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Technical Analysis: The Confirmation "Thing" Everyone Has Heard About

By  Jun 16, 2011

Topics: Finance & Investing

Most traders have heard about confirmation as an important part of entry and exit signals. In a nutshell, before acting on a signal, you need independent confirmation from a second signal. Many traders understand the concept, but many make their trade without confirmation, believing that they don’t dare miss the opportunity available right now. Confirmation might take time. Even so, it is time well spent.

Confirmation may involve seeing two separate signals at the same time, so little or no extra time is required. Remember, timing entry and exit is tricky and your odds of excellent timing are slim. This is where confirmation improves your percentages.

There are at least three forms of confirmation to be aware of, including:

            1. Signals between traditional technical indicators. The strongest signals involve failed tests of resistance or support (such as head and shoulders, double tops or double bottoms, to name a few). But even these fail at times. So if you can confirm what these signals seem to be saying with MACD, RSI, CMF, and other price and volume signals, you vastly improve your odds of being accurate in your trades.

            2. Signals between traditional (Western) and candlestick (Eastern) indicators. One of the strongest versions of confirmation involves both forms of analysis. For example, a failed test of resistance or support, taking place at the same time as a strong candlestick reversal sign, gives you the confidence to act immediately. You will probably be right most of the time when both Western and Eastern signals say the same thing.

            3. Candlestick to candlestick. Some formations indicate reversal, but not strongly. So you may have to wait for a second, stronger indicator in the form of another candlestick formation. If you do find two occurring in close proximity, it greatly strengthens the likelihood of reversal.

Any intelligence you are able to gather will help improve your chances of being right more often than wrong. Beating this 50% threshold is a worthy goal because, without confirmation, most traders do not beat that level. You can have too many indicators and a lot of contradiction among them, so you have to pick and choose wisely. But using a few reliable and relatively simple signals will greatly improve outcomes overall.

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches three options courses: “Swing Trading with Options,” “The Amazing World of Options,” and “Synthetic Options Strategies.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to the CBOE blog and to the Seeking Alpha blog.