PART - I

1.1 Philosophy of Technical Analysis 9

- Introduction

- Philosophy or Rationale

- Technical versus Fundamental Forecasting

1.2 Dow Theory 14

- Introduction

- Basic Tenets

- The use of Closing Prices and the Presence of Lines

- Some Criticisms of Daw Theory

1.3 Basic Concepts of Trend 20

- Definition of Trend

- Types of Trend

- Three Classifications

- Support and Resistance

- The Fan Principle

- The Channel Line

- Percentage Retracements
PART - II

2.1 Constructing The Candlesticks 33

- Drawing the candlestick lines

2.2 Reversal Patterns 35

- Hammer and hanging-man lines

- Inverted hammer and shooting star

- Dark-cloud cover

- Piercing pattern

- Engulfing pattern

- The morning star

- The evening star

2.3 Small Bodies 41

- Spinning Tops and High Wave

2.4 The Magic Doji 42

- The importance of the doji

- Doji at tops

- Doji after a long white candlestick

- The long-legged doji and the rickshaw man

- The gravestone doji

- Doji as support and resistance

- The tri-star
PART - III

3.1 Market Indicators 47

- The Moving Average

- Moving Average Envelopes

- Bollinger Bands

- Average Directional Movement Index

- Commodity Channel Index

- MACD

- Momentum

- Relative Strength Index

- Stochastic Oscillator

- Rate of Change

- KST (Know Sure Thing)

- Volume

- Volume Profile

- Ichimoku

Tenkan Sen

Kijun Sen

Chikou Span

Kumo Cloud Components

Senkou Span A

Senkou Span B

Kumo Cloud

Components

Strategy Description
PART - IV

4.1 Trade Patterns 85

- Market Structures

- Three Bar Groups

- Matching High/Lows

- 7 Day Narrow Range & Inside Day

- 7 Day Wide Range & Outside Day

- Double Top and Double Bottom

- Triple Top and Triple Bottom

- Head and Shoulders & Inverted Head and Shoulder

- Round Top and Round Bottom

- Symmetrical Triangle

- The Ascending and Descending Triangle

- Flags and Pennants

- Wedge

PART - V

5.1 Time Cycles 111

- Introduction

- How Cyclic Conceptsand Charting Techniques

- Left and Right Translation

- Sesonal Cycles

- Stock Market Cycles

PART - VI

6.1 Point and Figure 119

- Introd uction t o Point and Figure Charts

- History and development

- Where did Point and Figure charts get their name?

- The voice of the market

6.2 Charateristics and Construction 124

- Characteristics o f Point and Figure charts 53 Constructed with XS
and Os
- Up moves and down moves
- Xs and Os called boxes
- Box size

- Reversal size

6.3 Understanding Point and Figure Chart 127

- Point and Figure signals

- Double-top and bottom patterns
- Continuation as well as reversal
- Reversal patterns in I -box charts
- Triple-top and bottom patterns
- I -box charts
- Compound patterns
- Knowing when to ignore signals
- 1 -box and 3-box patterns
- Trend line breaks
- Projecting Price Targets
- Counts on I-box reversal charts

- Counts on 3-box reversal charts

PART - VII

- Risk and reward 139

PART - I
INTRODUCTION
Before beginning a study of the actual techniques and
tools used in technical analysis, it is necessary first to
define what technical analysis is, to dicuss the philosophical
premises on which it is based, to draw some clear
distinctions between technical and fundamental analysis
and, finally, to address a couple of criticisms frequently
raised against the technical approach.
I strong belief is that a full appreciation of the
technical approach must begin with a clear understanding
of what technical analysis claims to be able to do and,
maybe even more importantly, the philosohy or rationale
on which it bases those claims.
First, let's define the subject. Technical analysis is the
study of market action, primarily through the use of
charts, for the purpose of forecasting future price trends.
The term "market action" includes the three principal
sources of informatioon available to the technician price,
volume and open interest. (Open interest is used only in
futures and options.) The term "price action," which is
often used, seems too narrow because most technicians
include volume and open interest as an integral part of
their market analysis. With this distinction made, the
terms "price action" and "market action" are used
interchangeably throughout the remainder of this discussion.

PHILOSOPHY OR RATIONALE
There are three premises on which the technical
approach is based :
1. Market action discounts everything.
2. Prices move in trend.
3. History repeats itself.
Market Action Discounts Everything
The statement "market action discounts everything"
forms what is probably the cornestone of technical analysis.
Unless the full significance of this first premise is fully
understood and accepted, nothing else that follows makes
much sense. The technician believes that anything that can
possibly affect the price fundamentally, politically,
psychologically, or otherwise is actually reflected in the
price of the market. It follows, therefore, that a study of
price action is all that is required. While this claim may
seem presumptuous, it is hard to disagree with if one
takes the time to consider its true meaning.
All the technician is really claiming is that price
action should reflect shifts in supply and demand. If
demand exceeds supply, prices should rise. If supply
exceeds demand, prices should fall. This action is the basis
of all economic and fundamental forecasting. The technician
then turns this statement around to arrive at the conclusion
that if prices are rising, for whatever the specific reasons,
demand must exceed supply and the fundamentals must
be bullish. If prices fall, the fundamentals must be bearish.
If this last comment about fundamentals seems surprising
in the context of a discussion of technical analysis, it
souldn't. After all, the technician is indirectly studying
fundamentals. Most technicians would probably agree that
it is the underlying fores of supply and demand, the
economic fundamentals of a market, that cause bull and
bear markets. The charts do not in themselves cause
markets to move up or down. They simply reflect the
bullish or bearish psychology of the marketplace.
As a rule, chartists do not concern themselves with
the reason why price rise or fall. Very often, in the early
stages of a price trend or at critical turning points, no
one seems to know exactly why a market is performing
a certain way. While the technical approach may sometimes
seem overly simplistic in its clims, the logic behind this
first premise that markets discount everything becomes
more compelling the more market experience one gains.
It follows then that if everything that affects market price
is ultimately reflected in market price, then the study of
that market price is all that is necessary. By studying
price charts and a host of supporting technical indicators,
the chartist in effect lets the market tell him or her which
way it is most likely to go. The chartist does not
necessarily try to outsmart or outguess the market. The
chartist knows there are reasons why markets go up or
down. He or she just doesn't believe that knowing what
those reason are is necessary in the forecasting process.

Price Move In Trends

The concept of trend is absolutely essential to the
technical approach. Here again, unless one accepts the
premise that markets do in fact trend, there's no point in
reading any further. The whole purpose of charting the
price action of a market is to identify trends in early
stages of their development for the purpose of trading in
the direction of those trends. In fact, most of the techniques
used in this approach are trend-following in nature,
meaning that their intent is to identify and follow existing
trend.
There is a corollary to the premise that prices move
in trend a trend in motion is more likely to continue than
to reverse. This corollary is, of course, an adaptation of
Newton's first law of motin. Another way to state this
corollary is that a trend in motion will continue in the
same direction until it reverses. This is another one of
those technical claims that seems almost circular. But the
entire trend-following approach is predicated on riding an
existing trend until it shows sings of reversing.
History Repeats Itself
Much of the body of technical analysis and the study
of market action has to do with the study of human
psychlogy. Chart patterns, for example, which have been
identified and categorized over the past one hundred
years, reflect certain pictures that appear on price charts.
These pictures reversal the bullish or bearish psychology
of the market. Since these patterns have worked well in
the past, it is assumed that they will continue to work
well in the future. They are gbased on the study of human
psychlogy, which tends not to change. Another way of
saying this last premise that history repeats itself is that
the key to understanding the future lies in a study of the
past, or that the future is just a repetition of the past.

TECHNICAL VERSUS FUNDAMENTAL FORECASTING

While technical analysis concentrates on the study of
market action, fundamental analysis focuses on the economic
forces of supply and demand that cause prices to move
higher, lower, or stay the same. The fundamental approach
examines all of the relevant factors affecting the price of
the market in order to determine the intrinsic value of
that market. The intrinsic value is what the fundamentals
indicate something is actually worth based on the law of
supply and demand. If this intrinsic value is under the
current market price, then the market is overpriced and
should be sold. If market price is below the intrinsic
value, then the market is undervalued and should be
bought.
Both of these approaches to market forecasting attempt
to solve the same proble, that is, to determine the
direction prices are likely to move. They just approach the
problem from different directions. The fundamentalist studies
the cause of market movement, while the technician studies
the effect. The technician, of course, believes that the effect
is all that he or she wants or needs to know and that
the reasons, or the causes, are unnecessary. The fundamentalist
always has to know why.
Most traders classify themselves as either technicians
or fundamentalists. In reality, there is a lot of overlap.
Many fundamentalists have a working knowledge of the
basic tenets of chart analysis. At the same time, many
technicians have at least a passing awarness of the
fundamentals. The problem is that the charts and
fundamentals are often in conflict with each other. Usually
at the beginning of important market moves, the
fundamentals do not explain or support what the market
seems to be doing. It is at these critical times in the trend
that these two approaches seem to differ the most. Usually
they come back into sync at some point, but often too late
for the trader to act.
One explanation for these seeming discrepancies is
that market price tends to lead the known fundamentals.
State another way, market price acts as a leading indicator
of the fundamentals or the conventional wisdom of the
moment. While the known fundamentals have already
been discounted and are already "in the market," prices
are now reacting to the unknown fundamentals. Some of
the most dramatic bull and bear markets in history have
begun with little or no perceived change in the fundamentals.
By the time those changes become known, ther new trend
was well underway.
After a while, the technician develops increased
confidence in his jor her ability to read the charts. The
technician learns to be comfortable in a situation where
market movement disagrees with the so-called conventional
wisdom. A technician begins to enjoy being in the minority.
He or she knows that eventually the reasons for market
action will become common knowledge. It is just that the
technician isn't willing to wait for that added confirmation.
 In accepting the premises of technical analysis, one
can see why technicians believe their approach is superior
to teh fundamentalists. If a trader had to choose only one
of the two approaches to use, the choice would logically
have to be the technical. Because, by definition, the
technical approach includes the fundamenta. If the
fundamentals are reflected in market price, then the study
of those fundamentals become unnecessary. Chart reading
becomes a shortcut form of fundamental analysis. The
reverse, however, is not true. Fundamental analysis does
not include a study of price action. It is possible to trade
financial markets using just the technical approach. It is
doubtful that anyone could trade off the fundamentals
alone with no consideration of the technical side of the
market.

DOW THEORY
INTRODUCTION
Charles Dow and his partner Edward Jones founded
Dow Jones & Company in 1882. Most techncians and
students of the markets concur that much of what we call
technical analysis today has its origins in theories first
proposed by Dow around the turn of the century. Dow
published his ideas in a series of editorials he wrote for
the Wall Street Journal. Most technicians today recognize
and assimilate Dow's basic ideas, whether or not they
recognize the source. Dow Theory still forms the cornerstone
of the study of technical analysis, even in the face of
tody's sophiticated computer technology, and the proliferation
of newer and supposedly better technical indicators.
On July 3, 1884, Dow published the first stock market
average composed of the closing prices of eleven stocks:
nine railroad companies and two manufacturing firms.
Dow felt that these eleven stocks provided a good indication
of the economic health of the country. In 1897, Dow
determined that two sparate indices would better represent
that health, and created a 12 stock industrial index and
a 20 stock rail index. By 1928 the industrial index had
grown to include 30 stocks, the number at which it stands
today. The editors of the Wall Street Journal have updated
the list numerous times in the ensuing years, adding a
utility index in 1929. In 1984, the year that marked the
one hundredth anniversary of Dow's first publication, the
Market Technicians Association presented a Gorham-silver
bowl to Dow Jones & Co.According to the MTA, the award
recognized " the lasting countribution that Charles Dow
made to the field of investment analysis. His index, the
forerunner of what oday is regarded as the leading
barometer of stock market activity, remains a vital tool
for market technicians 80 years after his death."
Unfortunately for us, Dow never wrote a book on his
theory. Instead, he set down his ideas of stock market
behavior in a series of editorials that The Wall Street
Journal published around the turn of the cedntury. In
1903, the year after Dow's death, S.A.Nelson compiled
these essays into a book entitled The ABC of Stock
Speculation. In that work, Nelson first coined the term
"Dow's Theory." Richard Russell, who wrote the introduction
to a 1978 reprint, compared Dow's contribution to stock
market theory with Freud's contribution to psychiatry. In
1922, William Peter Hamilton (Dow's accociate and successor
at the Journal) categorized and published Dow's tenets in
a book entitled The Stock Market Barometer. Robert Rhea
developed the theory even further in the Dow Theory
(New York: Barron's) published in 1932.
Dow applied his theoretical work to the stock market
averages that he created; namely the Industrials and the
Rails. However, most of his analytical ideas apply equally
well to all market averages.
BASIC TENETS
1. The Average Discount Everything
The sum and tendency of the transactions of the Stock
Exchange represent the sum of all Wall Street's knowledge
of the past, immediate and remote, applied to the discounting
of the future. There is no need to add to the averages,
as some statisticians do, elaborate compilations of commodity
price index numbers, bank clearings, fluctuations in exchange,
volume of domestic and foreign trades or anything else.
Wall Street considers all these things.
The idea that the markets reflect every possible
knowable factor that affects overall supply and demand
is one of the basic premises of technical theory, as was
mentioned. The theory applies to market averages, as well
as it does to individual markets, and even makes allowances
for " acts of God." While the markets cannot anticipate
events such as eqrthquakes and various other natural
calamites, they quickly discount such occurrences, and
almost instantaneously assimilate their affects into the
price action.

2. The Market Has Three Trends

Before discussing how trends behave, we must clarify
what Dow considered a trend. Dow defined an uptrend
as a situation in which each successive rally closes higher
than the previous rally high, and each successive rally low
also closes higher thant the previous rally low. In other
words, an uptrend has a pattern of rising peaks and
troughs. The opposite situation, with successively lower
peaks and troughs, defines a downtrend. Dow's definition
has withstood the test of time and still forms the cornestone
of trend analysis.
Dow believed that the laws of action and reaction
apply to the markets just as they do to the physical
universe. He wrote, "Records of trading show that in many
cases when a stock reached top it will have a moderate
decline and then go back again to near the highest figures.
If after such a move, the price again recedes, it is liable
to decline some distance"
Dow considered a trend to have three parts, primary,
secondary, and minor, which he compared to the tide,
waves, and ripples of the sea. The primary trend represents
the tide, the secondary or intermediate trend represents the
waves that make up the tide, and the minor trends behave
like ripples on the waves.
An observer can determine the direction of the tide
by noting the highest point on the beach reached by
successive waves. If each successive wave reaches further
inland than hte preceding one, the tide is flowing in.
When the high point of each successive wave recedes, the
tide has turned out and is ebbing. Unlike actual ocean
tides, which last a matter of hours, Dow conceived of
market tides as lasting for more than a year, and possibly
for several years.
The secondary, or intermediate, trend represents
corrections in the primary trend and usually lasts three
weeks to three months. These intermediate corrections
generally retrace between one-third and two-third of the
previous trend movement and most frequently about half,
or 50% of the previous move.
According to Dow, the minor (or near term) trend
usually lasts less than three weeks. This near term trend
represents fluctuations in the intermediate trend.

3. Major Trends Have Three Phases

Dow focused his attention on primary or ajor trends,
which he felt usually take place in three distinct phases:
an accumulation phase, a public participation phase, and
a distribution phase. The accumulation phase represents
informed buying by the most astute investors. If the
previous trend was down, then at this point these astute
investors recognize that the market has assimilated all the
so-called "bad" news. The public participation phase, were
most technical trend-followers begin to participate, occurs
when prices begin to advance rapidly and business news
improves. The distribution phase takes place when
newspapers begin to print increasingly bullish stories;
when economic news is better than ever; and when
speculative volume and public participation increase. During
this last phase the same informed investors who gegan to
"accumulate" near the bear market bottom (when no one
else wanted to buy) begin to "distribute" before anyone
else starts selling.

4. The Average Must confirm Each Other

Dow, in referring to the Industrial and Rail Average,
meant that no important bull or bear market signal could
take place unless both averages gave the same signal, thus
confirming each other. He felt that both averages must
exceed a previous secondary peak to confirm the inception
or continuation of a bull market. He did not believe that
the signals had to occur simultaneously, but recognized
that a shorter length of time between the two signals
provided stronger confirmatin. When the two averages
diverged from one another, Dow assumed that the prior
trend was still maintained.

5. Volume Must Confirm The Trend

Dow recognized volume as a secondary but important
factor in confirmin price signals. Simply state, volume
should expand or increase in the direction of the major
trend. In a major uptrend, volume would thant increase
as prices move higher, and diminish as prices fall. In a
downtrend, volume should increase as price drop and
diminish as they rally. Dow considered volume a secondary
indicator. He based his actual buy and sell signals entirely
on closing price. Today's Volume indicators help determine
whether volume is increasing or falling off.

6. A Trend Is Assumed To Be In Effect Until It Gives

Definite Signals That It Has Reversed
It relates a physical law to market movement, which
states that an object in motion (in this case a trend) tends
to continue in motion until some external force causes it
to change direction. A number of techncal tools are
avalable to traders to assist in the difficult task of spotting
reversal signals, including the study of support and resistance
level, price paterns, trendlines, and moving aaverages.
Some indicators can provide even earlier warning signals
of loss of momentum. All of that not withstanding, the
odds usually favor that the existing trend will continue.
The most difficult task for a Dow theorist, or any
trend-follower for that matter, is being able to distinguish
between a normal secondary correction in an existing
trend and the first leg of a new trend in the opposite
direction. Dow theorists often disagree as to when the
market gives an actual reversal signal. This reversal
pattern is sometimes referred to as a "failure swing."

THE USE OF CLOSING PRICES AND THE PRESENCE

OF LINES
Dow relied exclusively on closing price. He believed
that averages had to close higher than a previous peak
or lower than a previous trough to have significance. Dow
did not consider interday penetrations valid.
When traders speak of lines in the averages, they are
referring to horizontal that sometimes occur on the charts.
These sideways trading ranges usually play the role of
corrective phase and are usually referred to as consolidations.
SOME CRITICISMS OF DOW THEORY
Dow Theory has done well over the years in indentifyng
major bull and bear markets, but has not escaped criticism.
On average, Dow Theory misses 20 to 25% of a move
before generating a signal. Many traders consider this to
be too late. A Dow Theory buy signal usually occurs in
the second phase of an uptrend as price penetrates a
previous intermediate peak. this is also, incidentally, about
where most trend-following technical systems begin to
identify and participate in existing trends.
In response to this criticism, traders must remember
that Dow never intended to anticipate trend; rather he
sought to reconize the emergance of major bull and bear
markets and to capture the large middle portion of
important market moves.

BASIC CONCEPTS OF TREND

Definition Of Trend
The concept of trend is absolutely essential to the
technical approach to market analysis. All of the tools used
by the chartist support and resistance levels, price patterns,
moving averages, trendlines, etc. Have the sole purpose
of helping to measure the trend of the market for the
purpose of participating in that trend. We often hear such
familiar expressions as "always trade in the direction of
the trend," "never buck the trend," or " the trend is your
friend."
In a general sense, the trend is simply the direction
of the market, which way it's moving. But we need a more
precise definition with which to work. First of all, markets
don't generally move in a straight line in any direction.
Market moves are characterized by a series of zigzags.
These zigzags resemble a series of successive waves with
fairly obvious peaks and troughs. It is the direction of
those constitutes market trend. Whether those peaks and
troughs are moving up, down or sideway tells us the
trend of the market. An uptrend would be defined as a
series of successively higher peaks and troughs; a downtrend
is just the opposite, a series of declining peaks and
troughs; horizontal peaks and troughs would identify a
sideways price trend.

TYPE OF TREND
Trend Has Three Directions
We've mentioned an uptrend, downtrend, and sideways
trend for a very good reason. Most people tend to think
of markets as being always in either an uptrend or a
downrend. The fact of the matter is that markets actually
move in three directions up, down, and sideways. It is
important to be aware of this distinction because for at
least a third of the time, by a conservative estimate, price
move in a flat, horizontal pattern that is referred to as
a trading range. This type of sideways action reflects a
period of equilibrium in the price level where the forces
of supply and demand are in a state of relative balance.
(If you'll recall, Dow Theory refers to this type of pattern
as a line.) Although we've defined a flat market as having
a sideways trend, it is more commonly referred to as
being trendless.
Most technical tools and systems are trend-following
in nature, which means that they are primarily designed
for markets that are moving up or down. They usually
work very poorly, or not at all, when markets enter these
lateral or "trendless" phases. It is during these periods of
sideways market movement that technical tradrs experience
their greatest frustriation, and systems traders their greatest
equity losses. A trend-following system, by its svery
definition, needs a trend in order to do its stuff. The
failure here lies not with the system. raterh, the failure
lies with the trader who is attempting to apply a system
designed for trending markets into a nontrending market
environment.
There are three dicisions confronting the trader whether
to buy a market(go long), sell a market(go short), or do
nothing(stand aside). When a market is rising, the buying
strategy is preferable. When it is falling, the second
approach would be correct. However, when the market is
moving sideways, the third choice to stay out of the
market is usually the wisest.

TREND HAS THREE CLASSIFICATIONS

In addition to have three directins, trend is usually
broken down into the three categories. Those three categories
are the major, intermediate, and near term trend. In
reality, there are almost an infinite number of trends
interacting with one another, from the very short term
trends covering minutes and hours to superlong trend
lasting 50 or 100 years. Most technicians, however, limit
trend classifications to three. There is a certain amount of
ambiguity, however, as to how different analysts define
each trend.
Dow Theory, for example classifies the major trend
as being in effect for longer than a year. Because futures
operate in a shorter time dimension than do stock investors,
the major trend to anything ove six months in the
commodity markets. Dow defined the intermediate, or
secondary, trend as three weeks to as many months, which
also appears about right for the futures markets. The near
term trend is usually defined as anything less than two
or three weeks.
Each trend becomes a portion of its next larger trend.
For example, the intermediate trend would be a correction
in the major trend. In a long term uptrend, the market
pauses to correct itself for a couple of months before
resuming its upward path. That secondary correction would
itself consist of shorter waves that would be identified as
near term dips and rallies. This theme recurs many times
that each trend is part of the next larger trend and is
itself comprised of smaller trend.
The major trend is up as reflected by the rising peaks
and troughs (point 1,2,3,4). The corrective phase (2-3)
represents an intermediate correction within the major
uptrend. But notice that the wave 2-3 also breaks down
in the three smaller waves (A, B, C). At point C, the
analyst would say that the major trend was still up, but
the intermediate and near term trends were down. At
point 4, all three trends would up. It is important to
understand the distinction between the various degrees of
trend. When someone asks what the trend is in agiven
market it is difficult, if not impossible, to respond until
you know which trend the person is inquiring about. You
may have to respond in the manner previously discussed
by defining the three different trend classifications.

Quite a bit of misunderstanding arises because of

different traders' perceptions as to what is meant by a
trend. To long term position traders, a few days' to a few
weeks' price action might be insignificant. To a day trader,
a two or three day advance might constitute a major
uptrend. It's specially important, then, to understand the
different degrees of trend and to make sure that all
involved in a transaction are talking about the same ones.
As a general statement, most trend-following approaches
focus on the intermediate trend, which may last for several
months. The near term trend is used primarily for timing
purposes. In an intermediate uptrend, short term setbacks
would be used to initiate long positions.

SUPPORT AND RESISTANCE

In the previous discussion of trend, it was stated that
prices move in a series of peaks and troughs, and that
the direction of those peaks and troughs determined the
trend of the market. Let's now give those peaks and
troughs their appropriate name and, at the same time,
introduce the concepts of support and resistance.
The rtroughs, or reaction lows, are called support.
The term is self-explanatory and indicates that support is
a level or area on the chart under the market where
buying interest is sufficiently strong to overcome selling
pressure. As a result, a decline is halted and prices turn
back up again. Usually a support level is identified
beforehand by a previous reaction low. Point 2 and 4
represent support levels in an uptrend. Resistance is the
opposite of support and represents a price level or area
over the market where selling pressure overcomes buying
pressure and a price advance is turned back Usually a
resistance level is identified by a previous peak. Point 1
and 3 are resistance level.
In an uptrend, the resistance levels represent pauses
in that uptrend and are usually exceeded at some point.
In a downtrend, support levels are not sufficient to stop
the decline permanently, but are able to check it at least
temporarily.

TRENDLINES
Now that we understand support and resistance, let's
add another building block of technical tools the trendline.
The basic trendline is one of the simplest of the technical
tools employd by the chartist, but is also one of the most
valuable. An up trendline is a straight line drawn upward
to the right along successive reaction lows as shown by
the solid line. A down trendline is drawn downward to
the right along successive rally peaks.
Drawing a Trendline
The correct drawing of trendlines is a lot like every
other aspect of charting and some experimenting with
different lines is usually necessary to find the correct one.
Sometimes a trendline that look correct may have to be
redrawn. But there are some useful guidelines in the
search for that correct line.
First of all, there must be evidence of a trend. this
means that, for an up trendline to be drawn, there must
be at least two reaction lows with the second low higher
than the first. Of course, it always takes two points to
draw any straight line. Only after price have begun to
move higher from point 3 is the chartist reasonable
confident that a reaction low has been formed, only than
can a tentative up trendline be drawn under point 1 and
3.

How To Use The Trendline

Once the third point has been confirmed and the
trend proceeds in its original direction, that trendline
becomes very useful in a variety of way. One of the basic
concepts of trend is that a trend in motion will tend to
remain in motion. As a corollary to that, once a trend
assumes a certain slope or rate of speed, as identified by
the trendline, it will usually maintain the same slope. The
trendline then helps not only to determine the extremities
of the corrective phases, but maybe even more imortantly,
tells us when that trend is changing.
In an uptrend, for example, the inevitable corrective
dip will often touch or come very close to the up
trendline. Becaus the intent of the trader is to buy dips
in an uptrend, that trend line provides a suppot boundary
under the market that can be used as a buying area. A
down trendline can be used as aresistance area for selling
purposes.
As long as the trendline is not violated, it can be
used to determine buying and selling areas. However, at
a point, the violation of the trendline signals a trend
change, calling for liquidation of all position in the
direction of the previous trend. Very often, the breaking
of the trendline is one of the best early warnings of a
change in trend.

THE FAN PRINCIPLE

This brings us to another interesting use of the
trendline the fan principle. Sometimes after the violation
of an up trendline, prices will decline a bit before rallying
back to the bottom of the old up trendline(now a resistance
line). Notice how prices rallied to but failed to penetrate
line 1. Second trendline(line 2) can now be drawn, which
is also broken. After another failed rally attempt, a third
line is drown (line 3). The breaking of that third trendlineis
usuallyand indication that price are headed lower. the
breaking of the third down trendline (line 3) constitutes
a new down trend signal.
Notice in these examples how previously broken
support line become resistance and resistance lines became
support. And another important point to remember here
is that the breaking of the third line is the valid trend
reversal signal.

THE CHANNEL LINE

The channel line, or the return line as it is sometimes
called, is another useful veriation of the trendline technique.
Sometimes prices trend between two parallel lines the
basic trendline and the channel line. Obviously, when this
is a case and when the analyst recognizes taht a channel
exists, this knowledge can be used to profitable advantage.
The drawing of the channel line is relatively simple.
In an uptrend, first draw the basic up trendline along the
lows. Then draw a line from the first prominent peak
which is parallel to the basic up trendline. Both lines
move up to the right, forming a channel. If the next rally
reaches and backs off trom the channel line, then the
channel may exist. The same holds true for downtrend,
of course in the opposite direction.
One useful thing for channel technique is to spot
failures to reach the channel line, usually a sing of a
weakening trend. The failure of price to reach the top o
the channel may be an early warning that the trend is
turning, and increases the odds that the other line will
be broken.

PERCENTAGE RETTRACEMENTS
In all of the previous examples of uptrends and
downtrends, the trader has no doubt noticed that after a
particular market move, price retrace a portion of the
previous trend before resuming the move in the original
direction. These countertrend moves tend to fall into
certain predictable percentage parameter. The best know
application of the phenomenon is the 50% retracement.
Let's say, for example that a market is trending higher
and travels from the 100 level to the 200 level. Very often,
the subsequent reaction retraces about half of the prior
move, to about the 150 level, before upward momentum
is regained. This is a very well-known market tendency
and happens quite frequently. Also, these percentage
retracements apply to any degree of trend major, secondary,
and near term.
Besides the 50% retracement, there are minimum
and maximum percentage parameters that are also widely
recognized the one-third and two-thirds retracements. In
other words, the price trend can be divided into third.
Usually, a minimum retracement is about 33% and a
miximum about 66%. What this means is that, in a
correction of a stron trend, the market usually retraces at
least a third of the previous move. This is very useful
information for a number of reasons. If a trader is looking
for a buying area under the market, he or she can just
compute a 33-50% zone on the chart and use the price
zone as a general frame of reference for buying opportunities.
The maximum retracement parameter is 66%, which
becomes an especially critical area. If tthe prior trend is
to be maintained, the correction must stop at the two-
thirds point. This then become relatively low risk buying
area in an uptrend or selling area in a downtrend. If
prices move beyond the two-thirds point, the odds then
favor a trend reversal rather than just a retracement. The
move usually then retraces the entire 100% of the prior
trend.
You may have noticed that the three percentage
retracement parameters we've mentioned so far 50%, 33%,
and 66% are taken right from the original Dow Theory.
PART - II
CONSTRUCTING THE CANDLESTICK
Drawing The Candlstick Line
The first step in using the power of candles is
learning how to construct the basic candle line. The candle
line consists of a rectangular section and two thin lines
above or below that rectangular section. We see why
these are named candlestick chart; the individual lines
often look like candles with their wicks. The rectangular
part of the candlestick line is called the real body. It
represents the range between the session's open and close.
When the real body is black (e.g, fill in), it shows that
the close ofthe session was lower than the open. If the
real body is white, it means the close was higher than
the open.

The thin lines above and below the real body are
the shadows. The shadows represent the session's price
extremes. The shadow above the real body is referred to
as the upper shadow and the shadow under the real body
is the lower shadow. Accordingly, the peak of the upper
shadow is the high of the session and the bottom of the
lower shadow is the low of the session.
Candle charts can be used throughtout the trading
spectrum, from daily, to weekly, and intra-day charting.
For a daily chart, one would use the open, high, low and
close of the session. For a weekly chart, the candle would
be composed of Monday's one, then the high and low of
the week, and Friday's close. On an intra-day basis, it
would be the open, high, low, and close for the chosen
time period.
A strong session in which the market opened near
the low and closed near its high. We know that the close
is higher than the open because of the white body. And
black candle is opened near its high and close near its
low, mean beaish.
While an individual candle usually should not be
used alone to place atrade, the size and color of its real
body and the length of its shadowscan provide a wealth
of information. Specifically, looking at a line’s real body
and shadows gives a sense of the supply and demand
situation.We will discuss this basic idea, and how to use
real bodies and shadows to get clues about the market’s
underlying strength or weakness. By using the candle
lines, you may be able to get an early and tentative
indication of market direction.

Long Real Bodies

A long white real body is defined as a session that
opens at or near the low of session, and then closes at
or near the session’s high. The close should be much
higher than the open. For example, if a stock opens at
$40 and closes at $41 it would not be a long white candle
since the opening and closing range were relatively close.
For a long white candle to have meaning, some Japanese
candlestick traders believe that the real body should be
at least three times as long as the previous day’s real
body.
Just as a long white candle could be an early signal
that the market may be trying to build a bottom, so it
is that a distinctively long black real body at a high price
may be a tentative warning of a top. The long black real
body should be significantly longer than the candles
preceding it.
Such a long black real body displays that the bears
had grabbed control of the market.

Shadows
While the real body is often considered the most
important segment of the candle, there is also substantial
information to be gleaned from the length and position
of the shadows. Thus, the location and the size of the
shadow should also be considered when analyzing the
psychology behind the market.
A tall upper shadow is especially important when it
appears at a high price level, at a resistance area, or when
the market is overbought. This is because such a candle
line would hint that there is either heavy supply entering
at higher prices or an evaporation of buying.
A long upper shadow could be a bearish development.
And long lower shadow candle that bounces from a
support area, or appears in an oversold market, could be
an important clue that the bears are losing control.

REVERSAL PATTERNS
Hammer and Hanging-man lines
The hammer, with its long lower shadow and a close
near or at the high, is easily understood to be a bullish
signal. The term "hammer" derives from the fact that the
market is "hammering out a base," or that a bottom is
so solid that it does not break, even when a hammer
knocks away at it.
An aspect of the hammer is that it must appear after
a significant downturn or in an oversold market to have
significance. The hammer is a reversal indicator, and as
such, should have a downtrend to reverse. A hammer that
appears after a fall of, say, two or three days is usually
not important. Since the hammer is most useful after a
significant downturn, it should be noted that there may
be selling on a rally from the hammer. As such, the first
bounce from the hammer may fail and the market may
return to test the hammer’s support.
A hanging man, has a very long lower shadow, a
small real body (white or black) near the upper end of
the trading range and little or no upper shadow. This is
the same shape as the hammer line. However, as expressedi
n the Japaneseli terature, "If it appearsf rom below, buy,
and if appears from above, sell."
This phrase means that the same shape line can be
bullish or bearish, depending on where it appears in a
trend. If this line appears "from below," that is, during
a decline, it is a bullish hammer. However, if this same
shape line appears "from above," that is, during an
uptrend, it is a sell signal and is referred to as a hanging
man line.
The Shooting Star And The Inverted Hammer
A shooting star is a pattern that sends a warning
of an impending top. It looks like its name, a shooting
star. It is usually not a major reversal signal as is the
evening star. The shooting star has a small real body at
the lower end of its range with a long upper shadow.
The color of the real body is not important. The shooting
star pictorially tells us that the market opened near its
low, then strongly rallied and finally backed off to close
near the opening. In other words, that session’s rally could
not be sustained.
An inverted hammer looks like a shooting star line
with its long upper shadow and small real body at the
lower end of the range. But, while the shooting star is
a top reversal line, the inverted hammer is a bottom
reversal line. As with a regular hammer, the inverted
hammer is a bullish pattern after a downtrend.The reason
bullish verification of the inverted hammer is important
is because the price action that forms the inverted hammer
appears bearish.on the inverted hammer session the market
opens on, or near its low, then rallies. The bulls fail to
sustain the rally and prices close at, or near, the lows of
the session.
Dark-Cloud Cover & Piercing Pattern
Our next reversal pattern is the dark-cloud cover. It
is a two candlestick pattern that is a top reversal after
a uptrend or, at times, at the top of a congestion band.
The first day of this two candlestick pattern is a strong
white real body. The second day’s price opens above the
prior session’s high (that is, above the top of the upper
shadow). However, by the end of the second day’s session,
the market closes near the low of the day and well within
the prior day’s white body. The greater the degree of
penetration into the white real body the more likely a top
will occur. Some Japanese technicians require more than
a 50% penetration of the black session’s close into the
white real body. If the black candlestick does not close
below the halfway point of the white candlestick it may
be best to wait for more bearish confirmation following
the dark cloud cover.

A piercing pattern. Just as a dark-cloud cover is a

top reversal, its opposite, the piercing pattern, is a bottom
reversal. It is composed of two candlesticks in a falling
market. The first candlestick is a black real body day and
the second is a long, white real body day. This white day
opens sharply lower, under the low of the prior black day.
Then prices push higher, creating a relatively long, white
real body that closes above the mid-point of the prior
day’s black real body.An ideal piercing pattern will have
a white real body that pushes more than halfway into the
prior session’s black real body.
But in future market, Dark-Cloud Cover, second
candle will not be open above the prior season close or
high. As like Dark-Cloud Cover, second candle of Piercing
Pattern, will not open below the prior season close or low.

Bullish And Bearish Engulfing Pattern

The engulfing pattern is a major reversal signal with
two opposite color real bodies composing this pattern.
Bullish engulfing pattern. The market is in a downtrend,
then a white bullish real body wraps around, or engulfs,
the prior period’s black real body. This shows buying
pressure has overwhelmed selling pressure.
A bearish engulfing pattern. At the market is trending
higher. The white real body engulfed by a black body
is the signal for a top reversal. This shows the bears have
taken over from the bulls.
Both of the second real body of the engulfing pattern
should be the opposite color of the first real body.
The Morning Star and Evening Star
The morning star is a bottom reversal pattern. Its
name is derived because, like the morning star (the planet
Mercury) that foretells the sunrise, it presages higher
prices. It is comprised of a tall, black real body followed
by a small real body which gaps lower (these two lines
comprise a basic star pattern). The third day is a white
real body that moves well within the first period’s black
real body. This pattern is a signal that the bulls have
seized control.

The market is in a downtrend when we see a black

real body. At this time the bears are in command. Then
a small real body appears. This means sellers are losing
the capacity to drive the market lower. The next day, the
strong white real body proves that the bulls have taken
over.
An ideal morning star would have a gap before and
after the middle line’s real body (that is, the star). This
second gap is rare, but lack of it does not seem to vitiate
the power of this formation.
The evening star is the bearish counterpart of the
morning star pattern. It is apply named because the
evening star (the planet Venus) appears just before darkness
sets in. Since the evening star is a top reversal it should
be acted on if it arises after an uptrend. Three lines
compose the evening star. The star is the first hint of a
top. The third line corroborates a top and completes the
three-line pattern of the evening star. The third line is a
black real body that moves sharply into the first periods
white real body.
In future market hard to see gap at star pattern.

SMALL BODIES
Spinning Tops And High Wave
We have seen the power inherent in tall white or
black real bodies. A tall white body reflects a strong
session in which the bulls are in control, whereas a long
black real body means that the bears are in charge. Now,
what would it mean if, instead of tall real bodies, there
were small real bodies? This would tell us that the bulls
and bears are in a tug of war and that there is more
of a balance between supply and demand. Such small real
bodies, called spinning tops, tell us that the power to
move up or down is lacking, or as the ]apanese phrase
it, the "market is losing its breath."
Spinning tops even if the lower and/or upper shadows
are large. It is the diminutive size of the real body that
defines a spinning top. A spinning top is a warning sign
that the market is losing its momentum. For instance, if
the market is at or near a new high-especially after a
steep advance-the emergence of a spinning top could be
a signal that the bulls are having trouble in continuing
their ascent. This could be a cautionary signal that the
prior move is stalling.
A candle with a long upper and lower shadows is
called a high-wave candle. It shows that the market is in
a standoff between the bulls and bears. When a high-wave
emerges after a downtrend or uptrend, the japanese say
that the market has lost its sense of direction. This lack
of market orientation means that the prior trend is in
jeopardy.

THE MAGIC DOJI

A doji is a candlestick in which the opening and
closing prices are the same. The perfect doji session has
the same opening and closing price, yet there is some
flexibility to this rule. If the opening and closing price are
within a few ticks of each other (for example, a 1/4 cent
in grains or a few thirty-seconds in bonds, and so on),
the line could still be viewed as a doji. How do you
decide whether a near-doji (that is, where the open and
close are very close, but not exact) should be considered
a doji? This is subjective and there are no rigid rules but
one way is to look at a near-doji in relation to recent
action. If there are a series of very
small real bodies, the near-doji day would not be viewed
as significant since so many other recent periods had small
real bodies.
Doji At Tops
Doji are valued for their ability to call market tops.
This is especially true after a long white candlestick in
an uptrend. The reason for the doji’s negative implications
in uptrends is because a doji represents indecision. Indecision,
uncertainty, or vacillation by buyers will not maintain an
uptrend. It takes the conviction of buyers to sustain a
rally. If the market has had an extended rally, or is
overbought, and then a doji surfaces (read "indecision"),
it could mean the scaffolding of buyers’ support will give
way.
Yet, as good as doji are at calling tops, they tend
to lose reversal potential in downtrends. The reason may
be that a doji reflects a balance between buying and
selling forces. With ambivalent market participants, the
market could fall due to its own weight. Thus, an uptrend
should reverse but a falling market may continue its
descent. Because of this, doji need more confirmation to
signal a bottom than they do a top.

Doji After A Long White Candlestick

A doji after a long white candlestick, especially after
a prolonged uptrend, is often a forewarning that a top is
near.

The Long-legged Doji And the Rickshaw man

The long-legged doji is an especially important doji
at tops. this doji has long upper and lower shadows,
clearly reflecting irresolution. Throughout the session, the
market pushed strongly higher, then sharply lower (or vice
versa). It then closed at, or very near, the opening price.
If the opening and closing are in the center of the session’s
range, the line is referred to as a rickshaw man. To the
Japanese, very long upper or lower shadows represent a
candlestick that has, as they say, "lost its sense of
direction." These long-legged doji reflects a market that
has "lost its sense of direction."

The Gravestone Doji

The gravestone doji is another distinctive doji. It
develops when the opening and closing prices are at the
low of the day. The shape of the gravestone doji makes
its name appropriate. Many of the Japanese technical terms
are based on military analogies, and in this context, the
gravestone doji also represents the graves of those bulls
or bears who have died defending their territory.
The reason for the bearish implications of the gravestone
doji after a rally can be explained simply. The market
opens on the low of the session. It then rallies (preferably
to a new high for the move). Then trouble occurs for the
longs as prices plummet to the day’s lows. The longer the
upper shadow and the higher the price level, the more
bearish the implications of the gravestone doji.

Doji As Support And Resistance

Doji, especially at significant tops or bottoms, can
sometimes turn into support or resistance zones.

The Tri-star
The tri-star is a very rare, but a very significant
reversal pattern. The tri-star is formed by three doji lines.
The middle doji is a doji star.
PART - III
MAREKT INDICATORS
The Moving Average
Moving averages smooth the price data to form a
trend following indicator. They do not predict price direction,
but rather define the current direction with a lag. Moving
averages lag because they are based on past prices.
Despite this lag, moving averages help smooth price action
and filter out the noise. The two most popular types of
moving averages are the Simple Moving Average (SMA)
and the Exponential Moving Average (EMA). These moving
averages can be used to identify the direction of the trend
or define potential support and resistance levels.

Simple Moving Average Calculation

Daily Closing Prices: 11,12,13,14,15,16,17

First day of 5-day SMA: (11+12+13+14+15) / 5 = 13
Second day of 5-day SMA: (12+13+14+15+16) / 5 = 14
Third day of 5-day SMA: (13+14+15+16+17) / 5 = 15

A simple moving average is formed by computing

the average price of a security over a specific number of
periods. Most moving averages are based on closing
prices. A 5-day simple moving average is the five-day
sum of closing prices divided by five. As its name implies,
a moving average is an average that moves. Old data is
dropped as new data comes available. This causes the
average to move along the time scale. Below is an
example of a 5-day moving average evolving over three
days. The first day of the moving average simply covers
the last five days. The second day of the moving average
drops the first data point (11) and adds the new data
point (16). The third day of the moving average continues
by dropping the first data point (12) and adding the new
data point (17). In the example above, prices gradually
increase from 11 to 17 over a total of seven days. Notice
that the moving average also rises from 13 to 15 over
a three-day calculation period. Also, notice that each
moving average value is just below the last price. For
example, the moving average for day one equals 13 and
the last price is 15. Prices the prior four days were lower
and this causes the moving average to lag.

Exponential Moving Average Calculation

Initial SMA: 10-period sum / 10

Multiplier: (2 / (Time periods + 1) )=(2 / (10 + 1) )
= 0.1818 (18.18%)
EMA: {Close - EMA(previous day)} x multiplier +
EMA(previous day).

Exponential moving averages (EMAs) reduce the lag

by applying more weight to recent prices. The weighting
applied to the most recent price depends on the number
of periods in the moving average. EMAs differ from
simple moving averages in that a given day's EMA
calculation depends on the EMA calculations for all the
days prior to that day. You need far more than 10 days
of data to calculate a reasonably accurate 10-day EMA.
There are three steps to calculating an exponential
moving average (EMA). First, calculate the simple moving
average for the initial EMA value. An exponential moving
average (EMA) has to start somewhere, so a simple
moving average is used as the previous period's EMA in
the first calculation. Second, calculate the weighting
multiplier. Third, calculate the exponential moving average
for each day between the initial EMA value and today,
using the price, the multiplier, and the previous period's
EMA value. The formula below is for a 10-day EMA.
Simple vs Exponential Moving Averages
Even though there are clear differences between simple
moving averages and exponential moving averages, one is
not necessarily better than the other. Exponential moving
averages have less lag and are therefore more sensitive
to recent prices - and recent price changes. Exponential
moving averages will turn before simple moving averages.
Simple moving averages, on the other hand, represent a
true average of prices for the entire time period. As such,
simple moving averages may be better suited to identify
support or resistance levels.

Lengths and Timeframes

The length of the moving average depends on the
analytical objectives. Short moving averages (5-20 periods)
are best suited for short-term trends and trading. Chartists
interested in medium-term trends would opt for longer
moving averages that might extend 20-60 periods. Long-
term investors will prefer moving averages with 100 or
more periods.
Some moving average lengths are more popular than
others. The 200-day moving average is perhaps the most
popular. Because of its length, this is clearly a long-term
moving average. Next, the 50-day moving average is quite
popular for the medium-term trend. Many chartists use the
50-day and 200-day moving averages together. Short-term,
a 10-day moving average was quite popular in the past
because it was easy to calculate. One simply added the
numbers and moved the decimal point.

Double Crossovers
Two moving averages can be used together to generate
crossover signals. In Technical Analysis of the Financial
Markets, John Murphy calls this the “double crossover
method”. Double crossovers involve one relatively short
moving average and one relatively long moving average.
As with all moving averages, the general length of the
moving average defines the timeframe for the system. A
system using a 5-day EMA and 35-day EMA would be
deemed short-term. A system using a 50-day SMA and
200-day SMA would be deemed medium-term, perhaps
even long-term.
A bullish crossover occurs when the shorter moving
average crosses above the longer moving average. This is
also known as a golden cross. A bearish crossover occurs
when the shorter moving average crosses below the longer
moving average. This is known as a dead cross.
Moving average crossovers produce relatively late
signals. After all, the system employs two lagging indicators.
The longer the moving average periods, the greater the
lag in the signals. These signals work great when a good
trend takes hold. However, a moving average crossover
system will produce lots of whipsaws in the absence of
a strong trend.
There is also a triple crossover method that involves
three moving averages. Again, a signal is generated when
the shortest moving average crosses the two longer moving
averages. A simple triple crossover system might involve
5-day, 10-day, and 20-day moving averages.

Support and Resistance

Moving averages can also act as support in an
uptrend and resistance in a downtrend. A short-term
uptrend might find support near the 20-day simple moving
average, which is also used in Bollinger Bands. A long-
term uptrend might find support near the 200-day simple
moving average, which is the most popular long-term
moving average. In fact, the 200-day moving average may
offer support or resistance simply because it is so widely
used. It is almost like a self-fulfilling prophecy.
Moving Average Envelopes
Moving Average Envelopes are percentage-based
envelopes set above and below a moving average. The
moving average, which forms the base for this indicator,
can be a simple or exponential moving average. Each
envelope is then set the same percentage above or below
the moving average. This creates parallel bands that
follow price action. With a moving average as the base,
Moving Average Envelopes can be used as a trend
following indicator. However, this indicator is not limited
to just trend following. The envelopes can also be used
to identify overbought and oversold levels when the trend
is relatively flat.

Calculation
Calculation for Moving Average Envelopes is straight-
forward. First, choose a simple moving average or
exponential moving average. Simple moving averages weight
each data point (price) equally. Exponential moving averages
put more weight on recent prices and have less lag.
Second, select the number of time periods for the moving
average. Third, set the percentage for the envelopes. A 20-
day moving average with a 2.5% envelope would show
the following two lines:

Upper Envelope: 20-day SMA + (20-day SMA x .025)

Lower Envelope: 20-day SMA - (20-day SMA x .025)

Interpretation
Indicators based on channels, bands and envelopes
are designed to encompass most price action. Therefore,
moves above or below the envelopes warrant attention.
Trends often start with strong moves in one direction or
another. A surge above the upper envelope shows
extraordinary strength, while a plunge below the lower
envelope shows extraordinary weakness. Such strong moves
can signal the end of one trend and the beginning of
another. With a moving average as its foundation, Moving
Average Envelopes are a natural trend following indicator.
As with moving averages, the envelopes will lag price
action. The direction of the moving average dictates the
direction of the channel. In general, a downtrend is
present when the channel moves lower, while an uptrend
exists when the channel moves higher. The trend is flat
when the channel moves sideways.
Sometimes a strong trend does not take hold after
an envelope break and prices move into a trading range.
Such trading ranges are marked by a relatively flat
moving average. The envelopes can then be used to
identify overbought and oversold levels for trading purposes.
A move above the upper envelope denotes an overbought
situation, while a move below the lower envelope marks
an oversold condition.

Parameters
The parameters for the Moving Average Envelopes
depend on your trading/investing objectives and the
characteristics of the security involved. Traders will likely
use shorter (faster) moving averages and relatively tight
envelopes. Investors will likely prefer longer (slower)
moving averages with wider envelopes.

Overbought/Oversold
Measuring overbought and oversold conditions is
tricky. Securities can become overbought and remain
overbought in a strong uptrend. Similarly, securities can
become oversold and remain oversold in a strong downtrend.
In a strong uptrend, prices often move above the upper
envelope and continue above this line. In fact, the upper
envelope will rise as price continues above the upper
envelope. This may seem technically overbought, but it is
a sign of strength to remain overbought. The reverse is
true for oversold. Overbought and oversold readings are
best used when the trend flattens.

Bollinger Bands
Developed by John Bollinger, Bollinger Bands® are
volatility bands placed above and below a moving average.
Volatility is based on the standard deviation, which
changes as volatility increases and decreases. The bands
automatically widen when volatility increases and narrow
when volatility decreases. This dynamic nature of Bollinger
Bands also means they can be used on different securities
with the standard settings. For signals, Bollinger Bands
can be used to identify M-Tops and W-Bottoms or to
determine the strength of the trend.

Calculation

Middle Band = 20-day simple moving average (SMA)

Upper Band = 20-day SMA +(20-day standard deviation
of pricex2)
Lower Band = 20-day SMA -(20-day standard deviation
of price x 2)

Bollinger Bands consist of a middle band with two

outer bands. The middle band is a simple moving average
that is usually set at 20 periods. A simple moving average
is used because the standard deviation formula also uses
a simple moving average. The look-back period for the
standard deviation is the same as for the simple moving
average. The outer bands are usually set 2 standard
deviations above and below the middle band. Settings can
be adjusted to suit the characteristics of particular securities
or trading styles. Bollinger recommends making small
incremental adjustments to the standard deviation multiplier.
Changing the number of periods for the moving average
also affects the number of periods used to calculate the
standard deviation. Therefore, only small adjustments are
required for the standard deviation multiplier. An increase
in the moving average period would automatically increase
the number of periods used to calculate the standard
deviation and would also warrant an increase in the
standard deviation multiplier. With a 20-day SMA and 20-
day Standard Deviation, the standard deviation multiplier
is set at 2. Bollinger suggests increasing the standard
deviation multiplier to 2.1 for a 50-period SMA and
decreasing the standard deviation multiplier to 1.9 for a
10-period SMA.

Signal: W-Bottoms
Bollinger uses these various W patterns with Bollinger
Bands to identify W-Bottoms. A “W-Bottom” forms in a
downtrend and involves two reaction lows. In particular,
Bollinger looks for W-Bottoms where the second low is
lower than the first but holds above the lower band. There
are four steps to confirm a W-Bottom with Bollinger
Bands. First, a reaction low forms. This low is usually,
but not always, below the lower band. Second, there is
a bounce towards the middle band. Third, there is a new
price low in the security. This low holds above the lower
band. The ability to hold above the lower band on the
test shows less weakness on the last decline. Fourth, the
pattern is confirmed with a strong move off the second
low and a resistance break.

Signal: M-Tops
Bollinger uses these various M patterns with Bollinger
Bands to identify M-Tops. According to Bollinger, tops are
usually more complicated and drawn out than bottoms.
Double tops, head-and-shoulders patterns, and diamonds
represent evolving tops. In its most basic form, an M-Top
is similar to a double top. However, the reaction highs
are not always equal. The first high can be higher or
lower than the second high. Bollinger suggests looking for
signs of non-confirmation when a security is making new
highs. This is basically the opposite of the W-Bottom. A
non-confirmation occurs with three steps. First, a security
creates a reaction high above the upper band. Second,
there is a pullback towards the middle band. Third, prices
move above the prior high but fail to reach the upper
band. This is a warning sign. The inability of the second
reaction high to reach the upper band shows waning
momentum, which can foreshadow a trend reversal. Final
confirmation comes with a support break or bearish indicator
signal.

Average Directional Movement Index

The Average Directional Index (ADX), Minus
Directional Indicator (-DI) and Plus Directional Indicator
(+DI) represent a group of directional movement indicators
that form a trading system developed by Welles Wilder.
Although Wilder designed his Directional Movement System
with commodities and daily prices in mind, these indicators
can also be applied to stocks.
Positive and negative directional movement form the
backbone of the Directional Movement System. Wilder
determined directional movement by comparing the difference
between two consecutive lows with the difference between
their respective highs.
The Plus Directional Indicator (+DI) and Minus
Directional Indicator (-DI) are derived from smoothed
averages of these differences, and measure trend direction
over time. These two indicators are often referred to
collectively as the Directional Movement Indicator (DMI).
The Average Directional Index (ADX) is in turn
derived from the smoothed averages of the difference
between +DI and -DI, and measures the strength of the
trend (regardless of direction) over time.
Using these three indicators together, chartists can
determine both the direction and strength of the trend.

Calculation
Directional movement is calculated by comparing the
difference between two consecutive lows with the difference
between their respective highs.
Directional movement is positive (plus) when the
current high minus the prior high is greater than the prior
low minus the current low. This so-called Plus Directional
Movement (+DM) then equals the current high minus the
prior high, provided it is positive. A negative value would
simply be entered as zero.
Directional movement is negative (minus) when the
prior low minus the current low is greater than the current
high minus the prior high. This so-called Minus Directional
Movement (-DM) equals the prior low minus the current
low, provided it is positive. A negative value would
simply be entered as zero.

Trend Strength
At its most basic, the Average Directional Index
(ADX) can be used to determine if a security is trending
or not. This determination helps traders choose between
a trend-following system or a non-trend-following system.
Wilder suggests that a strong trend is present when ADX
is above 25 and no trend is present when below 20. There
appears to be a gray zone between 20 and 25. As noted
above, chartists may need to adjust the settings to increase
sensitivity and signals. ADX also has a fair amount of lag
because of all the smoothing techniques. Many technical
analysts use 20 as the key level for ADX.

Trend Direction and Crossovers

Wilder put forth a simple system for trading with
these directional movement indicators. The first requirement
is for ADX to be trading above 25. This ensures that
prices are trending. Many traders, however, use 20 as the
key level. A buy signal occurs when +DI crosses above
-DI. Wilder based the initial stop on the low of the signal
day. The signal remains in force as long as this low holds,
even if +DI crosses back below -DI. Wait for this low to
be penetrated before abandoning the signal. This bullish
signal is reinforced if/when ADX turns up and the trend
strengthens. Once the trend develops and becomes profitable,
traders will have to incorporate a stop-loss and trailing
stop should the trend continue. A sell signal triggers when
-DI crosses above +DI. The high on the day of the sell
signal becomes the initial stop-loss.

Comodity Channel Index

Developed by Donald Lambert and featured in
Commodities magazine in 1980, the Commodity Channel
Index (CCI) is a versatile indicator that can be used to
identify a new trend or warn of extreme conditions.
Lambert originally developed CCI to identify cyclical turns
in commodities, but the indicator can be successfully
applied to indices, ETFs, stocks, and other securities. In
general, CCI measures the current price level relative to
an average price level over a given period of time. CCI
is relatively high when prices are far above their average.
CCI is relatively low when prices are far below their
average. In this manner, CCI can be used to identify
overbought and oversold levels.
Calculation
The example below is based on a 20-period Commodity
Channel Index (CCI) calculation. The number of CCI
periods is also used for the calculations of the simple
moving average and Mean Deviation. Lambert set the
constant at .015 to ensure that approximately 70 to 80
percent of CCI values would fall between -100 and +100.
This percentage also depends on the look-back period. A
shorter CCI (10 periods) will be more volatile with a
smaller percentage of values between +100 and -100.
Conversely, a longer CCI (40 periods) will have a higher
percentage of values between +100 and -100.
As noted above, the majority of CCI movement occurs
between -100 and +100. A move that exceeds this range
shows unusual strength or weakness that can foreshadow
an extended move. Think of these levels as bullish or
bearish filters. Technically, CCI favors the bulls when
positive and the bears when negative. However, using a
simple zero line crossovers can result in many whipsaws.
Although entry points will lag more, requiring a move
above +100 for a bullish signal and a move below -100
for a bearish signal reduces whipsaws.

Overbought/Oversold
Identifying overbought and oversold levels can be
tricky with the Commodity Channel Index (CCI), or any
other momentum oscillator for that matter. First, CCI is
an unbound oscillator. Theoretically, there are no upside
or downside limits. This makes an overbought or oversold
assessment subjective. Second, securities can continue moving
higher after an indicator becomes overbought. Likewise,
securities can continue moving lower after an indicator
becomes oversold.
The definition of overbought or oversold varies for
the Commodity Channel Index (CCI). ±100 may work in
a trading range, but more extreme levels are needed for
other situations. ±200 is a much harder level to reach and
more representative of a true extreme. Selection of
overbought/oversold levels also depends on the volatility
of the underlying security.

Bullish Bearish Divergences

Divergences signal a potential reversal point because
directional momentum does not confirm price. A bullish
divergence occurs when the underlying security makes a
lower low and CCI forms a higher low, which shows less
downside momentum. A bearish divergence forms when
the security records a higher high and CCI forms a lower
high, which shows less upside momentum. Before getting
too excited about divergences as great reversal indicators,
note that divergences can be misleading in a strong trend.
A strong uptrend can show numerous bearish divergences
before a top actually materializes. Conversely, bullish
divergences often appear in extended downtrends.
Confirmation holds the key to divergences. While
divergences reflect a change in momentum that can
foreshadow a trend reversal, chartists should set a
confirmation point for CCI or the price chart. A bearish
divergence can be confirmed with a break below zero in
CCI or a support break on the price chart. Conversely, a
bullish divergence can be confirmed with a break above
zero in CCI or a resistance break on the price chart.

MACD
Developed by Gerald Appel in the late seventies, the
Moving Average Convergence/Divergence oscillator (MACD)
is one of the simplest and most effective momentum
indicators available. The MACD turns two trend-following
indicators, moving averages, into a momentum oscillator
by subtracting the longer moving average from the shorter
moving average. As a result, the MACD offers the best
of both worlds: trend following and momentum. The
MACD fluctuates above and below the zero line as the
moving averages converge, cross and diverge. Traders can
look for signal line crossovers, centerline crossovers and
divergences to generate signals. Because the MACD is
unbounded, it is not particularly useful for identifying
overbought and oversold levels.

Calculation

MACD Line: (12-day EMA - 26-day EMA)

Signal Line: 9-day EMA of MACD Line
MACD Histogram: MACD Line - Signal Line

The MACD Line is the 12-day Exponential Moving

Average (EMA) less the 26-day EMA. Closing prices are
used for these moving averages. A 9-day EMA of the
MACD Line is plotted with the indicator to act as a signal
line and identify turns. The MACD Histogram represents
the difference between MACD and its 9-day EMA, the
Signal line. The histogram is positive when the MACD
Line is above its Signal line and negative when the MACD
Line is below its Signal line. The values of 12, 26 and
9 are the typical setting used with the MACD, however
other values can be substituted depending on your trading
style and goals.

Interpretation
As its name implies, the MACD is all about the
convergence and divergence of the two moving averages.
Convergence occurs when the moving averages move
towards each other. Divergence occurs when the moving
averages move away from each other. The shorter moving
average (12-day) is faster and responsible for most MACD
movements. The longer moving average (26-day) is slower
and less reactive to price changes in the underlying
security.
The MACD Line oscillates above and below the zero
line, which is also known as the centerline. These crossovers
signal that the 12-day EMA has crossed the 26-day EMA.
The direction, of course, depends on the direction of the
moving average cross. Positive MACD indicates that the
12-day EMA is above the 26-day EMA. Positive values
increase as the shorter EMA diverges further from the
longer EMA. This means upside momentum is increasing.
Negative MACD values indicate that the 12-day EMA is
below the 26-day EMA. Negative values increase as the
shorter EMA diverges further below the longer EMA. This
means downside momentum is increasing.

Signal Line Crossovers

Signal line crossovers are the most common MACD
signals. The signal line is a 9-day EMA of the MACD
Line. As a moving average of the indicator, it trails the
MACD and makes it easier to spot MACD turns. A bullish
crossover occurs when the MACD turns up and crosses
above the signal line. A bearish crossover occurs when the
MACD turns down and crosses below the signal line.
Crossovers can last a few days or a few weeks, it all
depends on the strength of the move.

Centerline Crossovers
Centerline crossovers are the next most common
MACD signals. A bullish centerline crossover occurs when
the MACD Line moves above the zero line to turn
positive. This happens when the 12-day EMA of the
underlying security moves above the 26-day EMA. A
bearish centerline crossover occurs when the MACD moves
below the zero line to turn negative. This happens when
the 12-day EMA moves below the 26-day EMA.

Divergences
Divergences form when the MACD diverges from the
price action of the underlying security. A bullish divergence
forms when a security records a lower low and the MACD
forms a higher low. The lower low in the security affirms
the current downtrend, but the higher low in the MACD
shows less downside momentum. Despite less downside
momentum, downside momentum is still outpacing upside
momentum as long as the MACD remains in negative
territory. Slowing downside momentum can sometimes
foreshadow a trend reversal or a sizable rally.
A bearish divergence forms when a security records
a higher high and the MACD Line forms a lower high.
The higher high in the security is normal for an uptrend,
but the lower high in the MACD shows less upside
momentum. Even though upside momentum may be less,
upside momentum is still outpacing downside momentum
as long as the MACD is positive. Waning upward momentum
can sometimes foreshadow a trend reversal or sizable
decline.
Divergences should be taken with caution. Bearish
divergences are commonplace in a strong uptrend, while
bullish divergences occur often in a strong downtrend.
Yes, you read that right. Uptrends often start with a
strong advance that produces a surge in upside momentum
(MACD). Even though the uptrend continues, it continues
at a slower pace that causes the MACD to decline from
its highs. Upside momentum may not be as strong, but
upside momentum is still outpacing downside momentum
as long as the MACD Line is above zero. The opposite
occurs at the beginning of a strong downtrend.
Conclusions
The MACD indicator is special because it brings
together momentum and trend in one indicator. This
unique blend of trend and momentum can be applied to
daily, weekly or monthly charts. The standard setting for
MACD is the difference between the 12 and 26-period
EMAs. Chartists looking for more sensitivity may try a
shorter short-term moving average and a longer long-term
moving average. MACD(5,35,5) is more sensitive than
MACD(12,26,9) and might be better suited for weekly
charts. Chartists looking for less sensitivity may consider
lengthening the moving averages. A less sensitive MACD
will still oscillate above/below zero, but the centerline
crossovers and signal line crossovers will be less frequent.
The MACD is not particularly good for identifying
overbought and oversold levels. Even though it is possible
to identify levels that are historically overbought or oversold,
the MACD does not have any upper or lower limits to
bind its movement. During sharp moves, the MACD can
continue to over-extend beyond its historical extremes.

Momentum
The Momentum indicator compares where the current
price is in relation to where the price was in the past.
How far in the past the comparison is made is up to the
technical analysis trader. The calculation of Momentum is
quite simple (n is the number of periods the technical
trader selects):
The current price minus the price n-periods ago

Hence, if the current price is higher than the price

in the past, then the Momentum indicator is positive. In
contrast, when the current price is lower than the price
in the past, then the Momentum indicator is negative.
Momentum Potential Buy Signal
When the Momentum indicator crosses above the zero
line. The crossing of the zero line implies that the price
of the stock, future, or currency pair is reversing course,
either by having bottomed out or by breaking out above
recent highs; this is typically viewed as a bullish signal.

Momentum Potential Sell Signal

Momentum indicator crosses below the zero line. A
cross of the zero line can generally mean two things: the
future, currency pair, or stock's price has topped out and
is reversing or that the price has broken below recent
lows, either way, these events are often interpreted by
traders as bearish signals.

Momentum Potential Exit Signals

Generally speaking the potential buy and sell signals
discussed above are poor exits, either selling out of a long
position or buying to cover a short position. By the time
the Momentum indicator returns back to the zero line,
most or all of the profits have probably eroded, or even
worse the trader has let a winning position turn into a
losing position.
When the Momentum is reversing course and is
heading back towards the zero line, that means profits
have been eroded. How much of a retracement back
towards the zero line before an exit is triggered is up
to the trader. Another possible alternative is to draw a
trendline; when the trendline is broken, that might act as
the exit signal. Like most technical analysis indicators,
interpreting them is part science, part art form.
Potential buy and sell signals are not the only use
of the Momentum indicator. The next page discusses using
Momentum to detect divergences, an important trading
concept.
Momentum Divergences
Identifying divergences between price and technical
indicators can be an important aspect of technical analysis
trading. Bullish divergences might signal a trader to exit
their short position; similarly, bearish divergences could
warn that prices could correct and that it might be
advisable to exit any longs.

Relative Strength Index

Developed by J. Welles Wilder, the Relative Strength
Index (RSI) is a momentum oscillator that measures the
speed and change of price movements. RSI oscillates
between zero and 100. Traditionally, and according to
Wilder, RSI is considered overbought when above 70 and
oversold when below 30. Signals can also be generated
by looking for divergences, failure swings, and centerline
crossovers. RSI can also be used to identify the general
trend.
RSI is an extremely popular momentum indicator that
has been featured in a number of articles, interviews, and
books over the years. In particular, Constance Brown's
book, Technical Analysis for the Trading Professional,
features the concept of bull market and bear market ranges
for RSI. Andrew Cardwell, Brown's RSI mentor, introduced
positive and negative reversals for RSI. In addition, Cardwell
turned the notion of divergence, literally and figuratively,
on its head.

Calculation

100
RSI = 100 - --------
1 + RS
RS = Average Gain / Average Loss
 To simplify the calculation explanation, RSI has been
broken down into its basic components: RS, Average Gain
and Average Loss. This RSI calculation is based on 14
periods, which is the default suggested by Wilder in his
book. Losses are expressed as positive values, not negative
values. The very first calculations for average gain and
average loss are simple 14-period averages.

First Average Gain = Sum of Gains over the past 14

periods / 14.
First Average Loss = Sum of Losses over the past 14
periods / 14
The second, and subsequent, calculations are based on the
prior averages and the current gain loss:
Average Gain = [(previous Average Gain) x 13 + current
Gain] / 14.
Average Loss = [(previous Average Loss) x 13 + current
Loss] / 14.
Wilder's formula normalizes RS and turns it into an
oscillator that fluctuates between zero and 100. In fact, a
plot of RS looks exactly the same as a plot of RSI. The
normalization step makes it easier to identify extremes
because RSI is range bound. RSI is 0 when the Average
Gain equals zero. Assuming a 14-period RSI, a zero RSI
value means prices moved lower all 14 periods. There
were no gains to measure. RSI is 100 when the Average
Loss equals zero. This means prices moved higher all 14
periods. There were no losses to measure.

Overbought-Oversold
Wilder considered RSI overbought above 70 and
oversold below 30.Like many momentum oscillators,
overbought and oversold readings for RSI work best when
prices move sideways within a range.
Divergences
According to Wilder, divergences signal a potential
reversal point because directional momentum does not
confirm price. A bullish divergence occurs when the
underlying security makes a lower low and RSI forms a
higher low. RSI does not confirm the lower low and this
shows strengthening momentum. A bearish divergence
forms when the security records a higher high and RSI
forms a lower high. RSI does not confirm the new high
and this shows weakening momentum.

Failure Swings
Wilder also considered failure swings as strong
indications of an impending reversal. Failure swings are
independent of price action. In other words, failure swings
focus solely on RSI for signals and ignore the concept of
divergences. A bullish failure swing forms when RSI
moves below 30 (oversold), bounces above 30, pulls back,
holds above 30 and then breaks its prior high. It is
basically a move to oversold levels and then a higher low
above oversold levels.
A bearish failure swing forms when RSI moves above
70, pulls back, bounces, fails to exceed 70 and then breaks
its prior low. It is basically a move to overbought levels
and then a lower high below overbought levels.

Stochastic Oscillator
Developed by George C. Lane in the late 1950s, the
Stochastic Oscillator is a momentum indicator that shows
the location of the close relative to the high-low range
over a set number of periods. According to an interview
with Lane, the Stochastic Oscillator “doesn't follow price,
it doesn't follow volume or anything like that. It follows
the speed or the momentum of price. As a rule, the
momentum changes direction before price.” As such, bullish
and bearish divergences in the Stochastic Oscillator can be
used to foreshadow reversals. This was the first, and most
important, signal that Lane identified. Lane also used this
oscillator to identify bull and bear set-ups to anticipate a
future reversal. Because the Stochastic Oscillator is range
bound, is also useful for identifying overbought and
oversold levels.

Calculation

%K = (Current Close - Lowest Low)/(Highest High -

Lowest Low) * 100
%D = 3-day SMA of %K
Lowest Low = lowest low for the look-back period
Highest High = highest high for the look-back period
%K is multiplied by 100 to move the decimal point two
places

The default setting for the Stochastic Oscillator is 14

periods, which can be days, weeks, months or an intraday
timeframe. A 14-period %K would use the most recent
close, the highest high over the last 14 periods and the
lowest low over the last 14 periods. %D is a 3-day simple
moving average of %K. This line is plotted alongside %K
to act as a signal or trigger line.

Overbought Oversold
As a bound oscillator, the Stochastic Oscillator makes
it easy to identify overbought and oversold levels. The
oscillator ranges from zero to one hundred. No matter
how fast a security advances or declines, the Stochastic
Oscillator will always fluctuate within this range. Traditional
settings use 80 as the overbought threshold and 20 as the
oversold threshold. These levels can be adjusted to suit
analytical needs and security characteristics. Readings above
80 for the 20-day Stochastic Oscillator would indicate that
the underlying security was trading near the top of its
20-day high-low range. Readings below 20 occur when a
security is trading at the low end of its high-low range.

Bull Bear Divergences

Divergences form when a new high or low in price
is not confirmed by the Stochastic Oscillator. A bullish
divergence forms when price records a lower low, but the
Stochastic Oscillator forms a higher low. This shows less
downside momentum that could foreshadow a bullish
reversal. A bearish divergence forms when price records
a higher high, but the Stochastic Oscillator forms a lower
high. This shows less upside momentum that could
foreshadow a bearish reversal. Once a divergence takes
hold, chartists should look for a confirmation to signal an
actual reversal. A bearish divergence can be confirmed
with a support break on the price chart or a Stochastic
Oscillator break below 50, which is the centerline. A
bullish divergence can be confirmed with a resistance
break on the price chart or a Stochastic Oscillator break
above 50.
50 is an important level to watch. The Stochastic
Oscillator moves between zero and one hundred, which
makes 50 the centerline. Think of it as the 50-yard line
in football. The offense has a higher chance of scoring
when it crosses the 50-yard line. The defense has an edge
as long as it prevents the offense from crossing the 50-
yard line. A Stochastic Oscillator cross above 50 signals
that prices are trading in the upper half of their high-
low range for the given look-back period. This suggests
that the cup is half full. Conversely, a cross below 50
means that prices are trading in the bottom half of the
given look-back period. This suggests that the cup is half
empty.
Rate Of Change (ROC)
The Rate-of-Change (ROC) indicator, which is also
referred to as simply Momentum, is a pure momentum
oscillator that measures the percent change in price from
one period to the next. The ROC calculation compares the
current price with the price “n” periods ago. The plot
forms an oscillator that fluctuates above and below the
zero line as the Rate-of-Change moves from positive to
negative. As a momentum oscillator, ROC signals include
centerline crossovers, divergences and overbought-oversold
readings. Divergences fail to foreshadow reversals more
often than not so this article will forgo a discussion on
divergences. Even though centerline crossovers are prone
to whipsaw, especially short-term, these crossovers can be
used to identify the overall trend. Identifying overbought
or oversold extremes comes naturally to the Rate-of-Change
oscillator.

Calculation

ROC = [(Close - Close n periods ago) / (Close n periods

ago)] * 100

Interpretation
The Rate-of-Change indicator is momentum in its
purest form. It measures the percentage increase or decrease
in price over a given period of time. Think of its as the
rise (price change) over the run (time). In general, prices
are rising as long as the Rate-of-Change remains positive.
Conversely, prices are falling when the Rate-of-Change is
negative. ROC expands into positive territory as an advance
accelerates. ROC dives deeper into negative territory as a
decline accelerates. There is no upward boundary on the
Rate-of-Change. The sky is the limit for an advance. There
is, however, a downside limit. Securities can only decline
100%, which would be to zero. Even with these lopsided
boundaries, Rate-of-Change produces identifiable extremes
that signal overbought and oversold conditions.

KST (Know Sure Thing)

Developed by Martin Pring, Know Sure Thing (KST)
is a momentum oscillator based on the smoothed rate-of-
change for four different timeframes. Pring referred to this
indicator as the “Summed Rate of Change (KST)” in a
1992 article in Stocks & Commodities magazine. In short,
KST measures price momentum for four different price
cycles. It can be used just like any momentum oscillator.
Chartists can look for divergences, overbought/oversold
readings, signal line crossovers and centerline crossovers.
Pring frequently applied trend lines to KST. Although
trend line signals do not occur often, Pring notes that such
breaks reinforce signal line crossovers.
The formula box below shows the four different
combinations with their default settings. These combinations
are then weighted and summed. The shortest timeframe
carries the least weight (1) and the longest timeframe
carries the most weight (4). A 9-period simple moving
average is added as a signal line. The default parameters
are as follows: KST(10,15,20,30,10,10,10,15,9). The first four
numbers represent the rate-of-change settings, the second
four represent the moving averages for these rate-of-change
indicators and the last number is the signal line moving
average.

RCMA1 = 10-Period SMA of 10-Period Rate-of-Change

RCMA2 = 10-Period SMA of 15-Period Rate-of-Change
RCMA3 = 10-Period SMA of 20-Period Rate-of-Change
RCMA4 = 15-Period SMA of 30-Period Rate-of-Change

KST = (RCMA1 x 1) + (RCMA2 x 2) + (RCMA3 x 3) +

(RCMA4 x 4)
Signal Line = 9-period SMA of KST
Interpretation
KST fluctuates above/below the zero line. At its most
basic, momentum favors the bulls when KST is positive
and the bears when KST is negative. A positive reading
means the weighted and smoothed rate-of-change values
are mostly positive and prices are moving higher. A
negative reading indicates that prices are moving lower.
After basic centerline crossovers, chartists can look for
signal line crossovers and gauge general direction. KST is
generally rising when above its signal line and falling
when below its signal line. A rising and negative KST
line indicates that downside momentum is waning.
Conversely, a falling and positive KST line indicates that
upside momentum is waning.
Even though there are many different signals possible
with KST, the basic centerline and signal line crossovers
are usually the most robust. Unlike RSI and the Stochastic
Oscillator, KST does not have upper or lower limits. This
makes it relatively ill-suited for overbought and oversold
signals.

Divergences
Bullish and bearish divergences are also possible for
signals, but chartists need to be selective when using
these. Most divergences in the basic rate-of-change indicator
do not result in price reversals. Similarly, divergences in
MACD and RSI are also prone to failure. It is probably
best to use divergences when there is a large and blatant
divergence.

Strong Trends
Chartists should be careful with bearish signal line
crossovers in strong uptrends and bullish signal line
crossovers in strong downtrends. KST can move into
positive territory and remain in positive territory for an
extended period during a strong uptrend. The indicator
will reach a relatively high level and then turn down, but
never move into negative territory. This simply signals
that upside momentum is slowing. Upside momentum is
still stronger than downside momentum, but upside
momentum is not a strong as in previous periods.

Volume
Volume is a measure of how much of a given
financial asset has been traded in a given period of time.
It is a very powerful tool but is often overlooked because
it is such a simple indicator. Volume information can be
found just about anywhere, but few traders or investors
know how to use this information to increase their profits
and minimize risk.
For every buyer, there needs to be someone who sold
them the shares they bought, just as there must be a buyer
in order for a seller to get rid of his or her shares. This
battle between buyers and sellers for the best price in all
different time frames creates movement while longer-term
technical and fundamental factors play out. Using volume
to analyze stocks (or any financial asset) can bolster profits
and also reduce risk.
Volume is an extremely important metric to consider
when analyzing a security. In particular, volume is often
used as confirmation for technical indicators and chart
patterns. When analyzing volume, there are guidelines we
can use to determine the strength or weakness of a move.
As traders, we are more inclined to join strong moves and
take no part in moves that show weakness – or we may
even watch for an entry in the opposite direction of a
weak move. These guidelines do not hold true in all
situations, but they are a good general aid in trading
decisions.
Volume profile
Many traders are used to viewing volume as a
histogram beneath a price chart. This approach shows the
amount of volume traded during each price bar, whether
it’s a time-based bar (such as one-minute) or an activity-
based bar (such as 144-tick or 2000-tick volume). While
this is a popular way to analyze volume, knowing where
the volume occurs—in terms of price, rather than time—
can be more meaningful.
Volume profile, plotted on the vertical axis of the
price chart, does just that: It shows how much trading
activity has taken place at each price level touched
throughout the trading session. Why is this helpful to
traders? Volume profile points out the prices that have
been favored by the market as well as those that have
been ignored, which can give traders clues about where
price is likely to go in the near future.
Volume profile updates every time a new trade order
in the market is filled, and the point of control, value
area, high volume nodes and low volume nodes all change
numerous times throughout a given trading session—
especially on actively traded instruments—as more volume
activity is recorded. As volume profile develops throughout
the trading session, new patterns and trading opportunities
emerge.
For instance, at 11 a.m., following the morning push,
the point of control may be located at the top of the chart
(towards the session high), only to be replaced later in
the session with higher trading volume moving the point
of control to a price centered on the chart.
For active traders, it is the developing volume profile
that is most relevant. The volume profile at the end of
the day will show the history of volume, but not the
patterns that could pinpoint trading opportunities during
an active trading session. It is this constant evolution of
the volume profile during a trading session that can help
form trading decisions.

Ichimoku
History
The charting system of Ichimoku Kinko Hyo was
developed by a Japanese newspaper man named Goichi
Hosoda World War II with the help of numerous students
that he hired to run through the optimum formulas and
scenarios simulated back testing today to test a trading
system. The system itself was finally released to the public
in 1968, Hosoda published his book which included the
final version of the system.
Ichimoku Kinko Hyo has been used extensively in
Asian trading rooms since Hosoda published his book and
has been used successfully commodities, futures, and stocks.
Even with such wild popularity in Asia, Ichimoku did not
make its appearance in the West until the 1990s and then,
due to the utter lack of information in English on how
to use it, it was mostly releg category of another “exotic”
indicator by the general trading public. Only now, in the
early 21st century, are western traders really beginning
to understand the power of this charting system.

Tenkan Sen
The first indicator is the Tenkan Sen. It represents
the shor-term movement for price. The color that represents
the Tenkan Sen is red. The formula for the Tenkan Sen
(red) is:

(Highest High + Lowest Low)

for 9 periods
2

Most retail and institution traders use a 10 period

simple moving average of closing prices (SMA) to represent
the short term. By using the average of the Highest High
and the Lowest Low instead of the closing prices, the
Tenkan Sen takes into account the inter-day volatility.
* If price is above the Tenkan Sen is Bullish.
* If price is below the Tenkan San is Berish.
The Tenkan Sen should be pointing in the same
direction as the trend. The steeper the angle, the greater
the trend. The Tenkan Sen is pointing upward with a
steep angle. This is showing that the instrument is in a
strong bullish (upward) trend.

Kijun Sen
The second indicator is the Kijun Sen. It represents
the mediumterm movement for price. Therefore, it caters
to a majority of the traders in the market. The color that
represents the Ki jun Sen is green. The fonnula
for the Kijun Sen is:

(Highest High + Lowest Low)

for 26 periods
2
The Kijun Sen is similar to the 30 period simple
moving average that most retail and institution traders
use. Just like The Tenkan Sen, the Kijun Sen is based on
the Highest High and the Lowest Low. Instead of the 9
period of the Tenkan Sen, the Kijun Sen is based on 26
periods. For a daily time frame, the Kijun Sen roughly
represents one month (and one trading week and one
trading day) of history where the Tenkan Sen represented
roughly 1½ weeks (not including weekends on the chart).
The Kijun Sen is one of the key indicators for the
Ichimoku system. Many Ichimoku strategies focus around
this one indicator.
* If price is above the Kijun Sen is Bullish.
* If price is below the Kijun San is Berish.
The Kijun Sen should be pointing in the same
direction as the trend. The steeper the angle, the greater
the trend. The Kijun Sen was flat and then started to move
upward. The Kijun Sen only moved up when the current
price was higher than the average of the Highest High
and the Lowest Low for the last 26 days. Unlike the
Tenkan Sen, price has to move a lot in order to influence
the Kijun Sen.
* When the Kijun Sen is flat, it indicates that the
price is consolidating and not trending.
* The Kijun Sen is a key support/resistance value.
When price crosses the Kijun Sen, it is a major
accomplishment because it broke a major support/resistance
value.
* When price crosses the Kijun Sen, it indicates that
a trend change many occur. This is key to determine if
a major pullback or a trend reversal is about to occur.
Neither one of them can occur until price crosses over the
Kijun Sen.
* With price crossing over the Kijun Sen, one of two
possible scenarios can occur:
*Minor pullback: Price will bounce off the Kijun
Sen and continue on the original trend path. Some people
took profit but the major " player " are still holding their
positions and possibly increasing them now with the
minor pullback. People really believe that the trend will
continue strong.
* Major pullback: Price will cross over the Kijun
Sen and eventually cross back to continue the major trend
that was occuning. Long-term traders gained some profits
but they still have some open positions because they
believe the instrument will continue to move in the
direction of the trend.
* Trend reversal: Price crosses the Kijun Sen
once and then never crosses back over the Kijun Sen to
continue the major trend. Instead, the instrument will enter
a consolidation period or a trend reversal. The majority
of the long-term traders are exiting their positions.
* The Kijun Sen should be close to price. When price
is far away from the Kijun Sen it shows that price has
moved at a faster rate iJlan the Kijun Sen. A good trend
has price and the Kijun Sen moving at a constant rate.
Since the Kijun Sen represents 26 days, there is a high
probability that price will retract toward the Kijun Sen
causing a major pullback or even a trend reversal.

Chikou Span
The third indicator is the Chikou Span. It represents
the momentum of price. In other words, it tells you if a
trend can occur or not occur. Remember, a trend is where
price moves in one direction for a long period of time.
The color that represents the Chikou Span is purple.
The formula for the Chikou Span is:

Current Price Shifted back 26 periods

Simple as it sounds, basically, it is today's price

shifted back 26 periods. You compare today's price movement
to price from 26 periods ago.
Here are the things to note about the Chikou Span:
* If the Chikou Span is above price from 26 periods
ago is bullish.
* If the Chikou Span is below price from 26 periods
ago is berish.
* If the Chikou Span is touching or very close to price
is consolidation.

Kumo Cloud Components

The last two indicators remaining are the Senkou
Span A and Senkou Span B. These are discussed differently
from that of the other Ichimoku indicators. The reason is
that together they provide a lot of information. Together,
they form a cloud called the “Kumo Cloud.” The Cloud
is formed by filling the gap between the Senkou Span A
and Senkou Span B with a particular color. lf Senkou A
is greater than Senkou B then the color is yellow (bullish)
and if Senkou A is less than Senkou B then the color is
red (bearish). You can use any color for the Kumo Cloud.
In this section, reference two types of clouds;
1. Kumo Cloud: Cloud above/below current price.
2. Future Kumo Cloud: Cloud 26 bars into the future.

Senkou Span A
The fourth indicator is the Senkou A. The color that
represents the Senkou A is dark blue. The formula for the
Senkou A is:

(Tenkan Sen + Kijun Sen)

Shifted forward 26 period
2
This indicator confuses most people because there are
really two Kumo Clouds, the current Kuma Cloud and the
Future Kuma Cloud. You have to look at two Senkou A,
the current one and the future Senkou A. The current
Senkou A is the average of the Tenkan Sen and Kijun Sen
from 26 periods ago. Therefore, when you compare Ule
current price against Senkou A, you are really comparing
current price to the Tenkan/Kijun Sen values from 26
periods ago. The future Senkou A is the average of the
current Tenkan Sen and the current Kijun Sen. Current
price movement will influence the future.

Senkou Span B
The fifth indicator is the Senkou B. The color that
represents the Senkou B is purple. The formula for the
Senkou B is:
 (Highest High + Lowest Low) for 52 periods and
then shifted
2 forward by 26
period

This indicator deals with 52 periods, the most periods

out of all the Ichimoku indicators. For a weekly time
frame, this is 52 weeks. Remember, we have two Senkou
Bs just like Senkou A. The Senkou B is really the
calculation from 52 periods ago. The future Senkou B is
the current calculation. This is powerful because the Senkou
B incorporates many historical bars.
Some note about the Kumo Cloud:

Current Sentiment:
* Price is above the Kumo Cloud is Bullish.
* Price is below the Kumo Cloud is Berish.
Future Sentiment: (Senkou A & B)
* Senkou A is above Senkou B is Bullish.
* Senkou A is below Senkou B is Bearish.
* Senkou A is equal to Senkou B is Consolidation.
Strength:
* Kumo future is bullish and both future Senkou A
and future Senkou B are pointing upward is Strong
bullish.
* Kumo future is bullish, future Senkou A is point
upward and future Senkou B is flat mean Medium bullish.
* Future Kumo is bullish, futre Senkou A is point
downward, and future Senkou B is flat. In other words,
this can be major pullback or a trend reversal.
* Strong Bearish: Future Kumo Future is bearish and
both future Senkou A and future Senkou B are pointing
downward.
* Medium Bearish: Future Kumo Future is bearish,
future Senkou A is pointing downward, and future Senkou
B is flat. This means that there is minor pullback or major
pullback with high volatility.
* Weak Bearish: Future Kuma Future is bearish,
future Senkou A is pointing downward, and future Senkou
B is flat. This means that there is a major pullback or
trend reversal.
* Kumo shadow represents major support and resistance
values. A Kumo shadow is a cloud that exists behind
price. They are created from past consolidation patterns
and trend reversals.
* The flat Senkou B of the Kumo Cloud is a major
support and resistance value. The longer the flat part of
Senkou B, the greater the support/resistance value it is
going to be to cause problems for the current or future
trend. Price just penetrated barely above the Senkou B
(past) resistance of the Kumo Cloud (shadow). Notice how
flat the Senkou was in the past around that price range.
It acts as a major resistance to a point and it caused a
major pullback in the bullish trend action.
* The peaks created by Senkou A of the Kuma Cloud
are a major support and resistance value.
* The spacing between Senkou A and Senkou B for
the future Kumo Cloud represents volatility.

Strategy Description
Useful Guide lines for Bullish Instrument
* Price has to be above Kumo Cloud.
* Tenkan Sen is greater than Kijun Sen.
* Chikou is showing strong bullish momentum ("Open
Space")
* There should be at least 50 pips to the next major
support or resistance value.
* Kumo future is bullish.
* Entry pirce has to be less than 200 pips from the Tenkan
Sen. If not, you have to wait for it to equalize and come
back into range.
* Entry buffers equals 40 pips.
* All Ichimoku indicator have to bullish.
* If price is greater than 200 pips from TS, exit if TS is
flat.
* If profit is equal or greater than 300 pips, use TS with
buffer as your stop.
* Exit buffer equals 40 pips.

Useful Guide lines for Bullish Instrument

* Price has to be below Kumo Cloud.
* Tenkan Sen is less than Kijun Sen.
* Chikou is showing strong bearish momentum ("Open
space").
* There should be at least 50 pips to the next major
support or resistance value.
* Kumo future is bearish.
* Entry price has to be less than 200 pips from the Tenkan
Sen. If not, you have to wait for it to equalize adn come
back into range.
* Entry buffers equals 35 pips.
* All Ichimoku indicators have to be bearish.
* If price is greater than 200 pips from TS, exit if TS is
flat.
* If profit is equal or greater than 250 pips, use TS with
buffer as your stop.
* Exit buffer equals 35 pips.
PART - IV
Market Structures
I first read about the Market Structures concept from
Dr. Ron Lockhart. Then I read more detailed Market
Structures work from Michael Jardine’s book, Fibonacci
Trading. The Market Structure concept is simple, yet a very
powerful structuring concept. Markets have structures and
traders miss most cues as they are constantly hunting
some pattern, momentum, oscillator or some Zen-type
signals. Market Structure formation is a price phenomenon
occurring at major turns. Prices start with a wave (lets
say Up) and it ends at some point and then there is a
down-wave, and it ends some time and then begins
another up-wave. These wave formations start with the
Market Structures. Market Structure Low (MSL) and Market
Structure High (MSH) formation is continuous and is
repetitive at every wave begin and at every wave end.
Market Structures form in all markets, in all time-frames
and in all instruments. They fail and re-fail, form and re-
form. Market Structure is a concept pattern. It needs other
indicators, support/resistance levels, triggers to confirm
the theory and its works.
Market Structures are well explained with Candlestick
charts. Market Structure Low (MSL) is explained with
three candle pattern. A new low, lower low, higher low
of CLOSE. Please see the word in BOLD, MSL is based
on close values not lows or highs. A MSL based long is
triggered when prices close above the highest close value.
A stop is being placed below the low of the MSL to
protect the trade.

Market Structure High (MSH)

A Market Structure High (MSH) is formed when
markets are making major tops. They form near key
resistance area or key moving average levels, which is
very significant. There are manytheories of using MSHs
in trading. One theory of MSH, is to find a critical
resistance area and trade a short position. The other way
is to find a series of past MSHs and build a trend line
for resistance. The third way is to use MSH in a fractal
wave form and build a larger wave structure using the
distances between them.
The Market Structure High (MSH) definition is when
markets make a new high followed by higher high
followed by lower high. This pattern is shown with a
three candle pattern. But many cases it may not be. It can
form in 5-6 candles in a time-frame, but the internal
candles should be mostly inside-bars suggesting indecision.

Trade
A MSH short trigger (after 3-bar MSH formation) is
signaled when price closes below the low of the third
candle.
Stop
Place a "stop" order above the MSH pattern's high.
Target
There are two ways to target MSH shorts. One is to
trade until another MSL forms near a key significant level.
The second method is to trade with a trailing stop using
the previous bar's high as the stop.
Three Bar Groups
Chart formations in Technical analysis require a
group of bars to derive a pattern. Sometimes a single bar
or two bars can show great patterns, but as a group, 3-
bar series groups provide reliable patterns or confirmations
for other major developing patterns. These groups of bars
are called "key reversal" bars. This 3-bar group may also
consist of well known two-bar reversals or a single bar
patterns within inside this group. Most of these 3-bar
groups are part of a "fractal" formations or part of "market
structures" where a prevailing trend showing signs of
pausing or reversal of current trends. Bars with exhaustion
price-action, "narrow range (with inside-days)" or "spike
with ledges" are some of the 3-bar group pattern.
Within the 3-Bar Groups, intra-bar relations like close
and open values relative to other bar, close and open
values and how they are formed could give signals of
continuation or reversal of trends. Gaps within the 3-bar
patterns also have significance.
Three Bar Pattern groups as the name suggests, will
have three continuous bars. It can be in any time-frame
or in any market instrument. A 3-bar group pattern is
defined using the three bar’s inter-bar Open, High, Low,
Close relationships with each other.
Three Bar patterns are relatively short trade setups
and should be traded using other indicators. They are
more effective as reversals near the end of prolonged
trends than in the middle of the trends.
When markets making new highs and showing a
series of signs of pausing or reversals, 3-bar patterns are
more reliable than 3-bars formed in the middle of the
trend. Two out of three 3-Bar Groups may be successful
but the concept also applies to bigger structures with three
continuous major "swing highs" and three continuous major
"swing lows". When trading three-bar groups, look for the
third bars' range. When the range of the third bar is
greater than prior two bars, it tends to produce more
reliable results.

Matching Highs/Lows Pattern

Matching Highs and Matching Lows patterns occur at
market bottoms and tops. Prices form key support and
resistance areas at certain price ranges, and attempt to
break these levels for at least 3 bars in a row. When the
prices fail to break these levels, they form "matching lows"
and matching high patterns for a minimum of 3 bars, and
these "matching highs" or "matching lows" may signal a
potential trend reversals. These patterns are more effective
in daily and weekly charts. Intra-day tick charts with
higher tick counts or time-frames are used when finding
reliable matching highllow patterns.
Trade:
Trades are taken in the opposite direction prior to
the matching highsllows pattern. After a "matching lows"
pattern, a "long" trade may be entered above the high of
the breakout bar. For a matching highs pattern, a "short"
trade is entered below the low of the breakdown bar.
Stop:
Place a "stop" order below the low of the pattern for
a "matching lows" pattern. For a matching highs pattern,
place a "stop" order above the high of the pattern.
Target:
Targets are placed from the trade entry in multiples
of length of the breakout bar. For a long entry, place the
first target at the length of the breakout bar above the
entry, and the second target is set at twice the length of
the breakout bar above the entry. For short entry, place
the first target at length of the breakout bar below the
entry level, and the second target is set at twice the length
of breakout bar below the entry.
NR7ID with ORB
Toby Crabel popularized a trading pattern called
NR7ID with ORB in his book, Day Trading with Short
Term Price Patterns and Opening Range Breakout.
7-Day Narrow Range (NR7): NR7 is defined as the daily
range which is narrower than the prior 6-Day range.
Inside Day (ID): Inside Day is defined as a trading day
that has range which is completely encompassed by the
previous days’ range. The prior day’s high is higher than
the current days’ high and the prior day’s low is lower
than current days low.
Opening Range Breakout (ORB): Is a trade executed
when prices trade a predetermined amount above or below
the opening range. The predetermined range is calculated
as the 10-bar average distance between open to high and
open to low.
Trade: Enter a trade after the NR7ID in the direction of
the breakout. Enter a long trade on breakout at the ORB
value above the high. For a short trade, enter a short
trade on breakdown at the ORB value below the Low.
Stop: For breakout trades, place a stop order at (low-
ORB). For breakdown trades, place a stop order at (high
+ ORB).
Target: “NR7ID with ORB” is primarily a trade entry
technique and the targets are set at prior “swing highs”
and prior “swing lows” or at key resistance and support
areas.
WR7OD Pattern
A 7-day Wide Range bar is formed when a current
bar has the widest range in the last 7 bars. An outside
bar develops when the low of the current bar is lower
than the previous bar and the current high is higher than
the previous bar. Trades are only entered in the direction
of the current trend.
Wide Range bars forming at the start of a trend or
at key reversal levels could signal strong bullish and
bearish trends. If Wide-Range bars are forming out of a
consolidation range, they signal price continuation in the
direction of breakouts. And Wide-Range bars forming at
the end of the rallies and sell-offs, the bars may be
signaling exhaustion and potential trend reversals.

Trade: Wait for WR7OD to form in the current up or

down trend. In an uptrend, trade only “long” one tick
above the high of the WR7OD bar. In down trends, trade
only “short” one tick below the low of the WR7OD bar.

Stop: Place a “stop” order one-tick below the low of the

WR70D bar (for breakouts). Place a “stop” order one-tick
above the high of the WR7OD bar (for breakdowns).

Target: Set targets of 50% to 100% of the WR7OD range

from the breakout or breakdowns levels.

Double Top and Double Bottom

"Double Top" patterns occur when prices fail to make
new highs at significant previous high levels. "Double top"
patterns are relatively reliable and easy to trade. Also,
these patterns fail as they may potentially form "triple"
or "multiple" top formations. "Double tops" usually signal
the end of a bull run, depending on the width of the top
formation. Volume in the first swing should be heavier
than the volume on the second swing. In addition, the
volume maybe heavier on the breakdown bars. If the
breakdown volume is weaker, it may be signaling a
"triple" or "multiple" top formation.

Trade: A "Double top" pattern confirmation occurs at the

breakdown level of "swing lows" at neckline. Enter a
"short" trade below the previous "swing low" at neckline.

Target: "Double Top" patterns do offer a good risklreward

ratio. Measure the distance between the top of the pattern
to the neckline for potential target range from the trade
entry.

Stop: "Double tops" also fail and form "triple" or "multiple"

top patterns. Usually the "Double top" pattern failure
occurs when prices reverse and trade at the middle of the
"Double top" pattern. Enter a "stop" order at the middle
of the pattern range to protect the trade.

"Double Bottom" patterns form when prices fail to

make new lows at a significant bottom area. Most of the
time, the lows on the two “bottom bars” form within 2
to 5 percent of the applicable price range. “Double bottom”
patterns are easily detected after the apparent formation,
and can be traded with good confirmation signals. Volume
may provide a good confirmation signal as the volume
in the first swing would be heavier than the volume in
the second swing. Volume may also be heavier on the
breakout. If the breakout volume is weaker, it may be
signaling a third bottom.

Trade: A "Double bottom" can only be traded after

confirmation of the pattern breakout. Confirmation of the
pattern occurs when prices close above neckline. Enter a
"long" trade above the high of the breakout bar from the
neckline.

Target: "Double bottom" patterns also have a good

riskheward ratio. The first target would be 100% of the
swing range of the pattern. The second target would be
127% to 162% of the depth of the "double bottom" pattern.

Stop: "Double bottom" patterns do fail. This pattern failure

occurs if the price closes below in the middle of the
pattern for multiple bars. Trading below the bottom of the
pattern could be a signal of triple bottom. Place a "stop"
order below the middle of the pattern to protect the trade.

Triple Top & Triple Bottom

"Triple Top" patterns are multiple top patterns indicating
when prices try to make new highs and fail on the last
attempt. "Triple top" patterns look like "Head and Shoulders"
patterns, and are moderately reliable patterns to trade.
However, "Triple top or bottom" patterns do fail and
failures may be probably more reliable and stronger as
they trade in opposite direction. Most "Triple top" pattern
lows occur within 2% to 5% of price range. "Triple tops"
are relatively easy to detect and offer a good risk to
reward ratio. A confirmation is needed before trades are
initiated. Heavy volume is traded in the first swing up,
but the remaining swings will incur with diminished
volume. In addition, heavy volume is followed at the
breakdown of the pattern.

Trade: There are two types of possible trades that occur

in "Triple top" patterns. An aggressive trade (short) is
placed near the last attempt at the lower high of the
previous two swing highs. The second trade is possible
when prices close below the lower low of the previous two
swings at breakdown.

Target: "Triple top" patterns have excellent risWreward

ratio. Measure the depth of the "Triple top" between
swings and subtract the depth from breakdown level.

Stop: "Triple top" patterns fail when prices attempt to close

above the highest "swing high" of the pattern. Place a
"stop" order above the "swing high" of the "triple top" to
protect the trade.

Head and Shoulders Pattern

"Head and Shoulders" patterns are reversal formations
that usually form at the market tops. "Head and Shoulders"
patterns are very reliable, but failures do occur. When
Head and Shoulders patterns fail, they reverse the pattern
and trade in an explosive manner. Most "Head and
Shoulders" patterns can be detected using volume patterns.
During the left shoulder and the beginning of the "Head"
formations, the volume will be heavy. While forming,
volume dissipates on the right shoulder, and the volume
increases during the breakdown. A trend line or neckline
is drawn connecting the "Head and Shoulders" pattern to
determine the potential trade opportunities and targets.
The neckline can be also formed in an angle (slanted).

Trade: Connect "Head and Shoulders" bottoms in a trend

line or neckline. When the price closes below the neckline,
a potential short trade is signaled. Short one tick below
the breakdown bar's low.

Target: Compute the vertical distance between the "apex"

of the "Head and Shoulders" pattern and the neckline. The
target is set below this distance from the neckline.

Stop: After a trade entry, if the price closes above the

neckline, a potential failure of the pattern is signaled.
Place a "stop" order above the neckline.
Round Top Pattern
"Round Top" formations are usually reversal patterns
that generated over a long periods of time. Indecisive
markets move in slow and gradual changes near the tops
and bottoms. "Roun Top" patterns are formed when prices
trade in a tight range making sporadic "lower highs" an
"higher lows". Usually the volume traded in this pattern
is very low compared to the prior trend before the pattern
formation. Breakdowns from "Round top" patterns will be
fast and sharp when price movement occurs. "Round top"
patterns also have a high failure rate.

Trade: A trend line is drawn connecting the "Round top"

to the previous swings to find the possible trade opportunity.
A close below the trend line indicates a trend change and
provides a trading opportunity. A "short" trade is entered
below the low of the breakdown bar.

Target: Successful "Round top" patterns have very sharp

moves to the downside from the breakdown levels. There
may be two targets possible. The first target is set at the
depth of the "Round top" pattern from the trend line
breakdown level. The second target is set at or near the
prior "swing lows" before the pattern formation.
Stop: For trades taken on inclined trend line breakdowns,
place a “stop” order above the trend line (on close basis)
and for trades using horizontal trend line breakdowns, use
the mid point of the “Round top” pattern to protect the
trade.

Round Bottom Pattern

"Round Bottom" patterns are also called "saucers" and
they form at the market bottoms. "Round bottoms" form
after a prolonged down-trend, slow and gradual markets.
"Round bottoms" are relatively reliable patterns and are
easy to spot (in curve form) at the bottom and have weak
volume markets. "Round bottom" trading is similar to a
"rectangle" pattern trading and they may be better visible
in higher time-frames. A trend line is drawn connecting
the "swing highs" of the "round bottom" pattern to initiate
the trades at the trend line breakout levels. "Round
bottom" patterns with a long base may provide more
profitable trades.

Trade: A trend line is drawn connecting previous "swing

highs" prior to the "Round bottom." Price trading above
the trend line signals a breakout and a "long" trade. Enter
a "long" trade above the high of the breakout bar from
the trend line.

Target: Two potential trade targets are possible in "Round

bottom" patterns. The first target is the depth of the
"Round bottom" pattern from the breakout level. The
second target is the previous "major swing highs".

Stop: The "Round bottom" pattern trade is based on the

trend line breakout. Pattern failure can occur if the market
closes below the trend line for a series of bars. Place a
"stop" order below the trend line to protect the trade.
Symmetric Triangle
"Symmetric Triangles" form when the markets are in
indecision mode. The "Symmetric triangles" can be easily
detected when prices make alternate "lower highs" and
"higher lows" in upside and downside slopes defining a
symmetry. "Symmetric" triangles form when supply and
demand are near equal resulting in market indecision.
Most triangles result in a clear breakout and breakdown
in the direction of the prior trend.

Trade: Trades are only initiated at the trend line breakouts

of the "Triangle." Enter trades only when "Symmetric
triangle" breakoutsibreakdowns are confirmed by price
trading one or two ticks aboveibelow the breakoutibreakdown
bar's highllow.

Target: Most "Symmetric triangles" result in 100% of the

depth riselfall of the entire triangle range in the direction
of the breakout. Partial trade exit targets are set at 50%
of the depth from the trade entry. Protect targets by using
trail stops.

Stop: "Symmetric triangle" failures occur when price results

in false breakouts. Stop below the first major "swing low"
below the trend line for a long setup. Place a "stop" order
above the first major swing high from the trend line for
a short-setup.
Ascending Triangle
"Ascending Triangles" form when prices attempt to
make "higher highs" and "lower lows" suggesting a bullish
price trend. The "Ascending triangle" is bound by two
trendlines: a horizontal line at the top and an upward
slope trend line connecting the lower lows. "Ascending
triangles" form in any market and are quite reliable. The
"Triangle" prices must intersect the trend lines at least
twice (each) before the pattern is complete. Usually at the
third or fourth attempt to trade outside the top trend line
results in a breakout. Breakouts occur near the apex of
the triangle. This pattern has a high success rate as it
meets its target about 75% of the time.

Trade: Trade a clear breakout of the top trend line. Enter

a "long" trade one tick above the high of the breakout
bar. Confirm the breakout by volume or other indicators.

Target: "Ascending triangles" have excellent success in

reaching target areas. The usual target would be the depth
of the "Triangle". Measure the distance (depth) between the
top trend line and lowest of the upward slope trend line.
Add this depth to the breakout point from the top of the
trend line. Targets are also set at 50% of depth level for
partial exits.
Stop: Place a "stop" order when the price closes below the
low of the lower trend line or a major swing low.

Descending Triangle
"Descending Triangles" are similar to "Ascending
Triangles" formation rules except they are bearish.
"Descending triangles" form in bear markets and favor
breakdowns. A "descending" triangle is bound by two
trend lines connecting a downward slope trend line and
a flat trend line connecting the lows of the pattern. Trades
usually occur near the apex as the price closes outside the
bottom trend line suggesting a breakdown. The price must
intersect trend lines at least twice before the pattern
emerges. Like the Ascending triangles, "Descending Triangles"
also have a high success rate.

Trade: Trade one tick below the low of the breakdown

bar (outside of the triangle). Confirm the breakdown with
increased volume.

Target: "Descending" triangles have similar targets like

"Ascending" triangles. Measure "Triangle" depth at the
lowest and highest points and set targets at 50% and 100%
range from the breakdown point.
Stop: Place a "stop" order outside the downward slope
trend line. If price closes above the top trend line, exit
the trade.

Flag
"Flags" are continuation patterns representing a small
pause in the market trend. They can be easily spotted as
they appear right after a sudden and quick burst from
a trading range. In dynamic and quick markets, Flags
form as prices pause and move in the same direction as
the prior trend after a clear breakout. Flags are known
to be very reliable patterns. "Bull Flag" patterns can be
spotted when the market breaks out from a range and
makes "lower highs" and "lower lows" in a tight formation.
The trend lines connecting these highs and lows are near
parallel. Also, tight and well defined "flags" perform
better than short and zigzag "flags."

Trade: After a series of "lower highs" and "lower lows,"

connect prices with two parallel trend lines. Wait for a
clear breakout to the upside. Price closing outside the
upper trend line is the first sign of a breakout. Enter a
"long" trade one tick above the high of the breakout bar.
Another clear signal of a "Bull flag" breakout occurs when
prices trade above the recent "swing high".

Target: Measure the prior distance from the "swing low"

at point A to the "flag" formation at point B. Target 70%
to 100% of this range from C. Secondary targets in bull
markets are 138% to 162% of AB from C.

Stop: Place a "stop" order below the "low" of the "flag."

Bear Flag
"Bear Flags" usually occur as markets fall from a
base and pause in a downtrend. They are almost identical
to "Bull flags," but in the opposite direction. "Bear flags"
can be easily spotted as they make "higher highs" and
"higher lows" within the "flag" area. The trend lines
connecting "highs" and "lows" are almost parallel. A clear
breakdown confirmation is needed to trade these patterns
as the price continues in the same direction prior to the
"flag" formation. Like "Bull flags," "Bear flags" are also
very reliable.

Trade: After a series of "higher high" tops and "higher

low" bottoms, prices will breakout of the lower-trend line.
Wait for confirmation of breakdown with a long range
bar. One of the best confirmations occur when prices
"close" below a previous "swing low" (of bear flag). Enter
a "short" trade one tick below the "swing low" or previous
bars' low.

Target: A typical target in "Bear flags" is from 76% to

100% of the AB range prior to the "Bear flag". The
secondary targets are from 138% to 162% of the range AB.

Stop: Place a "stop" order above C to protect the "short"

trade.
Wedge Pattern
Rising Wedge
"Rising Wedge" patterns are similar to "Symmetric
Triangles" but "Rising Wedge" patterns form in an angle
where as "Symmetric Triangles" are mostly horizontally
formed. "Rising wedge" patterns have higher highs and
higher lows and are connected with two angled (slanted)
trend lines. These trend lines converge at the top. The
price must intersect each trend line at least twice before
the pattern fblly emerges. "Rising wedges" are usually
bearish in both uptrend and downtrend markets. In addition,
they have a high failure rate and are relatively difficult
to spot them. They seem to work well in bullish markets.

Trade: "Rising wedges" are defined by the trend lines

connecting the highs and lows of the pattern. The price
trading outside the lower trend line signals a potential
short trade. A "short" trade is entered when the prices
close below the breakdown’s bars low (must be below the
trendline).

Target: After trade entry, a target is set at the lowest

point in the wedge formation. Another target measure
would be the length of "wedge" pattern from the breakdown
level.

Stop: Place a "stop" order above the last "swing high" of

the "wedge" pattern.

Falling Wedge
"Falling Wedge" patterns are similar to "Symmetric
Triangles" as they form in an angle; where as the
"Symmetrical Triangles" form horizontally. "Falling wedge"
patterns have lower highs and lower lows and are connected
with two angled, slanted trend lines. These trend lines
diverge at the bottom. Another type of "wedge" (inverse)
pattern has trend lines converging at the bottom. The
trend direction on the breakout from the "Falling Wedge"
pattern would be upside. "Falling wedges" are usually
bullish in uptrend and downtrend markets. Similarly,
"Falling wedge" patterns have a high failure rate. They
are relatively difficult to spot them, and tend to work well
in bearish markets.

Trade: The "wedge" patterns are defined by trend. lines

connecting the "higher-highs" and "lowerlows." A trend
line breakout suggests a "long" trade. Trades are entered
after a clear breakout from the trend line. Enter a "long"
trade, one tick above the high of the breakout bar from
the trend line.

Target: Place a target at the higher "swing high" level of

the "wedge" pattern. A secondary target is set at the depth
of the wedge pattern from the breakout level.

Stop: Place a "stop" order below the lowest level of the

"wedge" pattern.
PART - V
INTRODUCTION
Our main focus up to this point has been on price
movement, and not too much has been said about the
importance of time in solving the forecasting puzzle. The
question of time has been present by implication throughout
our entire coverage of technical analysis, but has generally
been relegated to secondary consideration. In this chapter,
we're going to view the problem of forecasting through
the eyes of cyclic analysts who believe that time cycles
hold the ultimate key to understanding why markets move
up or down. In the process, we're going to add the
important dimension of time to our growing list of
analytical tools. Instead of just asking ourselves which way
and how far a market will go, we'll start asking when
it will arrive there or even when the move will begin.
Consider the standard daily bar chart. The vertical
axis gives the price scale. But that's only half of the
relevant data. The horizontal scale gives the time horizon.
Therefore, the bar chart is really a time and price chart.
Yet, many traders concentrate solely on price data to the
exclusion of time considerations. When we study chart
patterns, we're aware that ther is a relationship between
the amount of time it takes for those patterns to form and
the potential for subsequent market moves. The longer a
trendline or a support or resistance level remains in effect,
the more valid it becomes. Moving averages require some
decision as to how many days to measure.
It seems clear then that all phases of technical
analysis depend to some extent on time consistent and
dependable manner. That's where time cycles come into
play. Instead of playing a secondary or supporting role
in market movement, cyclic analysts hold that time cycles
are the determining factor in bull and bear markets. Not
only is time the dominant factor, but all other technical
ools can be improved by incorporating cycles. Moving
averages and oscillators, for example can be optimized by
tying them to dominant cycles. Trendline analysis can be
made more precise with cyclic analysis by determining
which are valid trendlines and which are not. Price
pattern analysis can be enhanced if combined with cyclic
peaks and troughs. By the use of "time windows," price
movement can be filtered in such a way that extraneous
action can be ignored and primary emphasis placed only
on such times when important cycle tops and bottoms are
due to occur.

Basic Cyclic Concepts

In 1970, J.M Hurst authored The Profit Magic of
Stock Transaction Timing. Although it deals mainly with
stock market cycles, this book represents one of the best
explanations of cycle theory available in print.
First, let's see what a cycle looks like and discuss
it's three main characteristics. At figure shows two repetitions
of a price cycle the cycle bottoms are called troughs and
the tops referred to as crests. Note that toe two wave
shown here are measure from trough to trough. Cyclic
analysts prefer to measure cycle lengths from low to low.
Measurements can be taken between crests, but they are
not considered to be as stable or reliables as those taken

Crest

first cycle second cycle

between the troughs. Therefore, common practice is to
measure to beginning and end of a cyclic wave at a low
point, as shown in this example.

The three qualities of a cycle are amplitude, period,

and phase. Amplitude measures the heigh of the wave as
shown in figure. The period of a wave is masure the time
between troughs. Phase is measure of the time location
difference between two wave. Because there are several
different cycles occurring at the same time, phasing allows
the cyclic analyst to study the relationships between the
different cycle lengths.

Left and Right Translation

The concept of translation may ver well be the most
useful aspect of cycle analysis. Left and right translation
refers to the shifting of the cycle peaks either to the left
or the right of the ideal cycle midpoint. For example, a
20 day trading cycle is measured from low to low. The
ideal peak should occur 10 days into the cycle, or at the
halfway point. That would allow for a 10 day advance
allowed by a 10 day delcline. Ideal cycle peaks however,
raely occur. Most variations in cucles occur at the peaks
(or crests) and not at the troughs. That's why cycle troughs
are considered more reliable and are used to measure
cycle lenghts.
The cycle crests act differently depending on the
trend of the lext longer cycle. If the trend is up, the cycle
crest shifts to the right of the ideal midpoint, causing right
translation. If the longer trend is down, the cycle crest
shifts to the left of the midpoint, causing left translation.
Therefore, right translation is bullish and left translation
is bearish.

Seasonal Cycles
All markets are affected to some extent by an annual
seasonal cycle. The seasonal cycle refers to the tendency
for markets to move in given direction at certain times
of the year. The most obvious seasonals involve the grain
markets where seasonal low usually occur around harvest
time when suply is most plentiful. In soybeans, for
example most seasonal tops occur between April and June
with seasonal bottoms taking place between August and
October. One well known seasonal pattern is the "February
Break" wheere grain and soybean price usually drop from
late December or early January into February.
Although the reasons for seasonal tops and bottoms
are more obvious in the agricultural markets, virtually all
markets experience seasonal patterns. Copper for example,
shows a strong seasonal uptrend from the January/February
period with a tendency to top in Marck or April. Silver
has low in January with higher price into March. Gold
shows a tendency to bottom in August. Petroleum products
have a tendency to peak during October and usually don't
bottom until the end of the winter. Financial markets also
have seasonal patterns.
The U.S. Dollar has a tendency to bottom during
January. Treasury Bond prices usually hit important highs
during January. Over the entire year, Treasury Bond prices
are usually weaker during the first half of the year and
stronger during the second half.

Stock Market Cycles

Did you know that the strongest three month span
for the stock market is November through January? February
is then weaker, but is followed by a strong March and
April. After a soft June, the market turns strong during
July(the start of the traditional summer rally). The weakest
month of the year is September. The strongest month is
December (ending with the well know Santa Claus rally
just after Christmas).

The Presidential Cycle

Another well know cyce that affects stock market
behavior is the 4 year cycle, also called the Presidential
Cycle, because it coincides with the elected term of U.S
presidents. Each of the 4 years has a different historical
retur. The election year (1) is normally strong. The
postelection and midyears (2 and3) are normally weak.
The preelection year(4) is normally strong.
PART - VI
History and Development
No one really knows precisely where the Point and
Figure charts came from, or who invented them. They
weren’t always called Point and Figure charts, as you will
see. Writing in 1933 , Victor D e Villiers and Owen Taylor
state that the Point and Figure Method i s over 60 years
old. Some have therefore attributed them to Charles Dow,
which seems to be the easy option,as Dow is regarded
by many as the father of Technical Analysis. It is unlikely
that any one person invented Point and Figure charts. In
fact they probably weren’t invented at all. It is more likely
that they were born out of necessity - a need to be able
to record price movement quickly and efficiently whilst on
the move. ‘On the move’ being not at your desk, but
standing on the trading floor or in front of the ticker tape
machine in the broker’s office, as most private traders
would have been. What the trader wanted was a general
idea of what the share price was doing. The most obvious
way therefore, was to simply write down the prices on
the back of a cigarette packet or notebook as the share
traded as follows:
9¾, 10¼, 11½, 11¼, 12½, 12¼, 13¼, 15, 16½, 15, 14¼,
13½, 12, 10¼, 10, 11¾, 11½, 14, 15, 16, 17, 19½, 20,
21¾, 19, 18¾, 19½, 20
I t was not long before he realised that there was
no point in writing down all the fractions, because firstly
it took more time, and secondly the fractional changes
were irrelevant to the general trend, which is what he was
trying to see. He therefore left out the ¼‘s, the ¾‘s and
the ½, so his record of the day’s trading started to look
like this:
9, 10, 11, 11, 12, 12, 13, 15, 16, 15, 14, 13, 12, 10,
10, 11, 11, 14, 15, 16, 17, 19, 20, 21, 19, 18, 19, 20
He now had a record of what the share was doing,
but this is what it would look like at the end of a busy
trading session.
9, 10, 11, 11, 12, 12, 13, 15, 16, 15, 14, 13, 12, 10,
10, 11, 11, 14, 15, 16, 17, 19, 20, 21, 19, 18, 19, 20, 21,
19, 18, 19, 20, 21, 22, 23, 20, 19, 16, 15, 13, 12, 10, 8,
9, 11, 11, 12, 14, 13, 13, 12, 13, 13, 15, 15, 16,
It would have been a mass of numbers. The only
thing he could glean from it was the first price of the
day, 9, and the last price of the day, 16 . He could not
see, at a glance, how it had traded during the day; what
the high or low was; or where most of the trading had
taken place. So, he had to come up with a better way
of recording the prices. How about writing down the
numbers in columns so that the highest and lowest price
could easily be seen? Logically, he decided on a rising
column for rising prices and a falling column for falling
prices. Taking the first few prices from our series, his
tabulation would have looked something like this.

16
15
13
12
11
11
10
9
It didn’t take him long to work out that it was
unnecessary to write down a price twice if it traded at
the same price in succession. So, the double 11 s and 12s
disappeared. He also realised very quickly that when the
price changed direction he would have to move across to
the next column and write the number in the next free
space. So, having written ‘ 10 11 12 13 15 16 ‘ in the
first column as the price was rising, when the price fell
back to 15 , he realised he would have to move to the
next column to write ‘15‘ and then ‘13 12 10‘ as the price
fell further.
16
15 15
13 13
12 12
11
10 10
9
This immediately showed a flaw in the method. In
the first column, he initially missed out 14 because the
price had not traded at 14, but that meant there was
nowhere to put 14 in the second down-column as the price
traded at 14 on the way down. So, he had to ensure that
all price levels were recorded even though the price never
traded at that level and hence one of the basic tenets of
the method was established the charts take no account of
gaps.

17
16 16
15 15 15
14 14 14
13 13 13
12 12 12
11 11 11
10 10
9

As the columns grew longer, and more columns

appeared as the price changed direction, he realised that
squared paper would assist in keeping the tables neat and
regular and so his record (remember it was not intended
to be a chart) started to look like below. The figures
written into squares brought the word ‘box’ into the
language, although he had no idea at this stage that,
firstly, he was drawing a chart and, secondly, that it
would one day be called, Point and Figure.

Shows how a Figure chart was born. It is important

to note that it was not started as a method of charting,
but more as a sequential price recording method. Traders
now had a way of recording price movements that had
a number of benefits:
1. They could trace what the price had done during the
day by following the columns.
2. They could easily see what the high of the day was
(24).
3. They could easily see the low (8).
4. They could see where it closed on the day (16).
5. They could see where most of the trading had taken
place by looking at the most fi lled in row (20).
6. It was a portable system that could be written on the
back of an envelope and did not require the plotting
rigours and precise time and price scaling of a line
or bar chart. Thus, time is not an ingredient of the
method.
Some traders would have found it tedious to write
down the price all the time, preferring instead to ‘tick off’
or ‘mark off’ the price with a dot, a tick or cross as it
hit a particular price level. These charts constructed with
ticks or crosses started to appear towards the end of the
19th century and into the 20th. It is almost as if there
were several groups developing the charts to their own
specification, often not realising that others were doing the
same.

In fact, to this day, the X-oly method is still the best

method when a certain type of Point and Figure chart
called a 1-box chart is drawn. The X-onlymehtod makes
the 1-box chart clearer than the X and O method does.
The X and O method is, however, the clearest for all other
type of point and Figure Chart.

Where did Point and Figure charts get their name?

There has been much discussion and speculation
about the origin of the name Point and Figure, and,
although it is not that important, it is worth looking at
the written evidence. As stated earlier, Hoyle did not give
the method a name, other than to describe them as
‘fluctuation records ‘ . Although he described the recording
of figures, Hoyle ‘s charts were drawn with price scales,
and instead of numbers he used ‘ ticks’ , as if he was
ticking off the prices as they occurred. It is clear, therefore,
where the word ‘Figure ‘ came from. Figures were used
to plot the prices as they occurred. There is, however,
some confusion and speculation as to where the word
‘Point’ originated.

The voice of the market

Point and Figure charts are the voice of the market.
They are the only charts that come directly from the
trading floor and are plotted as and when the price
changes. Of course, all charts come from the market, but
remember that Point and Figure charts only change when
the price changes. All other charts having time-scales must
move forward as time passes, whether the price is changing
or not. When the market is quiet, Point and Figure charts
do not move. When the market is busy and the price is
moving up and down, Point and Figure charts show that
movement. Point and Figure charts plot every price box
size tick by tick, telling you exactly what is going on.
It’s like the market talking to you. When analysing Point
and Figure charts, that’s exactly what you get from the
charts - your own squawk box. Each minor and maj or
battle between bulls and bears is played out on the chart
and is there for you to see and analyse. If nothing is
happening, the chart falls silent as well.

Characteristics of Point and Figure Charts

Point and Figure charts have the following unique
features, all of which are explained in greater detail
below;
- They are usually constructed with Xs and Os instead
of lines or bars.
- Xs represent sequential up movements in price.
- Os represent sequential down movements in price.
- The Xs and Os are called 'boxes'.
- Each X and O represents a discrete price interval,
which is called the 'box size'.
- Price changes below this interval are ignored when
plotting the chart.
- A column of Xs changes to a column of Os (and vice
versa) when the price changes direction by a given
number of boxes. This is called the 'reversal size'.
- The columns of Xs and Os reprsent demand and
supply.
- The chart sensitivity can be varied to show the short,
medium and long-term position using the same data.
- No record is made of price gaps.
- Price is scaled on the vertical Y axis.
- There is no time-scale along the horizontal X axis.
- Time plays no part in the construction or analysis
of Point and Figure charts.
- Although there is no time axis, Point and Figure
charts are two-dimensional charts.
- Volum plays no part in the construciton or analysis
of Point and Figure charts.
- Point and Figure charts are named according to their
box and reversal size.

Constructed with Xs and Os

You will recall that early Point and Figure charts
were constructed with numbers or figures and that these
numbers were replaced by Xs, which were eventually
replaced with Os and Xs. Every time you look at a Point
and Figure chart, you must visualise this. You will learn
that it is often better to construct some Point and Figure
charts using Xs only.
Up moves and down moves.
Xs are used to indicate up moves in price and Os
are used to indicate down moves. Using two different
letters makes Point and Figure charts very readable. You
can instantly see the general trend, and within that
general trend you can see the intermediate pullbacks
against the trend represented by alternate columns of Xs
and Os. Computer-drawn Point and Figure charts allow
Xs and Os to be drawn in different colours, normally blue
for up and red for down.

Xs and Os called boxes

You have seen why they are called boxes, because
on squared paper the XS and Os are drawn in ‘boxes ‘
. You will find, when you look at construction, that the
word ‘box’ is used to describe the Point and Figure chart.

Box size
This meant that a figure could only be written down
when the price reached that level. The same applies to
Point and Figure charts constructed with Xs and Os. Each
X and O is given a sensitivity value before the chart is
constructed. This is called the box size. It may be 1 point,
½ point, or it may even be 50 points. No matter what
value is assigned, you may not plot and X or O until
the price has reached the next interval. For example, if
each X and O is 50 points, then the values of ascending
Xs would be 50, 100, 150, 200 and so on. A price move
from 50 to 99 would be ignored because it had not
reached 100. It is important to note that the 'box' represents
the price and not the line. Point and Figure charts are
plotted differently from line or bar charts. With line or
bar charts the price scale is represented by line, so a price
of 100 is on the horizonal line at 100. With Point and
Figure charts however, 100 is a square with and X or an
O above the 100 line. This often confuses student of Point
and Figure and will be seen when the construction
procedure is explained.

Reversal size
The reversal size is an important part of Point and
Figure chart construction. It is the number of boxes
required to change from a column of Xs to a column of
Os or from a column of Os to a column of Xs. Depending
on the type of Point and Figure chart you are drawing,
the reversal size can be 1-box, which is the original
method, 3-box, 5-box, or any other value. It is, however,
important to note that this terminology has changed for
the better over the years. Cohen and others before him
referred to 3-point reversal charts, meaning that the box
size was 1-point and so a reversal of 3 boxes was 3
points. This was fine when Point and Figure charts were
constructed with a box size of 1 -point, but started to get
confusing when the box size was, say, 5 points. The
reversal was then referred to as a 15-point (5 x 3) reversal
chart. You will however still hear Point and Figure
analysts talk of their 3-point reversal charts, meaning their
3-box reversal charts.

Point and Figure signals

One of the great advantages of Point and Figure
charts is the unambiguity of the buy and sell signals they
generate. Of course, not every signal will result in a profit,
but the fact that the signals are unambiguous makes the
charts easier to interpret. These buy and sell signals are
created by demand overcoming a resistance level or
supply overcoming a support level. This can be seen in
many ways, from simple patterns to quite complex ones.
Furthermore, the terminology used to identify many of the
patterns has changed over the years. Although this
terminology does not affect the way the patterns work, it
is important to understand the differences and the changes.
There are also differences in the way patterns are treated
in 3-box and 1-box charts; so instead of dealing with them
separately, they are dealt with together so that you can
compare and contrast them.

Double-top and bottom patterns

If, demand, represented by a new column of Xs,
overcomes supply and the column of Xs breaks above the
previous column of Xs, this is the most basic Point and
Figure buy signal. This pattern is essentially a 3-box
reversal pattern that has little or no significance in 1-box
reversal charts. The same pattern created from exactly the
same data and in both cases the signal occurs when, after
a small correction, an X is plotted above the highest X
in the pattern.

X Buy
X X
X O X
X O X
X O
X

O
O X
O X O
O X O
O O
O Sell
Continuation as well as reversal
In 3-box charts, it is important to note that double-
top and double-bottom patterns can be either continuation
or reversal patterns. That is to say, they can either occur
after a pause during an up or downtrend, or at the end
of a trend as a trend reversal.

Reversal patterns in 1-box charts

In 1-box charts reversal patterns have different names,
called fulcrums. For a reversal to occur, there must be
move into a pattern and a move out in the opposite
direction. As you have seen.

Triple-top and bottom patterns

Triple-top and bottom patterns As stated earlier, all
Point and Figure patterns which generate buy and sell
signals are built around the two basic double-top and
double-bottom patterns; however, the stronger the resistance
or support, the more important the subsequent buy or sell
signal. Consequently, a triple-top buy or triple-bottom sell,
where the level breached has been attained twice already,
will lead to a stronger move.
The reason that the wider pattern generally leads to
a stronger and more reliable signal is that the battle for
control has taken three upthrust columns instead of two.
Having been forced back twice, demand from the bulls
eventually manages to overcome supply on the third
attempt by breaking up above the resistance level. This
catches the bears off-guard because they will have built-
up confidence every time they managed to push the bulls
back when the price reached the same level as the
previous column of Xs. Bears taking out shorts on the blue
line resistance level will find that they are on the wrong
side and have to cover (buyback their shorts). It is this
process that leads to potentially good moves.

Triple-top and bottom for 1-box chart

In 1-box charts there is no distinction between the
patterns as there is with 3-box double-top/bottom and
triple-top/bottom patterns. 1-box reversal fulcrums are
wider.

Compound patterns
There is no point looking for the perfect pattern, you
won’t find it. Instead, you will see combinations and
variations of the standard patterns like the ones below.
The important thing in Point and Figure analysis is
'looking left' and understanding what creates the patterns.
Look left on the chart and make a subjective decision as
to the support or resistance being offered by previous
columns of Xs or Os, remembering that the more times
a level has held, the stronger it will be.

Knowing when to ignore signals

It is sometimes advisable to ignore the minor double-
top buy and bottom sell signals, especially as the pattern
becomes larger and more complex.
1-box and 3-box patterns
There are ssentially only two 1-box patterns: semi-
catapult, if the pattern is acontinuation pattern; and fulcrum
if it is a reversal pattern. Within these two types there
are hundreds of variations.
With 3-box charts there are many more defined
patterns. Because 3-box chart have been researched more
than 1-box charts, many of the 3-box patterns have
beengiven names.

Trend Line breaks

Trend lines play an important, if not an essential,
part in Point and Figure analysis. They bring Point and
Figure charts alive. There is, however, a subtle difference
between trend lines drawn on line or bar charts and those
drawn on Point and Figure charts. With line and bar
charts, trend lines show the line at which there is constant
rate of change. This is because line and bar charts show
price versus time. The trend line on a bar chart therefore
shows constant change in price per unit time. With Point
and Figure charts, however, there is no time. Instead, the
x-axis shows the number of columns, which is the number
of times the price has reversed. So, a trend line on a Point
and Figure chart shows constant price change per reversal.
Uptrend lines connect higher lows and downtrend lines
connect lower highs.The downtrend line connects lower
highs and the uptrend line connects higher lows.
 A 45° uptrend line remains
a double-bottom sell signal. Once
reversal is indicated, you must
line. You do this by finding the
an unbroken downtrend line to
intact until broken with
this happens and a trend
draw a 45° downtrend
highest top which allows
be drawn.
Projecting Price Targets
Looking for a congestion pattern
You must look for a congestion pattern, which could
be a top, a bottom, or a continuation pattern. At the time
of counting, you may not actually know what it is. It is
only when the price breaks out ofthe pattern that you will.
It is for this reason that every pattern yields valid upside,
as well as downside, counts up until the breakout.

Price Target for 1-box reversal

(number of columns in the row at the count level)x(box
size) + the level at which the count is taken
* The box size is 10.
* The level at which the count is made is row at 1130.
* Upside target for method is ( 11 x 10 ) + 1130 = 1240
* Downside target for method is 1130 - ( 11 x 10 )= 1020
Price Target for 3-box reversal
Column 3 is a wall of Os entering the bottom pattern,
and colum 8 is the wall of Xs leaveing it. Between the
two walls, there is some congestion. This allows count 1
to be established as follow:
* (number of columns in the pattern) x (box size) x
(reversal) + lowest low between columns 3 and 8
* There are 6 columns between the walls(including the
walls), the box size is 5 and the reversal is 3.
* The value of the lowest O in the pattern is in column
5, which is 455.

* Target = ( 6 x 5 x 3 ) + 455 = 545

PART - VII
The Three Elements of Successful Trading
Any successful trading program must take into account
three important factors: price forecasting, timing and money
management.
Price Forecasting indicates which way a market is
expected to trend. It is the crucial first step in the trading
decision. The forecasting process determines whether the
trader is bullish or bearish. It provides the answer to the
basic question of whether to enter the market from the
long or short side. If the price forecast is wrong, nothing
else that follows will work.
Trading tactics, or timing, determines specific entry
and exit point. Timin is especially crucial in futures
trading. Because of the low margin requirements and the
resulting high leverage, there isn't much room for error.
It's quite possible to be correct on the direction of the
market, but still lose money on a trade if the timing is
off. Timing is almost entirely technical in nature. Therefore,
even if the trader is fundamentally oriented, technical tools
must be employed at this point to determine specific entry
and exit points.
Money management covers the allocation of funds. It
includes such areas as portfolio makeup, diversification,
how much money to invest or risk in any one market,
the use of stop, reward-to-risk ratios, what to do after
periods of success or adversity, and whether to trade
conservatively or aggressively.
The simplest way to summarize the three different
elements is that price forecasting tells the trader what to
do ( buy or sell ), timing helps decide when to do it,
and money management determines how much to commit
to the trade. The subject of price forecasting has been
covered in the previous chapters.
Some traders believe that money management is the
most important ingredient in a trading program, even
more crucial than the trading approach itself. Money
management deals with the question of survival. It tells
the trader how to handle his or her money. Any good
trader should win in the long run. Money management
increases the odds that the trader will survive to reach
the long run.

Some General Money Management Guidelines

Admittedly, the question of portfolio management can
get very complicated, requiring the use of advanced
statistical measure. We'll approach it here on a relatively
simle level. The following are some general guidelines that
can be helpful in allocating one's funds and in determining
the size of one's trading commitments. These guidelines
refer primarily to futures trading.

1. Total invested funds should be limited to 50%

of total capital. The balance is placed in Treasury
Bill. This means that at any one time, no more than
half of the trader's capital should be committed to
the markets. The other half acts as areserve during
periods of adversity and drawdown. If, for examle,
the size of the account is $100,000, only $50,000
would be available for trading purposes.
2. Total commitment in any one market should be
limited to 10 - 15% of total equity. Therefore, in a
$100,000 account, only $10,000 to $15,000 would be
available for margin deposit in any one market. This
should prevent the trader from placing too much
capital in any one trade.
3. The total amount risked in any one market
sould be limited to 5% of total equity. This 5% refers
to how much the trader is willing to lose if the trade
doesn't work. This is an important consideration in
deciding how many contracts to trade and how far
 away a protective stop should be placed. A $100,000
account, therefore, should not risk more than $5,000
on a single trade.
4. Total margin in any market group should be
limited to 20 - 25% of total equity. The purpose of
this criteria is to protect against getting too heavily
involved in any one market group. Markets within
groups tend to move together. Gold and silver are
part of the precious metals group and usually trend
in the same direction. Putting on full positions in
each market in the same group would frustrate the
principle of diversification. Market commitments in
the same group should be controlled.
These guidelines are fairly standard in the futures
industry, but can be modified to the trader needs. Some
traders are more aggressive than others and take bigger
positions. Other are more conservative. The important
consideration is that some form of diversification be
employed that allows for preservation of capital and some
measure of protection during losing periods. (Although
these guidelines relate to futres trading, the general principles
of money management and asset allocation can be applied
to all forms of investing.)

Using Protective Stops

Strongly recommend the use of protective stops. Stop
placement, however, is an art. The trader must combine
technical factors on the price chart with money management
cosideration. The trader must consider the volatility of the
market. The more volatile the market is, the looser the
stop that must be employed. Here again, a tradeoff exists.
The trader wants the protective stop to be close enough
so that losing trades are as small as possible. Protective
stops placed too close, however, may result in unwanted
liquidation on short term market swings(or "noise"). Protective
stops placed too far away may avoid the noise factor, but
will resul tin larger losses. The trick is to find the right
middle ground.

Reword to Risk Ratios

The best futures traders make money on only 40%
of their trades. That's right. Most trades wind up being
losers. How then do traders make money if they're wrong
most of the time? Because futures contracts require so little
margin, even a slight move in the wrong direction results
in forced liquidation. Therefore, it may be necessary for
a trader to probe a market several times before catching
the move he or she is looking for.
This brings us to the qutstion of reward-to-risk ratios.
Because most trades are losers, the only way to come out
ahead is to ensure that the dollar amount of the winning
trades is greater than that of the losing trades. To
accomplish this, most traders use a reward-to-risk ration.
For each potential trade, a profit objective is determined.
That profit objective(the reward)is then balanced against
the potential loss if the trade goes wrong(the risk). A
commonly used yardstick is a 3 to 1 reward-to-risk ration.
The profit potential must be at least three times the
possible loss if a trade is to be considered.
"Letting profits run and cutting losses short" is one
of the oldest maxims of trading. Large profits are achieved
by staying with presistent trend. Because only a relative
handful of trades during the course of a year will generate
large profits, it's necessary to maximize those few big
winners. Letting profits run is the way that is done. The
other side of the coin is to keep losing trades as small
as possible. You'd be surprised how many traders do just
the opposite.
Trading Multiple Positions: Trending Versus Trading
Units
Letting profits run isn't as easy as it sounds. Picture
a situation where a market starts to trend, producing large
profits in a relatively short period of time. Suddenly, the
trend stalls, the oscillators show an overbought situation
and there's some resistance visible on the chart. What to
do? You beleive the market has much higher potential, but
you're worried about losing your paper profits if the
market should fail. Do you take profits or ride out a
possible correction?
One way to resolve that problem is to always trade
in muliple units. Those units can be divided into trading
and trending positions. The trending portion of the position
is held for the long pull. Lose protective stops are
employed and the market is given plenty of room to
consolidate or correct itself. There are the postions that
produce the largest profits in the long run.
The trading portion of the portfolio is earmarked for
shorter term in-and-out trding. If the market reaches a first
objective, is near resistance and overbought, some profits
could be taken or a tight protective stop utilized. The
purpose is to lock up or protect profits. If the trend then
resumes, any liquidated positions can be reinstated. It's
best to avoid trading only one unit at a time. The
increased flexibility that is achieved from trading multiple
units makes a big difference in overall trading results.

Combining Technical Factors And Money Management

Besides using chart point,s money management
guidelines should play a role in how protective stops are
set. Assuming an account size of $100,000, and using the
10% criteria for maximum commitment, only $10,000 is
available for the trade. The maximum risk is 5%, or
$5,000. Therefore, protective stops on the total position
must be placed in such a way that no more than $5,000
would be lost if the trade doesn't work.
A closer protective stop would permit the taking of
larger positions. A looser stop would reduce the size of
the postion. Some traders use only money management
factors in determining wher to place a protective stop. It's
critically important, however, that the protective stop be
placed over a valid resistance point for a short position
or below a valid support point for a long position. The
use of interday charts can be especially effective in finding
closer support or resistance levels that have some validity.