Support and-resistance-simplified[1]

Support and ResistanceSimplified

By Michael C. Thomsett

Foreword byDavid S. Nassar, Founder/CEO,

MarketWise Trading School, L.L.C.

MARKETPLACE BOOKSColumbia, Maryland

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MARKETPLACE BOOKSSimplified SeriesTechnical Analysis Simplified

by Clif Droke

Elliott Wave Simplifiedby Clif Droke

Moving Averages Simplifiedby Clif Droke

Gann Simplifiedby Clif Droke

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Copyright © 2003 by Michael Thomsett.

Published by Marketplace Books.

All rights reserved.

Reproduction or translation of any part of this work beyond thatpermitted by Section 107 or 108 of the 1976 United States CopyrightAct without the permission of the copyright owner is unlawful.Requests for permission or further information should be addressedto the Permissions Department at Traders’ Library.

This publication is designed to provide accurate and authoritativeinformation in regard to the subject matter covered. It is sold with theunderstanding that neither the author nor the publisher is engaged inrendering legal, accounting, or other professional service. If legaladvice or other expert assistance is required, the services of acompetent professional person should be sought.

From a Declaration of Principles jointly adopted by a Committeeof the American Bar Association and a Committee of Publishers.

ISBN 1-59280-067-X

Printed in the United States of America.

1 2 3 4 5 6 7 8 9 0

This book, along with other books, is available at discountsthat make it realistic to provide them as gifts to yourcustomers, clients, and staff. For more information on theselong-lasting, cost-effective premiums, please call John Boyerat (800) 272-2855 or you may email him [email protected]

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Contents

SUPPORT AND RESISTANCE SIMPLIFIED 5

Foreword 7

By David S. Nassar

Introduction 11

Chapter 1SR: The Foundation of Technical Analysis 17

Chapter 2The Dow Theory: Applying SR to Individual Stocks 37

Chapter 3Trend Lines and Channels: Techniques to Identifying SR Levels 49

Chapter 4Chart Patterns: Visual Confirmation ofPrice Movement 59

Chapter 5Swing Trading: Creating MaximumProfit Opportunities 77

Chapter 6Learning to Forecast SR Levels 87

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Chapter 7Volume: The Other Confirming Measure 97

Chapter 8Applying Modern Innovations to SR Applications 105

Glossary 115

Educational Resources 119

6 SUPPORT AND RESISTANCE SIMPLIFIED

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Foreword

It has been stated that the simplicity of the marketis its greatest disguise. The concept of “Supportand Resistance” (S&R) in the trading markets

dates back to the original “Dow Theory,” and isperhaps often overlooked today due to its per-ceived simplicity. The reality is, support and résis-tance is perhaps the greatest contribution andmost widely held concept in technical analysis, andhas since become an invaluable method for techni-cal trader and investor alike.

At its most basic level, support and resistance rep-resents the “consensus of value” of all market par-ticipants at any given time. With the advent oftechnology and electronic quote dissemination andexecution, newly devised applications make sup-port and resistance an even more robust and far-reaching precept. The progression of S&R’sapplication to market analysis and psychology,when integrated with real-time data derived fromtoday’s new software charting programs, has beenexplosive. As a result, applying support and resist-ance methods has never been simpler or moreeffective for trading in today’s markets. Conversely,with real-time technology, many participants seesupport and resistance analysis too microscopically,

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subjecting them to volatile and choppy whipsawsignals and creating diminished conviction. There-fore, while the concepts have changed little fromoriginal Dow Theory, the application of the conceptin today’s market environment has changed signifi-cantly. This excellent new primer explains thesenew dynamics, and the proper use of S&R usingmodern-day technology.

As the founder and president of the nations mostrecognized research and education facility fortraders, Marketwise Trading School’s core curricu-lum and analysis begins with a thorough under-standing of S&R. The integral role “S&R” plays intechnical trading is a recurring theme of our classesand seminars and—more importantly—in our owntrading methodology. It’s absolutely one of themost basic, yet most important, elements of tech-nical analysis, and should be understood by anyonehoping to achieve sustained market success. Why?Because it eliminates most of the “guesswork”and allows you to make logical, well-supportedtrading decisions—rather than impulsive, emotion-driven decisions.

While Fundamental Analysis answers the questionwhy there is movement in the market, TechnicalAnalysis answers the question when through theuse of chart formations and S&R analysis. Chartsare comprised of many forms of market data—including moving averages, patterns, and indica-tors. This collection of data over time begins toreveal symmetrical patterns of market psychologyknown as “trendlines.” They are primarily repre-sented through the uptrend line (the support line),the downtrend line (the resistance line), and the


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channels between them called the consolidationand stabilization lines. The interplay between theselines, or the forces of supply and demand, form thebasis of S&R. By learning to read these patternsand trends across varying time frames, and becom-ing familiar with the psychology that drives them—you gain an edge that can more accurately timeyour entry and exit points, thereby putting yourselfahead of buyers and sellers to come. And, as savvyinvestors know, the only way to profit from direc-tional strategies is to buy and sell before others.

Michael Thomsett’s Support and Resistance Simpli-fied provides an excellent starting point. While nota comprehensive text on technical analysis, it is—bycontrast—very accessible. It outlines the primaryprinciples of S&R, furnishes basic applications, andgives you a solid foundation for moving forward tomore advanced concepts currently available. Forthe experienced trader, this book will also serve asa “refresher” for reinforcing good trading habitsthat are enduring and foundational.

Once you’ve read Support and Resistance Simpli-fied I hope you will be motivated to continue edu-cating yourself on the vast array of technicalanalysis tools available to today’s traders, and con-tinue to sharpen your charting skills. There aremany excellent books on technical analysis to helpyou with this endeavor, including: Market Evalua-tion and Analysis for Swing Trading by myself andBill Lupien (former Chairman/CEO of Instinet), JohnMurphy’s Technical Analysis of the Financial Mar-kets, Thomas Bulkowski’s Encyclopedia of ChartPatterns, and his new Trading Classic Chart Pat-terns, and the all-time classic Technical Analysis of


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Stock Trends. There are also courses, workshopsand seminars you can attend that will help yourefine skills and benefit from the experience ofexperts—and I encourage you to do so.

As a passionate and dedicated trader, I’ve learnedsome hard lessons, and yes painful and costly les-sons over the years. But I also know without doubt,the stock market is—and has always been—thesingle greatest institution to acquire wealth. Everytime I took a trading misstep, it strengthened myresolve to develop a way to gain an edge in themarket. To this day, the simplicity of S&R is thefoundation to our successful method of gainingthe often-elusive edge. We are all students of thisdynamic business called trading, and because youare reading these words now, you have taken avaluable step toward continuing your education. Icongratulate you, and encourage you to continueon this path. Sometimes it’s a wild and crazy ride—but it’s definitely worth it!

Trade Wise!

David S. NassarFounder/CEOMarketWise Trading School, L.L.C.


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Beating the averages—that is every investor’sultimate goal. Technical analysis is a sciencethat anticipates short-term price changes by

using recent patterns, trends, reversals, and ranges.This fascinating topic has as its foundation in theconcept of support and resistance, the borders of atrading range in which trading action occurs.

This book explores the important aspects of sup-port and resistance, and shows you how to use theconcepts that technicians have developed toimprove their own market performance. As thecornerstone of virtually all-technical approaches toprice study, support and resistance is perhaps themost important concept you can master in devel-oping your own analytical program. Since it isimpossible to consistently and accurately identifythe duration of any price trend, we have to dependon support and resistance patterns to look for sig-nals of either change or continuation in price. Thesupport and resistance levels represent a concen-tration of buying and selling activity. When thatconcentration begins to evolve, signals develop.The astute technician, recognizing those emerging


Introduction

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changes, is then able to act quickly and make buyor sell decisions before the market as a whole seesthe effects. Once the effects have become obvious,the opportunity to profit has been lost, and that isthe essence of the book: by mastering a few basicobservations about price patterns as they relate tosupport and resistance, you will be able to improveyour overall timing in the market.

This doesn’t mean that you will be able to predictthe near-term future—especially concerning stockprice movement—even though that idea is com-pelling. Investors, who assume that the purpose isto reliably predict emerging price trends each andevery time, often misunderstand technical analysis,and specifically the various charting tools that itinvolves. The goal of creating and monitoringcharts is not specifically to predict the future;rather, the goal is to improve our forecasting abili-ties, to better understand the likelihood of the nextphase in a pattern.

Market technicians regularly monitor or chart priceand volume, and in this process they have devel-oped several specific methods used to analyze andforecast likely price trends and patterns. SR (as werefer to support and resistance throughout thisbook) has often been equated with the economicforces of supply and demand. However, this is notentirely accurate. Rather, SR acts more as a definingvisual representation of price potential versus likelyexhaustion levels, a broad range of the current sup-ply and demand factors that are at work on a spe-cific stock. While supply and demand are forcesmotivating buyers and sellers to interact with oneanother, SR concentrations—and the trading range



itself—define the relative distance between the twolevels: the lowest price at which sellers are willing tosell and the highest price at which buyers are willingto buy. From the point of view of technical analysis,in which stock market price is the most importantelement of study, SR is the defining range, literallythe lines of definition. Without the existence of SRrange, we have nothing but an unpredictable andrandom movement of price from one point toanother. For example, highly volatile stocks fit thatdescription because price has not settled down intoa trading range. By its very definition, “volatility”means rapidly moving, unpredictable, and even ran-dom change. No form of analysis—technical or fun-damental—can be applied to understand nor topredict the next course of price movement for highlyvolatile stocks.

With this in mind, the concepts explained in thisbook can be applied to that vast range of stocksthat are trading in a relatively narrow range ofprice. A very low-volatile stock cannot be submittedto the typical technical tests because it lacks ade-quate movement and, for that matter, real trendother than the trend of continuing inertia. For anytechnician, a degree of change is necessary, but notso much that change itself cannot be predicted.

Support and Resistance Simplified offers a thor-ough overview of how understanding SR functionsis an important aid to today’s trader. Information ispresented in building block fashion, beginning withthe basics and introducing in each subsequentchapter the elements of SR that you need in orderto master this useful analytical tool. This book illus-trates not only the technical elements of SR but also



how to apply them to market theories, such as TheDow Theory. Having mastered the various tech-niques, we conclude with modern day innovationsthat, while they will not make you right all of thetime, you will gain enough of an edge to put youahead of the averages.

The astute technical analyst recognizes the need toconsider and follow a range of potential informa-tion. Isolating your analysis only to SR and othercharting techniques would only weaken your effec-tiveness at interpreting information. There are nosecrets to anticipating price movement, but thereare signals that you can find and use. It is your abil-ity to interpret those signals effectively that willultimately define the degree of success you experi-ence as a technician and trader. Too many investorsare overly focused on charting in isolation and, as aconsequence, they overlook the value of othersources of information, including aspects of funda-mental analysis and economic or market news. Tothe degree that other non-technical analysis isincluded in a comprehensive program, your abilityto interpret data will improve. No one system isgoing to work in every case. The utilization ofmany types of information cannot provide initialindications of likely market movement; dissimilarinformation may either confirm what you interpretelsewhere or contradict, and thereby disprove whatappears to be an emerging trend.

It is within this concept of confirmation that thereal value of analysis is born. By improving yourability to understand the meaning of emerging pat-terns and signals—and then using independentsources to either confirm or contradict what you



have observed—you will vastly improve your owninterpretive skills. The use of SR as a foundation fortechnical observations is an excellent place to start.

While not a thorough primer on every facet of tech-nical analysis itself, this guide gives you the back-ground that all active traders and investors need tomake the most timely market moves in today’s fast-changing marketplace.




The defining nature of SR (Support and Resis-tance) is what gives it such prominence in thepractice of technical analysis. We should

remember that the purpose in price analysis is notto accurately predict the future, but to improve ourability to forecast correctly more often than not.

This is where support and resistance play a keyrole. In studying a chart of recent price move-ments, we are likely to see a trading range. This isthe area of prices that can be clearly identified;recent trading activity is taking place within thatrange. At the bottom of the trading range is theprice (or price trend) known as support. The sup-port price level is an important signal point foridentifying likely emerging new trends. This price iswhere the trend is likely to halt and possibly reversea down trend—thus the name, “support,” whichmeans price support in the current perception ofbuyers. Support is essentially the lowest price forthe stock that is likely to be reached and consid-ered a worthwhile price to pay. If the price of asecurity has been moving downward, for exampledropping from $50 to $25 over recent trading


Trading range:

The level of

trading in a

stock, topped by

the price resist-

ance level and

bottomed by the

price support

level.

Support: The

lowest price or

price trend at

which a stock is

trading currently

in its trading

range; the price

that buyers cur-

rently consider

the lowest

worthwhile price

for that stock.

CHAPTER 1

SR: The Foundation ofTechnical Analysis

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periods, the price of $25 is the current supportlevel. (Figure 1-1). Resistance serves a similar identi-fying purpose, but on the top price side of thetrading range. A resistance level is the highest pricethat buyers consider worth paying for the stock. Ifthe stock has been trading between $25 and $30per share, the $30 level is the current resistancelevel (Figure 1-2).

Several writers have treated SR in purely economicterms, equating support with demand and resist-ance with supply. While this analogy is useful forunderstanding the market on economic terms, weshould also realize that the market forces that gointo the creation of price movement often have little to do with economic forces.

In studying fundamental analysis (financial andother recent historical trends of a company), therecertainly are economic forces at work. However,


FIGURE 1-1

Resistance: The

highest price or

price trend at

which a stock is

trading currently

in its trading

range; the price

that buyers con-

sider the highest

worthwhile price

for that stock.

c01.qxd 7/29/03 12:01 PM Page 18

technical indicators have to be distinguished fromthe economics of corporations and viewed in termsof the forces at work in the market itself. When wethink of supply and demand, we usually visualize abusiness model. A company creates and markets aproduct or service and has to compete with othercompanies in the same industry. When there is alot of demand for that product, sales rise; whendemand is soft, sales (and profits) fall. In this exam-ple, “supply and demand” are factors affecting acompany’s profitability.

A study of the stock market reveals entirely differ-ent forces at work. Price of stocks really has little todo with economics as applied to sales and profits,the traditional models. Rather, prices change dueto investor demand rather than market demandand the demand itself has nothing to do directlywith a company’s competitive success. Of course,


FIGURE 1-2

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the more profitable companies will have strongerprice attributes in its stock, but the forces of supplyand demand really do not affect price. In fact, it isfair to say that stock prices rise and fall as a resultof a collective market perception of value. Today’srise or fall in a stock’s price occurs in anticipation ofwhat will happen next. When investors buy stock,they do so assuming that the price is going to rise;and when they sell, they are taking profits or react-ing to changed perceptions about future value. Anattempt to tie together the traditional supply anddemand features of economics and market pricemovement is not an accurate approach.

As technical analysts, chartists generally are not atall interested in economic forces such as supply anddemand (on a purely market level). Rather, they areinterested in the perception of price support andresistance for individual stocks given a number ofother factors: current trading range, recent tradingpatterns within the trading range, whether therange itself has been drifting up or down, signs ofsupport exhaustion, profit-taking, and other trendsrelated to price, not to the economy. SR does notapply well to market indexes, because no onetrades the index (except through limited indexoptions). Since an index represents a broad cross-sample of many stocks, it cannot possess an indi-vidual SR. While an index trading range mayappear to be acting in the same manner as that ofan individual stock, it is not the same. The tradingrange of the index is a culmination of many tradingranges, and it is simply the averaging effect ofthose components that creates this artificial “trad-ing range.”


It is fair to say

that stock prices

rise and fall as a

result of a col-

lective market

perception of

value.

c01.qxd 7/29/03 12:01 PM Page 20

By the same argument, an index cannot exhibit thepatterns known to belong to individual stocks.Since the index is a composite of many stocks,including those with disparate trading ranges andtrends, there is a washing effect in the index itself.For many technicians, the index is useless for thepurpose of evaluating individual stocks, which iswhat most investors would be expected to use SRto accomplish.

Even the individual stock will exhibit certain charac-teristics that may be signals or, in some cases,merely coincidence. We have to assume a certainamount of random movement in the market, ifonly because the underlying forces are rarely con-sistent. The interests of sellers and buyers areopposite one another, so no legitimate weightshould be given to “the market” as a single entity.In fact, the trading range itself is nothing but theaverage of market sentiment about that stock.This, however, is where SR is most valuable. Weassume that within that overall market for a partic-ular stock, the trading range exists because buyersand sellers have entered into a silent agreementconcerning the reasonable price level. Fluctuationsoccurring within that level, or trading range, repre-sent the day-to-day buying and selling—thejostling among participants—as the price movesaround within its trading range. However, the trad-ing range is not the range of supply and demand,but rather a reflection of the current status of theauction marketplace. Supply and demand is aneconomic force that affects prices within markets,and market trading ranges and accompanying SRare the defining qualities inherent in the free


Market trading

ranges and

accompanying

SR are the defin-

ing qualities

inherent in the

free exchange

between buyers

and sellers.

c01.qxd 7/29/03 12:01 PM Page 21

exchange between buyers and sellers. The distinc-tion is an important one.

Not everyone agrees that there should be such aprecise distinction between economic supply anddemand versus stock price trends. One authorreferred to concentrated demand and supply aspart of the analysis of why and how prices arelikely to move next, and what those trends actuallymean in economic terms.1 The same authorobserved one general rule of price trends: “supply”(or, more accurately, a new support level) often willbe found at a previous trading range’s resistancelevel (Figure 1-3). In other words, when today’strading range is replaced with a new higher tradingrange, such a shift could be expected to becomeestablished. The same is true in the opposite direc-tion: When today’s trading range is replaced with a


FIGURE 1-3

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new lower trading range, then “demand” (a newresistance level) is likely to be located at or near theprevious trading range’s support level (Figure 1-4).This is an important concept in the analysis of SR,because as the trading range shifts, we can expectto identify these new support or resistance levels asa starting point for further analysis. However, thedebate continues: Do these levels represent supplyand demand? Or are they markers for the pricelevels that provide limits to the auction itself? Anobserver of market forces will notice that pricesseem to move in the most illogical ways, often sur-prising everyone and defying any logical economicanalysis. This alone gives credibility to the beliefthat SR is a feature of the auction. Were these SRlevels truly representative of valid supply anddemand forces, then their movement would beexpected to occur in some dependable, predictable,


FIGURE 1-4

c01.qxd 7/29/03 12:01 PM Page 23

and economically sensible manner. In the stockmarket, this is not a likely manner for prices tomove. Instead, the tendency is for the tradingrange to become established (assuming the stockprice is not behaving in an overly volatile manner),which provides a sense of reliability for near-termprice movement. In fact, some technical analystsmove back and forth between long and short posi-tions based on relative price position within thetrading range, based on the presumed dependabil-ity of that range in the near term. For such traders,success is most likely when the trading range hasbeen well established in terms of breadth. Thismeans it may be edging upward or downward, butthe relative distance between support and resist-ance remains constant. While trading ranges oftenbroaden or narrow, the most desirable model for atrading range is based on the likelihood that, giveninterim distortions, the breadth of the tradingrange is consistent. The longer this consistencylasts, the more stable (and less volatile) price move-ment is considered to be; and the easier it is for thetechnician to anticipate price change.

The study of SR usually involves these well-established trading ranges, meaning that, in addi-tion to breadth remaining constant, they unfoldover a period of days, weeks or even months.While prices can and do change rapidly within asingle trading day, the usual purpose to SR analysisinvolves current price changes within or away fromwell-established SR parameters. Trends up or downwithin a single day may be given many names bychartists, but single-day changes should not beconfused with the concept of SR. The usefulness ofSR analysis is in providing an established starting


The usefulness

of SR analysis is

in providing an

established

starting point

to analyze or

explain daily

fluctuations.

c01.qxd 7/29/03 12:01 PM Page 24

point to analyze or explain daily fluctuations. Thus,any exceptional spikes may be discounted and evenignored as long as they do not become part of arepetitive pattern, testing or violating SR limits. Theoccasional aberration should be treated as just thatand largely ignored.

Some technicians have observed trends in price as“buying and selling waves,” noting that suchwaves can vary in duration, can be exhaustedrather quickly, or may be offset by other wavesmoving in the opposite direction.2

This is an important point. A “wave” of short dura-tion might, in fact, serve as a false indicator just likethe exceptional spike, misleading the analyst frommore dependable, longer-term conclusions. In thestudy of statistics, such misleading indicators haveto be discounted because they do not represent theongoing trend. They are a reflection of the short-term chaos that is going to characterize any popu-lation (individuals, age ranges, political partymembers, or the random short-term movement ofstock prices, for example). The established tradingrange, with its support and resistance levels, is themore dependable, established trend that is worthobserving. By understanding the importance of therange—and also knowing that a breakout (pricemovement above resistance or below support) doesnot occur frequently, we are able to stay on courseand not be misled by day-to-day aberrations. This isone value to SR; it provides us with a reliable meansfor evaluating short-term price movement and pat-terns, ignoring one-time changes and acting onlyon trends that are confirmed independently (moreon these methods later).


Breakout: A

price movement

above resistance

or below sup-

port, often the

signal that a

new trading

range is being

formed in the

stock pricing

pattern.

c01.qxd 7/29/03 12:01 PM Page 25

The long-term trend in a stock’s price is the estab-lished trading range. It probably is not flat buttends to move gradually in one direction oranother, but still with easily distinguished features.Within the overall direction of the long-term trendare weekly trends that are up and down, andwithin the weekly trends, there are daily trendsthat are up and down (Figure 1-5). These move-ments may temporarily violate the established trad-ing range; but without confirming signals, they arenot proof of a permanent change. It is the interme-diate trend that could forecast an emerging newtrend, or one that could become exhausted anddisappear. Of even shorter duration, short-termtrends last from hours up to days, and finally, thesmallest of trends, intra-day trends, last from min-utes to hours. Chartists are constantly referring toprices that “test” support or resistance. Thus, aprice might move up to resistance and break


FIGURE 1-5

A price might

move up to

resistance and

break through,

only to retreat,

or move below

support momen-

tarily, but imme-

diately return to

the range.

c01.qxd 7/29/03 12:01 PM Page 26

through, only to retreat, or move below supportmomentarily, but immediately return to the range.A few points to remember about prices “testing”the outside levels of the trading range:

1. Prices are not conscious, so they cannot“test” as a human can. The terminology ismisleading in that regard.

2. Short-term trends are entirely unreliable, andin the next chapter, we will examine the twomajor market theories, both of which agreethat short-term trends have to be discountedand even ignored. Chartists know that “tests”are not really forms of reconnaissance on thepart of some conscious being but are part ofthe chaotic nature of price movement itself.

3. The actual price dynamics are not controlledby individuals but as a collective market. Themarket version of supply and demand is farfrom the economic form; the auction market-place reflects the interactions between buyersand sellers, all bidding and asking at thesame time. Institutional investors (mutualfunds, insurance companies, and pensionfunds, for example) have far more influenceon price than the individual or retail investor.

4. You are better off acting within the longer-term price range analysis than reacting toshort-term price movement. Such intra-daytrends are entirely unreliable for the morestudious chartist.

The chartist views SR as the starting point of thechart. Once SR is established, the chartist beginslooking for signs of new emerging trends. Threetypes of charts have come into popular use in


c01.qxd 7/29/03 12:01 PM Page 27

studying price trends: vertical, figure (today knownas point & figure) and wave charts. The verticalcharts are the open-high-low-close charts com-monly used today (Figure 1-6). Some technicianshave not considered chart patterns or technicalindicators to be of any value. Instead, they havefavored vertical charts for identifying price trendlevels, comparative strength and weakness, andfrom these items the timing of when to buy, sell orplace stop orders.3

Point and figure charts (Figure 1-7) are used todetermine accumulation or distribution areas, aswell as forecasting price levels that could represent


FIGURE 1-6

Accumulation

area: A price

range in which

buying activity

is taking place,

indicating grow-

ing support.

c01.qxd 7/29/03 12:01 PM Page 28

future support or resistance levels. The point andfigure chart does not use time for the horizontalaxis. Figure 1-7 shows what is called a 3 X 3 chart.If the stock moves up by $3 dollars then an “X” isplotted. As long as there is not a retracement(retreat in the opposite direction) of $3 or more,then the trend is up. If the stock falls by $3, thenan “O” is plotted. In Figure 1-7 the downtrend inthe middle of the chart is a series of lower supportand resistance points.

SR, of course, is not an isolated factor, but theunderlying guiding force in chart analysis. Wave


FIGURE 1-7

Distribution

area: A price

range in which

trading is taking

place over a

longer than

average time, in

which sellers

want to support

prices to avoid a

decline.

c01.qxd 7/29/03 12:01 PM Page 29

charts help identify emerging patterns in SR.Remember, the trading range is rarely unchangingfor long. An active stock is likely to trade in a pro-gressing series of trading ranges that graduallymove upward and downward, and sometimesreversing course as a matter of trading pattern overtime. This is where the wave chart is a useful toolin SR analysis.

Wave charts are line charts (Figure 1-8). They areused to track smaller and shorter-term waves,medium-duration waves, and longer-durationwaves. We can measure the duration of eachwave, thus identifying the relative strength in what


SR, of course, is

not an isolated

factor, but the

underlying guid-

ing force in

chart analysis.

Retracement: A

movement in

prices in the

opposite direc-

tion from a

recent trend.

FIGURE 1-8

c01.qxd 7/29/03 12:01 PM Page 30

we perceive to be (a) current trading range and (b) trend direction. For example, Figure 1-8 is a 30-minute line chart of Microsoft, and you can see onthe left hand side of the chart how the downtrendfrom $58 to $48 is a series of falling price points.Notice that during the decline support points giveway while resistance levels hold. Next, a doublebottom (two tests of the same support level) occursjust above $48, a major warning. Then the resist-ance level at $52.50 is broken, and now we see ris-ing support points and falling resistance levels.

A cautionary word: Applying the theory of yieldingor holding SR levels within single days is contraryto the very idea of longer-term SR significance. Theabove example is useful for illustrative purposesand momentary changes could serve as dramaticsignals as long as they are confirmed indepen-dently, and as long as that conclusion is supportedin subsequent price changes. However, SR is notuseful for making decisions on Intra-day trading.Most day traders are less concerned with SR andare far more interested in price aberrations. Underthe SR concept, we prefer to ignore the daily aber-rations, recognizing them as just that; and we pre-fer to use SR as a tool for identifying longer-termtrading range trends.

The purpose of SR analysis is far more applicable tolonger-term analysis. Some technicians haveobserved that accumulation and distribution areas,or trends relating price to volume, are helpful inidentifying likely price tops and bottoms.4

Under that theory, a downtrend ends when marketdemand reverses a downtrend. Market supply


SR is not useful

for making deci-

sions on Intra-

day trading. The

purpose of SR

analysis is far

more applicable

to longer-term

analysis.

c01.qxd 7/29/03 12:01 PM Page 31

reverses an uptrend in the same manner. This inter-action between demand and supply of securitiescreates trends and the subsequent reversal of thosetrends under this theory. Here again, we have toqualify the observation about supply and demandas a matter of definition. It is dangerous to confuseprice trends in the auction marketplace with thesupply and demand forces at work in the economy.Price of stocks is not directly caused by economicsupply and demand. In the context that identifyingmarket tops and bottoms is associated with supplyand demand, it is perhaps more accurate to statethe theory in another way:

“Observing the accumulation and distributionareas of price in a stock, coupled with observationsof changing volume on the buy side or sell side,can be used to confirm the pricing trends that areobserved in SR analysis.”

We avoid mixing up economic supply and demandin this restated version of the theory to help avoidthe confusion. It is a mistake to come to believethat technical analysis and, specifically, charting is ascience rooted in economic supply and demand.We can learn a lot, though, from watching howbuying and selling activity change along withchanges in volume as a means for confirming whatwe see happening to the stock’s trading range.

Interpretation of Price andVolume TogetherIf we limit our observations to price alone, we arelikely to miss some important emerging signals. Wealso need to keep an eye on trading volume. Whenbuying or selling volume levels change significantly,


When buying or

selling volume

levels change

significantly, it

could signal a

coming change

in the price

trend as well.

c01.qxd 7/29/03 12:01 PM Page 32

it could signal a coming change in the price trendas well.

Figure 1-9 is a 30-minute bar chart of Microsoft(MSFT). Price trendline A is up but the volumetrendline A is down. As prices have moved higher,volume has waned, indicting that fewer and fewerbuyers are coming into the market. It appears thatthe upward drive is exhausting itself. The pricereacts by retreating back down to form a low at$55. Here, the volume expanded noticeably,exhibiting a bottom-heavy activity coupled with adownside price trend. Bargain hunters step up toabsorb the stock at its softer price level. At point C,the market opens lower and rallies with volume atits highest level to this point. But as prices begin to


FIGURE 1-9

c01.qxd 7/29/03 12:01 PM Page 33

climb at trend line D, volume recedes. The marketrolls over as prices fall; volume expands (Point E)but prices continue to slip lower. Demand is notstrong enough to support that price level. Volumecontinues to rise (trend line F) as price falls, untilthe price gaps down to $53, and volume reachesits highest point on the chart.

When prices climb and volume falls, buying activityis weakening. As prices fall and volume declines,selling activity is exhausted. As prices fall and vol-ume rises, and as prices then hold in the same areawith rising volume, that means buying activity isgrowing in strength; if prices rise to a point thatthey stall and volume continues to rise, it indicatesthat sellers are gaining momentum.

Daily movements of price, as a chaotic andmomentary force, may appear to be setting net SRtrends but, in fact, are merely part of a larger andlonger-term pattern. Of equal importance, remem-ber that identifiable trading ranges are not alwayspresent. Highly volatile stocks often have not yetfound a trading range, so prices rise or fall in reac-tion (often overreaction) to many market forces. Inthose cases of extreme volatility, few charting tech-niques are of any value. Highly volatile stocks, bydefinition, do not possess a single trading rangeand have to be viewed in a larger perspective. Astock’s high volatility, in and of itself, makes SR andother charting inapplicable.

SummarySupport and resistance, the study of the interactionbetween buyers and sellers in relatively low-volatility


c01.qxd 7/29/03 12:01 PM Page 34

stocks, is the foundation of technical analysis. Astraders, the study of SR gives us a window intohow most traders react to price movement. Mosttraders do not try to forecast short-term pricemovements, they follow trends as they emerge.The professional or active trader’s ability to reactswiftly to a new trend helps him to understand theinteraction between volume and price. The obser-vant technician understands that SR serves as astarting point for developing an idea of what mayoccur next in price movements or patterns. How-ever, he also knows that short-term price move-ment has a random quality to it, and spikes orwaves may mislead the impatient trader, causingmistakes and misjudgments. A patient traderawaits confirmation from a suspected change inthe current trend, remembering that importantchange is not going to take place every day. By uti-lizing other indicators, the technician is able to useSR and emerging chart patterns to anticipate thenext step in price trends. The next chapter explainshow SR applies to one of the most important theo-ries of the market, the Dow Theory.

NOTES

1 Edwards & Magee, Technical Analysis of Stock Trends,Amacon, 1948, 1997

2 Wyckoff, Richard D., The Richard D. Wyckoff Method ofTrading and Investing in Stocks

3 Ibid

4 Gartley, H. M., Profits in the Stock Market


The observant

technician

understands that

SR serves as a

starting point

for developing

an idea of

what may occur

next in price

movements or

patterns.

c01.qxd 7/29/03 12:01 PM Page 35

c01.qxd 7/29/03 12:01 PM Page 36

The application of SR to specific stock pricetrends has its genesis in many of the theoriesfirst suggested by Charles Dow. Among these

theories is that of confirmation, the independentsignals derived from one indicator that support thesame conclusions previously found in another. Alltechnical analysts should recognize the importanceof confirmation as they study SR and other chartpatterns.

Formulated by Charles Dow in the late 19th cen-tury, what later became known as the “Dow Theory” was originally intended to be used as aforecasting system to anticipate economic condi-tions, not as a trading system for the stock market.Dow believed that the market was the best prog-nosticator of the economic future long before thedays when such forecasting became dominated bymarket analysts and fund managers. Dow saw thestudy of market averages as a viable method forforecasting the direction of the economy. Today,with the Dow Theory used almost exclusively toforecast market-wide trends, there is little economic


Confirmation: A

signal or indica-

tor that supports

a previous signal

and thus adds to

the evidence

that a specific

technical change

is occurring in a

price trend.

CHAPTER 2

The Dow Theory:Applying SR to Individual Stocks

c02.qxd 7/29/03 12:06 PM Page 37

application other than to use the Dow Jones Indus-trial Averages (DJIA) to explain other economicchanges. However, the DJIA is more often citedtoday as reacting to economic conditions, ratherthan anticipating them. So Dow’s original theoryhas been modified to serve different needs, thoseof the technical analyst. The study of SR as part ofthe Dow Theory is worthwhile in the sense thatthese ideas can be applied to individual stockswhere they are more useful. Overall market trendsare of less interest to the technician, whose time isbetter spent trying to anticipate price and trendchanges in individual stocks.

As a model for studying price movement, the DowTheory sets down specific “rules” or observationsto anticipate future changes. Dow and his partnerEdward C. Jones (the two are better known todayas “Dow Jones”) came up with the idea of usingmarket indexes to track broader trends. Their ideaswere published in the financial newspaper thatwas first printed on July 8, 1889, called The WallStreet Journal. (The paper was originally calledCustomer’s Afternoon Letter and was in publica-tion since 1882.)

The Dow Theory itself was not formulated untilafter Dow’s death in 1902. Samuel Nelson identi-fied the attributes of the modern theory in hisbook, The ABCs of Stock Speculation.

The Dow Theory originally had one 12-stock mar-ket index, later expanded to two; these were basedon industrials and transportation stocks (originallycalled “rails” because only railroad companies wereincluded). These are referred to today as the Dow


As a model for

studying price

movement, the

Dow Theory

sets down spe-

cific “rules” or

observations to

anticipate

future changes.

c02.qxd 7/29/03 12:06 PM Page 38

Jones Industrial Average and the Dow Jones Trans-portation Average. A third index, the Dow JonesUtilities Average, was added later on. Dow madeextensive use of confirmation. As a basic premise,he determined that in order for a primary trend toexist, both indexes had to confirm the factorsrequired: specifically, in order to call a trend a pri-mary trend, both needed to break through thesupport or resistance level. If the two averagesdiverged, that meant the indicator was a false one,because it failed the confirmation test.

The Dow Theory views the three averages asbarometers of likely future market activity. If themarket climate is positive (bullish) then trends inprices should be upward. If the mood of the marketis pessimistic, that will be reflected in weakeningstock prices, and a negative climate (bearish) islikely to pull prices downward. We must rememberthat, although Dow’s original essays discussed theuse of market trends to forecast business activity, inmodern application it works in the opposite direc-tion: stock price trends among market leaders areused to predict market movement. Thus, weakeningeconomic factors affecting a company’s sales andprofits are later reflected in lowering stock prices.

The averages are studied in search of confirming orcontradicting signals. The Dow Theory is premisedon the idea that trading trends—or overall support

To view the components of the three averagesor statistical performance summaries, check theDow Jones website at http://averages.dowjones.com/jsp.


Primary trend:

The main move-

ment in the

market, usually

lasting for

months or even

years, establish-

ing an overall

direction for

broadly based

price trends.

The Dow Theory

is premised on

the idea that

trading trends—

or overall

support and

resistance—

can be antici-

pated by way of

confirmation.

c02.qxd 7/29/03 12:06 PM Page 39

and resistance—can be anticipated by way of con-firmation. Figure 2-1 shows an example of a lateconfirmation of the trend by the DJIA versus theDJT. At point A the Dow sells off, breaking supportlevels along the way, but the Transportations con-tinues to trend higher. Then at B, the Dow confirmsthe up trend again by breaking resistance.

Figure 2-2 is an example of the weekly closingchart for the DJIA and the DJTA for 1997–98. Atpoint A, the DJIA trades down, breaking the previ-ous support points. Next, the DJIA makes a peakfollowed by a lower peak (trend line C), and closesbelow support at point D. However, the DJTAdiverges by making a new high, but holds support.Next, at point E, both averages are once again ingear, confirming the up trend.

When one average breaks through resistance andthe other does not, the “failure to confirm” is a


FIGURE 2-1

c02.qxd 7/29/03 12:06 PM Page 40


FIGURE 2-2

c02.qxd 7/29/03 12:06 PM Page 41

warning, also called divergence. This should not beconstrued as a market reversal, but as a trendreversal when both averages break support levelsand have falling resistance levels (Figure 2-3).

The divergence between the two averages oftenprecedes confirmation of a newly established downtrend. Figure 2-4 illustrates how the divergence indi-cates trading range price action or a trend reversal.Trend line A is upwards on the Dow, while it isdownwards on the Transportations, a typical diver-gence pattern. Trend line B is up on the Transporta-tions and down for the Dow. Finally, trend line C forthe Dow is horizontal, showing strong resistance at11,250 while trend line C for the Transportations isdown. This divergence series ultimately led to amajor decline for both indexes. Still, the tradingrange encompassed approximately two years’ trad-ing range activity with multiple divergences beforethe breakdown occurred. Trading ranges are calledlines and can last for a considerable period. Duringthese periods, the astute technician may adopt amore conservative trading approach, as the trendmoves sideways until a confirmed new trend begins.


FIGURE 2-3

c02.qxd 7/29/03 12:06 PM Page 42


FIGURE 2-4

c02.qxd 7/29/03 12:06 PM Page 43

Elements of the Dow TheoryA study of overall market trends based on marketindexes may indicate future likely trends; however,using SR in that analysis is not necessarily an accu-rate exercise. SR is more often used for trackingindividual stock prices. Understanding the DowTheory is useful, however, in viewing how overallmarket trends may influence prices on specificstocks.

The first observation of the Dow Theory is that themarket tends to follow the leaders. Thus, anindex of 30 industrial stocks, representing about20% of overall equity value in the United States, isindeed a strong market-wide indicator.1

A second belief of the Dow Theory is that marketshave three trends: primary (lasting months oryears), secondary (20 to 60 days) and tertiary(day-to-day).2

Trends, which were of great interest to CharlesDow, are what Dow watchers follow, constantlyseeking out signals of reversal. After all, just aschartists look for breakouts from SR ranges on indi-vidual stocks, broader market watchers look forthree signs when new trends are established;this is the third belief of the Dow Theory. Thosethree signs for establishment of a new bull marketare:

1. Experienced investors begin buying stockswhen market prices are low and the mood iscautionary. This contrarian approach is wellknown today.

2. Corporate earnings begin to rise.


c02.qxd 7/29/03 12:06 PM Page 44

3. Buying activity in the broader market beginsto increase.

A bear market trend would be signaled by thesethree events:

1. Experienced investors recognize that stocksare over-bought and they begin selling offshares. Even though corporate earnings maybe higher than in the past, these investorsalso know that companies are not going tobe able to sustain those growth rates.

2. Buying activity slows down as prices peak out.3. Market prices decline broadly. Investors rush

to sell, creating an accelerating price decline.

These three-step processes are widely recognized,notably by experienced investors whose task is totry and recognize these emerging trends beforeformal recognition by the market as a whole (andspecifically as confirmed under the Dow Theory).

The fourth belief under the Dow Theory is that ofconfirmation. Once an average begins to showsigns of a reversal in direction, it must be con-firmed by the same indication in a second aver-age. For example, if the industrial averages meetthe three tests above, the trend will only be recog-nized if and when the transportation averages mir-ror the same steps.

As a final “rule” under the Dow Theory, a trend issaid to remain in effect until both averagesagain reverse direction. This is the opposite sideof belief number four, requiring confirmation of achange in direction.


c02.qxd 7/29/03 12:06 PM Page 45

Market Trends versus Business TrendsThe tendency in the market to apply trend analysisagainst price has the result of confusing two sepa-rate functions. Price is affected indirectly by corpo-rate earnings, and short-term price is far more achaotic result of market interactions. Price changein short- and intermediate-term periods should notbe given great weight; to truly follow the long-term pricing trends, longer-term moving averagesare the only realistic method for following a com-pany’s market fortunes.

A business trend, in comparison, is based on fun-damentals: sales, costs, expenses and profits.Charles Dow recognized the importance of trendanalysis as part of the corporate internal budgetingprocess, and his original intention was to developeconomic models to help anticipate fundamentalchanges. In modern application, however, thescience of trend analysis is applied to overall indextrends and to purely technical features, especiallyto market price. Thus, the concept of applying theDow Theory to SR is misleading.

To the extent that SR patterns can be anticipated,there are many useful chart patterns and signalsand, by using the Dow Theory along with othertools, what appears to be emerging can certainlybe confirmed through many outside means. How-ever, SR should be viewed as a separate function ofcharting—it serves as the basis for technicalassumptions, and the Dow Theory is one of manytechniques that are used to anticipate price move-ment. However, remember that there are vast dif-ferences between index trends (the net offsettingmovements of that index’s components) and


To truly follow

the long-term

pricing trends,

longer-term

moving averages

are the only

realistic method

for following a

company’s mar-

ket fortunes.

c02.qxd 7/29/03 12:06 PM Page 46

individual stock trends, which have isolated andunique price patterns, SR, and other features.

Dow Theory is a useful tool for understanding thenature of moving averages and price patterns.When the concepts employed within the DowTheory are applied as tools for confirming SRtrends in individual stocks, it is quite valuable.However, there is no rational method for applyingindex trends to individual stocks. SR proponentsmay gain valuable skills in anticipating stock pricepatterns using Dow Theory rules, but they shouldalso recognize the built-in limitations when trendanalysis, intended as a fundamental tool, is appliedin a purely technical environment.

SummaryThe Dow Theory is perhaps the best-known oftechnical theories about the stock market. Byunderstanding how it is applied to indexes ofstocks, we can also gain insight into how SR workson individual stocks, at least to a degree.

Just as market-wide forces affect overall bull orbear trends in the market, individual stocks exhibit price swings reflecting ever-changing interaction between buyers and sellers. The trad-ing range identifies the agreed-upon “fair price”area of the stock. Buyers will continue to buy upto the resistance level, but not above; and sellerswill be willing to sell down to the support level,but not below. Once prices break out of that trading range, the whole agreement has to berevised. While market-wide changes require con-firmation to identify new trends, the same is true


Buyers will con-

tinue to buy up

to the resistance

level, but not

above; and sell-

ers will be will-

ing to sell down

to the support

level, but not

below.

c02.qxd 7/29/03 12:06 PM Page 47

for individual stocks. However, breakout signalsare given different names. The next chapter iden-tifies how trend lines and channels can be used tospot emerging changes in SR and trading ranges.

NOTES

1 Source: Dow Jones & Company

2 Hamilton, William, in The Wall Street Journal, September 17,1904


c02.qxd 7/29/03 12:06 PM Page 48

Trend lines are straight lines drawn on a chartconnecting support points for a rising trend orresistance points for a down trend. Figure 3-1

shows a support point using a three-bar patternwhere the center bar is the lowest bar. This chartpattern is called a pivot low, isolated low or a three-bar head and shoulders pattern. This pattern is asupport point. It represents three attempts by pricesto move below support. This pattern occurs fre-quently at many upturns in the market. The patternfor resistance is called a pivot high, isolated high orthree-bar head and shoulders pattern. Downturnsin the market often are signaled with one of thesepatterns.

A trend line may rise, fall or move sideways. Trendlines are not drawn through any price bars; theyare used to connect two or more support pointsthat define the trend and indicate its direction(Figure 3-1).

Horizontal trend lines are drawn along the twolowest support points in the trending range. A hor-izontal trend line is also drawn along two or more


Support point: A

point in a price

pattern in which

support is tested

successfully by

prices attempted

to break lower.

Resistance point:

A point in a price

pattern in which

resistance is

tested unsuccess-

fully by prices

attempting to

break higher.

CHAPTER 3

Trend Lines and Channels:Techniques to Identifying SR Levels

c03.qxd 7/29/03 12:12 PM Page 49

of the highest resistance points in the tradingrange. As long as the prices trade between thesupport trend line and the resistance trend line, thetrading range continues (Figure 3-2).

Two Modern Trend Line TechniquesOne expert developed a system for drawing trendlines to clearly define tops and bottoms of the trad-ing range. This technique is referred as the 1-2-3formation.1

First, for a downtrend, the line is plotted along thehighs so that the last high shown then becomesthe next high preceding the lowest low. A break ofthis down trend line is step 1 of the formation. Thisis followed by an upward price movement and


FIGURE 3-1

Pivot high or

low: The price

point at which

support or

resistance are

tested unsuccess-

fully, after which

prices retrace

back toward the

middle of the

trading range.

c03.qxd 7/29/03 12:12 PM Page 50

then a retest of the low. This is step 2. The thirdand final step is a breakout of the resistance pointbetween the first low and the retest. Figure 3-3 is aweekly chart of Genuine Parts (GPC). The downtrend line is plotted across the highs that precededeach new low. At point 1, the down trend line isbroken. The market rallies and forms a resistancepoint. Next, there is a retest of support at point 2.Support holds and the market trades up andbreaks through resistance at point 3. A pricebottom has been established.

For a top formation the support line has to bedrawn along a series of lows that precedes thefinal high. The first sign of the top is the up trendline is broken. Next, the price pulls back, forms a


FIGURE 3-2

c03.qxd 7/29/03 12:12 PM Page 51

support point and then retests the high. This isstep 2. The third step occurs when prices returnback down through support.

Figure 3-4 is a daily chart of the S&P 500 index.The up trend line is drawn along the lows that pre-cede each new high. At point 1, the trend line isbroken. The market retraces almost 50% of thedecline (point 2). Next, the support level is broken(point 3), and the top formation is complete.

Another method for using trend lines with supportand resistance levels is the Andrew’s pitchfork ormedial line method. Developed by Dr. AlanAndrews, this technique identifies the trend aswell as its outer boundaries. The technique identi-fies three points. For up trends there will be two


FIGURE 3-3

c03.qxd 7/29/03 12:12 PM Page 52

support points and one resistance point, and fordown trends there will be one support point andtwo resistance points.

Figure 3-5 has both an up and a down trend usingthe Andrew’s Medial Line method. For an up trend,this method first finds the support point (point 1),the resistance point (point 2) and support point tothe right (point 3). A line connects the high of theresistance point (point 2) to the low of the secondsupport point (point 3), and determines the halfwayor median point of this line. Another line is drawnbetween the low of the first support point (point 1)bisecting the median point and extending upward.One line is also drawn upwards from the resistancepoint parallel to the median line, and another


FIGURE 3-4

c03.qxd 7/29/03 12:12 PM Page 53

upwards from the support point parallel to themedian line. Technicians use the pitchfork methodto identify decision points. For example, they maybuy when the median line is pointed upwards andprices have retraced to the support line. Similarly, ifthe median line is pointed down, they may enter asell order if and when prices rally back to the resist-ance line. Penetrations of the support or resistancelines of the Andrews pitchfork may signal that anew trend is underway.

Figure 3-5 shows how prices during late Octoberstayed within the lower channel side and onlyclosed above the median line once before pricesmoved out of the upward channel. Moving belowthe lower up-channel line signaled an end to the


FIGURE 3-5

Penetrations of

the support or

resistance lines

of the Andrews

pitchfork may

signal that a

new trend is

underway.

c03.qxd 7/29/03 12:12 PM Page 54

up trend. Next, the market rolled over and newchannel pointed downward. When the marketgapped down in mid-December, prices reversed atthe lower side of the downward channel.

Classic ChannelsThe up-trend line may also be referred to as thedemand line and the resistance points as the over-bought line. The down-trend line plotted over theresistance points may be called the supply lines. Aparallel line may be drawn along the lows of thesupply lines to identify the oversold area.

Figure 3-6, the weekly chart for the S&P 500,shows a down-trend line along resistance points


FIGURE 3-6

c03.qxd 7/29/03 12:12 PM Page 55

1 and 2, and then a parallel line (the oversold line)from support point 3, which lies between the tworesistance points. Notice how the marketrebounded from the oversold line.

Figure 3-7, a daily chart of Phillip Morris (MO),shows an up-trend channel. The demand line isplotted along the support points 1 and 2, and thena parallel line is plotted from the resistance pointupward. The prices stopped right at the overboughtline in January.

VolumeVolume is an important confirming tool for breaksof trends lines. Figure 3-8, a chart of trading in


FIGURE 3-7

c03.qxd 7/29/03 12:12 PM Page 56

Microsoft, shows at point A prices breaking downthrough support. At the same time, volumeexpands noticeably. Once support is broken itbecomes resistance in a newly established tradingrange. At point B, the market retraced back nearthe original support level, and volume was heavy,but prices did not return above the original supportlevel. A supply line may be along the two resistancepoints and the oversold line along the supportpoint D. Prices fell below the oversold line butreversed back into the down-trend channel,accompanied by heavy volume. The next day, themarket gapped above the down-trend line (dashed)with heavy volume confirming the breakout. Theguideline is to look for an increase in volume toconfirm a break of any trend line. In this respect,


FIGURE 3-8

c03.qxd 7/29/03 12:12 PM Page 57

volume can serve as yet another confirming factorwhen studying SR—especially when spottingbreakouts.

SummaryTrend lines are used to identify support and resist-ance levels, which may be extended out into thefuture with a straight line through price and time.Penetration of trends lines may also be accompa-nied with an increase in volume, further confirmingthe newly established trend. Light volume breaks oftrend lines tend to be false, with that low volumeindicating lack of widespread participation or inter-est on the part of traders and investors.

The next chapter extends trend line analysis to anequally interesting visual study of price. Chart pat-terns help you to place the trend line into a valu-able context.

NOTE

1 Sperandeo, Victor, Trader Vic—Method of a Wall Street Master


Volume can

serve as yet

another con-

firming factor

when studying

SR—especially

when spotting

breakouts.

c03.qxd 7/29/03 12:12 PM Page 58

Chart patterns are visual representations ofwhat is taking place in a stock’s price move-ment. Technicians seek out price stability for

the purpose of establishing the SR (support andresistance) levels that define trading range. Allprice patterns can be classified either as continua-tion or reversal patterns. A continuation reinforcesthe existing trend and may be characterized bypausing in price activity, followed by a return to aprevious pattern. Reversal patterns provide strongsignals that price movement is about to head in anopposite direction, or that an existing tradingrange is about to be broken and reestablished at ahigher or lower level.

In highly volatile stocks, there are no apparent SRlevels, because price movement is both erratic andunpredictable. It is erratic because there is no trad-ing range to speak of; and it is unpredictablebecause no one knows what is going to happennext. For the chartist, the highly volatile stock ismost troubling. As long as there is no SR level, it is


Continuation

pattern: A pat-

tern that rein-

forces the

current price

trend, including

pauses in price

movement fol-

lowed by a

resumption of

the previous

direction.

Reversal pat-

tern: A pattern

preceding a

change in direc-

tion of price

movement, or

the breaking of

a previously

established trad-

ing range.

CHAPTER 4

Chart Patterns: VisualConfirmation of Price Movement

c04.qxd 7/29/03 12:21 PM Page 59

also impossible to identify breakout signals, or tomake any kind of predictions.

A similar problem exists in low-volatility stocks. Ifthe trading range is well established and move-ment is generally horizontal, the relatively smallprice fluctuations provide only one kind of signal:a lack of any change whatsoever. The chartist hasnothing to do because no apparent or real changeis on the verge of occurring.

In between these two extremes is a rather broadrange of stocks, neither entirely volatile nor stable.They are subject to the types of trading range“rules” that make SR analysis interesting; occa-sional trading ranges keep the chartist activelyinvolved in watching for breakout signals and SRtests; and the trading range itself is dynamic inone direction or the other, or to a degree, movingin alternating waves. This middle range of stocksis far more interesting to the chartist (and to mostother analysts) than the extremes. Remember, onthe extremes, analysis is either meaningless orimpossible, and the chartist can only wait forsomething to change. However, as long as astock’s activity is dormant or overly volatile, futurechange cannot be anticipated with any scientificcertainty.

An interesting stock exhibits movement. That move-ment can be studied and quantified using analysisof chart patterns, and changes in trading range andSR can then be made. For example, a stock mayover the course of six months move from $45 up to$60, and then trade sideways between $55 and$60. The $55 level would become support and the$60 level would become resistance once price levels


If the trading

range is well

established and

movement is

generally hori-

zontal, the rela-

tively small

price fluctua-

tions provide

only one kind of

signal: a lack of

any change

whatsoever.

c04.qxd 7/29/03 12:21 PM Page 60

off. However, that is a relatively narrow tradingrange, so the applicable chart pattern should con-sider the likely effect of the original $45 per sharelevel. That could be considered as initial support,while also recognizing that the trading range hasnarrowed in more recent sessions. This is a commonpattern, but the narrowing is not necessarily perma-nent. The recent horizontal trading pattern couldbe merely a short-term price consolidation, mean-ing that the market is marking time awaiting fur-ther news that could propel the price of the stockupwards, or it could be a reversal pattern, signifyingthe end of the previous up trend and the beginningof a new down trend.

The Double TopThe double top shows two price peaks (tests) thatare separated by a declining point or range. Theinitial peak in price often is accompanied by heavyvolume, as participants react to bullish news andbid prices higher. The market peaks and retraces aportion of the last move. This pullback will often beaccompanied by relatively light volume as theretracement represents profit taking off the high.The price next returns to the original up trend butas it nears the previous peak, buying interest provesnot strong enough to push prices to new highs.This inability to break out above resistance is recog-nized early during the assault on the old high bycomparing the volume of the second run to the vol-ume of the first run. If the volume is lighter, it indi-cates that fewer buyers are joining in on the rally.The signal that indicates when the double top for-mation is complete comes when prices break downthrough the support level established between the


Consolidation: A

temporary slow-

ing of price

movement and

narrowing of

trading range,

awaiting realign-

ment of buyers

and sellers.

Double top: A

chart pattern

characterized by

two price peaks

testing resist-

ance, with a

decline in

between. The

unsuccessful test

of resistance is

viewed as a

bearish sign,

often anticipat-

ing a breakout

below previous

support levels.

c04.qxd 7/29/03 12:21 PM Page 61

two peaks. Often, volume will increase dramaticallyas this occurs, representing the possibility of amajor shift in trader expectations.

Figure 4-1, a weekly chart of AT&T, shows a doubletop with a price break at the support pointbetween the two price peaks. Volume expandednoticeably, confirming the top formation.

The Double BottomThe double bottom is characterized by two pricetroughs that are separated by a price peak. As theprice falls to form the first low, volume often is rel-atively high, at times exceptionally high. However,


FIGURE 4-1

Double bottom:

A chart pattern

characterized by

two price drops

testing support,

with a price rise

in between. The

c04.qxd 7/29/03 12:21 PM Page 62

in the typical double bottom, sellers are unable tobreak through the support level and a retracementof the decline follows. The price rallies, due to acombination of short covering and bargain hunt-ing. A popular interpretation of the retracement isthat the bad news that caused the first pricedecline is discounted by the point of the secondleg, and the market then advances as buyers takeup well-priced shares.

Figure 4-2 shows a double bottom on a weeklychart for American Express. The large volumeoccurred as the price reached its bottom. A healthylevel of support appeared as the double bottomunfolded.


unsuccessful test

of support is

viewed as a bull-

ish sign, often

anticipating a

breakout above

previous resist-

ance levels.

FIGURE 4-2

c04.qxd 7/29/03 12:21 PM Page 63

The Head and Shoulders TopThe head and shoulder top is so named for theshape of the chart pattern. It involves a center highlevel (the head) with lower plateau levels precedingand following (left and right shoulders). Also calledan ‘M’ because of its shape, the head and shoul-ders is one of the most reliable of all chart patterns.The volume characteristics commonly involve a peakduring the left shoulder or at the head, and muchlower volume during the right shoulder tradingperiod. The trading area in between each shoulderand the head is often called the neckline. Penetra-tion of the neckline following completion of thepattern signals that the top is complete and adownward price trend is likely to follow. Volumemay expand as the price breaks down through theneckline. The price may also retrace and test theneckline in subsequent movements. The head andshoulder top may establish a new resistance pointat (or below) the neckline, and a new trading rangecould become established at or below that level.

Figure 4-3 shows a complex head and shoulderstop that developed in IBM. It is complex becausethe two shoulders show multiple tests of the resist-ance level. After the neckline at $110 was broken,the price dropped to below $90.

The Head and Shoulder BottomThe inverse of the head and shoulders top, thispattern marks the end to a previously downwardtrend. The pattern consists of three price bottomlevels with the center (the head) trading lower thanthe left and right shoulders. A breakout above the


Neckline: The

trading area in a

head and shoul-

ders pattern

found between

the head and

each of the two

shoulders.

Head and shoul-

ders pattern: A

chart pattern

resembling a

left and right

plateau with a

higher center

plateau (head

and shoulders

top) or the

reverse (head

and shoulders

bottom), with a

middle lower

trading level and

higher plateaus

trading before

and after.

c04.qxd 7/29/03 12:21 PM Page 64

neckline is a sign that a new support level is likelyto be established there as part of a new, highertrading range. This pattern is also referred to as‘W’ due to its distinctive shape.

Figure 4-4 shows that the head and shoulders pat-tern can represent both a bottom as well as a con-tinuation pattern. The first head and shouldersbottom occurred in March, then proceeded to rally,followed by a price decline in April, and finallyanother smaller head and shoulders bottom forma-tion. This indicated strong support, and the pricesadvanced once again.

As a general observation, the head and shouldersformation is a strong signal that is either bearish


FIGURE 4-3

Also called an

‘M’ because of

its shape, the

head and shoul-

ders is one of

the most reliable

of all chart

patterns.

c04.qxd 7/29/03 12:21 PM Page 65

(top pattern) or bullish (bottom pattern). Therepeated test of the SR levels is met with weaknessand an inability to break through, and then is fol-lowed by a strong price movement in the oppositedirection.

The importance of head and shoulder formations isin the way that resistance (top pattern) and support(bottom pattern) are tested, and in the forecastingadvantage that these patterns provide. Head andshoulders is one of the more popular methods foranticipating breakout of SR. The triple signalattempt at breakout, with each one failing, providesconfirmation that, in fact, prices are going to headin the opposite direction.


FIGURE 4-4

The importance

of head and

shoulder forma-

tions is in the

way that resist-

ance (top pat-

tern) and support

(bottom pattern)

are tested, and in

the forecasting

advantage that

these patterns

provide.

c04.qxd 7/29/03 12:21 PM Page 66

TrianglesThe triangle pattern, so called for its shape, is onecontinuation pattern closely associated with theestablishment of a new SR and trading range; or, thetriangle may precede a period of increased volatility.

Triangles may be symmetrical, descending orascending. The symmetrical triangle, also called thecoil, has a rising support line and a falling resistanceline. The two lines converge near the middle of theinitial range. The volume will often peak at the endof the trend just as or right before the triangle pat-tern starts to unfold. As the market moves side-ways, the volume will continue to recede. If thevolume is higher on the support side, this suggeststhat the market is likely to break through on theupside. On the other hand, if the heaviest volumeappears when the prices are trading near resistance,and the price bars close near the lower end of thebar’s range, a downside breakout can be antici-pated. The symmetrical triangle typically indicatesthat, at least for the moment, buying and sellinginterests are balanced against one another.

Figure 4-5 shows Johnson & Johnson (JNJ) tradingsideways as a symmetrical triangle. Volume declinedduring the triangle and then expanded as the pricebroke out.

The descending triangle has a falling resistance lineand a horizontal support line. As the market movessideways, the prices fail to achieve higher levels;yet, the support line holds. The volume characteris-tics are important to analyze along with the emerg-ing triangle pattern, since the combination of priceand volume are required to properly anticipate the


Triangle: A pat-

tern that may be

symmetrical,

ascending, or

descending. The

triangle is a con-

tinuation pattern

which, when

combined with

an analysis of

volume charac-

teristics, can be

used to antici-

pate near-term

price movement.

c04.qxd 7/29/03 12:21 PM Page 67

next price move direction. Despite the observationthat support is holding throughout the develop-ment of the triangle, if the volume is heavier onthe failed attempts to move through resistance,then support may collapse. In that instance, theinability of price to move through resistance evenwith heavy volume indicates that buyers are tooscarce to create a breakout. The descending trian-gle is usually a bearish price pattern and, whenconfirmed with other information, can be used toanticipate a weakening price trend.

Figure 4-6 shows a descending triangle for Yahoo!(YHOO). The test of support saw a price rally withexpanded volume. However, during the week ofAugust 10, the price closed at the low for the


FIGURE 4-5

c04.qxd 7/29/03 12:21 PM Page 68

week and the volume broke the down-trend line,which anticipated a breakout below support.

The ascending triangle is composed of a rising sup-port line and a horizontal resistance line. In thispattern, buyers are coming into the stock, creatinghigher and higher prices, while sellers hold at afixed price level. Volume is essential to determiningthe significance to this price pattern. Heavy volumeat resistance indicates weakening buyer activity anda possible downside breakout. If the volume is ris-ing when price is at or near support, that maypoint to an impending breakout above resistance.The ascending triangle pattern is usually consideredbullish and can be useful in anticipating an upwardprice trend.


FIGURE 4-6

If the volume is

rising when

price is at or

near support,

that may point

to an impending

breakout above

resistance.

c04.qxd 7/29/03 12:21 PM Page 69

Figure 4-7, Brocade Communications (BRCD),traced out an ascending triangle before resuminganother up leg in the trend.

One useful technique for trading a triangle is toplot the trend lines to the point they cross, andthen determine the 50–66% range from the pointwhere the triangle begins to the point where itends. This 50–66% zone is the typical area thatprices will exit the triangle. If the price stays withinthe confines of the triangle past this exit zone, thebreakout will not develop into a longer-term trend.

Triangles are likely to serve only as short-term priceindicators. They can anticipate SR breakouts, ofcourse, and that is ultimately their usefulness. Theyshould not be viewed for price patterns alone,


FIGURE 4-7

c04.qxd 7/29/03 12:21 PM Page 70

however. An expected breakout should be con-firmed by volume trends as explained above. If thecorresponding volume changes are not found, thenthe triangle could be a short-term aberration ormerely a coincidental and random pattern. Whentriangles are short-term in nature, they are moreproperly classified as flags.

Short Term and Intraday PatternsFlags and short-term triangles are quick consolida-tion periods with tight boundaries of support andresistance that occur within existing trends. A flagis so named because the trading action has parallelsupport and resistance trend lines that are eitherhorizontal or slope downward. Figure 4-8 is a


FIGURE 4-8

c04.qxd 7/29/03 12:21 PM Page 71

30-minute bar chart of Johnson & Johnson show-ing a series of flags during the up trend.

The value of identifying flags often is in specificallydistinguishing them as pausing in the establishedtrend rather than as a sign of newly emergingtrends. The short-term flag tends to slope in adirection opposite the trend. Thus, if prices areinching upward, the flag will have a downwardshape, with a tendency for prices to climb uponcompletion of the flag’s pattern.

A pennant looks like the triangle, but is usuallyshorter-term in duration, usually lasting no longerthan a week or two. The pennant is a type of slow-down or pause in the price trend and usually is fol-lowed by a resumption of the previouslyestablished price movement direction.

Short term triangles, or pennants, often occur asbrief pauses in a steep up or down trend, but maybe more pronounced due to the rapid and volatilenature of that steep price change. Figure 4-9shows CMGI Inc. (CMGI) with a number of short-term triangles during a larger down trend.

The classic chart patterns may occur not only inlong-term trend patterns, but also in short-termdaily price patterns or Intra-day trading patterns.The technical analyst faces the challenge of tryingto distinguish between patterns that representemerging new trends, and those that are only falsestarts. This is the great challenge, of course,because as trends emerge, it is more difficult tointerpret them than it is to look back and identifywhat happened in the past. However, this does not


Flag: A short-

term pattern

usually caused

by a pause in

the trend, with a

parallel shape

sloping in a

direction oppo-

site the larger

trend. The flag

is useful for

short-term

analysis, but of

questionable

value as a long-

term indicator.

Pennant: A

short-term trian-

gular pattern

representing a

pause in the

established price

trend. It is usu-

ally followed by

a resumption of

the price move-

ment in the

same direction.

c04.qxd 7/29/03 12:21 PM Page 72

mean that seemingly brief or short-term patternscan be ignored; they may be the beginning ofimportant reversals. Many price swings on stocksbegin from Intra-day chart patterns. Figure 4-10 isthe 30-minute chart of AT&T, showing a doubletop formed before the price fell from $20 to below$18. Figure 4-11 shows trading the 30-minutechart for Microsoft (MSFT), which formed a sym-metrical triangle as a reversal pattern.

GapsA gap is a space in between price range from oneday to the next. For example, if a stock tradestoday between $18 and $21 per share, but openstomorrow at $23, a two-point gap occurred.


FIGURE 4-9

The technical

analyst faces the

challenge of try-

ing to distin-

guish between

patterns that

represent

emerging new

trends, and

those that are

only false starts.

c04.qxd 7/29/03 12:21 PM Page 73

Gaps can be interpreted in three different ways. Abreakaway gap signals a strong market move. Forexample, if the gap occurs above the neckline of ahead and shoulders bottom, that could stronglyconfirm the head and shoulders trend.

A second interpretation is called the runaway gap,which occurs within an established trend, normallyone in which prices are rising or falling strongly.The third type of gap, an exhaustion gap, is likelyto occur at the end of a strong price trend andcould indicate that the trend is about to end out.For example, if prices have been climbing rapidlyand strongly, an exhaustion gap may signal thatprices are about to top. This type of gap may be


FIGURE 4-10

Gap: A space

between daily

trading ranges

from one day to

the next, signifi-

cant because it

may signal im-

portant changes

in price trading

patterns.

c04.qxd 7/29/03 12:21 PM Page 74

followed shortly by a breakaway gap heading inthe opposite direction. Together, this pattern, oftencalled an island reversal, is a sign that prices aregoing to head in the opposite direction.

SummaryChart patterns may serve as indicators that con-tinue or reverse established SR and trading ranges.It is not a simple matter to distinguish short-termor false starts from the stronger and more perma-nent changes in price direction. The key is to studyvolume trends along with those price patterns. Thetwo together are more likely to anticipate breakoutor confirm the current SR range.


FIGURE 4-11

c04.qxd 7/29/03 12:21 PM Page 75

In order to more thoroughly understand the natureof SR and why price may breakout and establish anew trading range, the study of interim patterns isa useful exercise. As prices test SR levels, volumetrends confirm what the price pattern appears toimply; however, every technician also needs toremember that there is a random element to short-term price movement. Not every pattern is signifi-cant. It is prudent to always watch volume as well,and to ensure that the elements of price move-ment—SR tests, price spikes at top or bottom, headand shoulders patterns, and triangles—are inter-preted properly, and are not misunderstood in error.The value in price movement patterns is alwaysconfirmed when SR is tested and either holds or isbroken.

With that observation in mind, how can you bestuse price patterns to take advantage of extremelyshort-term changes? The next chapter shows howswing trading puts these valuable patterns to work.


Every technician

also needs to

remember that

there is a ran-

dom element to

short-term price

movement.

c04.qxd 7/29/03 12:21 PM Page 76

You can use chart patterns to time yourentry and exit points. By analyzing con-secutive high and low points and spotting

SR test signals, you can invest as prices swingfrom one direction to the other. As a “swingtrader,” you combine well-known price patternswith gaps, volume analysis and confirmation sig-nals, to anticipate which direction prices are goingto take.

One popular swing trading method is based on athree-bar pattern demonstrating peaks with threehigher highs, or dips with three lower lows.1 Forexample, Figure 5-1 shows an upswing as the pricebars achieve higher highs, but when the bars makethree lower lows, the swing turns down. Once theswing turns direction, the highs or lows do nothave to be consecutive. If the market traces outtwo higher highs and the next high is a lower high,and then prices rally to another new high, theswing is still up. A swing chart determines thetrend by tracking the highs and lows. Whetherconsecutive or not, the pattern is established by


Swing trade: A

trade timed to

anticipate a

swing in price

movement from

one direction to

the other, so

that entry and

exit are timed

based on pat-

tern signals.

CHAPTER 5

Swing Trading: CreatingMaximum Profit Opportunities

c05.qxd 7/29/03 12:20 PM Page 77

highs outpacing previous levels, or lows decliningbelow previous levels.

Support and ResistanceOn Figure 5-1, the support point is the swing bot-tom as prices moved from a downswing to anupswing. If movement were taking place in theopposite direction, the resistance point would beidentified as the point where an upspring reversedinto a downswing. As with all cases of patterns,SR levels are established by unsuccessful attemptsto break through, and these are usually followedby a reversal in price movement.

3-bar Swings versus 2-bar SwingsSome traders have observed significant differencesbetween swings lasting over two bars and those


FIGURE 5-1

c05.qxd 7/29/03 12:20 PM Page 78

taking three bars. According to these traders, twobar swings are preferable to three-bar swingsbecause the likelihood of picking and timing theimpending movement correctly is stronger with theshorter-term swing pattern.2 Figure 5-2 shows atwo-bar swing chart.

According to proponents of the preferred two-barmethod, if and when a two-bar swing top is vio-lated, the trend turns up. If a two-bar swing bot-tom is broken, then the trend turns down. Figure5-2 shows an example within the box on the chart.At point A, two consecutive higher highs precedean upturn of the swing. At point B, two consecu-tive lower lows precede a downturn of the swingline, and a swing top is established. At point C, the


FIGURE 5-2

c05.qxd 7/29/03 12:20 PM Page 79

previous swing bottom is violated so the trendturns down and the swing line is dashed.

Reviews of charts show well-defined up trends as aseries of rising support swing bottoms (supportpoints). Downtrends consist of falling swing tops(resistance points). By applying the definition of thetrend to the chart, the swing trader can time entryinto long positions at the bottom of the channel,or right at support, or short positions at the topwhere resistance is established. On the closing side,the long position exit should be made when resist-ance appears to weaken, and short positionsshould be closed when support appears about toerode and give way.

Swing traders may advance this technique by usingmultiple time frames alone or in combination. Forexample, your current trading pattern could be setusing daily bars, and the next time frame would bethe weekly bars. By using a multiple time approach,you are able to differentiate between major andminor signals. Swing tops and bottoms would beinterpreted as major SR on a weekly basis and minorsupport and resistance on a daily basis, for example.

Figure 5-3 (Microsoft) shows that the Weekly GannSwing is up, but the trend is down (dashed lines)indicating that prices recently broke a weekly swingbottom. The Daily Swing Lines are solid and form aswing bottom. When prices broke the swing bottom,the Daily Swing Trend came into agreement with theindicators on the Weekly Swing Trend. With thisinformation, breakouts of major SR levels would bemore easily identified than minor SR probes, provid-ing you with useful confirming signals.


The long posi-

tion exit should

be made when

resistance

appears to

weaken, and

short positions

should be closed

when support

appears about

to erode and

give way.

c05.qxd 7/29/03 12:20 PM Page 80

Other Swing Trading ConceptsMany swing traders have further observed that uptrending markets tend to move in patterns exhibit-ing swings of higher highs and higher lows.3 Byusing specific setups for entering into trades basedon market direction, swing traders can employ thestrategy of simply watching for consecutive lowerhighs or consecutive higher lows.

Once the price reaches a new high it may be fol-lowed by three to five consecutive lower highs. Thisdownswing is due to late buyers coming in andbuying at the short-term top. As the market moveslower, the same late buyers will be likely to exittheir positions to cut their losses. The same strategyworks on the downside. Once the price falls to a


FIGURE 5-3

c05.qxd 7/29/03 12:20 PM Page 81

new low it may be followed by three to five consec-utive higher lows. Similarly, following market actionpresents the short seller with timing opportunities.

This type of trading action is typical of the majorityof market followers, who chronically buy after aprice peak and sell only to cut losses. This presentsthe astute swing trader with an opportunity to takepositions in the up trend by buying after this seriesof three to five consecutive lower highs or higherlows. This variation on swing trading is a chartist’sversion of contrarian investing—going against theaction of the market. By timing long or short entryto consecutive lower highs or consecutive higherlows, the contrarian swing trader is able to takeadvantage of the common trading patterns of mar-ket reaction.

For example, Figure 5-4 is Affymetrix. This markethad been making higher highs and higher lows.The expectation is that this pattern represents anew support point in a general up trend. If thesupport point does not hold, the swing tradershould exit with a small loss. Partial profits can betaken when the market returns to the old high,and a trailing stop order placed for the remainderof the position.

For stocks in a down trend consisting of a series oflower lows and lower highs, look for stocks thathave rallied with three to five consecutive higherlows. Here, a stock may be advancing because buy-ers believe that the market has come down too fartoo fast and may be making a bottom—this isbelieved despite the fact the market is clearly in adown trend. For example, Figure 5-5 shows Yahoo


For stocks in a

down trend con-

sisting of a

series of lower

lows and lower

highs, look for

stocks that have

rallied with

three to five

consecutive

higher lows.

c05.qxd 7/29/03 12:20 PM Page 82

(YHOO) in a downtrend with a short term rallyconsisting of four higher highs, after which theprice rolled over again.

Traders who buy against the trend will likely sellout quickly if the trade does not work. This pres-ents another opportunity. If the price trades belowthe low third or higher consecutive low, the con-trarian swing trader may go short and remain atrisk up to the high of the entry bar or the previousbar, whichever is higher. In this trade, the setuptakes advantage of a potential resistance level justas it is forming. If the resistance level does form,then prices should fall to new lows typical of thedown trend. Partial profits can then be taken near


FIGURE 5-4

c05.qxd 7/29/03 12:20 PM Page 83

the previous low, entering a trailing stop for theremainder of the position.

SummarySwing trading takes maximum advantage of thetendency for prices to ebb and flow in the shortterm, to move in directions against the trend, andto reestablish that trend again. By waiting for thecounter trends to occur and then trading in thedirection of the trend, you create many more short-term profit opportunities. Swing trading utilizes SRas points to enter stop losses for trades, as well astargets for profit-taking.


FIGURE 5-5

c05.qxd 7/29/03 12:20 PM Page 84

This is the essence of swing trading, and ultimatelyit defines your success in technical market trading.Beyond the short-term effectiveness of swing trad-ing techniques, you can employ the same skills toforecast likely SR trends into the immediate future.The next chapter shows how to spot the signals foremerging SR trends.

NOTES

1 This system was developed in the 1930s by trader W. D. Gann

2 Krausz, Robert, A W. D. Gann Treasure Discovered, citing ahandwritten W. D. Gann trading course

3 Velez, Oliver, and Greg Capra, Tools and Tactics for the MasterDay Trader


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c05.qxd 7/29/03 12:20 PM Page 86

Can we forecast SR levels? Many technicalmethods offer an objective or target on thecompletion of a particular pattern or tech-

nique. You can think of these targets as fore-casted SR levels. In this section, we review chartpattern targets, ratio analysis, and the Elliott Wavetechnique.

Chart Pattern Measured MovementsIn the head and shoulders pattern (Figure 6-1), pre-diction is possible because the pattern itself is sucha strong indicator. By measuring the differencebetween the neckline and the head (A-B) andanticipating that the price will move through theneckline, we can anticipate that the price will fall atleast as far below the neckline (B-C) as the differ-ence between the top of the head to the neckline.This symmetrical offsetting pattern is a populartechnique used by many chartists. The expectationin a head and shoulders bottom is the same. If theneckline is violated, the market should rise anequal distance above the neckline as the difference


Target: A price

range expected

in the near

future based on

current trading

signals within

chart patterns.

CHAPTER 6

Learning to ForecastSR Levels

c06.qxd 7/29/03 12:18 PM Page 87

between the head and the neckline. This price areathen becomes a target. In addition, when the neck-line is first penetrated, prices may retest the neck-line (Point D) before continuing the new trend.Typically, the volume during the retracement is low,implying a counter trend movement.

The double and triple top or bottom patterns aresubject to the same price patterns. For the double(Figure 6-2) or triple top, the difference betweenthe extreme price of the pattern and the supportpoints occurring between the price peaks (A-B) isthe starting point for anticipating a price target.When the support point gives way, this differenceis subtracted from the support level (B-C), and thatbecomes the target within this pattern. Increasedvolume with a weakening support level indicatesthat sellers are picking up momentum.


FIGURE 6-1

For the double

or triple top,

the difference

between the

extreme price of

the pattern and

the support

points occurring

between the

price peaks is

the starting

point for antici-

pating a price

target.

c06.qxd 7/29/03 12:18 PM Page 88

The double or triple bottom objective is the differ-ence between the extreme low and the resistancelevel formed between the low points. If the markettrades through the resistance level then the differ-ence is added to the resistance level, to identify thenew target or next resistance level.

Larger triangles, which form over several weeks oreven months, have a measured target. Targets canbe set for symmetrical, ascending, and descendingtriangles with the same technique. The widest ver-tical range in the triangle is added to the apex foran upside breakout or subtracted from the apex fora downside breakout. For example, in Figure 6-3,subtract the difference between points A and Band then add this difference to the apex (C to D).

For short-term triangle and flag formations, thesame techniques are used to identify an initial


FIGURE 6-2

c06.qxd 7/29/03 12:18 PM Page 89

target. However, as shown in Figures 4-8 and 4-9(see Chapter 4), short term flags and triangles maydevelop quickly, so using a trailing stop rather thana target price could be more profitable.

Traders may identify targets based on chart pat-terns, especially reversal patterns, as a first objec-tive in the trend. Therefore, many traders takepartial profits when the target is hit, and thenmove their stop loss point to the initial entry price.If the market reverses, profits are locked in on apart of the position and are at breakeven on theremainder. If the market continues the trend, atrailing stop can be used to exit the remainder ofthe position.

Ratio AnalysisTechnicians use ratios to calculate future SR levels.The most common approach looks for a 50%


FIGURE 6-3

c06.qxd 7/29/03 12:18 PM Page 90

retracement of the previous swing. For example,Figure 6-4 shows two cases, one for an up trendand one for a downtrend. The counter trend move-ment is expected to retrace 50% of the previousswing from points A to B, and then to C.

A method identified by one trader is called the“Rule of Seven,” a formula used to set price objec-tives.1 First, calculate the difference between thehigh and the low of the initial upswing, multiplythe difference by seven, divide the product by four,and add that to the low for the first objective. Forthe second objective repeat the steps but divide bythree, and for the third objective divide by two.Here are the formulas:

Upside objective #1: High minus low, multiply by1.75, add to low price.



FIGURE 6-4

c06.qxd 7/29/03 12:18 PM Page 91


Downside objectives use 5, 4 and 3 for the divisor:

Downside objective #1: High minus low, multiplyby 1.40, subtract from the high price.



These objectives can be applied to either swingmeasurements or for confirmation of classic chartpattern objectives. Figure 6-5 is a weekly chart ofBoeing. Points A to B is the first leg up from the


FIGURE 6-5

c06.qxd 7/29/03 12:18 PM Page 92

bottom where the high has a lower high precedingand following it, and the low has a higher low pre-ceding and following it. The difference in price is$38.9375 − $32 = $6.9375. Therefore, by applyingthe Rule of Seven to project the targets, objective 1is $32 + (1.75 × $6.9375) = $44.14; upside objec-tive 2 is $32 + (2.33 × $6.9375) = $48.16, upsideobjective 3 is $32 + (3.50 × $6.9375) = $56.28.

Figure 6-6 is an example of the Rule of Seven fordownside objectives from a top using a weeklychart of Boeing. Swing A to B is $70.9375 −$54.56 = $16.38. Objective 1 is $70.9375 − (1.40× $16.38) = $48.00 Objective 2 is $70.9375 −(1.75 × $16.38) = $42.28; Objective 3 is $70.9375 − (2.33 × $16.38) = $32.78.


FIGURE 6-6

c06.qxd 7/29/03 12:18 PM Page 93

Fibonacci TargetsTechnicians also employ ratios derived from amathematical phenomenon called the Fibonacciseries. This series is a sum of the previous twonumbers (0, 1, 1, 2, 3, 5, 8, 13, 21 . . .). If youcalculate the ratios of two numbers in a series youwill note the progression is 100%, 50%, 66%,62.5%, 61.5% . . . 61.8%. Calculating the differ-ence between 100% and 61.8% is 38.2%. TheFibonacci series is considered the basis for naturallyoccurring change. Technicians have developedmany elaborate uses of the ratios. One of the mostcomplex is the Elliott Wave.

Elliott WaveThe Elliott Wave up trend consists of five waves orswings (Figure 6-7). Waves 1, 3 and 5 are consideredimpulse (trend) and waves 2 and 4 are corrective


Fibonacci series

is considered

the basis for

naturally occur-

ring change.

FIGURE 6-7

c06.qxd 7/29/03 12:18 PM Page 94

(counter trend) waves. Wave 1 peaks, with resist-ance at the top of wave 1, and wave 2 correctswave 1. Wave 2 can be expected to retrace any-where from 38.2 to 61.8% of wave 1, and some-times back to the origin point. If wave 2 retraces allof wave 1, a double bottom is formed.

As the peak of wave 1 is surpassed, resistance maygive way, and the price would then accelerate. Thisis typical after resistance level breakout. Wave 3 isoften the longest of the waves. Followers of theElliott Wave often project that wave 3 will com-plete a new higher level for resistance, whichwould then form a Fibonacci expansion of wave 1,such as 138.2% to 261.8% of wave 1 (Figure 6-8).

The peak of wave 3 establishes a new level ofresistance, and wave 4 corrects wave 3. Wave 4establishes a new support level. Wave 4 isexpected to unfold in some manner different from


FIGURE 6-8

c06.qxd 7/29/03 12:18 PM Page 95

the characteristic of wave 2. For example, if wave 2was deep, retracing 61.8% of wave 1, then wave 4may be shallow and only retrace 38.2% of wave 3.

Wave 4 should be expected to retrace back to thesupport level formed when wave 3 completed itsinternal wave 4 level. Wave 4 is complete and wave5 breaks through the resistance level (wave 3’speak). The peak of wave 5 will form a new resist-ance level. Elliott Wave technicians will project wave5 peak to be a ratio related to the height of wave 3,or from the height of the beginning of wave 1 tothe peak of wave 3.

SR levels are significant factors in computationsand projections under the Elliott Wave technique,invariably based upon the relationships explainedunder the Fibonacci ratio relationships.

SummaryPatterns emerge in prices that can be useful formaking informed target projections. Assuming thatprice patterns are themselves dependable, themethods developed by technicians can be used asfirst signs of an emerging target, or as confirma-tion for more familiar patterns, such as head andshoulders patterns or strong testing of SR levels.

As much intelligence as you gather from this studyof price, it is only one aspect of the larger question.You improve your analytical skills with the com-bined study of price and volume trends. This idea isthe topic of the next chapter.

NOTE

1 Sklarew, Techniques of a Professional Chartist


c06.qxd 7/29/03 12:18 PM Page 96

Confirmation remains the key to SR analysisand to all other forms of price study, notablywhen trying to anticipate target levels. Con-

firmation is especially important when trading deci-sions are going to be made based on what appearsto be going on with price.

However, price alone does not reveal every form ofconfirmation. Volume and the way that it changesis also critical in validating a breakout from SRlevels. For example, if the neckline of a head andshoulders top is broken, the technician wouldexpect to see an increase in volume as prices rise.This volume trend associated with price breakoutserves as a confirming indicator in establishing thechange in a trend.

Volume analysis can also serve as an indicator thatdisproves what appears to be happening in the pricemovement. For example, if the volume does notincrease during a breakout from SR, then what oth-erwise appears as solid evidence may be consideredsuspect and due to some event unrelated to thestock or simply a false indicator. For example, a


CHAPTER 7

Volume: The OtherConfirmation Measure

c07.qxd 7/29/03 12:14 PM Page 97

broad market index such as the Dow Jones IndustrialAverage may break through resistance and manystocks may breakout as well. However, some maybid up due to crowd mentality, while others maymove higher due to improving fundamentals andinstitutional buying activity. While breakouts accom-panied by a substantial increase in volume are solidconfirming signals, an apparent breakout with lowvolume may be a false indicator, and a retreat backto the established trading range is likely.

Volume should change in a consistent and measur-able form if it is to be considered as confirminginformation. For up trends, the volume will expandin the direction of the trend, and during pull backsor consolidations, the volume numbers will recede.However, if the volume reaches an unusually highlevel in a short period of time, that could signal theculmination of the trend and serve as a contrarysignal. This buying or selling climax would predicta reversal.

A bottom may take the shape of a two-step processforming a major support level and involving changesin volume. A bottom formation took place in Dia-monds (DIA), in March of 2001 shown in Figure 7-1.The first leg was a climatic sell-off. Here, institu-tional investors liquidated their long positions atPoint A. Next, the market rallied as short positionholders took profits. The rally stalled, and the priceretreated back down to the low, retesting the firstbottom. During this decline, the volume did notexpand, indicating that there were no more sellersin response to the lower prices (Point B). Technicianscall this a sold out market. The major support levelwas established at the heavy volume day. At this


Climax: A peak

in trading vol-

ume signaling

the end of the

current trend

and anticipating

a price move-

ment reversal.

Volume should

change in a con-

sistent and

measurable form

if it is to be con-

sidered as con-

firming

information.

c07.qxd 7/29/03 12:14 PM Page 98

point, the market has discounted all of the negativefundamentals and formed a major support level. Amarket top started with a buying climax (Figure 7-2,Point A). Here, the news had been positive, andmore and more buyers jumped onto the trend.Profit-taking caused a decline in price, retracing38% to 50% of the previous rally. After this, theprice began to advance, retesting the first majorresistance level, but this time volume did not rise ashigher prices were paid (Point B). This anemic retestof the previous high indicated that everyone whocould have bought was already long. Resistance wasset one day after the big volume day, and a second,lower resistance level followed. Any negative newsat that point would have caused profit-taking. If thenews had been negative, the likelihood of a major


FIGURE 7-1

c07.qxd 7/29/03 12:14 PM Page 99

top was high. Major resistance had been establishedon the charts.

Volume IndicatorsTechnicians have developed a host of volume-basedindicators to confirm a breakout of SR levels. Themost common is the on-balance volume indicator(OBV) developed by Joe Granville.1 This is the run-ning sum of the cumulative volume weighted bywhether the market closes up or down for the day.If the market closes up, then the entire day’s vol-ume is added to the previous day’s OBV value. Ifthe market closes down, then the entire day’s vol-ume is subtracted from the previous day’s OBVvalue. Traders look for the OBV line to confirmbreakouts and the trend. Thus, if the market breaks


FIGURE 7-2

Traders look for

the OBV line to

confirm break-

outs and the

trend. Thus, if

the market

breaks out of a

trading range,

then the OBV

line should break

out as well.

c07.qxd 7/29/03 12:14 PM Page 100

out of a trading range, then the OBV line shouldbreak out as well. As an even stronger indicator,the OBV may lead and, thus, anticipate the pricebreakout. Once in an up trend, the OBV line shouldsteadily rise as the price trends higher. If the OBVline begins to diverge, tracing out lower highswhile the market is making new highs, a reversal ofthe trend is anticipated.

For market tops, when prices break, a key supportline the OBV line should also break. It is even astronger indicator if the OBV trend precedes theprice. A down-trending OBV line indicates thatmore volume is occurring on down closing daysthan on up closing days. If price continues to trade


FIGURE 7-3

c07.qxd 7/29/03 12:14 PM Page 101

within its trading range, the OBV line may predictthe direction that price can be expected to move inthe coming breakout. Figure 7-3 is the Nasdaq 100Trust (QQQ). The daily chart edged to a new highin September, but the OBV Line stopped at the pre-vious high. Next, as the QQQ began to work lower,the OBV line broke through support before thesame move in price, a good example of the OBVleading. One problem with the OBV indicator is theprice may close down just a few cents for the day,causing all of that day’s volume to be subtractedfrom the OBV line. The calculation is an all-or-nothing without weight being given for volumevariations. The accumulation/distribution line2 isanother indicator that weights the volume by thepercentage placement of the closing price relative


FIGURE 7-4

c07.qxd 7/29/03 12:14 PM Page 102

to the day’s range, and then adds that adjustedvolume number to the previous day’s accumulation/distribution line. This indicator takes into accountwhere the market is closing each day and tracksvolume accordingly. Most technicians view theaccumulation/distribution line as superior to theOBV line based on the weighted volume. The accu-mulation/distribution line was improved further bytaking the sum of the weighted volume over theapplicable period and dividing it by total volume.Figure 7-4 illustrates a positive reading that con-firms a breakout above resistance.

SummaryThe level of volume accompanying breakout belowsupport or above resistance provides confirmationof the breakout; or a lack of corresponding volumeincreases serves as an indicator that those breakoutsare false and will retrace. The addition of volume-based indicators vastly improves the technician’sability to accurately predict price movement.

Remember, though, that the forward-lookinganalysis of price and volume serve only to improveyour outcome, not to completely eliminate risk. Wehave to accept the reality that the whole purposeof this study is to improve our predicting and ana-lytical skills. The next chapter summarizes moderntrends in the science of SR.

NOTE

1 Granville, Joe, New Strategy of Daily Stock Market Timing forMaximum Profits

2 Developed by Larry Williams and later improved upon by MarcChaikin


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c07.qxd 7/29/03 12:14 PM Page 104

The science of technical analysis is constantlyin a state of change and development. Thewidespread availability of online information

and home computers, for example, has made evencomplex mathematical computations automatic,easy, and accessible. Real-time chart pattern analy-sis, moving average computation, and turnoveranalysis are all simple in comparison to the manualsystems used in the past.

One modern innovation is a form of turnoveranalysis, which compares outstanding shares ofstock to trends in the trading range. This is calledthe Woods Cumulative-Volume Float Indicator. Itcompares a running sum of the volume relative tothe available float of shares outstanding, to thetrading ranges established or changed each timethe entire float turns over (on average).1

The “turnover” is an average. The calculation doesnot require a complete change of ownership butdoes represent the trading of a number of sharesequal to total outstanding shares. For example, astock has a float of 10 million shares. From July 1 to


CHAPTER 8

Applying Modern Innovations toSR Applications

c08.qxd 7/29/03 12:13 PM Page 105

August 1 the trading volume was 10.1 millionshares, and the range of prices was a high of $21 to$14. In this example, the entire float of stock hasturned over; in fact, actual turnover is 1.01 times(10.1 divided by 10). According to this technicaltheory, it is considered to be very significant if pricebreaks the support or resistance level establishedduring the period required for one completeturnover of the float. For example, if the stock pricehas been in a down trend and then drops to a pricelow enough that institutional buyers consider it abargain, they will accumulate positions in the stock.That creates more rapid turnover which, in effect,was caused by the breakout below support.

Prices will tend to advance following institutionalbuy decisions, as individual or retail investors followsuit. Under the theory, the shares have changedhands as part of a support breakout, and subse-quent bargain buying forms a new bottom level forthat stock.

If the market has been in an up trend and theentire float turns over, then a new market top iscreated as resistance is broken and a new levelcreated above.

When the market is trending up, the resistancelevels are broken and higher support levels areestablished. Float Channel Lines connecting theright hand corner of the SR levels identify eachturnover period. The Float Channel Lines mark theSR boundaries. Figure 8-1 illustrates an example ofthe Float Channel Lines for market bottoms, topsand trends. When the market is trending up, theseFloat Channel Lines trend up as well, but if the


It is considered

to be very sig-

nificant if price

breaks the sup-

port or resist-

ance level

established dur-

ing the period

required for

one complete

turnover of the

float.

c08.qxd 7/29/03 12:13 PM Page 106

market trades sideways and the support leveldetermined by the turnover of the float gives way,then a market top is confirmed.

Down trending markets are followed by the stairstepping downward Float Channel Lines. As themarket moves sideways, the Float Channel Linesestablish the significant SR levels. A major bottom isestablished when the float turnover resistance levelis broken. Figure 8-2, Juniper Networks (JNPR),shows an example of such a market bottom. Duringthe month of September and early October, 2001,there was a complete turnover of the share float.The two horizontal lines represent the high and lowof the price range during that period. In early


FIGURE 8-1

c08.qxd 7/29/03 12:13 PM Page 107

October, Juniper closed above the Float ChannelLine. Figure 8-3 shows a substantial gain during thedays immediately following the breakout.

Intermarket AnalysisA rising interest rate environment may have a neg-ative influence on the stock market because higherinterest rates raise expense for business and cutinto profits. In addition, investors may begin toview debt securities as more attractive than equi-ties, so capital tends to move out of stocks andinto bonds. If interest rates fall, the opposite mayoccur, with more capital moving into stocks andcreating greater buying pressure. Given these gen-eral observations, it is fair to note that the stockmarket often is a lagging indicator of the interestrate market. Technicians have observed this linkage


FIGURE 8-2

c08.qxd 7/29/03 12:13 PM Page 108

among markets, and those observations havebecome the basis for several technical theoriesconcerning SR analysis.2

Technicians applying intermarket analysis use a com-bination of trend analysis and major breaks of key SRpoints to identify changes in the trend and to illus-trate how these changes may impact other markets.Using market interest rates as an example, comparethe two-year T-note Futures contract (Figure 8-4) andthe NASDAQ 100 Index (Figure 8-5). When the priceof a two-year T-note is falling the yield is climbing. Inlate 1998, the price of the two-year T-note was ris-ing (interest rates were falling) and the NASDAQmarket ended a decline and advanced until the firstquarter of 2000. The T-note broke support (point A)and falling prices (rising rates) indicated that theeconomy was strong, at which point the NASDAQ


FIGURE 8-3

Technicians

applying inter-

market analysis

use a combina-

tion of trend

analysis and

major breaks of

key SR points to

identify changes

in the trend.

c08.qxd 7/29/03 12:13 PM Page 109

100 index continued to advance. The T-note reacheda bottom in January 2000 and then broke throughresistance (point B). The NASDAQ 100 Index toppedin March of 2000, and formed a lower high (point C,Figure 8-5). The fact that the trend of the T-note wasdown was a clear indication that the stock marketwas due for a serious retracement. However, theNASDAQ 100 Index plummeted, and the two-yearT-note price rose, demonstrating how one marketmay affect another.

T-note prices rose as the economy continued toexpand, which was one reason why the NASDAQ100 Index continued to climb. However, as interestrates continued moving, the economy slowed, andthe NASDAQ 100 Index fell on falling earnings


FIGURE 8-4

c08.qxd 7/29/03 12:13 PM Page 110

expectations. As the NASDAQ 100 Index fell, inter-est rates began to fall as well, and falling stockmarket levels induced investors to buy T-notesrather than leaving capital in stocks. By observingthe interaction between key SR levels, you canidentify the important inter-market trends as theybegin to emerge.

Sector and Group AnalysisA “top down” technical approach based on Indexrather than stock analysis is another popular mod-ern technique, especially for market-wide technicalanalysis. This starts with identification of the lead-ing market sector, group or industry and thendetermining the leaders from within those groups.


FIGURE 8-5

c08.qxd 7/29/03 12:13 PM Page 111

Watching for the breaks of key SR levels may pointto the more profitable stocks to trade. A leadinggroup or sector may show that a number of stockstrend in the same direction at the same time, butthe real leaders will exhibit the best relativestrength compared to the group index and to themarket as a whole. Watching how SR levels giveway or hold offers clear insight into the technicalhealth of the stock.

For example, during the summer of 2001 the S&P500 trended lower, breaking the March supportlevel, while the biotech index held above Marchsupport (Figure 8-6). The better relative strengthof the biotech index was an important indication


Watching how

SR levels give

way or hold

offers clear

insight into the

technical health

of the stock.

FIGURE 8-6

c08.qxd 7/29/03 12:13 PM Page 112

that the biotech sector had higher relative strengththan the broader S&P 500.

SummaryMany aspects of technical analysis are built uponthe concepts of SR trends, from chart patterns totrend lines. These trends provide dependable con-firming or contradicting signals that every techni-cian can employ to strengthen a belief aboutimpending price movement. The use of moderntechniques, as well as traditional tried and truechart patterns, enables the technician to grasp therhythm of price movement, especially as it relatesto SR trends. We may view the trading range,defined by support on the bottom and resistanceon the top, as the sensible trading range reflectedin the interaction between buyers and sellers,which should remain dependably stable until oneside or the other gives way. For very low-volatilitystocks, such short-term trends are unlikelybecause there is little market interest in movingprice in either direction. For highly volatile stocks,no form of analysis will work, because the insta-bility and chaos in present price movement cannotbe predicted.

Just as any form of technical analysis is easily evalu-ated in hindsight, we must strive to remember thatthe real challenge is in the interpretation of emerg-ing, new information. Looking ahead and attempt-ing to anticipate the degree and direction of thenext price change is where technicians make orbreak their theory. The successful technical analystis not going to be correct all of the time. However,


c08.qxd 7/29/03 12:13 PM Page 113

being right more often than being wrong isenough of an edge for most people—it putsyou ahead of the averages.

NOTES

1 Woods, Steve, the Woods Cumulative-Volume Float Indicator,The Precision Profit Float Indicator

2 Murphy, John, Intermarket Analysis and Martin Pring, The All-Season Investor: Successful Strategies for Every Stage in theBusiness Cycle


c08.qxd 7/29/03 12:13 PM Page 114

accumulation areaA price range in which buying activity is taking place, indicatinggrowing support.

breakoutA price movement above resistance or below support, often thesignal that a new trading range is being formed in the stockpricing pattern.

climaxA peak in trading volume signaling the end of the current trendand anticipating a price movement reversal.

confirmationA signal or indicator that supports a previous signal and thusadds to the evidence that a specific technical change is occur-ring in a price trend.

consolidationA temporarily slowing of price movement and narrowing oftrading range, awaiting realignment of buyers and sellers.

continuation patternA pattern that reinforces the current price trend, includingpauses in price movement followed by a resumption of theprevious direction.


Glossary

bgloss.qxd 7/29/03 12:03 PM Page 115

distribution area

A price range in which trading is taking place over a longerthan average time, in which sellers want to support prices toavoid a decline.

double bottom

A chart pattern characterized by two price drops testing sup-port, with a price rise in between. The unsuccessful test of sup-port is viewed as a bullish sign, often anticipating a breakoutabove previous resistance levels.

double top

A chart pattern characterized by two price peaks testing resist-ance, with a decline in between. The unsuccessful test of resist-ance is viewed as a bearish sign, often anticipating a breakoutbelow previous support levels.

flag

A short-term pattern usually caused by a pause in the trend,with a parallel shape sloping in a direction opposite the largertrend. The flag is useful for short-term analysis but of question-able value as a long-term indicator.

gap

A space between daily trading ranges from one day to the next,significant because it may signal important changes in pricetrading patterns.

head and shoulders pattern

A chart pattern resembling a left and right plateau with ahigher center plateau (head and shoulders top) or the reverse(head and shoulders bottom), with a middle lower trading leveland higher plateaus trading before and after.



necklineThe trading area in a head and shoulders pattern foundbetween the head and each of the two shoulders.

pennantA short-term triangular pattern representing a pause in theestablished price trend. It is usually followed by a resumption ofthe price movement in the same direction.

pivot high or lowThe price point at which support or resistance are tested unsuc-cessfully, after which prices retrace back toward the middle ofthe trading range.

primary trendThe main movement in the market, usually lasting for monthsor even years, establishing an overall direction for broadly-basedprice trends.

resistanceThe highest price or price trend at which a stock is trading cur-rently in its trading range; the price that buyers consider thehighest worthwhile price for that stock.

resistance pointA point in a price pattern in which resistance is tested unsuc-cessfully by prices attempting to break higher.

retracementA movement in prices in the opposite direction from a recenttrend.

reversal patternA pattern preceding a change in direction of price movement,or the breaking of a previously established trading range.



supportThe lowest price or price trend at which a stock is trading cur-rently in its trading range; the price that buyers currently considerthe lowest worthwhile price for that stock.

support pointA point in a price pattern in which support is tested successfullyby prices attempting to break lower.

swing tradeA trade timed to anticipate a swing in price movement from onedirection to the other, so that entry and exit are timed based onpattern signals.

targetA price range expected in the near future based on currenttrading signals within chart patterns.

trading rangeThe level of trading in a stock, topped by the price resistancelevel and bottomed by the price support level.

triangleA pattern that may be symmetrical, ascending, or descending.The triangle is a continuation pattern which, when combinedwith an analysis of volume characteristics, can be used toanticipate near-term price movement.



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Support and-resistance-simplified[1]

Business

resistance analysis

sr analysis

market analysis

resistance line

sr levels87 support

support line

sr applications

resistance rep