The Game of Investing, Vol. 22
After covering the basics of technical analysis in our last issue, we’re taking a look at a popular and effective technical trading tool: DeMark indicators.
In the late 1970s, while trading through one of the most severe stock market crashes in history, trading legend Tom DeMark developed a system of indicators to help judge when a market is sufficiently oversold and expected to form a bottom. His same rules, in reverse, apply to predicting market tops.
In this issue, we’ll cover 2 things:
- DeMark indicators — what are they and who uses them?
- A TD Sequential strategy — how is it applied?
Now let’s get started.
Welcome to the Game
Welcome to The Game of Investing, a bi-weekly newsletter bringing you “aha” moments and actionable lessons from Real Vision experts. No matter your level of expertise, markets are tough — which is why we all have to put in the work. Ultimately, the game of investing is a competition with yourself. Our mission is to help you navigate the path to success. Prepare to level up.
Let’s get started.
LEVEL 1 — DeMark Analysis
If you’ve spent any time playing around with indicators on your preferred trading platform or perusing #FinTwit, you’ve probably seen one of these charts with seemingly random green and red (and sometimes even purple) numbers scribbled on it.
These are TD sequential and combo indicators, which are part of a large library of proprietary indicators created by Tom and used by many prominent traders and investors like Real Vision favorite Tom Thornton, hedge fund trading legend Steve Cohen, and even Real Vision co-founder and CEO Raoul Pal.
In his course in the Real Vision Academy, Tom says that he developed the system after one simple realization:
- “Markets don’t bottom until the last seller has sold,” he says. “Markets don’t make bottoms because of buyers — it’s because of a lack of sellers. And markets don’t peak because of smart sellers, just a lack of buying.”
DeMark (DeM) indicators are designed to pinpoint those turning points in the market, helping traders anticipate price action rather than simply reacting to it.
- DeM indicators are used by technical traders to time market entry and exit points.
- The typical time period for DeM analysis is 14 days. It can be used with any time horizon, but the trends begin to smooth out and become less obvious over longer intervals.
Many traders use DeM analysis in conjunction with other signals, helping them determine price exhaustion, identify market tops and bottoms, and assess risk levels.
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LEVEL 2 — TD Sequential and Combo Analysis
With DeM analysis, traders can more accurately track and predict the “terminal point of trends,” says Tom, “providing the opportunity to strike when a new trend is just getting started.”
DeM analysis can be used in uptrends or downtrends, so many traders incorporate the indicators in both trend-following and contrarian strategies.
There are many indicators under the DeMark umbrella — like Absolute Retracement, the Alignment oscillator, and the Arc indicator — but TD sequential and combo analysis is the basis for DeMark analysis.
A TD sequential indicator is designed to find overextended moves that are likely to reverse direction. To get a buy signal for a countertrend position, the following 3 steps must be followed:
- Setup: There must be a decline of at least 9 or more consecutive closes that are lower than the corresponding closes 4 days earlier.
- Intersection: The high of any day on or after the eighth day of the setup must be greater than the low of any day 3 or more days earlier. This ensures that you’re trading an orderly market, rather than a dangerous plunge.
- Countdown: Next, you count the number of days in which the market closes lower than the close 2 days ago. When the countdown reaches 13, you get a buy signal unless there’s a close higher than the highest intraday high of the setup stage, or a sell setup takes shape (inverse setup for the buy signal).
These trends typically take at least a month to develop, so patience and close tracking is required. Luckily, most modern trading systems have indicators that will track this for you.
Thanks for reading. In our next issue, we’ll look at how to think about time horizons when constructing your portfolio.
See you then.
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