Technical Price Objectives

Traders who believe in price charts make them work.

Chartists try to find repetitive price patterns which have a high degree of accuracy and usually are self-fulfilling. Gaps and specific formations frequently meet these criteria.

Gaps are one of the most easily recognizable technical indicators. A gap is simply an empty spot formed on a chart when price lines don't overlap the previous day's price action. Sometimes market psychology changes overnight or over a weekend. That change in psychology forces prices to open and stay above or below the previous day's range.

Time-tested rule

Gaps are filled is another time-tested rule of the market. That is why gaps become future price objectives. Quite often, prices retreat to fill a gap in a bull market before continuing the move. Likewise, prices often rally in a bear market to fill gaps.

Gaps may serve one of three purposes. They are used to spot the beginning of a move, to measure a move and to signal the end. There are four different kinds of gaps: common or temporary, breakaway, measuring or runaway, and exhaustion.

The most frequently occurring gap is the common gap. When this gap occurs because of a slight change in psychology, traders expect it to be filled soon. Once a gap is filled, it no longer has significance.

The early portion of the soybean chart on this page shows common gaps during the December and January period which were later filled.

The breakaway gap on this chart occurred on May 7 and begins a major bull move. Breakaway gaps often occur after a stretch of sideways trading and in the leading days of an uptrend or downtrend. This type of gap remains unfilled for a long time.

It sometimes is difficult to tell right away that it's a breakaway gap and not a common gap. When the market fails to fill this gap after a couple of weeks, this confirms the breakaway gap.

Additional gaps

A measuring gap typically occurs in the middle of a price move and predicts how much farther the move will go. It is also called a midpoint gap and a runaway gap.

On this soybean chart, the measuring gap, which occurred on June 8, left an empty spot from $6.16 to $6.26. The April 5 low at $4.90 marked the beginning of this move. The distance from the low at $4.90 to the measuring gap is $1.26 to $1.36. Adding this distance to the measuring gap projects a move to at least $7.50. Whether you add the distance to the top, bottom or middle of the measuring gap depends on your preference.

An exhaustion gap shows frustrated bears giving up and aggressive bulls trying to make the market go their way. It is the first sign of sputtering before the end.

Though prices may go higher after an exhaustion gap at the top, the rally will not last long before the market dies. An extreme exhaustion gap may form an island reversal.

What about gaps that remain unfilled? They become future chart objectives.If gaps are unfilled when a futures contract expires, there are usually corresponding gaps on the charts of subsequent contract months.

Gaps also appear on longer-term charts such as weekly commodity charts, but gaps on monthly charts are rare because they generally are constructed to avoid gaps caused by contract changeover. Like those on the daily charts, gaps on weekly charts are also "made to be filled".

A downtrend may slide to a slow, gradual halt in the saucer bottom formation. Open interest and volume follow the same pattern as prices in this formation, reflecting speculator disinterest in a market with little action and little profit potential. Our example on the monthly cocoa chart took three years to form. Saucer bottoms on daily charts may take at least four weeks to become visible.

Although this bottom formation doesn't meet the requirements of other bottom formations, it's just as significant in signaling a trend change. Usually, the longer it takes to form a saucer bottom, the more violently prices will rise out of their lows.

Key reversals

One of the most easily recognizable technical signals in trend change is the key reversal. A key reversal often has an unusually wide trading range. Its requirements are a day's range outside the previous day's range with a close higher than the previous close for an upward turnaround and a lower close for a downward turn.

Here again, this chart formation reflects market psychology. A key reversal is the climax of a period of buying or selling fever. In extremely volatile markets, two or more key reversals may occur. The key reversal on the silver chart defined the top of its rally and signaled a fall in prices.

To be a valid key reversal top, trading volume must be heavy and the daily trading range should be wide. Prices first surge to new highs, but fall back and close lower for the day.

For a key reversal bottom, the characteristics are the same. The selling climax has to have heavy volume with a wide trading range which first breaks to new lows, rebounds above the previous day's high and closes higher. Frequently, the highest trading volume and the highest or lowest price of the year will be set on a key reversal day.

An island reversal takes gaps to the extreme. It receives its name for obvious reasons. An island reversal can be only one day or a few days of trading above (or below) the previous and following day's trading activity The action is isolated by gaps on both sides. Thus, it leaves a day or a few days of price action surrounded by empty space.

The Japanese yen chart shows two island reversals. The 1-day island top of marked the climax of a bull move and the beginning of falling prices. The 3-day island reversal bottom in mid-May signaled a halt to the decline and the Island reversal beginning of a bear market rally.

Island reversals occur less frequently than key reversals. The exhaustion gap which marks the beginning of the island reversal will remain unfilled for a lengthy period because the island reversal is usually the climax to an existing trend.

Technical analysis is not an absolute tool. Because it is more an art than a science, individuals will interpret formations and trends differently.

"Thin markets" — those with very low open interest and trading volume — will create false technical signals. These markets, as well as deferred contracts which also have low open interest, should be avoided by inexperienced traders.

Despite these cautions, technical analysis is a powerful tool and if used with common sense, can enhance a trader's perspective and profits.

The Commodity Futures Trading Commission has asked us to also advise you that trading futures and options is not without risk. While there is opportunity for incredible wealth building, there is also the risk of losing even more than you invested. Of course, that's not unlike most other businesses. But informed traders are the best traders! Opinions expressed by Market Spotlight authors are not those of INO.com.

Finding A Friend In The Trend

"The trend is your friend" is an important trading guideline.

Because trends persist for long periods, a position taken with the trend will more likely be successful than one taken randomly or against the trend. Trading with the trend in a bull market means buying on dips; in a bear market, selling on rallies.

On a bar chart, each vertical line connects the day's, week's, or month's high and low. The horizontal tick to the right of the line indicates that time period's closing price.

A trend is easily spotted on a bar chart. An uptrend is a series of higher lows and higher highs. Uptrend lines are drawn under the lows of the market and give support. A downtrend is a series of lower lows and lower highs. Downtrend lines are drawn across the highs and give resistance to the market. The soybean chart shown below has both uptrend lines and a downtrend line.

Lows and highs vs. closes

A trendline can be drawn when two points are available. The more times a trendline is touched, the more technically significant this support or resistance line becomes.

While some chartists draw trendlines through lows and highs, others may prefer drawing lines through closes in hopes of detecting a change in trend more quickly.

Trendlines may change angles, requiring another line drawn through new high or low points. For example, the sideways trading action in March and April broke the steeper uptrend line connecting the Feb. 13 and March 20 lows. But when the uptrend resumed in early May, a more shallow uptrend line can be drawn connecting the February and late-April lows.

The most reliable trendlines are those near a 45° angle. If about four weeks have elapsed between the two connecting points, this increases the trendline's validity. However, steep trendlines that don't fit these guidelines, like the uptrend line in the early portion of the soybean chart, may be just as useful.

Often, minor uptrends or downtrends will confuse the beginner. It may seem the market has turned around. However, sharp chartists will see these minor trends as small ripples within a major wave. Remember, if the trendline isn't broken, that trend remains intact. Two closes outside the trendline are the criteria for detecting a change in trend. However, very seldom do markets go directly from uptrend to downtrend. At the end of a move, traders become less aggressive and prices may swing in a sideways pattern or consolidation period.

Many times, markets break into an uptrend or downtrend out of a sideways trading pattern or consolidation period. In the soybean chart, prices traded in a 50

Because traders need time to be convinced that they should put their money into the market, sideways patterns are more likely to occur near the bottom of a move. The beginning of a downtrend often will be sharp and sudden as investors pull money out of the market.

False breakouts

Another way beginners might be fooled is seeing false breakouts of tops and bottoms. As prices begin to make their move in switching from a downtrend to an uptrend, traders with short positions will "cover." This buying many times will cause the market to rally above the downtrend line. This short covering rally seldom holds, and prices may drop back to the breakout point. The uptrend is confirmed when prices close above the high of the short rally.

On a topping formation, long liquidation takes prices through the uptrend line on a short break. Before the downtrend begins, the market sometimes rallies back to "test" the uptrend line as shown on the soybean chart in September. As the downtrend unfolds, the second reaction rally could not top the highs of the first rally.

Channel lines are an extension of the trendline theory. The October through January downtrend on the soybean chart shows prices staying in a "channel" between the downtrend line and a line drawn parallel to it, connecting the lows. A channel line in a downtrending market helps identify where support may be found.

Speedlines are another line which show where prices may find support or resistance. Frequently, speedlines and trendlines will overlap, emphasizing that line's importance to the market.

The speedline on the soybean chart starts from the June 29 low. To find the points to connect with the low, divide the range between the low ($6.40) and the high($9.94) into thirds and subtract from the high.

Plot the point obtained by subtracting one-third of the range from the high on the day the high was made. A line drawn between this point ($8.76) and thelow established the 1/3 speedline. The 2/3 speedline is drawn through the point that is two-thirds of the range subtracted from the high ($7.58) plotted on the day the high was made.

Another way to detect a change in trend is by looking for a price from which the market reacts two or three times.

A double bottom, such as the one on the T-Bill chart, indicated the 87.10 to 87.20 area gave support to the market. Although a recovery had begun from the late-May low, prices broke the short-term uptrend in mid-June. The question then became: Will aggressive short-selling and long liquidation overwhelm the short-covering and new buying that come from support at the May low?

The soybean chart displays a triple top, where prices met resistance in approximately the same area three times before falling. Just the inverse of making the double bottom goes through traders' minds as the market makes a top: Will new buying and short-covering be able to overwhelm the new selling and long liquidation coming from the triple-top resistance area?

As with trendlines, the more time that elapses between the tests of support and resistance in double or triple tops or bottoms, the more valid the formation becomes. Also, the greater the reaction between tests of the support or resistance, the more likely the point will hold.

Though these examples are from daily bar charts, technical analysis works just as well on weekly and monthly charts. Because the longer-term charts cover more time, their trendlines are more important in identifying areas of support and resistance to the market.

How do I know?

In identifying the trend in a market, it is wise to start with the longer term charts to identify the long-term trend. The daily charts offer trends for the shorter-run.

Technical analysis is more an art than a science. The answer to your question, "How do I know where to draw the trendlines?" is, "They're your charts, draw them wherever they seem to work best for you."

The Commodity Futures Trading Commission has asked us to also advise you that trading futures and options is not without risk. While there is opportunity for incredible wealth building, there is also the risk of losing even more than you invested. Of course, that's not unlike most other businesses. But informed traders are the best traders! Opinions expressed by Market Spotlight authors are not those of INO.com.

A Winning Attitude

Everyone wants to be a winner; at least, they think so. Unfortunately, most are not willing to perform the tasks necessary to become a consistent winner.

Winners generally achieve success by being focused on a goal. Being focused allows winners to remain committed to the tasks at hand. Most winners perform a lot of hard work; including a willingness to deal with sometimes mundane duties. Most of all, winners perform with an "I am responsible for both my failures and successes" attitude.

So, where does the would-be trader start to become a success? By focusing on the tasks at hand. Most of all, treat trading as a business. And, as in any business, money management is critical.

Money management, next to trend, is probably the aspect of trading most overlooked by smaller investors. Man, by nature, is an optimistic creature and the amateur trader often acts instinctively. Unfortunately, this instinct or optimism is often the undoing of the smaller trader.

When a person enters a trade, he does so with the hope it will be a winner. When the position goes against him, he keeps thinking (or hoping) "it will come back." He knows he should have a stop in place, but hope keeps telling him to stay just a little longer since everybody knows "you always get stopped out the day the market turns." Eventually, hope turns into frustration, desperation and, finally, panic, prompting the trader to issue a GMO (get me out) order.

If the trader hasn't learned his lesson by this point, he develops the "I have to get it back" syndrome. He generally rushes into another poorly planned trade, throwing good money after bad.

Winners show several different characteristics. They enter the market knowing they can be wrong and, in fact, are wrong as often as they are right. They have learned markets don't run on hope. They understand markets tell them when they are right or wrong. When a trade is losing money and getting worse, the market is telling them to get out. A bad trade is like a dead fish: The longer you keep it, the worse it smells.

When a trade is making money, the market is telling them they are right and to let the position ride. Winners don't add to, or "average", losing positions. They dump the trade and go looking for a new opportunity. Successful investors may add to the winning trades. When ahead, they press their advantage while remembering that at any time the market can turn on them and prove them wrong.

Identifying and Trading Trend Lines

Trend lines are one of the most basic technical analysis tools. The are the foundations of any chart patterns and the basis for most chartistic trades. Today we will teach how trend lines are identified and trade, for maximum profits.
Strip Of All Your Indicators and Learn To Trade Naked!
Trading With Price Action is the Only Way to Trade!

What Are Trend Lines
Trend lines are Support and Resistance lines. Unlike traditional Support and Resistance levels which are horizontal, trend lines are sloped - Rising or Falling.

Fig. 1: Support trendlines and Resistance trendlines at the GBP\USD pair

Fig. 2: Support trendlines and Resistance trendlines at the GBP\USD pair

Identifying Trend Lines
We will now describe simple rules for identifying trend lines correctly and quickly. All rules rely on a proper identification of Upswings and Downswings. Upswings are candlestick that are higher than all candles around them. Downswings are candle that are lower than all candles around them.

Fig. 3: Upswings and Downswings at the GBP\USD pair

After upswings and downswings are clearly defined, we proceed to the first rule of identifying Trend lines early: After two consecutive up\down swings are present - connect the two with a trendline.
This rule implies that every two swings are connected with a line. It ensures that you will have the fastest identification of trendlines. Most of the trend lines that you will draw this way will not be valid trendlines, but as price approaches one of these lines and bounces, you will have an advantage over fellow traders as you already expected the bounce and now ready to take the trade.

Make Sure Trend Line is Strong
Here's a tip on making sure the trendline is strong. There is the simple guideline about the number of times price respected the trendline, which I will discuss later. Now I wish to describe a more powerful, less known trick: Demand strong bounces.
The power of trend lines is drawn from their ability to make price bounce when it touches them. The quicker and stronger the bounce, the more powerful the trendline. Many beginners make the mistake of looking only at the upswings and downswings and disregarding the strength of the bounce. I will demand that each time price touched my trendline, it bounced quickly and decisively. If price did not react for several bars before respecting the trendline, it is weaker and I would not trade it. Main Guideline: Make sure that reversal happens at the very next bar after the touch of the trendline.

Number of Touches on Trendline
This is a well-known truth in Technical Analysis: The more times trendline has been touched and respected by price, the stronger it is. The minimal touches for a trendline is two, with trade entered at the 3rd touch (after confirmation).

Fig. 4: Resistance trendline was respected 4 times, hence it is a strong trendline

Fig. 5: Support trendline has been tested for 3 times

How To Trade Trendlines
Trendlines are generally traded like regular Support and Resistance levels, with one difference: When trading trendlines, once must pay attention not only to current trendline, but to its opposite one. Example: If you are trading a support trendline, you should look for the Resistance trendline and find out their relation (Which Chart Pattern they form, etc.). I will now describe the main ways to trade Trendlines.
Bounce
The simplest, most used technique of trading trendlines. Wait for price to touch a valid trend line (that was tested at least twice), and perform a bounce. Exact entry point is signaled by Japanese Candlestick formations. Read about using candlesticks for entry points here.
Make sure you identify the opposite trend line and look for a chart pattern. Chart Patterns can give you priceless clues on the direction of the breakout, and you should aim at taking bounces only at the general direction of patterns. Moreover, take long bounces only on Ascending Trend lines and short trades only at Descending trend lines. This allows you to always trade with the general trend. The only exception to this rule is the Megaphone, in which we take Aggressive trades against the direction of trendlines.

Fig. 6: Bounce trade on Support trendline.

Fig. 7: Short bounce trade trade on Resistance trendline.

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