Using technical analysis to spread-bet

Of course, there's a lot more to it than simply identifying things that are going up or down in price. Technical analysis also provides ways of determining reversal points, price targets and trend-strength. All these are of critical importance when spread-betting. Although they aren't hard to grasp, applying them correctly only comes with experience.

Fortunately for us, there's a wealth of charting know-how within the spread betting firms themselves. All the leading institutions employ at least one dedicated technical analyst to map out the markets for clients and colleagues. So, we’ve asked some of these gurus to share some of their wealth of experience with us.

Although all the experts we approached have their own favourite techniques and strategies, one phrase cropped up again and again: keep it simple. Technical analysis consists of a huge range of indicators as well as some often rather esoteric theories that purport to explain market behaviour. But more complicated seldom equals more profit in spread betting.

"Trying to learn too much too quickly is a really common mistake," says Darren Sinden, sales trader at LITE Trading. "Concentrating on simple stuff like price, volume and momentum is always a good idea. Look for things that are out of the ordinary, perhaps by looking at trades in relation to a security's normal market size."

For straightforward interpretation, straightforwardly-presented data is also helpful. "I prefer open-hi-lo-close bars to Japanese candlesticks," says Sandy Jadeja, of www.spreadbettingtowin.com. "Candlesticks can be a powerful tool, but far too many people get bogged down in looking for specific patterns and they end up forcing them on the chart when they aren't really there."

In order to have faith in the charts, traders also need to be able to trust the underlying data. "Getting clean data is crucial," says Mr Jadeja. "It's probably worth paying more for good data even if that means spending less on the charting package itself. Traded prices – rather than theoretical prices – are essential. For UK markets, MetaStock and Sharescope score well here."

Latching on to a nice trend – up or down – is probably the most basic sort of strategy for spread betters, but also one of the most effective ones. "Especially for those just starting out, you want to be able to just scroll through the securities on your charting package and pick out nice, smooth charts of movements in one direction or the other," says Mr Jadeja.

The accompanying chart contains a good example of a trending market. The price has risen consistently in one direction at a measured pace. We can have quite a bit of faith in a trend like this. The longer a trend-line and the more times the price series touches it, the greater its significance. A basic strategy in these situations is to buy into the security on pullbacks to the trend-line or moving average in hope of catching the next rally.

Spread bettors also need to pay close attention to support and resistance levels. Recognising where a trend is likely to halt – if only temporarily – can help investors plan their entries and exits more effectively. In BP's chart, you can see that the price reversed from a year-long decline as it approached a major support level around 500p. Identifying that level in advance gave technical analysts a good hint that the descent might stop near there.

"Having picked out an important support or resistance level, you can set up your trade accordingly,”"says James Hughes, market analyst at CMC Markets. "What we've seen in the recent bout of stock market weakness is many shares that were previously trending strongly pulling back to big support levels on the downside. Knowing these levels also helps us to place stop losses."

While trend, support and resistance are the basic technical ingredients of a winning trading plan, there's nothing wrong with combining them with other straightforward tools. Exploiting more common – and less complicated – chart patterns can also deliver decent results.

"I'm sceptical about the usefulness of double tops and triple bottoms," says Sandy Jadeja. "But I find the flag pattern really does work. What you're doing here is looking for a very small consolidation pattern and looking for a breakout above or below and then trading with the trend. The beauties of this pattern are that it is easy to spot, it occurs frequently, and you've got a high probability of success."

A bullish flag appears in the chart of Rank. First, the share price spikes upwards almost vertically, which forms the "flagpole." Then it catches its breath, briefly trading sideways and slightly downwards, which resembles a flag hanging out. Finally, the share regains its previous momentum, breaking out above the top of the flag, and rising sharply. Technicians would expect gains at least equal to the height of the flagpole. This formation also works in a downtrend, when the flagpole extends downwards, followed by a flag fluttering upwards before a break to the downside.

Basic candlestick patterns can also provide signals to get in and out of spread bets. This doesn't mean you have to get to grips with such delights as the "abandoned baby" or "frying pan bottom" formations. "Candlestick interpretation can become as elusive as Elliott Wave counting," says Sandy Jadeja.

According to James Hughes of CMC, the most practical Japanese candlestick formation is the engulfing pattern. "It's easy to spot and its meaning is very clear," he says. For example, a bullish engulfing pattern occurs after a downturn. It simply consists of a small candle followed by a large white candle that totally completely engulfs the candle before it, hence the name. It signifies the bulls wresting control from the bears – see chart.

Exploiting moves through major support and resistance levels is another potentially profitable strategy. Trending securities often halt at or near these levels, perhaps for quite a while. After trading sideways for a time, the eventual breakout can lead to some excellent moves, particularly if it takes the instrument into 'blue sky territory'. Point-and-figure charts are especially useful for spotting such a situation.

That said, spread bettors need to be cautious when approaching these set-ups, even when they appear to be straight out of the textbook. "Something like three-quarters of breakouts ultimately turn out to be 'fakeouts'," says Simon Dixon, trainer at Benedix Investments, a financial education firm. "The key is to learn how to distinguish a phoney one from the real deal."

"Say you've got resistance at 6500," says CMC's Mr Hughes. "People see the price hit 6501 and they jump straight into the trade, only to see it fall straight back below 6500. What you should do is give it a little more time, so as to make sure it really has broken out. Also, price movement isn't the only criterion here. Make sure there is confirmation, maybe from volume."

The mentality that prompts some spread bettors to trade on the first signs of a breakout also leads to other costly errors. While it's only human to dream of buying at rock bottom and selling at the absolute peak, this rarely happens in practice. "Never be too greedy – that's how a lot of people come unstuck," says LITE Trading's Darren Sinden. "Rather than trying to capture that one entire big move, get in and out quickly and often."