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

New frontiers in trendline analysis

Understanding the synergies

But why are FLIR and synthetics so successful? The answer seems to lie in the regularity, or memory, of markets. Old trendlines never die; they just fade in and out as support and resistance. So they remain a factor in many indicator studies for long periods, though the math connection may not be obvious to the user. What also may not be obvious is that trendline divergence often is incorporated into many indicators, which helps explain FLIR’s success.

For example, moving average convergence-divergence (MACD) contemplates all price within a period, including inflections. Another way of saying this is that each moving average in the MACD pair is a limit function with one high and one low parameter, and intermediate values moving toward these parameters.

At some point, a price inflection occurs. At this same point, there is a specific amount of divergence between the two moving averages, shown by the histogram. The next time that amount of divergence occurs, large market participants (or their high-speed algorithms) remember it and behave accordingly, creating an inflection. This divergence value and market response may be repeated several times before seeming to expire, and new values are added all the time. That divergence is represented graphically in FLIR. An explanation for the success of synthetics is similar, though we’d have to add a trendline to the MACD itself, a method far more cumbersome and far less visually informative than synthetic trendlines.

In lengthy trends, FLIR is at a disadvantage because it’s hard to get a good pair of trendlines to intersect in an accurate and useful way. By also using synthetics, we can identify a great many more inflections. FLIR accurately locates inflections about 85% of the time, allowing for one-period slippage. Failures range from simply no inflection to the rare and disastrous case of mistakenly flagging as an inflection what turns out to be an acceleration in the current trend. Synthetics just indicate possible trends and, to date, haven’t been known to indicate an inflection that turned out to be an accelerating trend.

So why use FLIR at all? Why not just use synthetic trendlines?

The simple answer is that FLIR is easier and faster to use than synthetics, though with a little practice you can generate synthetic trendlines in less than a few minutes. FLIR also has a better likelihood of noting large inflections if you create trendlines using major tops and bottoms, as shown. Synthetics, though giving you an abundance of inflections of all sizes, are far more useful in providing a clear idea of trends, support and resistance.

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