Class 3: History and Construction of Charts Trends, Breakouts, Stops Flashcards
What are charts?
graphical displays of data
4 types of charts
line
bar
candle
point and figure
Data needed to construct most charts
Open
high
low
close
volume
why do line charts use losing price?
Used to study long term trends.
why use less data on line chart
More frequent data leads to detailed, cluttered charts making trend less obvious
which is the economists chart
Line Charts
advantage of line charts
Easy to construct and maintain
disadvantage of line charts
Gives little information
exact time or trend change can be unclear
Bar charts _|¯
Displays high, low, closing prices or HLC.
Each interval represented by one bar
Range is difference between high and low.
Left tick=open, right tick= closing price.
which are the best bar charts
OHLC
include the open price
advantages of bar chart
HLC can give you a better sense of direction.
More versatile, volume usually included below
disadvantage of bar chart
Harder to maintain
requires more space if done by hand
real body in candlestick chart
the rectangular box formed by open and close price
Real bodies look like candles
shadow in candlestick chart
price extremes of the session
look like wicks
White/open real bodies in candlestick chart
price advance at close > open price
Black/closed real bodies in candlestick chart
price decline at close < open price
advantage of candlestick charts
More visual
positive and negative easily seen
disadvantage of candlestick charts
Harder to calculate and maintain by hand
patterns must be studied
which chart can be constructed using intraday trading data
Point & Figure (P&F) charts
in which chart is volume usually excluded
Point & Figure (P&F) charts
Box size meaning in Point & Figure (P&F) charts
what does a smaller box mean
dollar amount representing one box
The smaller the box size the more sensitive the chart
Reversal size meaning in Point & Figure (P&F) charts
Column of X’s change to O’s or vice versa when the price reverses by this amount ($ amount needed to record X or O)
advantage of Point & Figure (P&F) charts
Information is compressed
resistance and support levels are easier to spot.
They are better price targets for buy/sell signals
Good charting method for continuous markets (commodities, currencie, crypto?)
disadvantage of Point & Figure (P&F) charts
They do not use time and volume as a consideration.
There are many and unique patterns to P&F charts that must be studied.
Scale – Arithmetic vs. Logarithmic charts
Changes charts to include percent changes rather than absolute price changes.
i.e. an increase from $10 to $20, is $10 or 100%, an increase from $100 to $110 is the same $ change but only 10%.
Logarithmic best used for long term charts and for > 20% increases in security values.
A DIRECTIONAL TREND
one of rising or falling prices from which a profit can be generated with a trend following method.
Trends tend to continue, rather than reverse
as long as it continues, is how the technician profits (vag reason why)
what do we mean by TRENDS are FRACTAL
their behavior is the same regardless of period.
Long term, intermediate and short term minute trends all behave the same.
They are made up the same way. They all break down in the same fashion
what is the larger primary trend made of
made up of smaller intermediate corrections, of which are made up of even smaller minor trends
If we dissect these minor trends, we will again find that these same trends are made up of the same trend patterns though at a much smaller degree, such as to the minutes.
This comes back to the fractal nature of trends.
definition of a trending price
remain headed in one direction and they tell us that there is an imbalance of demand and supply
what type of trend if we have more aggressive buyers (and sellers)
we have an uptrend (downtrend)
TRADING RANGES (or sideways trends) occur when?
occur when peaks and troughs appear at roughly similar levels
They can also be called CONSOLIDATIONS or CONGESTION AREAS or RECTANGLE FORMATIONS.
when does a resistance level becomes a resistance zone?
when more than one resistance level occurs a roughly the same price. The opposite is true for support levels.
Ironically when prices reach round numbers, what is the tendency?
to buy and sell increases, because people tend to think in terms of round numbers
we should determine entry and exit points based on the technical situation as opposed to these subconsciously important round numbers
what is a breakout?
If prices break below a support zone or above a resistance zone
DONCHIAN RULE (simple, but it works)
Buy when the highest high over the past 4 weeks has been broken, and sell when the lowest low over the past four weeks has been broken
Best used with price buy breakouts, sell breakouts
How are important reversal points determined?
DEMARK METHOD
GANN TWO-DAY SWING METHOD
GANN TWO-DAY SWING METHOD
DEMARK METHOD
In a low bar, we’d look for 2 bars with higher lows on either side of the on the suspected trough bar
The opposite is true for a resistance point or peak, we’d look for 2 bars with lower highs one either side of the peak.
GANN TWO-DAY SWING METHOD
To find a support point, or trough, a low bar is identified
Once it is identified, the 2 following trading days are observed. If these 2 days have higher highs than the low bar, then we’d consider the low bar a support point.
The opposite is true for a resistance point or peak. The high bar is followed by 2 successive bars with lower lows.
HIGH VOLUME METHOD
High volume on the reversal day, indicates that larger than usual activity occurred on that day – ultimately stopping the rally or sell off
This is a strong confirmation signal that previous trend may come to an end
problem with a steep angle of a trend
the more powerful the trend is, but this is not sustainable and we can expect a reversal in the trend if it gets too overheated
when is an uptrend overheated
Usually any uptrend steeper than a 45-degree angle
Some studies show that trends usually last for which proportion of the time?
20% of the time
How are up trends spotted?
USING A REGRESSION LINE
USING TREND LINES
how to use a recession line?
We would run a regression to determine the mathematical equation that would minimize the distance between all data points and the theoretical line
–> The line is said to be the BEST FIT to the data
We can also calculate standard deviations around this best fit line that will encompass most of the data
The outliers – the prices outside the standard deviation lines are considered anomalies to the technical analyst and they signify that the regression line may be flattening (the trend may be changing).
Most trendlines in Technical Analysis DO NOT use regression analysis but are drawn simply after 2 or more touch points
how to use trend lines
the lines are drawn between lows (support
points) when the line is rising (i.e., uptrend) and it is drawn between
tops (resistance points) when the price is declining (downtrend
A problem with trend lines
that they may not be a straight line
Often prices, especially in a speculative bubble or in a panic, will ACCELERATE upward or downward and run away from a standard, straight trend line. In this case, the trend line must be adjusted continually to account for the price action’s acceleration
The opposite of an accelerating trend line
DECELERATING trend line
This is called a FAN LINE
Fan lines are regular trend lines that are being broken without any obvious reversal in direction and then being redrawn to account for each new support level.
As a a general rule of thumb, after 3 fan lines are drawn, what should we expect?
we should expect a reversal in direction
Some general rules about trend lines
- The longer and the more times that the drawn line is touched by prices, the more significant it is when the trend line is finally broken.
2 . The steeper the trend line, the more unsustainable it is, the sooner it will be broken.
Retracements
Retracements are the corrections to the principal trend
They are counter trend moves (down in an uptrend, and up in a downtrend)
Both up and downtrends usually require only a 33% retracement of a previous trend.
opportunity of Retracements in healthy trends
can give a second chance to those who missed the earlier stages of the trend - a second chance to buy in an uptrend or a second chance to sell in a downtrend
The end of a retracement is usually a
The end of a retracement is usually a support/resistance point of the longer trend
Usual retracement levels are what? (Dow Theory)
33.33%
50%
66.66%
Usual retracement levels are what? (FibonacciTheory)
38.2%
50%
61.8%
PULLBACKS AND THROWBACKS
a variation on Retracements, they occur after a breakout in a horizontal support or resistance zone.
A THROWBACK
a price retracement back to the breakout zone on an upward breakout
A PULLBACK
a price retracement back to the breakout zone on a downside breakout
BREAKOUTS
Occurs when price breaks through a prior support or resistance level or zone, or a trend line
Signals a change in supply and demand and that a new trend is beginning.
Breakout Confirmation Methods
Closing price (Filter)
–> Intraday penetrations likely false
–> 2 days/bars
–> Tradeoff between probability vs. opportunity
Price or percent filters
–> Use of a breakout zone
–> 3% rule
Time since breaking support/resistance
–> 2 days +
–> Premise is that if prices remain outside the breakout zone for a certain time, it must be real.
Volume
–> Usually increasing
Volatility
Average True Range (ATR)
a moving average of the True Range (difference between each high and low bar over some past period)
a wider filter to account for false breakouts in highly volatile securities
True Range is calculated as the greatest of:
Difference between current bar high and low
Absolute value of the difference of the prior bar close and current bar high
Absolute value of the difference of the prior bar close and current bar lows.
effect of price volatility increase on ATR
daily True ranges will expand and ATR will be larger
This means that highly volatile securities will have a wider filter to account for its likelihood of a false breakout because of its higher volatility
Pivot Points
Used for confirmation with day trading to determine support/ resistance level and as confirmations of breakouts
Using the previous bar, P (pivot point) = (H + L + C) / 3.
To calculate support/resistance bands:
–> R1 = (2 x P) – low previous bar
–> S1 = (2 x P) – high previous bar
The theory behind this technique is that as time passes the effect of past prices diminishes
It’s use is questionable
Reward/Risk Ratio
Usually breakouts from support or resistance run to the next zone of support or resistance, giving the investor a price objective for the breakout.
From that price objective a return/risk ratio should be calculated.
The return/reward is the difference between the entry and exit. price. The risk is the amount the price must go against the entry price before exited on a stop.
Traditionally the reward/risk ratio should be 3 to 1.
The moving average
one of the oldest tools used by Technical Analysts
Moving averages are used to smooth erratic data and show trends.
Most popular moving averages used by analysts
10 – 2 weeks, 20 – 3 weeks
20 – approximately 1 month of business days
50 – 2 months
100, 150
200 – almost one year 250 trading days
Length of Moving Averages
The longer the SMA, the less influence each data point has on the SMA.
The longer the SMA, the slower it is to change direction but the more reliable it is.
The shorter the SMA, the faster it changes direction, but more frequently it errs.
Crossover signals using more than one SMA
Shorter SMA to longer SMA – crossover suggests change in trend.
Often late, relative to the reversal point, but more reliable.
Crossover points often turn into support and resistance levels.
Never use in a sideways market
Other Types of Moving averages
Exponential – other most popular
Exponential – other most popular
The most recent data has the most effect on the average. Old data is less important.
Determine Weight current = 2/(no days)+1
Determine Weight moving average = (100 - Weight current)
EMA today = (Weight current x today’s data) + (Weight moving average x yesterday’s EMA)
Thus old data becomes diminished over time and more emphasis is placed on current data.
In experiments, difference in results between SMA and EMA are usually small.
Envelopes percentage
used in trading ranges
Calculated as taking a percentage of a moving average and creates two symmetrical lines.
The percentage is determine by experiment and shouldn’t be too large or small.
Crossing the bands becomes a trigger for buy/sell.
One of biggest problem is that they do not account for the changing volatility of the underlying.
Bands
Same as envelope except adjusted for volatility (standard deviation)
Channel
Trading range tipped at an angle such that it trends up/downwards
Bollinger Bands
Named for John Bollinger, CFA, CMT who developed the bands.
Bands use standard deviation to measure volatility.
+/- 2 standard deviations of a 20 period SMA (simple moving average).
From statistics we know that approximately 95% of all price action should fall within these bands .
How to use bands and envelopes
Tightening bands represent shrinking volatility, sharp price move expected.
Broadening bands represent increasing volatility and potentially strong trend.
When outer edge of a band is broken, empirical evidence suggests buy the breakout, just like you would do with broken resistance.
MA can become stops, or support resistance.
Calculate %B (bandwidth indicator): difference between high band and low band, which represents increased volatility; breakouts can be confirmed with this, therefore volatility can warn of trend change.
