Head and Shoulder Patterns

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Probably the most popular and misdiagnosed chart reversal pattern is the head and shoulders. The basic pattern consists of a rally on good volume to new highs followed by a setback on lighter volume. This marks the left shoulder of the formation. The market then resumes its advance, again on decent volume, to make new highs. A correction follows somewhat similar in price and time as the previous setback, to create the head. Finally a third rally on light volume fails to make new highs and price falls back to create the right shoulder. A line between the lows of the two corrections is then drawn and extended to the right. This then represents the neckline. It is a penetration of the neckline by price that confirms the pattern and signals the trader that the market has indeed reversed.
There are two characteristics of head and shoulder patterns that Edwards and Magee emphasized as critical in their identification that most market pundits overlook. These are volume and symmetry. As I have already emphasized it is important that volume on the left shoulder be lower than on the right or the head. Remember that volume represents the sense of urgency or enthusiasm that market participant’s experience. Lower volume on the third and failing wave of a head and shoulder pattern (the left shoulder) exemplifies the dwindling conviction of market bulls.
typical head and shoulder pattern

Monthly Japanese Yen
head and shoulders chart
In the chart above notice how volume on the rallies to both (A) & (B) were significantly stronger than at (C). The second factor that often goes overlooked when identifying a head and shoulders pattern is symmetry. A valid formation will tend to have symmetrical right and left shoulders in both price and time. That means that the distance from the high bar on the left shoulder to the head, should be about the same as the difference from the right shoulder to the head. In the yen chart above you can see that from (A) to (B) the distance is 10 bars while that from (B) to (C) is 11. Once a head and shoulders pattern has signaled a reversal by breaking the neckline, the trader can make a measurement off the pattern to determine the minimum extent of the expected move. By measuring the distance between the low made the day that the head was formed at (B) and the neckline on the same day, one can expect a move of equal distance from the point of the breakout. In our example above, the low on the day the high was made came in at 126.00. The vertical distance between that point and the neckline at 118.50 gives a measured move of 7.50. Subtracting that distance from the neckline at the breakout point of 121.00 projects a minimum move to the 113.50 level, an objective that the market blew through in January 2013. Before moving on I want to point out that head and shoulders can also form at bottoms as well as tops. Head and shoulder patterns can be very excellent trading opportunities. The key is making sure to watch the volume and symmetry.

Swing Double

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I define a Swing Double as a set of 3 basic waves. First an initial impulse wave(A). Second a corrective wave(B), followed by another impulse wave(C). The key is that the second impulse must be very close to or equal to the first (less than 10%).

a double swing
The Length of A Equals C
Quite often, a swing of this type marks the end of a price move. The Jan 2016 WTI Crude Oil chart is a great example. If you look at the move from November 14th at $42.20 (A) to November 22nd at $49.20 (B), the difference is exactly $7.00. If you add that to the low on November 25th at $44.82 (C) you get $51.82. The high of $52.42 is pretty close (I look for less than 10% of the previous swing).
swing double example
Jan 2017 WTI Crude Oil

I find these types of patterns very common in charts of all time frames. While I would not base a system on the Swing Double concept, it is a great way to identify market opportunities and get an edge on other traders.

Technical Analysis

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In its most basic form, technical analysis is the examination of price series data for consistently recurring patterns. Most often data is graphically displayed in a standard bar chart format. This consists of a line connecting the high and low, with a small mark placed on the left for the open and the right for the close. Each bar represents whatever specific time frame the trader is interested in studying, and generally ranges from between 5 minutes to 1 month. Often below the price chart analysts will plot volume and open interest (for futures). There are also numerous mathematical renditions of the price data that can be overlaid or plotted on the chart, such as moving averages, oscillators and the like. The following bar chart shows the March 2015 Euro Currency with a volume and open interest plot.

technical analysis explained

A technical analyst will study charts for certain patterns or apply tools such as moving averages or trend lines in an effort to help make trading decisions. When analyzing charts a trader should begin by looking at the longer-term time frames and then stepping down to shorter and shorter periods. That’s because what may look like a strong down trend on a 30-minute chart will show up as a short-term correction in a strong up trend on the weekly. No matter what time frame a trader plans on holding positions, it is wise to have a full understanding of what all the longer-term charts are doing.
Technical analysis is a very excellent way to manage risk.

Continuation Patterns

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Continuation patterns are chart formations that regularly occur in the middle of price moves. Probably the most common are the flag and the pennant. Both are accompanied by falling volume and simply reflect traders taking a break from the recent trend. They are useful in that their setups and breakouts offer good short-term, low risk trading opportunities. They also act as excellent measuring tools as they can accurately project price objectives. “The flag flies at half mast” was one of the first adages I recall learning from an old time chartist. What that means is that a flag or pennant will form at the mid-point of a price move. The chart below shows a small continuation pattern of a pennant formation in July 2013 Natural Gas.

continuation patterns
Daily July 2013 Natural Gas

Note to Self – “Rain Makes Grain”

One of my first trades was during my summer break from college of my freshman year. The corn market had been in a serious downtrend into July as crop conditions continued to improve through out the summer. Some heavy rains over the weekend had done some minor damage in Iowa and Southern Illinois, which put a bid in the corn pit Monday morning. Being young and naive I sensed a bottom in the corn market and went long, expecting the damage to significantly affect the crop. The market traded in a narrowing range for the rest of the week and I was successful at buying the breaks to price support, and building my position. Over the weekend I bragged to my friends how well I had traded and the riches I was sure to accrue the following week. Well, Monday morning the market gapped lower and broke hard. I held on to my position not willing to admit I was wrong and take the big loss. The market trended lower most of the week and I continued to hope that the corn market would come back, but to no avail.
Thursday night after finishing up with back office work I walked to my car in an absolute downpour. I knew with the rain that corn would again be sharply lower the next morning. As I crossed LaSalle Street a panhandler approached and asked me for a buck. I turned to him and said “Buddy, are you kidding me, I’m long corn!” The look on his face was priceless and I still wonder today what he thought I meant.
Needless to say I blew out of my long corn position the next morning with a hefty loss. It was at that point I realized I needed to get a better handle on how the markets worked. Not long after I bought a book on technical analysis, began charting the markets, and understanding continuation patterns. One of the first continuation patterns the book talked about was the flag and pennant formation. It only took me an instant to realize that the narrowing range during which I built my long corn position was probably the most perfect flag formation you could ever imagine. It was at that point that my life long fascination with technical analysis began.

Swing Trading -A Definition

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Price fluctuation in a specific direction is equivalent to a single unbroken price change defined as a swing. As price rises, the bars on a chart will make higher highs and lows. At some point the move up (rally) will end and price will reverse lower (break). In its simplest form, the swing trading definition of a high represents a high bar surrounded by lower highs on either side. Just the opposite applies for a low. Understanding this is the key to the definition of swing trading.

swing trading definition
A Simple Swing High

As with Elliot Wave Theory, bar charts have an innate hierarchy of swings, which define trends, corrections, and reversals. For example a swing high is more significant if it is higher than the previous and following swing highs.

In the example below the high at (d) is more significant as it has lower swing highs on either side of it (b, f). Another absolute of the swing hierarchy concept is that after every swing high there must be an offsetting swing low before there is another swing high (and vise versa). In some situations there will be no evident alternating swing.

swing trading definition
A Swing Heiarchy

These so called hidden swings occur when as in the example below price makes a higher high (a) followed by a lower high, and then moves to new highs before making a lower low (b).
A hidden swing then is defined as the most extreme price reached in the opposite direction of the previous swing, without violating a previous bar, before price exceeds the previous swing. There are a large number of ways in which swings can be used in technical analysis, so it is important to understand them.

swing trading definition
A Hidden Swing
Swing trading definition and identification is critical to understanding markets. They can be easy to identify. The key is to be cognizant of the fact that if you can’t find one on a chart, drill down to a lower timeframe. You will then find it.