Masterforex-V: The 3rd grade. The principle of The Technical Analysis (TA). The figures of trend’s continuation and its turning. - Masterforex-V

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The 3rd grade. The principle of The Technical Analysis (TA). The figures of trend’s continuation and its turning.

#1 User is offline   Nestor 

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Posted 15 January 2011 - 18:25


#2 User is offline   Okhotnikov Dmitriy 

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Posted 20 January 2011 - 01:35

The 3rd grade. The principle of technical analysis (TA). The figures of trend continuation and its turning.

The main principles.

The nature of TA.

Generally TA can be identified as a method of the price prediction based on mathematical calculations, not economical. First, this method was created to reach any applied purposes for getting incomes in equity market and then in the Futures markets. All TA methods were being created separately and only in 70’s they were consolidated in one theory with common philosophy, axioms and main principles.

The Technical analysis is a method of price prediction with the help of a chart movement examination during previous periods of time. The practical usage of TA implies the axioms existence.

The 1st axiom. Market movements (or prices) include everything. So any factor which influence the price (stock market price, for instance): economical, political or psychological is included in it and shown in the chart beforehand.

The 2nd axiom. Any price has a direction.

This presumption became the basis for all creation methods of TA. The main purpose of TA is to identify the price directions (trends) for usage in markets.

The Dow Jones definition of trends looks like this: the ascending tendency (the bullish trend) shows us that every next peak and fall is higher then previous ones. To clear this we may say that the bullish trend must have the outline of curved line within sequentially ascending peaks and falls. Accordingly a falling tendency (bearish trend) has every next peak and fall lower then a previous one. Such tendency definition is fundamental and serves as a start point in the trend analysis.

There are 3 trend types: the bullish trend (the price goes up), the bearish trend (the price goes down) and the flat trend (almost the price does not move). We can come across all of these 3 trend types but not in its clear state because a straight movement is very seldom met on a price chart. The tendency runs till it gives us a signal to change.

The 3rd axiom. A trace happens again. Analysts suppose if some kind of analysis served in the past so it will work in the future because it is based on a durability of the human psychology.

Technical analysis is a market movement research via charts to learn more about future price directions.
So the term Market Movement includes 3 basic information sources which can be used by an analytic, they are: price, volume and an open interest (this is for the futures contracts).

Now we can formulate 3 postulates and they are like 3 whales which TA stands on.

*Price includes everything. Any factor influencing the price (economical, political and psychological) is already in the market and included in it. And that’s why all we need for proposing is to study a price chart.
*Any price movement is under tendencies (price movement directions). The main purpose of making a price movement chart is to search and find these tendencies during their precocious progress phase and trade in line with their direction.
*A trace happens again. Those rules which run in the past are actual now and will run in future again.

There are 3 types of trends (tendencies):
Bullish – prices go up.
Bearish – prices go down.
Flat – there is no any definite price direction.

Fundamental chart types:
1. Line chart – the close price is selected only for every next period in this chart.
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2. Bar chart – in this chart we can see the maximum price (the top bar point), the minimum price (the bottom bar point), the open price (a little line left of the bar), the close price (a little line right of the bar).
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3 Japan candlesticks (made like bar chart).

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4 Volume chart.

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The Dow Theory.
Originally Dow principles were used to analyze his American industrial and railroad indexes. But a lot of analytic resumes can be used in financial markets successfully as well.

The main principles of the Dow Theory.

1 Indexes includes everything. Under the Dow Theory every factor influencing demand and supply is shown in the index movement steadily. Of course these events are unpredictable and never the less they are allowed for market instantly and shown in the index movement.
2 There are 3 types of tendencies in the market. The ascending tendency has its every next peak and fall higher than previous ones (5C). The descending tendency has its every next peak and fall lower than previous ones (5A). And flat tendency has its every next peak and fall almost on the same level than previous ones (5B).
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Ch. Dow also marked out 3 tendency classes: primary, secondary and light. More meaningful was the primary one which could last more than a year and even several years. The secondary one (intermediate) was as a correcting trend to the primary tendency and could last from 3 weeks to several months. And these intermediate corrections are one or two thirds (a half) of distance which prices made during the primary tendency. The light or short-term tendencies last nearly 3 weeks and serve as short-term waves inside the secondary tendency.

3 The primary trend has 3 stages. The stage of collection comes (the 1st stage) when more farsighted and informed investors start to buy because all adverse economic information were allowed for the market. The second stage starts when people who use the TA begin their play. Economic information becomes more optimistic. The tendency goes in its final (3rd) stage when a mass of people starts their play and flurry takes place in the market which is also supported by mass media. Economic predictions are filled up with optimism. Speculation volume is growing up. And those informed investors who collected contracts during the previous tendency end when no one wants to collect, start to sell them out. And this tendency comes to its end.

4 Indexes must confirm each other. Here Dow spoke about his industrial and railroad indexes. He supposed that any important signal which can make the market to go up or down must take place both in industrial and railroad indexes.

5 The volume must confirm the tendency type.
The volume must increase according to the main tendency direction.

6 The tendency runs until there is a signal for changing the course.

Trend’s Analysis.

Trend or tendency – is a definite price movement direction. In the real life there is no market which goes in any direction like a line. Market movement looks like series of zigzags: there we can see how it rises and then falls and again. And exactly the direction of these rises and falls form the market tendency. We have the main rule here: “Trend is your friend”. And its consequence: “Do NOT work against the trend”.
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Resistance lines (A). They connect important market maximums, they appear when buyers don’t’ want to buy. And sellers’ pressure is stronger than buyers’. And as a result an ascent stops and changes to a descent.
Support lines (B). They connect important market minimums and appear when sellers don’t want to sell. At this level of the price a drive for buying is strong and can resist sellers’ pressure. A descent stops and changes its course.
When price goes through a resistance line it becomes a support line. And on the contrary, when price goes through a support line then it becomes a resistance line.
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A trend line is also serves as a support or resistance level but it is inclined. It is also built according to important maximums or minimums.
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A Channel line can be created when prices fluctuate between 2 parallel straight lines (channel lines). And then we can say about ascending, descending or horizontal channel.
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TA Methods

The TA can be divided into 2 methods:

* Chart method
* Math method is a computer research via indicators (will be studied later)

Chart method

This method is based on the analysis of price charts when price changing is shown on graph during a definite period of time.
It uses:
- Support\resistance levels
- Channels
- Figures of trend’s continuation and turning

Figures of trend’s turning.
The main principle of TA shows that currency prices move in tendency (trend). Also it is known that trends are not eternal. Finally they change the direction and while changing, they do it sharp seldom. Usually prices slow the movement, pause and then turn forming definite price models.

Before studying them we should learn about main aspects of turning point figures.
1) The precondition for the turning point figure appearance is the previous trend existence.
2) The 1st signal of a future turning can be an important trend line breakthrough. However this fact can not be the only signal of breakthrough. It can be false or can speak about the horizontal tendency.
3) The bigger the model is the stronger movement will take place next time. When we say BIGGER we mean height and width of a price model. The height says about the model volatility (a degree of the price volatility during its formation). The width fits a period of time while a model was being formed and finished.

There are explanations of some basic price models below.

Trend’s turning model “Head and Shoulders”.
The figure “head and shoulders” is one of the most reliable and famous chart figures. It is formed by 3 sequential price risings.

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In the point A an ascending tendency continues its rising without any reference to the top and prices make a new maximum. Then an intermediate descent comes (B point) and prices aim at new tops in the point C again.

After a new maximum formation prices begin falling to the point D. Prices go down to the level of the previous descent (B point) and go through a trend line. This is an emergency signal and it seems that an ascending tendency steps back.

After that prices rise again (E point) they can not go through the level of the previous peak (C point), and this last boom is half or two thirds of the previous descent in the point E (the distance between the C and D points) often. It is necessary that every next peak is higher than previous one to say about the continuation of an ascending tendency. And if prices could not have reached the level of the previous peak C in the point E than we have to face a half of circumstances that satisfy a new descending tendency. Prices’ movement formed 2 descending sequent peaks in the C and E points and a minimum between these peaks in the point D.

So now we have the broken trend line and an opportunity to make a descending channel connecting the C, D and E points. However, in spite of all these signals only one thing we can be sure of, that an ascending tendency stood down a horizontal tendency. And this is enough to close long positions so it is too early to make short ones.

And at this time we can figure more inclined trend line which goes through two last descent points (D and B points). It is called a “neck” line. As a rule, top models have it sloped to the top (sometimes it is horizontal, and it is incident seldom).
So we spoke that we had an opportunity to make a descending channel connecting the C, D and E points. To confirm this we need a new minimum under the point D. Thus an identified factor to finish “head and shoulders” model is a breakthrough of a “neck” line by a close price. At this moment a trend line is breached out which goes through descending points (B and D), and the market is under a support line (D point) and satisfies all descending tendency requirements so it looks like a row of sequentially descending peaks and falls. This new tendency forms descending maximums and minimums sequentially (C, D, E and F points).

As a rule after this model finishes its formation we can see a reverse which shows us that a short-term price rising to the level of a “neck” line or the previous descent D (G point) became one of higher resistance levels. And the reverse may not have place or be very weak.

After a neck line will be breached out the price can fall to the point H level which distance called a target price. The target price is a distance from a “neck” line to the top of the “head”. To measure it this distance line should be traced to a “neck” line breakthrough. A descending “head and shoulders” model is a mirror look of a top model. But there is a distinction here – a price probability can turn to the “neck” line direction and become a little bit higher than we saw it studying a top model.

A model of a tendency turning called a double or triple top (bottom).

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Many principles described in “Head and shoulders” model also take place in the other models of tendency turning. A model called a triple top (bottom) meets rather seldom than a “head and shoulders” model and it is supposed to be one of its kinds. The main difference here is that all 3 peak points (fall points) are nearly at the same level. Technical analytics are disagree with a fact that they’ve met a “head and shoulder” model or a triple top model (bottom).
A tendency turning model called a double top model meets rather often than the previous one. It is supposed to be one of the most famous and recognizable model after a “head and shoulders” model. The main characteristics are the same that we saw earlier but it only has 2 tops (bottoms) - not 3.

And now we can speak about some continuation trend figures.

A triangle.
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It is differed into 3 kinds of triangles:
- Descending triangle (A picture)
- Ascending triangle (B picture)
- And symmetric triangle (C picture)

A descending triangle is supposed to be a bearish target, an ascending – a bullish target and a symmetric – a neutral one. An ascending triangle shows us that bulls control the market more and can raise prices to the same resistance level when bears get weaker. A descending triangle shows that market is under bears’ control and they can descend prices to the same support level and bulls get weaker. And a symmetrical triangle tells us about bears’ and bulls’ temporary equality.
Usually the triangle is built by 3 maximum and minimum points which form 5 waves inside it. A triangle’s breakthrough appears between the half and three fourths of the figure’s length.
A signal to finish the model appears when a close price goes out one of the trend lines. Sometimes a price reverse to a trend line can be seeing after a breakthrough. After it the tendency continues its way to the triangle’s top.

A Flag and a pennant.
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A flag and a pennant show a short period of consolidation (flat tendency) inside a strong tendency. There must be a sharp price formatting line to make this model. The figure of consolidation itself is restricted by support and resistance lines which are parallel or connected forming a flag-like figure (parallelogram). As a rule it is inclined to a counter-trend side or horizontal. And after a breakthrough the price movement must take the distance passed before a figure formation.

A pennant model can be recognized by 2 converging trend lines and more horizontal position and it resembles a little symmetric triangle.

A wedge.
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A wedge looks like a triangle, it uses its form and a period of formation. But it differs by an inclination against the main tendency. Its breakthrough takes a counter-inclined direction but it consists with a previous trend direction. Depending on trends it can be bullish or bearish. If we see it on charts we can talk only about a continuation of the trend’s direction. Using it we can not find any target prices.

Used Literature:
- John J. Murphy Technical Analysis of the Futures Markets.
- Steven B. Achelis Technical Analysis from A to Z.
- Robert Colby and Thomas Mayers The thesaurus of technical market indicators.
- Charles Lebbo and David Lukas Futures market computer analysis
- T. Denmark Technical analysis is the new science.
- A. Elder How to play and win the market.

This post has been edited by Okhotnikov Dmitriy: 21 January 2011 - 22:08


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