Just as an animal leaves foot prints when it moves through the landscape, a market leaves tracks on a bar chart as it moves through time, and whether you are tracking game in the woods or a market on a chart, trackers and traders employ the many of the same skills.
“Tracking was one of the very first sciences ever developed,” says Del Morris, executive director of the International Society of Professional Trackers. “It’s the process of deduction and figuring things out. You are anticipating direction and direction change, mainly though the intensity of what you see on the ground.” He sums up the critical skill set of a professional tracker with an acronym: D.I.R.T., which stands for detection, identification, recording and trailing. “When you find someone who can do all four, you have found a good tracker,” he says.
Being a successful trader requires a very similar skill set, understanding the direction of the market, identifying important attributes, recognizing patterns and then, with an understanding of the market’s movements, placing a winning trade.
Direction
Virtually all successful trading decisions are based on the idea of deliberately trading with the trend or deliberately trading against the trend in anticipation of a reversal. To do either effectively, you must first identify the market’s direction.
The easiest way to determine the direction of the market is with a trendline. To draw a trendline, connect two prominent price bars such that a significant number of bars are above the trendline. The more bars that approach or touch the trendline you have just drawn, the more meaningful that trendline is because it indicates that the market is supporting trade at those price levels. You will probably find that the support level will vary depending on what time frame you have chosen for your chart.
A support level in a monthly chart will likely vary significantly from that of a 15- or 30-second chart. While it wouldn’t make sense for a day-trader to trade off a monthly chart, you can get a deeper understanding of how much and how fast your chosen market moves by looking at it in several different time frames.
“The first thing I look at in a bar chart is the trend,” says Darrell Jobman, editor in chief of Tradingeducation.com. “What is the trend? Is it going up or is it going down?” Jobman says. “Sometimes when you look back at it, it’s fairly obvious, but when it’s happening, it’s not so clear.” Jobman explains that you can identify an uptrend by spotting a series of higher highs accompanied by a series of higher lows; or in the case of a downtrend, a series of lower highs accompanies a series of lower lows (see “Downtrend”).
IDENTIFication
After you have identified the trendline and the channel line, and therefore understand where market prices are being supported and where they are meeting resistance, the next step is to look more closely at individual price bars.
A longer price bar indicates a wide range between the high and the low, and from that you can infer a wide discrepancy about the consensus value, also known as volatility.
“A big long bar will tell you that somebody is trading it at the high and somebody is trading it at the low. There are differing opinions on what [price] it should be,” Jobman says. For example, on a daily chart, if at the end of the trading day, gold closed at $730 per ounce, then you can infer that, right or wrong, the majority of gold traders agreed that $730 per ounce is the fair market value for an ounce of gold on that particular day.
Recognition
A single price bar tells you a great deal about the market in a single period, but when you compare a series of price bars, you begin to get an even more detailed view of the market and its tendencies. This is important because it is the market’s behavior over time, revealed in recognizable patterns created by the price bars, that will give you the most insight and opportunities to make profitable trades.
For example, Jobman says he will look for a series of higher lows and for the highs to starting to drop back. “The lows may be going a little higher, but the tops are starting to drop back and fade away from the channel line,” that would reveal a weakening market, he says. If the price action then penetrated the trendline, he would expect that to indicate a break in the market’s direction.
In addition to the price bar’s proximity to the trendline or channel line, its size relative to the bars around it also can reveal market sentiment. If a price bar’s high and low are within the high-low range of the prior day, this is know as an “inside bar,” and can be an indication of market consolidation, presaging a breakout. A price bar with a wider range, engulfing the range of the day prior, is referred to as an outside bar.
Multi-bar patterns generally fall into one of two categories: continuation patterns, such as flags and pennants, and reversal patterns, such as the double-top and triple-bottom formations, which are also called M-tops and W-bottoms and gaps.
Flags become obvious when you can draw parallel support and resistance lines with prices bouncing reliably between the two. This is sometimes referred to a being range bound. Flags are also preceded (or followed) by a sharp move up (or down), appearing as the flag’s pole. Flags can be ascending or descending, and typically indicate a period of consolidation before the market returns to the previous trend. Flags are also called boxes (see “Bull flag,” below).
Double tops and triple bottoms are the most important reversal patterns for you to know; and if you have drawn a meaningful trendline, they should be reasonably obvious, as the price action will have apparently bounced off a price level two or three times before penetrating that price level and thereby reversing the trend (see “M-Top,” and “W-Bottom,” left).
Gaps are holes in price action, indicating leaps in market sentiment. Therefore, they are potentially important. Very simply, a gap occurs anywhere that the opening price is higher or lower than the trading range of the previous day. There are several kinds of gaps, including measuring gaps, halfway gaps, blow-off gaps and island gaps. Though with the advent of 23- and 24-hour trading days, gaps are increasingly rare. For now, know that the technical trader’s conventional wisdom is that all gaps must be honored, meaning that eventually, the contract will return to price levels that fill those gaps.
Different trading systems ascribe different meanings to these bar chart patterns based on the contexts in which they appear. In fact, entire books have been written about chart patterns and the statistical likelihood of what the market will do next based on those patterns. Don’t let that overwhelm you.
“In any analysis, it’s pretty much an art. And what people see are different,” Jobman says. “You are only operating with probabilities not certainties.” Remember, you are looking for signs that the market generally agrees or disagrees about where prices should be and whether buyers have the upper hand, pushing prices lower; or sellers have the upper hand, pushing prices higher.
If the market agrees where prices should be, it is indicated by narrow or narrowing trading ranges, known as a lack of volatility, and therefore there is a smaller opportunity to turn a quick profit. If the market generally disagrees where prices should be, indicated by wide or widening trading ranges, this indicates more volatility and therefore a greater opportunity for a quick profit.
If the closing price is lower than the opening price, it indicates that buyers have the upper hand and are driving prices lower. If the close is higher than the opening price, then sellers have the upper hand.
“What you are looking for are signs,” says Kimberly A. Cabrera, of bear-tracker.com. “Everybody sees them, but your mind is not necessarily trained to identify it as a particular sign of a particular animal unless you have had that tracking background and that tracking practice.” She could just as easily be talking about the markets. When you can spot the direction of the market, identify its attributes, recognize patterns, then you can trade more effectively.
Note: See the tech analysis chart at www.futuresmag.com.