Directional Trends (Up and Down) in Technical Analysis

We have just considered trading ranges in which successive peaks and troughs occur at roughly the same price level. This results in a flat or sideways trend in prices. Whenever reversal points are occurring at higher (lower levels) than the previous reversal points, price is trending upward (or downward). 1. What Is a Directional

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Other Types of Trend Lines in Technical Analysis

The concept of trend is central to the field of technical analysis. Therefore, analysts have developed a number of applications and variations of trend lines. Trend lines are not just useful with bar charts; analysts using point and figure charts make use of trend lines. Speed lines, Andrews Pitchfork, and Gann fan lines are

Breakouts in Technical Analysis

A breakout occurs most often when a price “breaks out” through a prior support or resistance level or zone. A breakout often but not always signals that a significant change in supply and demand has occurred and that a new price trend is beginning. For this reason alone, a breakout is an extremely important

Stops in Technical Analysis

A stop order is an order to buy or sell once a specific price has been surpassed. For example, a buy stop would be an order to buy a security at a specified price above the current price. Should the price rise to the specified buy stop price, it will be bought at the

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Retracements in Technical Analysis

The final subject relating to trends is retracements. As mentioned and observed previously, a trend rarely follows a line without including a number of smaller trends. The smaller countertrends are called retracements, and several rules have been developed concerning them. Retracements are always corrections to the principal trend. As prices rise, for example, in

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Chapter Objectives

By the end of this chapter, you should Be aware of how moving averages are used to identify trends Be able to calculate a simple moving average Be able to calculate an exponential moving average Be familiar with the concept of directional movement Be familiar with the construction of envelopes, bands, and price channels

What Is a Moving Average in Technical Analysis?

The moving average is one of the oldest tools used by technical analysts. Daily fluctuations in stock prices, commodity prices, and foreign exchange rates can be large. Moving averages tone down these fluctuations— deemphasizing but sometimes distorting fluctuations. Technical analysts use moving averages to smooth erratic data, making it easier to view the true

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How Is a Simple Moving Average Calculated?

Table 14.1 contains the daily closing prices for WMT (Walmart) from November 18, 2014 through February 26, 2015. Most moving averages of prices are based on closing prices, but they can be calculated on highs, lows, daily means, or any other value as long as the price type is consistent throughout the calculations. We

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What Other Types of Moving Averages Are Used?

Although we have discussed various lengths of moving averages, up to this point our discussion has centered on the most basic type of moving average calculation—the SMA. Remember that each day’s calculation of the SMA represents adding the most recent day’s price figure and dropping the earliest day’s price figure. When calculating the simple

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Strategies for Using Moving Averages

We have looked at a number of ways to calculate moving averages. Although each of these methods has its advantages and disadvantages, our main concern is not how to calculate a moving average but how to use moving averages to make money. Moving averages are widely used in the practice of technical analysis. They

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What Is Directional Movement in Technical Analysis?

One of the great contributions to the concept of trend and direction is the concept of directional movement that Welles Wilder (1978) developed in his book New Concepts in Technical Trading Systems. Wilder compared a stock’s trading range for one day with the trading range on the previous day to measure trend. Positive directional

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What Are Envelopes, Channels, and Bands?

The simple moving average represents the center of a stock’s price trend. Actual prices tend to oscillate around that moving average. The price movement is centered on the moving average but falls within a band or envelope around the moving average. By determining the band within which prices tend to oscillate, the analyst is

What Is a Pattern in Technical Analysis?

In the literature and usage of technical analysis, the terms pattern and formation are used interchangeably. We will do the same. A pattern is simply a configuration of price action that is bounded, above and below, by some form of either a line or a curve. The lines that bind price movement in a

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Do Patterns Exist?

Some academics and investors believe that patterns do not exist. They believe either that price action is completely random or, at least, is indecipherable. We saw in Chapter 4, “The Technical Analysis Controversy,” that the concept of randomness is now being questioned, leaving open the possibility that order does exist in prices. However, even

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Computers and Pattern Recognition in Technical Analysis

Analysts began recognizing chart patterns in the days when prices were plotted daily by hand. Aside from trend lines, patterns were the beginning of technical analysis, and for this reason, many nontechnicians mistakenly believe that patterns are all that technicians study. Floor traders and market makers still plot intraday charts of prices for their

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Market Structure and Pattern Recognition in Technical Analysis

The markets, of course, have also changed since the beginning of technical analysis and the first recognition of patterns, and with this change, patterns have changed and become less accurate. First, the proliferation of technical knowledge has led to the recognition of specific patterns when they occur. Of course, once a pattern is widely

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Bar Charts and Patterns in Technical Analysis

From Chapter 11, you know how to plot a bar chart. It is the most common chart of price behavior and has been used ever since continuous trading data became available. In Chapter 12, you learned how to determine support and resistance zones and trend lines using bar charts. Bar chart patterns form by

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How Profitable Are Patterns?

Studies of chart performance and reliability are scarce. The problem, of course, is the difficulty in defining a chart pattern on a computer. In 1970, one of the authors of this book and Robert Levy (1971) devised a method to identify patterns by recording the sequence of reversal points relative to their immediate past

Classic Bar Chart Patterns in Technical Analysis

We begin by looking at classic chart patterns. These patterns generally have been recognized and used for more than a hundred years. Only recently have there been tests of their reliability and profitability. 1. Double Top and Double Bottom A double formation is about the simplest of the classic formations. A double top consists

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Patterns with Rounded Edges – Rounding and Head-and-Shoulders

The patterns we have considered up to this point have been defined by straight lines. When we begin to define patterns with curved lines, we become more indefinite than with using straight lines such as trend lines. This does not make the patterns any less useful, but it does make them more difficult to

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