is true for support level as well.
The figure above shows Bitcoin price from June to December 2019. As the chart shows, the blue color line is broken (the black color arrow) and performed as support level (The blue color arrows), which caused a pullback. In addition, it appeared as a resistance level (the orange color arrow) in late October.
4- John Murphy’s laws; Know how far it is to break the trend
Measure the percentage of returns. At the time of price correction, the market returns for a certain amount, which is around 50%.
5- Draw the trend line
Trend lines are the simplest and most effective technical analysis tools. Ascending trend lines are drawn from two successive bottoms. Meanwhile, the downtrend lines are drawn from two successive tops. The breaking of trend lines could be a signal of changing in a trend. A valid trend should be touched at least for three times. The more the line be touched, the more important it becomes.
The figure above, shows the Bitcoin price chart. The trend line is drawn by connecting the tops (orange color arrows). As it shows, by breaking the line (black color arrow) the trend line is changed to an uptrend.
6- Follow the moving averages
The movement of the price above or below the moving average is a signal of buying or selling. By using this indicator, a trader could understand that the existing trend is continuing or a new trend is going to form in the market. However, the moving average is not ahead of the trend. In fact, it can signal that a trend change is imminent.
The most important averages are 20-day for short-term, 50-day for mid-term and 200-day for the main trend. Crossing of two moving averages also provide useful information about the trend. The most popular combinations are 5-20 days, 20-50 days and finally 50-200 days. However, the EMA (Exponential Moving Average) is more suitable to study the crossing points.
The figure above shows the Bitcoin price from mid-2018 to mid-2019. The purple color line shows the EMA-50 and the black color shows EMA-200. The orange color arrow shows the lines crossing point. At this point the EMA-50 is moving downward, which signals a Bearish market. The blue color arrow shows the crossing point, where the EMA-50 is moving upward and crossed the EMA-200. This move shows the beginning of an uptrend.
7- John Murphy’s laws; Learn the turns
Oscillators are efficient in order to identify the overbought and oversold conditions. When the moving averages confirm the market trend change, oscillators are able to inform us earlier about that. The two most popular oscillators consist of RSI (Relative Strength Index) and Stochastic oscillator. Both oscillators work on a scale of zero to 100. If the RSI be above 70, it signals an overbought condition. On the other hand, it signals oversold condition when it is below 30. These numbers are 20 and 80 for the Stochastic oscillator. In addition, it is recommended to use 9 or 14 days or weeks for RSI and set the Stochastic oscillator on 14 days or weeks. Most traders use weekly intervals for daily signals and daily intervals for hourly or minutely signals.
As the figure above shows, before each price increase, the RSI shows the overbought condition. The RSI crossed the purple color range in April 2019 followed by a price surge. Then, same condition happened in May and 20 Jun.
8- Know the warning signs
The MACD (Moving Average Convergence Divergence) indicator combines a moving average system with the oversold or overbought elements of an oscillator.
A buy signals occurs when the faster line crosses the slower line upward and both lines are below zero.
Meanwhile, a sell signal occurs when the faster line crosses the slower line downward and both lines are above zero.
This indicator shows the difference between the two lines and gives an advanced warning of trend changes.
An MACD histogram plots the difference between the two lines and gives even earlier warnings of trend changes.
The figure above shows MACD indicator signaling. The faster line (blue color) crossed the slower line (orange color) upward in 11. Feb. 2019. In addition, both lines are below zero. After that, the price surged. In 26. Aug the slower line crossed the faster line and both are above zero. After that, the price declined.
9- Recognizing, is that a trend or not?
The ADX (Average Directional Movement Index) could be useful in order to identify whether the market is in trading or trending phase. This indicator measures the direction of the market or the degree of the trend. An upward ADX line shows a strong trend. While the downward line, shows a trading market and the absence of a trend. By recognizing and plotting the direction of the ADX line, the trader would be able to indicate which trading strategy or style and which set of indicators would be suitable for the existing market condition.
10- John Murphy’s laws; Know the signs of confirmation
Do not neglect the market volume. The market volume is recognizable by volume indicator, which plays a significant role for confirmation. Make sure that the heavier volume is in the same direction with the prevailing trend. In an uptrend, the heavier volume is the sign that new money is supporting the prevailing trend. On the other hand, the volume declining warns the end of the trend. As a result, a solid uptrend should always be followed by rising volume.
In this article we talked about the key guidance for amateur traders in technical analysis sector. In order to become a professional trader, one need to learn consistently and become experienced for this purpose. Keep in mind that in order to become a professional trader you should always be a student.