Now
that you know how to plot a bar chart, and having
introduced the three basic sources of information-price,
volume, and open interest-we're ready to look at how
that data is interpreted. Remember that the chart only
records the data. In itself, it has little value. It's
much like a paint brush and canvas. By themselves, they
have no value. In the hands of a talented artist,
however, they can help create beautiful images. Perhaps
an even better comparison is a scalpel. In the hands of
a gifted surgeon, it can help save lives. In the hands
of most of us, however, a scalpel is not only useless,
but might even be dangerous. A chart can become an
extremely useful tool in the art or skill of market
forecasting once the rules are understood.
Long Term Charts
Of
all the charts utilized by the market technician for
forecasting and trading the financial markets, the daily
bar chart is by far the most popular. The daily bar
chart usually covers a period of only six to nine
months. However, because most traders confine their
interest to relatively short term market action, daily
bar charts have gained wide acceptance as the primary
working tool of the chartist.
The
average trader's dependence on these daily charts,
however, and the preoccupation with short term market
behavior, cause many to overlook a very useful and
rewarding area of price charting-the use of weekly and
monthly charts for longer range trend analysis and
forecasting.
The
daily bar chart covers a relatively short period of time
in the life of any market. A thorough trend analysis of
a market, however, should include some consideration of
how the daily market price is moving in relation to its
long range trend structure. To accomplish that task,
longer range charts must be employed.
Whereas on
the daily bar chart each bar represents one day's price
action, on the weekly and monthly charts each price bar
represents one week's and one month's price action,
respectively. The purpose of weekly and monthly charts
is to compress price action in such a way that the time
horizon can be greatly expanded and much longer time
periods can be studied.
Continuation Chart Patterns
The
chart patterns covered here are called
continuation patterns. These patterns usually indicate
that the sideways price action on the chart is nothing
more than a pause in the prevailing trend, and that the
next move will be in the same direction as the trend
that preceded' the formation.
Another
difference between reversal and continuation patterns is
their time duration. Reversal patterns usually take much
longer to build and represent major trend changes.
Continuation patterns, on the other hand, are usually
shorter term in duration and are more accurately
classified as near term or intermediate patterns.
Notice
the constant use of the term "usually." The treatment of
all chart patterns deals of necessity with general
tendendes as opposed to rigid rules. There are always
exceptions. Even the grouping of price patterns into
different categories sometimes becomes tenuous.
Triangles are usually continuation patterns, but
sometimes act as reversal patterns. Although triangles
are usually considered intermediate patterns, they may
occasionally appear on long term charts and take on
major trend significance. A variation of the
triangle-the inverted variety-usually signals a major
market top. Even the head and shoulders pattern, the
best known of the major reversal patterns, will on
occasion be seen as a consolidation pattern.
Even
with allowances for a certain amount of ambiguity and
the occasional exception, chart patterns do generally
fall into the above two categories and, if properly
interpreted, can help the chartist determine what the
market will probably do most of the time.
Major Reversal Patterns
So
far we've touched on Dow Theory, which is the basis of
most trend following work being used today. We've
examined the basic concepts of trend, such as support,
resistance, and trend lines. And we've introduced volume
and open interest. We're now ready to take the next
step, which is a study of chart patterns. You'll quickly
see that these patterns build on the previous concepts.
In
Basic Concept of Trend, the definition of a trend was
given as a series of ascending or descending peaks and
troughs. As long as they were ascending, the trend was
up; if they were descending, the trend was down. It was
stressed, however, that markets also move sideways for a
certain portion of the time.
It
would be a mistake to assume that most changes in trend
are very abrupt affairs. The fact is that important
changes in trend usually require a period of transition.
The problem is that these periods of transition do not
always signal a trend reversal. Sometimes these sideways
periods just indicate a pause or consolidation in the
existing trend after which the original trend is
resumed.
The
five most commonly used major reversal patterns-the head
and shoulders, double and triple tops and bottoms, the
saucer, and the V, or spike. Of those, the most common
are the head and shoulders, and double tops and bottoms.
These patterns usually signal important trend reversals
in progress and are classified as major reversal
patterns. There is another class of patterns, however,
which are shorter term in nature and usually suggest
trend consolidations rather than reversals. They are
aptly called continuation patterns.
Free Online Chart Pattern
Recognition Lesson
