From the March 01, 2012 issue of Futures Magazine • Subscribe!

New frontiers in trendline analysis

Faking it

Synthetic trendlines come as two pairs of geometrically related trendlines. They are simply manual graphical drawings that are constructed based on basic spatial relationships taken from price action and then transferred back to the price chart.

Synthetic trendlines should be thought of as probability pairs, rather than definitive statements. Price almost always will follow one of the lines, though it may take two to four bars before choosing one. The intersects also define inflections. Further, synthetics geometrically incorporate rate of change in price over time, as the integral of two previous trends.

Three reference inflections are selected, forming a V or inverted V (see “Creating synthetics,” below). The vertical distances from the vertex of the V to each of the reference points define the lengths of the sides of a rectangle. Lines connecting the corners of the rectangle integrate the price differentials, creating one acute and one oblique pair of angles. Placing these angles at the reference points integrates time differentials — thus, a future price path is proposed.

Obviously, placing each of the four pairs at three different points results in 12 possible paths, but that much complexity is illusory because some paths will overlap and others will seem outrageous, even in a volatile market. After a few practice applications, you’ll find yourself placing only two or three pairs, and within a few periods this quickly narrows real pathways to only a couple of possibilities, then just one.

In dynamic plots (indicators) using pure math, time and price typically are integrated by means of moving averages, and are of the nature of real-time indicators. Synthetic trendlines sacrifice real-time behavior in favor of future price behavior. They extract from time and price a theory of where price could go, giving us idealized paths. The sacrifice must be made because, within a single function, we cannot know direction and magnitude simultaneously. (Traders are in good company. Quantum physicists have the same problem concerning position and momentum of high-energy particles.)

FLIR produces a one-dimensional event narrative; that is, at point X, the price path will reverse. Synthetics generate a two-dimensional event narrative, more complex and probability-based; that is, from point X forward, the price path will be one of these lines, and will reverse at this later point Y. Combining the two can yield a powerful inflection picture as well as the duration and magnitude of future moves.

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