Profiting from Market Trends E-Book

Tina Logan

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 449

Veröffentlichungsjahr: 2014

Beschreibung

An accessible guide to identifying and profiting from financial market trends

Profiting from long-term trends is the most common path to success for traders. The challenge is recognizing the emergence of a trend and determining where to enter and exit the market. No body is more familiar with this situation than author Tina Logan. Now, in Profiting from Market Trends, she shares here extensive insights in this area with you.

Divided into four comprehensive parts?trend development, change in trend direction, reading the market, and profiting from technical analysis?this reliable resource skillfully describes how to identify the emergence of a new trend; quantify the strength of the trend; identify signals that confirm the trend or warn that the trend may be ending; and place trades to profit from trends. Written in an easy to understand and engaging style, Profiting from Market Trends effectively addresses how to apply the information provided to make money in today's dynamic markets.

• Examines essential tools for making the most of trend analysis
• Offers insights on how to execute the techniques discussed in real-world situations
• Written by a well-respected trader and trainer of traders

Understanding and identifying trends is one of the most important factors in successful trading. This book will show you how to achieve this elusive goal.

Leseprobe

PROFITING FROMMARKET TRENDS

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

The Wiley Trading series features books by traders who have survived the market's ever-changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional, or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.

For more on this series, visit our website at www.WileyTrading.com.

PROFITING FROMMARKET TRENDS

Simple Tools and Techniques for Mastering Trend Analysis

Tina Logan

Cover image: © iStockphoto.com/E_Y_E Cover design: Wiley

Copyright © 2014 by Tina Logan. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Logan, Tina.   Profiting from market trends : simple tools and techniques for mastering trend analysis/Tina Logan.     pages cm.—(Wiley trading series)   ISBN 978-1-118-51671-3 (cloth); ISBN 978-1-118-72698-3 (ePDF);   ISBN 978-1-118-72700-3 (ePub) 1. Technical analysis (Investment analysis) 2. Investment analysis. I. Title.   HG4529.L64 2014   332.63′2042—dc23

2013034305

CONTENTS

Cover

Half Title

Series Page

Title Page

Copyright Page

Preface

What Makes This Book So Valuable?

Format of This Instruction

Acknowledgments

Part I: Trend Development

Chapter 1: Introduction to Trend Analysis

What Is a Market Trend?

It's All About the Trend

Profiting from Market Trends

Let's Build a Clock

Chapter 2: Trend Direction

Price Peaks and Bottoms

Trendlines

Moving Averages

Determining Trend Direction

Building upon the Basics

Chapter 3: Trend Duration

Long-Term Trend

Intermediate-Term Trend

Short-Term Trend

Longer Trends Are Dominant

Trends within a Trading Range

Rapid Price Moves

Starting and Ending Points of Trends

Drawing Trendlines

Trends within Trends

Chapter 4: Trend Interruptions

Minor Trend Interruptions

Larger Trend Interruptions

Trend Reversals

Profiting from Trend Interruptions

Chapter 5: Early Trend Reversal Warnings

Climax Move

Divergence

Failure to Break a Prior Peak or Bottom

Change in Trendline Slope

Break of a Tight Trendline

Approaching a Strong Ceiling or Floor

Candlestick Reversal Patterns

Responding to Early Warnings

Chapter 6: Later Trend Reversal Warnings

Break of Support or Resistance

Break of a Strong Trendline

Break of a Strong Moving Average

Change in Direction of Peaks or Bottoms

Multiple Warnings

Why Not Just Let Stops Get Me Out?

Swing Trading Tips

Categorizing and Quick Reference Guides

Part II: Putting Trend Analysis to Work

Chapter 7: The Broad Market

The Business Cycle

Let the Market Be Your Guide

Monitoring the Market

Market Statistics

Chapter 8: Bull Markets

Bull Markets of the Past 50 Years

Early Development of a Bull Market

An Intermediate-Term View of a Reversal

Further Development of the Major Uptrend

The Trends Create Support and Resistance

End of a Bull Market

Chapter 9: Bear Markets

Bear Markets of the Past 50 Years

Early Development of a Bear Market

Further Development of the Major Downtrend

End of a Bear Market

Chapter 10: Monitoring the Market Trends

Monitoring the Intermediate-Term Uptrends

Monitoring a Bull Market Correction

Be Ready to Pounce after the Correction

Monitoring Bull Market Consolidation

Beware of a Break in the Market's Rhythm

Profiting through Working the Trends

Chapter 11: Current Bull Market—Case Study

The Reversal from Bear to Bull Market

The Intermediate-Term Market Trends

Evaluation of the Intermediate-Term Trends

Conclusion

Chapter 12: Conclusion

A Strong Core of Knowledge Leads to Profitable Strategies

My Trading Philosophy

Bibliography

About the Author

Index

PREFACE

During trending phases, market participants can really boost their returns. Thus, analyzing trends effectively is one of the most important and relevant skills a trader can develop. That's what you will learn from this unique book. You'll be shown how a trend begins and progresses through its life span offering traders myriad opportunities to generate profits. You'll learn how to monitor the strength of a trend in order to take full advantage of it while it lasts, and recognize signs that suggest when it may be coming to an end.

The principal purpose of this instruction is to help novices build a strong base of knowledge in trend analysis in order to increase ­profitability. This book is a crucial part of the charting instruction I offer, and is part of the foundation from which successful trading strategies may be developed and implemented. This text will help you progress down the path to becoming a master trader.

The primary reasons for learning how to analyze trends efficiently are threefold:

1. To generate profits by implementing strategies that take advantage of a trend.

2. To protect the initial capital invested, as well as the gains accrued during a trend.

3. To prepare to participate in a new trend in the opposite direction when a trend reversal occurs.

Understanding how trends evolve is very important because a large number of trading strategies are designed to capitalize on lucrative trending phases. By carefully reviewing this instruction, beginner to ­intermediate-level traders will gain the knowledge and understanding of market movement that will help them successfully implement various strategies they may be shown, or to develop their own unique strategies if they choose.

■ What Makes This Book So Valuable?

I want to thank you in advance for putting your confidence in me to help you develop or expand your charting knowledge and trading skills. I realize this book is not only an investment of your money, but also of your time. I understand and respect the value of both. Therefore, you can rest assured that I have worked tirelessly for several years developing my training content in a manner worthy of your investment.

This is not just another technical analysis reference book. Rather, it is a lively publication that reveals my passion for the subject matter and capitalizes on the following training characteristics I am known for:

It's an easy read—Although the content is technical, and gets progressively more advanced as the chapters unfold, it is easy to understand and it keeps the readers engaged.Well-organized material—The content of each chapter is categorized in ways to make it easy to learn. Each chapter builds upon the prior chapter with smooth transitions from one topic to the next.Details matter—The content goes far beyond just the broad strokes of technical analysis. You will appreciate the fine details and nuances, combined with plenty of helpful chart illustrations.Application of the content—You will be shown how to apply the information provided. Throughout the book you'll be given suggestions for applying your newfound knowledge to generate profits and protect ­capital.

Definitions are provided and technical topics are dissected, but I strive to put a conversational tone to my writing. I write for you like I'd talk to you if we were sitting elbow to elbow at my trading desk analyzing charts, including injecting a bit of geeky trader humor where appropriate. I tell you about my chart analysis and trading activities, and share with you some of the struggles I've experienced, and lessons learned, during my years in this industry.

Who Will Benefit from This Book?

This book will appeal to intermediate-level traders, many of whom, in spite of having some knowledge and experience, struggle to achieve consistent success. They just can't quite get their arms around it all and get their trading activities running smoothly. If this describes you, I believe you'll find this instruction provides important pieces of the puzzle that you've been missing.

For newcomers to the stock market, this book will prove to be ­invaluable. It will save them a significant amount of time and frustration; and for most, it will save them a lot of money that otherwise would be lost in the ­marketplace. The biggest danger to beginners is that they'll lose their capital and/or confidence before they learn what they need to know. And unfortunately, they don't know yet what they don't know! Analyzing trends effectively is one of the skills that most novices don't realize the importance of early in their trading careers; so it is my job to see to it that they acquire this critical knowledge early on.

It took me many years to develop my knowledge. But you can shave several months, and for some of you a few to several years, off your own learning curve by carefully studying, and then applying with discipline, the ­information presented in this book.

I make no apologies for defining technical terms and describing concepts that experienced traders might consider familiar territory. In fact, advanced traders may find parts of this book to be elementary relative to their level of knowledge. My primary audience is beginner to intermediate-level traders, so I feel I must direct my instruction in a manner that assures their understanding of it.

With that said, even highly skilled chartists who read this book should appreciate the painstaking attention to detail and earnest approach to providing important insights for readers of all skill levels. Seasoned technicians understand the value in acquiring at least one helpful trading tip or tool that adds to their knowledge, or helps to make or save them time or money. It can pay for the price of a book, seminar, or other training resource many times over.

■ Format of This Instruction

This book is broken into two segments, each containing several chapters:

Part I: Trend DevelopmentPart II: Putting Trend Analysis to Work

Part I outlines in detail some key tenets of charting, and provides fairly simple yet effective tools and techniques for analyzing trends in general. That is, the information applies to the charts of stocks, indices, sectors, and so on. Those chapters provide the important foundation of knowledge for analyzing trends, which sets the stage for more advanced discussion in the later chapters.

Part II puts those analysis techniques, plus some additional tools, to work demonstrating how to analyze the charts of market averages to help guide your overall trading activities. Chapter 11 includes one of the most extensive case studies you will likely ever come across. It is a detailed analysis of the current bull market, which has been included in order to really drill the information into your brain.

To help you absorb the wealth of information included in this text, and to make it easier for you to remember the concepts, bulleted and numbered lists, and tables, have been included throughout for quick reference.

During your review of the chapters, you should notice that certain concepts are reiterated, sometimes several times throughout the book. That is not done because I forgot that I already mentioned it in a prior chapter! But rather, because repeatedly bringing important concepts back into the discussion helps readers retain the information. A concept stated one way may not be assimilated; but the reader may fully understand it, and/or recognize its importance, when it is stated again later with a different example or when applying that information.

Since I use candlesticks in lieu of standard bar charts, I often refer to a specific candlestick line or pattern throughout this text. Those who are new to candlestick charting will find this aids in their understanding of the sentiment they reveal, as well as learning to recognize some of the reversal patterns that often form on charts. Those of you who read my first book, ­Getting Started in Candlestick Charting (John Wiley & Sons, 2008), will appreciate that I've included plenty of candlestick references that will build upon that instruction. Note: The terms candles and candlesticks are often used to refer to candlestick charting.

Time Frames

Most of the charting concepts and analysis techniques described are demonstrated utilizing the daily time frame. However, they may also be applied to other time frames. Short-, intermediate-, and long-term trends form on charts from yearly down to one minute; as do pullbacks, corrections, reversal patterns, and periods of consolidation. The implication is the same as the concepts shown on the daily charts, but relative to the time frame being analyzed. For instance, a short-term trend on the daily chart may last for several days, whereas on the hourly chart, a short-term trend may last for several hours.

Chart Examples

In the first several chapters, the chart examples provided are of clean and orderly trends and patterns. That was done intentionally to make sure readers fully absorb the concepts. However, in real-time analysis not all trends and patterns are ideally formed or shaped. Thus, as readers progress to the later chapters, not-so-clean examples, and variations, may be observed.

In many of the chart illustrations, only price bars are shown. That is, they may not have volume bars or technical indicators displayed. This should not be construed to mean that I do not utilize volume or indicators. I do use those tools regularly. However, when introducing a concept, I want readers to hone in on the price action being described and not be distracted by other technical tools. When indicators or volume are discussed, those chart examples will include them since they will be significant to that particular discussion.

All chart examples within this text are produced by TC2000®, which is a registered trademark of Worden Brothers, Inc., Five Oaks Office Park, 4905 Pine Cone Drive, Durham, NC 27707; phone [phone] or [phone], www.worden.com. Version 7 of the platform (known to long time users as TeleChart®) was used for ease of instruction and in order to perform the multi-year analysis required for completion of the extensive case study in Chapter 11. TC2000 users may also wish to explore version 12 of the platform, which, while it includes limited historical data, incorporates some new tools and features.

Chart Symbols

The symbols for charts of stocks and exchange-traded funds (ETFs) that are illustrated are universal. However, the symbols for the index charts shown may vary from one charting platform to another. For instance, in TC2000, the symbol for the Dow Jones Industrial Average is DJ-30. On the popular website StockCharts.com, the symbol is $INDU.

For many indices, the core of the symbol is common to all platforms, but there may be additional lettering or characters before or after it. For instance, the symbol for the Philadelphia Housing Sector Index in TC2000 is HGX--X and is $HGX on StockCharts.com. The Philadelphia Semiconductor Sector Index is SOX--X in TC2000 and $SOX on StockCharts.com.

Additional Information

Readers should be aware of the following:

The discussion in this book, and the illustrations, represent the U.S. stock market. However, trends occur in all markets as they are necessary for a market's long-term survival. Thus, the basic precepts of trend analysis can be used for a wide range of trading instruments.The pronoun he is used generically to reference traders of either gender. No offense is intended to lady traders, for I am one myself.The terms trader and investor may be used generically throughout the text to refer to all market participants, whether they be active traders or long-term investors. However, when applied specifically, as a general rule traders tend to take a more active role than investors.The word price is used generically to refer either to prices of stocks or values of indices shown in the price column.When a topic is introduced, if there is more than one term that tends to be used, I provide the various labels that I am aware of. This helps beginners avoid confusion since they may come across different labels in various texts.The terms index and average may be used interchangeably throughout this book in reference to the chart of an index or market average.

ACKNOWLEDGMENTS

I've had the great fortune of being influenced and motivated by several remarkable individuals during my life's journey. I wish I could thank them all sufficiently, but how does one do so with mere words? Those individuals who have left an imprint on my life range from family members and friends to special teachers from high school, college, and beyond. And if not for the years I spent working at the Anthony Robbins Companies, I'm certain I would not have become a trader, for it was there that my interest in the stock market was first sparked. From there, I had the privilege of working with Chris Manning of Manning Advanced Trading Seminars for a few years, which was an integral step in helping me develop a strong knowledge base of technical analysis.

There are many trading books on my shelf that I could not imagine parting with. I wish to thank the authors of those great, classic books—including works by Victor Sperandeo, Steve Nison, Alan Farley, Dr. Alexander Elder, Dr. Van Tharp, Thomas Bulkowski, Oliver Velez, Gregory Morris, John Murphy, Martin Pring, and Martin Zweig. The contributions they have made to me, and to so many others, by sharing their vast knowledge and insights are very much appreciated. Special recognition goes to Herbert Otto, a skilled trader and chartist with more than four decades of experience. I was fortunate to be introduced to him in the trading community over 10 years ago and have gleaned much from his vast knowledge and trading wisdom.

I would like to thank my family, of course, and my close friends for their seemingly never-ending patience and support. They may not understand why I'm so obsessed with the stock market and helping others navigate in this business, but they respect that I feel compelled to do so. I must recognize three of my great, long time friends, Jelaine Whipple, Debbie Hagan, and Michelle Becker. They have stood by me without wavering through all my challenges and successes over the years. Thanks goes to Billie Sandoval and Solveig Perry, who care enough to give me a gentle push, and sometimes even a good shove, just when I need it most.

Thank you to the fine folks at John Wiley & Sons, especially my editor, Kevin Commins, who agreed it was time for me to write another book (what was I thinking?). Special thanks to Senior Development Editor, Meg Freeborn, for patiently waiting and waiting for the manuscript and for fielding my many questions. Thanks also go to Tiffany Charbonier and her colleagues for their contributions, including designing the fantastic cover, and to Steven Kyritz for guiding me through the final editing process. It really takes tremendous teamwork and persistence to get a book to its finale.

PART I

TRENDDEVELOPMENT

CHAPTER 1

Introduction to Trend Analysis

Markets move in trends. This phenomenon is one of the major organizing principles of market behavior and one of the tenets of the Dow Theory. Some well-known axioms have been coined over the decades regarding market trends, such as “The trend is your friend” and “Don't fight the trend.” Numerous trading and investment strategies have been developed around the fact that markets move in trends. Most traders find it easier to profit when a market is trending than while it is in a period of prolonged consolidation.

■ What Is a Market Trend?

A simplistic definition of a market trend is a directional price move—either up or down. An uptrend is a price move that starts from a specific low point. A downtrend is a price move starting from a certain high point.

Traders ask many questions about the trend, such as the following:

Which direction is it moving?How long might it last?How strong is it?How can I spot opportunities to participate in a trend's movement?What signs should I look for that suggest the trend may be weakening or changing direction?Is this a good time to get aboard the trend?When should I exit the trend?

My answers to these questions fill the chapters of this book. The charting tools and techniques described herein are intended for the purpose of identifying and participating in a trend, gauging its strength, and responding to changes in its direction. In my opinion, these trend analysis tasks are among the most important activities an active trader or investor will perform.

Trends are an integral part of market analysis, whether it is technical analysis, fundamental analysis, or analyzing market breadth. Although the primary focus of this book is analyzing price trends, in market analysis the word “trend” is not limited to describing price movement. It may also be used to refer to other analysis concepts. Following are some examples where an analyst may notice an upward or downward trend, or a change in trend direction:

A trend in volume.A trend in the market internals. For example, the number of stocks making new highs versus new lows.A trend in the number of stocks meeting the criteria of a specific filter (e.g., the number of stocks trading above or below their 200-period moving average).A trend in the quarterly earnings growth rate of a company.A trend in the growth rate of the economy or the employment numbers.

■ It's All About the Trend

A common challenge for aspiring traders is that they don't fully understand the essential constructs of technical analysis (charting) before attempting to move on to more advanced study and practice. I fell into that trap myself early in my trading career. When I first began my charting studies many years ago, I felt a bit overwhelmed. I found I was spinning my wheels and feeling that there was so much to learn. I was studying various charting-related topics—gaps, support-resistance, candlesticks, chart patterns, technical indicators, and so on—each in isolation. That is, I studied each area of charting as if it was a stand-alone topic. Hence, it is not surprising I felt overwhelmed. There are so many different topics to learn, or so I thought.

Then one day I had one of those crucial “aha moments.” I realized that all those topics I had been studying were actually directly related to the development of market trends. It was then that I recognized the study of trends is the primary role of technical analysis. It was so much easier to really understand and implement the various charting concepts when I put them in the context of how they contributed to the development of a trend. That realization simplified and streamlined my studies; and significantly impacted my trading activities and strategy development going forward.

Most everything in technical analysis relates to the concept of trends in some fashion; you'll see that clearly demonstrated throughout this book. Table 1.1 lists several charting concepts directly related to the start, advancement, or conclusion of a trend.

Table 1.1 Trend Development

Charting TopicRole in Trend AnalysisGapsGaps often occur at the beginning (breakaway gap), middle (continuation gap), or end (exhaustion gap) of a trend. Those gaps reflect the start, acceleration, or end of a trend, respectively. Morning gaps play a significant role in short-term trends.Volume and VolatilityBoth volume and volatility often tend to increase during trending periods and decrease during periods of consolidation.Classic Reversal PatternsIt is common to see a reversal pattern form at the end of a trend. For instance, a double top or head-and-shoulders top may form at the end of an uptrend. The inverse of those patterns may form at the end of a downtrend. Such patterns signal a potential trend reversal.Classic Continuation PatternsContinuation patterns may form within a trend stalling its movement for a short period of time (e.g., a flag or pennant) or for a longer duration (e.g., a triangle or trading range).Candlestick Lines and PatternsCandlestick lines reveal the sentiment of market participants as a trend develops. A bearish or bullish candlestick reversal pattern may form at the end of an up or down trend, respectively.Price SwingsMinor, wavelike price movements create the peaks and bottoms that are the building blocks of intermediate-term trends. Those price swings may provide opportunities for short-term trades and profit-taking opportunities for long-term positions.CorrectionsCorrections are retracements of the prior trend.TrendlinesTrendlines are used to determine the direction, slope, and duration of a trend (sloped lines), as well as to highlight support and resistance areas (horizontal lines). The break of a strong trendline can provide an important signal about the potential continuation or reversal of a trend.Technical IndicatorsThere are many technical indicators designed for analyzing trends (e.g., to determine the direction and/or momentum of a trend). Some indicators can help identify when a trend may be weakening. For example, a divergence between price and a strong indicator may occur, warning of a potential trend reversal.Market IndicatorsExperienced traders may consult market breadth readings (market internals) to gauge the day-to-day strength of the market trend, as well as cumulative market indicators for monitoring longer trends.Trading StrategiesMany trading strategies are developed around the fact that markets trend. Trend-following strategies take advantage of a trending market. The success of setups traded, and strategies employed, at any given time may depend greatly on the trend (or lack of) of the broad market.

■ Profiting from Market Trends

Because the phenomenon of trends is so pivotal, much of technical analysis is devoted to the identification of trends and gauging their strength, so chartists can implement appropriate trading strategies. A significant amount of the chart analysis I perform is dedicated to monitoring the trends of the stocks I trade, as well as the major market averages, sectors, and industry groups.

Clearly, it is essential to learn how to analyze trends effectively in order to become a proficient chartist, and for determining which trading methods to employ. Listed below are some of the key skills traders should learn in order to achieve those goals. Helping you develop those skills, and subsequently profiting from market trends, is the primary purpose of this book.

Identify a trend as early as possible in its development in order to profit from as much of that trend's movement as possible.Determine a trend's strength and potential duration. Continually monitor the strength of the trend.Recognize technical events and price formations that occur within a trend that may offer trading opportunities.Understand the concept of support and resistance and its role in a trend's evolution.Identify signs that a trend may be weakening or reversing direction in order to protect profits and/or get aboard a new trend when a change in direction occurs.

■ Let's Build a Clock

I've been providing private tutoring for traders for almost 12 years. I've sat side-by-side with numerous traders of varying skill levels. I'm sure if you asked any of them, or the hundreds of individuals who have read my books, e-books, or attended my webinars, they'd tell you I'm ridiculously organized, very detail oriented, and probably too verbose. A client once said to me, “I asked you what time it is and you showed me how to build a clock!” I'd say he summed up my training style. I err on the side of providing tremendous detail rather than risk leaving questions unanswered.

As you review this book, I hope you'll appreciate the pains taken to ensure that readers are provided the fine points needed to actually put the information to work. But if, after reading all the chapters at least once, you find anything confusing, you are welcome to e-mail me your question at [email protected]. Please keep inquiries to a question or two and not a lengthy questionnaire, or I'll challenge whether you've reviewed the material enough times! But with that said, I am accessible and attempt to respond to e-mails in a timely manner.

Repeated Study Leads to Proficiency

It has been said that “Repetition is the mother of skill.” There is a lot of information in this text. Therefore, I encourage readers to review the content over and over again, as many times as it takes to absorb the information. Afterward, put that knowledge to work through vigorous application using real-time analysis, and effective trade selection and management, in order to generate profits.

There are several great trading books on my shelves that I've reviewed many times each. A couple of them have broken spines due to so much use. Thus, I wouldn't ask you to do anything I haven't done, or wouldn't be willing to do. True understanding of the content comes from repeated study and persistent application.

Develop a Strong Foundation of Knowledge

The first book I wrote was Getting Started in Candlestick Charting (John Wiley & Sons, 2008). I'm hooked on candlesticks and cannot imagine going back to using a standard bar chart. It is my opinion that candlesticks should be utilized in conjunction with other technical events that develop on charts.

Candlestick charts are used exclusively in the illustrations provided in this publication. You'll see references to specific candlestick lines (e.g., the size of a bar's body), and several commonly formed reversal patterns are identified. If you don't already have some familiarity with the basics of candlesticks, I suggest a quick review of Part I of Getting Started in Candlestick Charting.

A brief introduction to Western chart analysis was provided in Getting Started in Candlestick Charting. In Profiting from Market Trends, you'll see some of those core tenets of chart analysis revisited, but covered much more extensively here. This book delves deeply into trend analysis, and adds the important task of continually monitoring the trend of the broad market. As the title suggests, a thorough understanding of trends, and utilizing that information regularly in analysis and trading strategy development, can result in significant profits for those who do so with consistency and discipline.

There is much to learn in order to become a skilled chartist and a master trader. Enthusiastic students of the markets can quickly become overwhelmed and discouraged if they fail to develop a crucial knowledge base of chart analysis. The markets are unforgiving to those who dive in without adequate knowledge. Be patient and committed to your study of the material in this book and you'll reap the rewards that attract, but elude, so many who attempt to extract profits from the markets.

CHAPTER 2

Trend Direction

The trend indicates the direction the market is moving. There are only two directions in which markets can trend—up or down. There will also be phases where no trend is present and price moves primarily sideways for a period of time. Those trendless periods are often referred to as consolidation, or a trading range.

Personally, I like to stay informed as to the fundamental reasons why the market may be trending or consolidating; and I find that doing so helps to explain certain charting phenomena. However, it is not necessary to know what's driving the market up or down in order to profit from that trend. In his book The Visual Investor (John Wiley & Sons, 1996, p. 5), John Murphy states, “Knowing the reasons behind a stock's movement is interesting, but not critical. If your stock goes up on a given day, they won't take the money away from you if you don't know why it went up. And if you can explain why it went down, they won't give you back your lost money.” He goes on to say, “The trick to visual investing is learning to tell the difference between what is going up and what is going down.” Making that determination is the focus of this chapter.

A stock's price, or a market's value, cannot trend, nor can it move sideways, without the movement being imprinted on its chart. The effective analysis of that movement, and taking prudent action based upon it, can give a trader an edge. This chapter provides instruction on how to quickly and easily determine the direction of the trend. Following are three simple charting concepts that will be used to determine trend direction:

1. Price peaks and bottoms

2. Moving averages

3. Trendlines

■ Price Peaks and Bottoms

Price peaks and bottoms are pivots that form on charts. They show where price turned resulting in at least a temporary change in direction. Peaks and bottoms may be simple in their concept and construct, but don't underestimate their importance. They play a significant role in the development of trends, as well as in the selection and management of trades.

A peak is formed after an advance when price stops making higher highs from one bar to the next and makes a lower high. A peak consists of three bars with the middle bar's high being higher than the highs of the bars on either side of it (Figure 2.1). The very high of that middle bar indicates the precise point where price stopped its rise followed by a change in direction.

Figure 2.1 Peak

A bottom is formed after a decline when price stops making lower lows from one bar to the next and makes a higher low. It consists of three bars with the middle bar's low being lower than the lows of the bars on either side of it (Figure 2.2). The very low of that middle bar indicates the precise point where price stopped its decline followed by a change in direction.

Figure 2.2 Bottom

There are instances, though infrequent, when the pivoting action is formed from more than three bars. After a price advance, the high of two or more consecutive bars may be exactly the same price. In candlestick charting this is referred to as a Tweezers Top. As long as there are lower highs on each side of those consecutive highs, there is a peak present. After a price decline, if the low of two or more consecutive bars is exactly the same price it is a Tweezers Bottom. As long as there are higher lows on each side of those consecutive lows, a bottom is present. Figure 2.3 shows a Tweezers Bottom. The bars numbered 1 through 3 have exactly the same low with higher lows on either side.

Figure 2.3 Tweezers Bottom

These price pivots are basic elements of charting; however, many novices are not clear on their construct. That may be partially due to the fact that there are several different terms used to label those turning points. When I first began my study of technical analysis, I was not aware that a peak and a swing high were the same thing; so I set out to find the definitions for each term. After some frustration, I realized what was called a swing high in one text was called a peak in another and a rally high in yet another! To help you avoid the same confusion, listed below are all the terms I am aware of:

A peak may also be referred to by any of the following terms: swing high, pivot high, reaction high, rally high, rally top, rally peak, top, or fractal.A bottom may also be referred to by any of the following terms: swing low, pivot low, reaction low, rally low, trough, valley, or fractal.

Note: I may refer to a peak or a bottom as a pivot because of the pivoting action that occurs when one is formed. However, that reference should not be confused with pivot points as defined on the website www.investopedia.com or with pivot point analysis, such as the techniques described in John Person's book Candlestick and Pivot Point Trading Triggers (John Wiley & Sons, 2007).

It is important to understand the difference between a peak and the high of a price bar. The high of a price bar is the highest price reached during a single, daily trading session; or during one time increment on other time frames. If a stock is making higher highs from one bar to the next (numbers 1 through 5 in Figure 2.4), there is no peak until a lower high is formed (bar 6). Likewise, there is a difference between a bottom and a low of a price bar. The low of a price bar is the lowest price reached during the trading period. If a stock is making lower lows from one bar to the next (numbers 1 through 6 in Figure 2.5), there is no bottom until a higher low is formed (bar 7).

Figure 2.4 A Peak Was Formed on Bar 6

Figure 2.5 A Bottom Was Formed on Bar 7

I recall once listening to an audio presentation created by a well-known trainer in this industry. He indicated the definition of an uptrend was one making “higher highs and higher lows.” I've also seen a similar definition in a few books on technical analysis. It occurred to me that, even though the statement was “higher highs and higher lows,” an experienced trader would interpret that to mean higher swing highs (peaks) and higher swing lows (bottoms). This may seem like an obvious conclusion to a seasoned chartist; however, new chartists may not know enough yet to make that important distinction.

If inexperienced chartists were to take the words “higher highs and higher lows” literally, they might interpret the rise shown in the boxed area of Peabody Energy (BTU) in Figure 2.6 as an uptrend. The stock did indeed make higher highs and higher lows from one bar to the next for a short period of time from March 5 to 8, 2013 (refer to the arrows in Figure 2.6). However, as the bigger picture of the chart clearly shows, this stock is in a downtrend. The stock was forming lower peaks and lower bottoms. The price advance that occurred from March 5 to 8 was just a temporary relief rally. That is, it was a short-term uptrend within the longer downtrend. If I were asked the direction of the trend in Figure 2.6, I'd respond, “The short-term trend shown at the right edge of the chart is up, but the intermediate-term trend is down.” The downtrend continued (not shown) after that relief rally. In Chapter 3 you'll learn more about short-, intermediate-, and long-term trends.

Figure 2.6 A Relief Rally within a Downtrend

Source: TC2000® chart courtesy of Worden Brothers, Inc.

Hopefully, this emphasizes the importance of making sure to be clear on the semantics and the context when learning about charting concepts. Read the text carefully and look closely at the accompanying chart or illustration if one is provided. Make sure you really understand what the author is attempting to get across to the readers. For example, if it is stated that price has made a new high, the author may be referring to one of the following:

A new high of day—The highest price reached during a single daily trading session.A new swing high (peak)—A pivot that forms after a price advance (see Figure 2.1).A new 52-week high—The highest price reached in the past year.A new all-time high—The highest price ever achieved by that stock or index.

Price Pivots Are the Building Blocks of Trends

Throughout this book you'll see how price pivots play an important role in the development of a trend. As price moves up and down in the general direction of the trend, a series of peaks and bottoms will form on the chart (Figure 2.7). Some of those price pivots will be prominent (obvious to many traders), while others will be minor. The prominent formations draw attention to the direction of the trend.

Figure 2.7 Peaks and Bottoms Form within a Trend

Source: TC2000® chart courtesy of Worden Brothers, Inc.

Price pivots also comprise the formation of classic chart patterns that tend to either interrupt (continuation patterns) or reverse (reversal patterns) a trend. For instance, note the double bottom bullish reversal pattern that formed on the chart in Figure 2.7. Two prominent bottoms formed at approximately the same price level, making the pattern very recognizable.

If you look at a triangle or trading range that forms on a chart, you'll see that it is formed from peaks and bottoms as price swings back and forth across the pattern. Those price pivots create the upper and lower boundaries of the consolidation pattern. Head-and-shoulders bottoms and tops are common reversal patterns. The head and the shoulders are comprised of pivots that define the setup of the potential reversal pattern.

Roles of Price Pivots

Price pivots are extremely important in trend analysis. They allow traders to perform tasks such as the following, all of which will be addressed within the chapters of this book:

Determine the direction of the trend. An uptrend is comprised of rising peaks and rising bottoms; and a downtrend is formed from declining peaks and declining bottoms.Draw trendlines to identify the direction, slope, and duration of the trend. Trendlines connect price pivots.Identify support and resistance levels that form within trends.Recognize when the trend may be losing momentum. For example, a divergence is present; or price is unable to surpass the prior peak (uptrend) or bottom (downtrend).Determine when a trend may be changing direction (e.g., price breaks support or resistance).Define the precise starting and ending points of a trend.Calculate the amount of gain or loss during a trend. That is, determine the distance price traveled either in points or percentage (or both).

Price pivots are also crucial for trade management decisions for many trading strategies. For instance, they may be utilized as setups for entering trades, for determining targets for taking profits, and for setting stop loss orders to protect capital.

■ Trendlines

One of the simplest tools available to chartists is the trendline. Its simplicity should not diminish its value, though. Trendlines can be very helpful for determining the direction, slope, and length of the trend, as well as alerting to a potential reversal of the trend when an important line is broken. Most charting programs offer a trendline drawing tool among their basic features.

A trendline is drawn touching the turning points of peaks or bottoms as follows:

Resistance trendline—The downward sloping trendline is drawn across and connecting the declining peaks (numbered 1 through 4 in Figure 2.8) trapping the price action below the line.Support trendline—The upward sloping trendline is drawn across and connecting the rising bottoms (numbered 1 through 3 in Figure 2.9) trapping the price action above the line.

Figure 2.8 Resistance Trendline

Figure 2.9 Support Trendline

There must be at least two peaks or bottoms present in order to draw a resistance or support trendline, respectively. Some chartists require a third touch before they consider the line to be valid. The more times price pivots at/near a trendline, the stronger the line is and the more meaningful when broken.

In most technical analysis texts, the word “trendline” is used in reference to an upward or downward sloping line. However, horizontal lines can also be drawn on charts to identify important support and resistance levels formed by prior peaks and/or bottoms, and extended to the right edge of the chart to identify when price is approaching those levels again. I draw as many, if not more, horizontal lines on charts as sloped lines. Thus, when I refer to the practice of utilizing trendlines, it includes drawing sloped trendlines as well as horizontal support-resistance lines in the chart window for the purpose of assisting with chart analysis. You'll see many examples of both types of lines drawn throughout this text.

External and Internal Trendlines

There are often debates among traders regarding how to draw trendlines. I'd say the most common argument is whether or not to clip the shadows of price bars when touching the lines to the price pivots. An external trendline rests on the very edges of the pivots—at the highest point of a peak (Figure 2.10) and the lowest point of a bottom (Figure 2.11). External lines do not cut through any price points. This is the traditional method of drawing trendlines described in many technical analysis books.

Figure 2.10 Peak

Figure 2.11 Bottom

An internal trendline rests on the bodies of the peaks and bottoms. For a peak, it rests on the top of the highest body in the pivot (Figure 2.10). For a bottom, it touches the bottom of the lowest body in the pivot (Figure 2.11). The line can slice off the shadow(s) of a pivot, but it should not cut through the body of a bar. The shadows represent the extreme prices, or outliers. Many experienced chartists use this method.

Note: The body is the boxed area of the candlestick line representing the area between the opening and closing prices. The shadows are the thin, vertical lines above and below the body. The upper and lower shadows represent the distance from the top of the body to the high of the bar and from the bottom of the body to the low of the bar, respectively.

In his book Getting Started in Chart Patterns (John Wiley & Sons, 2006, p. 18), Thomas Bulkowski provides the following easy-to-understand distinction: “If the price peak were a hill, an internal trendline would rest on the ground. An external trendline, by contrast, would only connect the tops of the tallest trees.”

Figure 2.12 illustrates the difference between an external and internal trendline. Which is best to use? Chartists will argue for their preference. As a general rule, I favor internal trendlines. I feel they show where most of the price action occurred; whereas the edges of the shadows (the external line) represent the extreme prices where there may have only been a few trades executed. However, I consider both lines to be valid; and the area between the two is a zone of support or resistance. As a general rule, though, when it comes to determining the actual break point, in most cases I'd suggest requiring price close beyond the external line to consider it a valid trendline break—especially when there is not much distance between the two lines as illustrated in Figure 2.12. Doing so puts price clearly outside that zone of support (up trendline) or resistance (down trendline).

Figure 2.12 External versus Internal Trendline

■ Moving Averages

Moving averages are trending indicators that are plotted over price. They help take some of the noise out of price movement. Plotting a moving average over price helps to smooth out the fluctuations and distortions that are inherent in most trends and draw the trader's eye to the primary direction of the trend. As a general rule, a rising moving average indicates an uptrend and a declining moving average indicates a downtrend. Think of a moving average as sort of a moving trendline.

The 20-period is a good moving average length to use for the purpose of determining the direction of an intermediate-term or longer trend (other moving average lengths will be discussed later). It is a fairly robust setting and works well on all time frames. During a strong upward move, the 20-period simple moving average (SMA) will be rising most of the time, and vice versa during a decline. When price moves sideways for a prolonged period of time (a trendless phase), the 20-period moving average will move sideways or exhibit a rolling motion until price begins to trend again. The daily chart of AT&T, Inc. (T) in Figure 2.13 illustrates all three scenarios. Note: The moving average will lag behind price, so it does not provide precise timing signals for trend reversals.

Figure 2.13 The 20-Period SMA Helps Identify the Trend Direction

Source: TC2000® chart courtesy of Worden Brothers, Inc.

Another way to use moving averages to determine trend direction is to plot two short-term moving averages over price, for example a 10- and 20-period moving average. During an uptrend, the faster 10-period moving average will remain above the slower 20-period moving average during most of the uptrend, and vice versa in a downtrend. During a trendless phase, the two moving averages will flatten out or roll, so they may intertwine until price begins trending again.

■ Determining Trend Direction

Since a stock or market may only trend up or down, it might seem as if the direction of the trend should be quite obvious; and often that is the case. However, trends do not develop in a straight line. Rather, price tends to zig and zag its way in the general direction of the longer trend, and may be in transition at the time of analysis.

With the help of price peaks and bottoms, trendlines and moving averages, we have the necessary tools to quickly determine the direction of the trend. The techniques described below can be used to determine the direction of intermediate-term trends and many long-term trends; however, trying to apply them to short-term trends may be futile because short price moves often don't last long enough to form two or more price pivots. You'll learn more about short-, intermediate-, and long-term trends in Chapter 3.

Criteria for an Uptrend

An uptrend can be identified by the technical events listed in Table 2.1.

Table 2.1 Criteria for an Uptrend

Peaks and BottomsAn uptrend is formed from primarily rising peaks and rising bottoms.Moving AveragesThe 20-period moving average will be rising, and price will remain above it, much of the time during the uptrend. If using two short-term moving averages, the faster one (e.g., 10-period) will remain above the slower one (e.g., 20-period) throughout much of the uptrend.Support TrendlineAn upward sloping trendline can often be drawn below and connecting the prominent rising bottoms.

During an uptrend, the upward price swings typically consist of primarily bullish candles. The magnitude of those upswings is usually greater than that of dips that follow; otherwise the uptrend could not continue. If price pulls back deeply enough, price may temporarily decline below the rising 20-period SMA. Price will move back above it when the uptrend resumes. In some cases, a pullback will be deep enough for the moving average to turn down temporarily; it will turn back up as price resumes the uptrend.

There must be at least one new, prominent rising bottom after the stock changes direction from a downtrend to an uptrend before a rising support trendline can be drawn. The trendline should touch the bottom that was the reversal point of the prior downtrend, and a higher bottom (labeled B1 and B2 in Figure 2.14). There may not be one specific price pivot that marks the precise reversal point; instead, there will often be some type of bottoming price action followed by rising bottoms. For instance, price may form a double bottom (see Figure 2.7) or a rounded or rectangular-type bottom before a new uptrend emerges. But at some point, rising bottoms will be present allowing for an up trendline to be drawn.

Figure 2.14 A Stock in an Uptrend

Source: TC2000® chart courtesy of Worden Brothers, Inc.

Figure 2.14 shows a daily chart of Zumiez, Inc. (ZUMZ). The shift from downtrend to uptrend began off the December 2012 bottom (labeled B1). The rising bottoms (labeled B2 through B4) represent the upward shift. The prominent peaks (labeled P1 through P4) are rising. The 20-period simple moving average (SMA) turned up and is rising. Additionally, a support trendline can be drawn connecting the rising bottoms (an internal trendline is illustrated). In fact, if desired, a parallel resistance trendline could also be drawn across the rising peaks identifying what is referred to as an ascending price channel.

Criteria for a Downtrend

A downtrend can be identified by the technical events listed in Table 2.2.

Table 2.2 Criteria for a Downtrend

Peaks and BottomsA downtrend is formed from primarily declining peaks and declining bottoms.Moving AveragesThe 20-period moving average will be declining, and price will remain below it, much of the time during the downtrend. If using two short-term moving averages, the faster one (e.g., 10-period) will remain below the slower one (e.g., 20-period) throughout much of the downtrend.Resistance TrendlineA downward sloping trendline can often be drawn above and connecting the prominent declining peaks.