Chapter 3 - Trend Analysis Flashcards

Question

How can one identify areas of support and resistance?

Answer 1

MARKET PROFILE.

Answer 2

Market Profile, a trading and charting technique developed by Peter Steidlmayer, allows its followers to combine these three pieces of history and project future support and resistance levels based on price and volume distributions. Market Profile allows technicians to find price levels on a chart where high or low volume has occurred, as well as what the market considers value areas (where 70% of volume has been traded). Originally developed for use in bond futures trading, a Market Profile chart records a letter for each 30-minute time period. These accumulate during the day and form distribution patterns, which highlight high- and low-volume areas. In essence, it is a time, price and volume chart that can be used for identifying support and resistance levels Remember, prices at high volume levels indicate market participants have strong emotional and financial commitments made at these levels. Therefore, we expect them to act as support and resistance levels in the future. The basic tenet of the psychology of support and resistance levels is that what was once support can become resistance and vice versa. Low volume levels also represent support and resistance in that the market has not traded there much or at all, and investors will err on the side of caution and show a fear of the unknown. Steidlmayer’s research has shown that these high- and low-volume areas tend to offer strong support and resistance levels in the future. These support and resistance levels are also very good leading indicators, as strong expectations can be based on them. Therefore, they carry a strong trading bias.

Answer 3

The value area represents the area of greatest trade facilitation and acceptance of value in the day timeframe and is signified by the price region where 70 percent of the day's volume occurred.

Answer 4

By analyzing the value area, we can gain valuable insights into supply and demand, as well as potential price movements. It is a crucial term to familiarize oneself with when delving into the world of finance and trading.

Answer 5

The amount that prices retreat following a higher-high can be measured using a technique referred to as "percent retracement." This measures the percentage that prices "retraced" from the high to the low.

Answer 6

Measuring the percent retracement can be helpful when determining the price levels at which prices will reverse and continue upward. During a vigorous bull market, prices often retrace up to 33% of the original move. It is not uncommon for prices to retrace up to 50%.

Answer 7

On balance volume (OBV) is a cumulative total of upside and downside volume based on the underlying security’s close, and indicates buying or selling pressure. The total volume for each timeframe is either positive or negative, depending on whether the security closed higher or lower. These values are then either added to, or subtracted from, a running cumulative total. OBV is plotted as a line, rising and falling depending on the direction of the price action. (Note that like most technical indicators, OBV can be applied to any timeframe. For example, 5-minute intraday charts would use the volume corresponding to each 5-minute bar, for weekly charts it would be the weekly volume, etc.). It is the overall trend of the OBV line that is important, not the specific value. If prices are trending higher, so too should be the OBV line. OBV is used to either confirm a current price trend or warn of a possible trend reversal when it diverges from the price action or breaks key support. On-Balance Volume (OBV) is a technical analysis indicator that accumulates volume based on whether a stock's price closes higher or lower than the previous period. Here's how it works: - **Calculation**: - If the closing price is higher than the previous period, the volume is added to the OBV. - If the closing price is lower than the previous period, the volume is subtracted from the OBV. - If the closing price is the same, the OBV remains unchanged. OBV is a running total and does not depend on a specific number of previous periods. It continually updates with each new data point. In a 5-minute timeframe, the OBV is updated every 5 minutes using the current volume and the comparison of the current and previous 5-minute closing prices. The running total includes all historical data up to the current point.

Answer 8

When certain investors and traders start booking profits in the primary uptrend, we face a short-term reverse movement, which is popularly called a correction in the market. This correction in the market is nothing but a secondary trend. Think of this as a minor counter-reaction to the larger movement in the market.

Answer 9

It is already accounted for in whatever you are looking at.

Answer 10

Investors often use trading volume to confirm a trend's existence or continuation, or a trend reversal. Trading volume can provide investors with a signal to enter the market. Trading volume can also signal when an investor should take profits and sell a security due to low activity. - Low Volume: Indicates fewer shares are being traded. Often seen during less decisive market movements or when the market is less active. - High Volume: Indicates a larger number of shares are being traded. Suggests strong interest and decisive action in the market, often accompanying significant price movements or trends.

Answer 11

The more a trendline is tested, the more valid the trend.

Answer 12

Market capitulation is a term used by investors and traders during times of market decline. It refers to an extreme point of panic selling, where investors are willing to sell their assets at any price, resulting in a rapid decline in prices.

Answer 13

In technical analysis, consolidation is referred to the time period when a stock does not cross its support and resistance lines. Instead, the stock movement sticks to a well defined pattern that doesn't rise over its previous high price, or doesn't fall under its recent lowest price in the past.

Answer 14

The Principle of Polarity states that once a Resistance (Support) level is breached, it changes its nature and becomes Support (Resistance) the next time it is approached. This happens due to change in Demand and Supply.

Answer 15

A sideways market, sometimes called sideways drift, refers to when asset prices fluctuate within a tight range for an extended period of time without trending one way or the other. Sideways markets are typically described by regions of price support and resistance within which the price oscillates.

Answer 16

Whenever a stock or index is trading between support and resistance, it is called range-bound. There is no strong move in either direction. Prices tend to ping back and forth near old highs and then fall to prior lows.

Answer 17

There are several types of fan line projections to be aware of, but they all have the same basic characteristics. They are another tool used to suggest where important reversal points and subsequent support and resistance levels will occur. Fan lines are trendlines drawn at specific angles from significant peaks or troughs, but are typically used when the initial trendline has broken, and will be covered from this perspective. Fan lines are used to estimate where prices may find support and where reaction rallies may find resistance. Once one fan line is penetrated, the next fan line becomes support (see Figure 3.15). The fan line can usually be redrawn three times before the entire rally will retrace (give back) its initial gains. Fan line ratios were developed by W. D. Gann2 and by Leonardo Fibonacci.3 These ratios suggest where prices are likely to find support or resistance, but they add very little value for trading purposes. Fibonacci fan lines are commonly drawn at angles that correspond to retracements of 38.2%, 50% and 61.8% of the move being measured. Gann fan lines are typically drawn at the fixed angles of 75º, 63.75º, 45º, 26.25º and 15º, but four other angles exist. Gann believed that the most important angle is 45º, which is the perfect symmetry of time and price.

Answer 18

* Th e Averages discount everything. * Th e market has three trends. * Primary trends have three phases. * Th e Averages must confirm each other. * Volume must confirm the trend. * A trend should be assumed to persist until it gives definite signals that it has reversed.

Answer 19

A primary trend is usually characterized by three phases in both bull and bear markets. While not all bull or bear markets are alike, they all share to various degrees certain characteristics. While Dow’s generalizations do not appear verbatim in any given market move, they do provide the technician with a helpful roadmap to use when charting the progress of a bull or bear market. BULL MARKET PHASES 1. The first is the accumulation phase. It actually begins at the end of the last stage of a bear market. At this point, prices are depressed and financial reports are negative. Farsighted investors use this period to take advantage of low prices and buy shares from discouraged and distressed sellers. This phase is thus characterized by aggressive buying by informed investors in anticipation of an economic recovery and long-term growth. Activity is moderate but begins to increase on rallies. 2. In the second phase of a primary uptrend, corporate earnings begin to increase as economic conditions improve. The stronger tone of business and the rising trend in corporate earnings generates positive business reports that begin to attract attention in both the public and the media. The buying public begins to amass stock. In this phase, the trend-following technician may profit handsomely as prices, when in a highly positive market environment and impulsive wave structure, have the tendency to rally strongly. 3. A market rife with activity characterizes the third and final phase of the bull market, as the public has now become heavily involved. Record corporate earnings and peak economic conditions are reported often by the media in bullish stories and newscasts. Speculative volume increases in the market since the public has all but forgotten the last time the market was bearish. A buying frenzy is often seen as investors become convinced that the market is unstoppable and is the place to be. Those more astute investors who bought during the initial accumulation phase, however, begin to sell their holdings in anticipation of a downturn (see Figure 3.2). BEAR MARKET PHASES 1. The first phase in a bear market is the distribution phase, which actually begins at the end of the last stage in a bull market). Farsighted investors observe the euphoria (with the help of statistical and sentiment indicators, which will be discussed later in the course), and begin selling their holdings at an increasing rate. While volume is still strong, it begins to weaken as oversupply leads to weakening prices. Basically, “informed” investors are selling, while “uninformed” investors and the general public continue to buy. 2. Th e second phase of a primary downtrend is characterized by near panic selling. Buyers become increasingly harder to find as sellers become more desperate. Prices begin to strongly accelerate downwards as more people try to liquidate their holdings. Volume is exceptionally strong in this phase as investors feed off one another’s shared panic. This serves to fuel both the speed and the weakness of an already falling market. 3. Th e final phase of a bear market sees discouraged investors, who held their stock throughout the panic in the second phase, finally capitulate and sell. This leads to further weakening and erosion of prices. The media is teeming with bearish headlines and news stories as the markets continue to fall from distressed selling by those willing to “get out at any price.” Th e bear market ends when all the bad news is finally discounted by the market. Those more astute investors who sold during the initial distribution phase, now begin to buy in anticipation of an upturn (see Figure 3.3).

Answer 20

Even if a long-term trendline that has been tested many times is violated, technicians still look to the following rules of thumb to distinguish a significant break from a minor penetration: 1. two daily closes above the down trendline or below the up trendline 2. significant increase in volume, particularly when breaking a down trendline 3. weekly close above the down trendline or below the up trendline 4. penetration above or below the trend by more than 3% (i.e., a $50 stock would need to break by $1.50 or more)