Murphy said he relies heavily on five or six “useful” technical indicators, including relative strength indicators, trendlines, moving averages, Bollinger bands, classic chart patterns such as triangles and double tops, and Fibonacci retracement levels.
“You must trade a combination of technical signals, not just one” indicator, said Murphy. He said that many times he’ll set up a “good” column and a “bad” column regarding technical studies. If the “good” column has the overwhelming evidence supporting a selected trade, Murphy will enter the trade. But if the evidence supporting a trade is not strong enough, he’ll bypass the trade.
Murphy correctly called the topping of the U.S. semiconductor stock index (SOX) during midsummer (of the year this story was written). His reasoning was plain and simple: the SOX uptrend line was broken, followed by a double-top formation. “The first sign of a top is breaking of an uptrend line,” he said.
On moving averages for individual stocks, Murphy likes to use the 50-, 100-, and 200-day moving averages. If the 200-day moving average on an individual stock is broken on the downside, “big trouble” is in store for that stock. Also for stock sectors, he said if a 50-day moving average breaks down, “that sector is in trouble.”
Charting a stock market sector divided by the S&P 500 is a favorite method the veteran technician uses to determine if a given sector is underperforming the broad market. (Examples: SOX index divided by S&P 500 index, or NASDAQ index divided by the S&P 500 index.)
Another good technical indicator is the Moving Average Convergence Divergence (MACD), said Murphy. The MACD uses exponential moving averages, as opposed to the simple moving averages used with an oscillator. Gerald Appel is credited with developing the study.
Longer-term technical signals are more powerful than shorter-term signals, said Murphy. “Longer-term charts give you the value of perspective,” he said.
Many traders consider Murphy’s book, “Technical Analysis of the Futures Markets” to be the bible of technical analysis.Murphy heads his own consulting firm, based in Oradell, N.J.