Do we really need all of this stuff on our charts?
People in the naked trading camp would answer a firm no to that question. To the naked trader, exotic indicators and other chart paraphernalia just create noise and confusion that serves to distract a trader’s attention from what is really going on.
In this article we’ll look at some of the popular methods that naked traders use, and ask in which situations these techniques can work.
Naked trading starts with decluttering your chart. That means removing all of the unnecessary indicators, price bands, and other studies that may be giving you information overload.
As a naked trader you will be relying on pure price action signals. What exactly are pure price action signals? Price action signals are the signals coming from the immediate price behavior on the right end of the chart.
Naked traders are highly focused on these few leading bars of the chart. The candles that are just printing tell them what is happening right now. That’s not to say they ignore historical prices altogether. They look at historical highs and lows and are mindful of moving averages, but these things have a lower priority than what’s happening now.
Here are some of the skills that all good naked traders need to learn.
An essential skill you’ll need to learn as a budding naked trader is how to read Japanese candlestick patterns. A naked trader might not necessarily know every pattern by name, but they’ll indeed know how to spot both bullish and bearish candle behavior by heart.
Some of the patterns that they’ll be on the lookout for include gaps (windows), stars, hammers, engulfings, marubozu and belt holds.
Gaps appear in many candlestick formations. The reason they’re so important is that they give a clue about a changing market dynamic.
Take for example the evening star. With this pattern, the market opens higher than the last close. The opening gap tells us there was a surge of buying interest at the open that was enough to push away from the previous closing high. The pattern then turns bearish as higher price is rejected and the candle closes at or near to the low.
That kind of market dynamic is a flashing light to the naked trader telling him that this rally is on its last legs, it is potentially in its exhaustion phase.
Hammers and shooting stars can equally signal a rally is near exhaustion. A hammer consists of a short body and a long shadow or pin. A shooting star is a bearish arrangement with the long shadow pointing upwards. The long shadow tells us that the price retraced a long way from the day’s high.
To the naked trader this is another sign of resistance in the short term towards breaking any new price high. That’s a naked sell signal.
An important tool in the naked trader’s toolbox is that of reading crowd psychology. There is a subtle difference between a technical trader and a naked trader. They do not just see candles on a screen, as technical trader would. Rather they see the human motivation behind the images on the chart.
Metrics like volume, and order flow data can be especially useful if it is accessible. This isn’t available for non-exchange traded instruments, but where it is it can be utilized to good purpose.
A bullish chart on falling volume for example is a divergence between price behavior and majority investor sentiment. This signifies that fewer people are sure of the higher price development.
To a naked trader, each transaction between buyer and seller is a confirmation of price at that level.
Fewer and fewer entrants at the higher prices will create a lack of support at those new levels. When that sentiment reaches a tipping point, those early buyers, who are in the majority, will turn into early sellers, causing a price collapse.
The opposite dynamic takes place in a bearish market. As a naked trader, you’ll be looking for signs of capitulation at the bottom of a steep market sell off.
A drop in volume, accompanied by a sharp fall in price may be one such sign. Other indications, like presence or absence of candlesticks gaps can make the call stronger or weaker either way.
Although volume isn’t available for many markets, there are certain ways to estimate it.
Order book data is another priceless bit of information if you can get hold of it. Order book data will show the depth of the market on the buy and sell side, where buyers and sellers are setting their price limits, and the spread between those two sides.
This leads to the next area of expertise; support and resistance.
Support and resistance
The naked trader will utilize support and resistance, but not in the same way as a classical chart trader. The naked trader will use less trend lines, channels and ranges, and rely more on emerging support and resistance arising from immediate price dynamics.
The naked trader will try to estimate where areas of support and resistance will develop before they become obvious. With order book data, this task is far easier but it is still possible without it.
An order book shows where buyers are placing their “bids” and sellers are placing their “ask”.
Weight of sellers at or around a certain ask price will possibly create resistance to price moving higher than that level in the near term. This will happen if there is a higher volume of sell orders around those price levels, with a majority of buyers biding much lower prices. This kind of dynamic can signal a short term bearish correction is building.
In a typical order book, the bulk of the volume, for both buyers and sellers will be away from the immediate bid/ask price. For example, if the current bid/ask is 101/102 there might be a big bulk of buy orders at 95 and a big bulk of sell orders at 108.
When order limits and volume is available, you can find the exact price regions using a weighted average. If the weighted average of buyers is farther below the weighted average of sellers, this can suggest rejection of the higher price level, and strong resistance to higher price moves.
The opposite holds true for support. A bigger mass of buyers underneath a price level, is a sure sign of strong support of that price.
When order book data isn’t available, in currencies for example, the naked trader falls back on reading candlesticks and volume estimates and inferring price dynamics that way.
Price patterns are another means by which naked traders make their decisions. Most indicators condense price information into a few data points. After this processes, inevitably some data is lost.
As a naked trader, you’ll be looking in detail at the structures that are forming over the short time horizon. You’ll be looking for things like higher highs, or lower lows, as well as areas of price congestion, signs of topping, or signs of bottoming.
The purpose of this is to look beyond the condensed picture you’d be getting from an indicator. While that may give you a good general summary, such as a rising trend, it misses the intricate detail.
Naked trading: Is it right for me?
Like other niche spheres of expertise, naked trading attracts a bit of a tribal following. There are those that see it as a nirvana while others just see it as common sense.
At the end of the day, we all have to decide which trading style we are suited to. Naked trading relies much more on intuition than other forms of trading. It has more of a visual and subjective element. Personal styles can flourish.
If this suits your character, then it could be a good fit. Once you find your niche, you can focus in on that, improve it, and zone out other things that may have simply served as distractions without adding value to your trading.