FuturesTechs Blog

In this article we’re going to have a look at continuation patterns. These are in contrast to the reversal patterns we’ve already treated in a previous blog post here. My main source is the comprehensive Technical Analysis of the Financial Markets by John J. Murphy (purchase here in association with FuturesTechs).

As the name suggests, continuation patterns imply that the prevailing trend will be maintained, not reversed. They occur as relatively short phases of consolidation or uncertainty within a longer-term trend.

We’ll start by looking at triangles. These come in three varieties: symmetrical, ascending and descending.

The symmetrical triangle occurs in the situation when we can draw trendlines above and below the price action (connecting at least two, and preferably three points for each line). Its forecasting implication depends on the prior trend. Here’s an example during a major rally in Corn in 1996:

The prevailing uptrend ran into a little bit of resistance. We dropped back, proceeded to find some support, and then created a lower high and a higher low. This narrowing consolidation was resolved to the upside with a clean break through the down-sloping trendline, when the uptrend continued strongly. The pattern is complete and the prior trend has resumed.

Next up is the ascending triangle. This is when we have a flat trendline at the top of the pattern, but a rising trendline at the bottom. It shows that demand is getting firmer, causing shorter pull-backs, but with the same resistance level being tested at the top of the pattern. So buyers are gaining in strength sufficiently to produce higher lows, but sellers are failing to do likewise by producing lower highs.

This is psychologically bullish and thus gives the positive forecastings implications for the pattern. We generally see this pattern during bull markets, and expect it to be resolved to the upside. Here’s an ascending triangle for BAY:

Now let’s look at the descending triangle. As you might imagine, we’ve got a descending upper line and a flat lower line with this one, and bearish forecasting implications. We see it in a downtrend, and we expect the trend to be maintained, just as we should have with TWOD:

There are measuring targets with all of these, which are simple to calculate: find the vertical distance between the lines at the first high or low being used for a trendline (this is the length of the base) and project that distance up or down from the breakout point.

Note that none of the forecasting implications described here are cast-iron certainties, merely tendencies. Sometimes, a triangle will turn out to be a reversal and not a continuation pattern. We are only ever dealing in probabilities when we try to forecast using price patterns.

Next, let’s look at the flag. We’ll look at an example which occurred during a downtrend in Natural Gas:

The flag is generally a shorter-term pattern than the ones we’ve already mentioned. It is really just a “blip” within a long-term bull or bear market, when the price briefly trades in the opposite direction to the prevailing trend. In the above bear market, then, we see a series of sessions when the price showed a bit of strength. We get parallel trendlines above and below the price, and the pattern was resolved when we were seen conclusively through one of the lines (this should be the lower line in a bear market, or the upper line in a bull market).

Here’s a flag visible on the 180-minute chart of a bull market in Copper:

Finally, let’s look at the pennant, a closely related pattern.

This could be possibly be described as a “small symmetrical triangle”. Like the flag, it appears as a short period when the prevailing trend loses its vigour. However, instead of seeing highs and lows in an opposite direction to that prevailing trend, we see the range narrow with higher lows and lower highs. Here’s an example in the CAC:

Flags and pennants should occur during a strong up or down move, and these patterns should just be a minor pause in that move. One method of projecting targets is to measure the length of the prior move and to project that far from the breakout point (i.e. assuming that the pattern happened roughly halfway along a bull or bear run).

As far as volume considerations for all of these patterns are concerned, the general principle is that volume goes with the major trends: that means it should initially be at normal levels for bulls or bear markets, calm down as the market consolidates, and than increase again when the pattern is resolved. Within the pattern, we would be encouraged to see the volume relatively larger during the small movements aligned with the major trend.

That rounds up our discussion of continuation patterns. None of them are fool-proof, but they can help to map out short term corrections and sideways movements. For more detail, and for other patterns, I recommend Murphy’s book.

To read our daily technical analysis of the futures markets, please sign up for a free trial.

Graham Neary MSTA (graham@futurestechs.co.uk)

Weekly Roundup, 19^th to 23^rd October.

Last week was a fairly mixed affair, particularly in Equity markets. The FTSE’s range for the week was 5166- 5299, and Friday saw the top end of this retested just before the US Markets opened, which triggered some afternoon selling. Quite often Friday afternoon sees traders tidying up positions that they’ve been holding all week, so if the market is long then you see selling on Friday afternoon as some of these longs are trimmed.

As far as individual stocks are concerned Miners and Resource stocks are still amongst the leaders, whereas Bank Stocks have been having a much tougher time. The “strong” banks like HSBC and Standard Bank are the safest bets for longs. We are seeing Utility Stocks finding support and starting to turn now and this is something that often happens at tops, with the real money moving into safe havens. We suggested buying United Utilities and Shire Pharma to our clients last week, which gives a clue as to our thinking. We are starting to short consumer related stocks as their charts are starting to agree that we are still in recession and things aren’t really improving.

The Dow has, as we suspected, shown a complete disregard for 10000, but we do seem to be having trouble getting through 10110-120, where we topped out each and every day last week. We are happy with our current “cautiously bullish” stance, and we continue to advise our clients not to get too excited about the prospects for higher prices.

Gold continues to go sideways, frustrating all of those who have piled in And got long because we got through $1000. We always thought $1034 was more important, and we’re happy to be long of this while this important technical level is holding firm.

In last week’s round up we talked about the change in skew we’ve been forced into in Oil. We had been favouring the bears but then we got above $75 to change our stance. Sure enough this has continued higher, and we want to see $78 holding now to give us a launch pad for a move to $90 and beyond.

Finally can I remind you it’s the World Money Show at the end of the week and we’re going to be exhibiting. We are running a competition to win an Apple iPod 3G, so if you can make it please come along and say hello.

Click here to register for free.

To request a free trial, with no obligation, of FuturesTechs’ daily analysis service please click here.

Have a good week,

The FuturesTechs Team.

Every week we send out a weekly round up e-mail to our database, and we figured it would probably be useful to post it here as well, so here goes!

FuturesTechs Weekly Round up - 19th October.

Here is your latest roundup of price movements on the major asset classes in the Investment arena. As regular readers will know by now we at FuturesTechs only look at the price action to determine what trend an instrument is in, and where this suggests it can head in the future. Many technicians use Cycle analysis to make longer term calls, and this is what allowed us to make the “call” that we were near a bottom back in March for Equity markets like the FTSE and DAX. Currently our analysis suggests there is a pullback imminent, but so far each time the market has threatened this sort of move the buyers have stepped back in and bought into the dips. There was some price action towards the tail end of last week that was slightly worrying, but once again the bulls appear to have averted the threat.

The Dow may be above 10000 as we write, but it’s failing to convince and we prefer maintaining a cautious stance for now. I heard a great line on the financial news channels last week. Someone said they were “at the party, but dancing near the door”. That sums up how we feel about the present state of things.

So we’d warn against getting too complacent about this recent rise, and we’d warn against worrying that you’ve missed the boat. Generally tops are formed when people pile in thinking they’ve got to get in because they’ll miss out otherwise!! If our analysis is right there will be a pullback soon, and it could even be a deep one, and just when people think we’re heading back to those March lows is just the time you want to be buying!

Gold has been front and centre on people’s minds of late, and the amount of mainstream press it’s been getting (all bullish) worries us, as far as whether this rally can sustain itself is concerned. BUT it has held above some important technical support levels like the $1027 to $1034 region, so we are happy to stay with the trend and back it to keep heading higher for now.

Oil has been the one that has surprised us. We weren’t expecting to see $75 again in a hurry but we’re above here at present, so now there’s scope for higher prices and we’ve been forced to readjust our thinking.

The Dollar’s weakness is the other big topic that many have had on their minds of late. We are keeping a particularly close eye on Dollar/Yen, actually, and want to see a move through 91.15 to take further pressure off the dollar.

Finally just a reminder that we are exhibiting at the World Money Show this year. It takes place at the QE2 Conference Centre in London (bang opposite Big Ben) on October 30^th and 31^st. Admission is free, so register and be sure to come along and say hello. Click here to register

If you wish to benefit from our analysis on a daily basis it is just £50 a month (+VAT). You can become a member by clicking here.

Have a good week,

The FuturesTechs Team.

With this article I will introduce Point and Figure charts: how to understand them, and how to recognise some simple patterns. My main source will be Jeremy du Plessis’ The Definitive Guide to Point and Figure, which you might be interested to purchase from the Global Investor Bookshop (in association with FuturesTechs).

Point and Figure is a very old method of charting price action, which originated when traders were simply recording the prices as they saw them happen: 14.50, 14.55, 14.60, 14.55, etc.

This gradually evolved to the point where traders were filling out boxes on a graph corresponding to price levels which the market had crossed, moving to the right each time that the price retraced over an old price level. Eventually, we got the modern Point and Figure chart.

Here’s the most recent NASDAQ chart:

As indicated, the X’s are drawn when the price has increased, while the O’s are drawn whenever the price has decreased.

In the example above the intervals used are just a point wide (the “box sixe”), meaning that we change from X to O (or O to X) and move to the next column whenever the price moves by just a point in the opposite direction to the previous move.

That makes this a very short-term chart, of course. With one-point reversals happening all the time, a couple of hours’ trading will quickly fill up the chart.

The two ways we can make it longer-term are:

• Increase the box size
• increase the reversal size

Increasing the box size should be obvious enough; instead of recording 1-point movements, we’ll record 10-point movements, for example. Here’s the first chart modified in this way:

These boxes stretch back a couple of weeks now, instead of a couple of hours.

Now let’s change the reversal size, the size of the reversal which needs to take place before we change between x’s and o’s and move into the next column. This is measured in terms of boxes, and is set to 3 in the below chart:

The above chart stretches back a couple of days. For a bigger picture view combining both changes, we could require 3-box reversals for 10-point boxes, i.e. requiring 30-points reversals before changing direction on the chart. The below chart represents the price action of a year:

One thing you might have noticed at this point is that we don’t really have a proper time axis. That’s true. While it’s true that time is progressing as we move from left to right on the chart, it’s not doing so on a constant basis. The chart only moves right when we get a sufficiently large change in direction (as defined by our parameters). The chart only changes when the price does. So, instead of being a traditional time vs. price chart, Point and Figure is instead an original way of drawing the price action.

We’re going to look at some patterns now, focusing on charts with 3-box reversal sizes. Any box reversal size can be used, and some care should generally be taken to choose the one that leads to the most favourable chart for the desired timeframe.

That said, we usually don’t like to use 1-box reversals. Charts look very different with 1-box reversals, being of a much shorter timeframe and with very different-looking patterns. Much of the difference is related to the fact that a 1-box reversal chart can have columns with just a single entry of , i.e. when we get two reversals in quick succession.

Check out the Difference between the CAC futures charts below. The top is a 10 x 1 (10 points, 1-box reversal) chart, while the bottom is 10 x 3.

Besides being of a much shorter timeframe in the same space, we can see that the one on the top does indeed have many columns with just a single X or O.

The advantage of sticking with reversal sizes of 2, 3 and more, is that we get to take advantage of the resulting asymmetric filter. The chart is biased to ignore movements in the opposite direction to the prevailing trend that do not satisfy the box size criterion. While a move of, say, 10 points in the prevailing trend will be charted, a move in the other direction won’t be plotted until it reached, say, 30 point.

So let’s have a look at some simple patterns.

The double-top buy is seen when the price reverses off a high, then comes back and breaks through it on the second attempt. It’s an awkward name since the Double Top bearish reversal pattern in mainstream bar/candlestick analysis, but the context is usually clear enough. Here’s an example of it in an uptrend:

Equally, the double-bottom sell occurs when we get the creation of a lower low:

These can be reversal or continuation patterns, depending on the previous trend. As continuation patterns, they tend to be a little more reliable (in accordance with the general principle that trends have a universal tendency to continue!)

In a similar vein to the above, we can have triple-top buy and triple-bottom sell signals. Indeed, we can have any number of tests before the breakout, with all manner of compound patterns.

The first of these buy signals comes after a failed attempt by the bulls to break through the previous highs (indeed, the correction causes a failed reversal triple-bottom sell signal. Our bias is to trade with the prevailing trend, so hopefully we would not have seized on that false signal):

In our next post on this topic, I’ll cover a selection of more advanced patterns and have a look at the price targets we can derive from them.

For now, this has been an introduction to Point and Figure charting. If you have any questions or comments, please don’t hesitate to get in touch. To subscribe to our daily technical analysis of the futures and FX markets, please sign up for a free trial.

Graham Neary MSTA (graham@futurestechs.co.uk)

I thought it would be a bit of fun to ask our Professional client base for their favourite market-related catchphrases, and to do a Blog thereon.

There were two things that I didn’t realise when I embarked upon this idea. Firstly that there are so many that are rude, and therefore may be tough to incorporate into such a blog, but secondly that so many had valuable lessons for any trader ingrained into their meaning.

So here’s a few, and I hope you enjoy this piece, as well as possibly get something out of it!

By far and away the one that came put top was (and I really hope this doesn’t offend anyone) “Don’t be a dick for a tick”. Clearly many of my clients have spent many a year working a 15 bid on something only for the market to trade down to 16 then set off on a stonking rally. It is one of the hardest things to deal with as a trader. I’d say it’s probably harder once you’re in a position and looking to get out. Putting an offer in at 30 because FuturesTechs has a level there, only to find out later that it traded 1000 lots at 29 but never got to trade 30 is highly frustrating, especially if this means a potential profit ends up being a scratch or worse.

The next one that really seemed to feature amongst answers given was something to do with what “Bottom Pickers” get. Apparently this isn’t a very fulfilling pastime. I couldn’t agree more, at least where the market is concerned!! Those who try to buy at the very bottom of a move often get in bother. Whenever I do seminars with people who are new to the City or trading I always try and convey the idea of trading in the direction of the Trend. Markets that are plummeting lower can often keep doing the same for longer than you can stay in your long trade. Actually that was a John Maynard Keynes quote: “The markets can stay irrational longer than you can stay solvent”. This whole debate doesn’t stop at one catchphrase though. There were plenty of candidates. “Don’t try and catch a falling knife”, or the one I heard in October 2008 “Don’t try and catch a falling fridge”. What you really should try and do is remember that “The Trend is your Friend”. Just be careful of the “Dead Cat Bounce” though, and don’t worry too much about those who tell you to “Sell in May and Go Away” – well not this year anyway!

This sort of trading is akin to “Picking up Pennies in front a Steam Roller”. Often people lose so much money on these sorts of ventures that they end up with a “Trade that turns into an Investment”. This is why we need to have stops, as long as we use them. “Stops are for buses” is on the “what not to do” catchphrase list, along with “double up to catch up” and “Don’t get out unless it’s a winner” (Very naughty!).

The better advice for stopping out trades may be that “The first cut is the cheapest”. If you end up in a losing trade it’s best to own up and take the loss. Don’t “stick it in the bottom drawer”, after all “Denial is not just a large river in Egypt”!

Trading psychology seems to enter the equation for a few phrases as well. The ones that cropped up a few times in our little survey were “Don’t get high on your own supply”, “Don’t get too long of yourself” and “Don’t believe your own publicity”. They all say the same thing, and it’s a really valuable lesson for any trader at any time of their career. The market is the most fantastic leveller, it seems!

Finally special mention needs to go to the following responses.

“More Shorts than the front row at a Wham concert” made me chuckle, as did “He who finesses, wears frilly dresses”, “Scratching is for DJ’s”, and “If you want to hedge get a Garden”.

Many thanks to all who proffered replies. It certainly made my Columbus Day go a bit quicker!

Have a good week all.

Cheers,

Clive.

One of the premises of tecnical analysis is that price patterns tend to repeat themselves. But what are these patterns? Today, we’re going to lookat reversal patterns, i.e. where a change of trend is indicated.

Perhaps the most famous of these is the Head and Shoulders pattern.

Here is the Dow weekly candlestick chart, showing how this topped out in 2007.

The general picture behind the Head and Shoulders is as follows: we start off with an uptrend, which proceeds as normal creating higher highs and higher lows.

The initial warning sign is a failure to create a higher high. This is the top of the “Right Shoulder” on the above chart.

Our technique then is to connect the two most recent lows. This isn’t a proper trendline (which should really connect three points) but instead is the “Neckline” of what is still only a potential Head and Shoulders pattern.

The Head and Shoulders pattern is completed by the break through the Neckline. Sometimes, the bulls will have a go at recapturing it, just as they did in the case of the Dow. What really strengthens the bear story, and is something you can look for, is if the broken Neckline then turns resistance. This happened with the Dow, making this a textbook case of the Head and Shoulders pattern.

Note that the Neckline was broken briefly on the retest; the danger of getting a false signal in this way is limited by placing certain conditions on what sort of a break is required. For example, demanding two consecutive closes above the Neckline (the “Two Day Rule”) would have prevented us from getting whipsawed by thinking that the Head and Shoulders pattern was being negated.

The above chart shows the standard method for constructing measuring targets with the Head and Shoulders pattern. Find the height of the head and then target that distance below the Neckline, measuring from where it broke (so we would target the red horizantal line in the above case).

The Inverse Head and Shoulders is based on the same idea, reversing a downtrend. Here’s Light Sweet Crude Oil changing direction in this way in 2007. Observe the broken Neckline providing support twice:

Now let’s look at Double Tops and Double Bottoms. The Double Top is formed when, in an uptrend, we run into resistance twice at the same level. We then fall through the intermediate low, completing the pattern and providing a sell signal. The broken Neckline can turn resistance, as it did with the DAX futures between 2007 and 2008; see the weekly candles chart below

Here’s an example of a Double Bottom, this time on a bar chart. It’s Vodafone at the bottom of the bear market in 2009, finding support at the same level twice, then beating the intermediate high and continuing the move.

In this case, our measuring target would be similarly calculated as with the Head and Shoulders patterns, i.e. the height of the pattern projected from the breakdown point. In this case, it’s 123.60 plus 12.40, i.e. 136.00.

Here’s an example of a Spike, or V-Reversal.

The Spike is really just the name for a market which reverses direction without giving any proper clue in tertms of hte preceding pattern that this was likely. This is the market turning “on a dime”, and the most difficult to trade.

The only clue at the top of the above chart that Wheat was turning was the “Harami Cross” candlestick pattern at the top (that’s the Doji contained within the range of the long green candle). When a Spike happens, our only recourse is to short-term signals such as candlesticks.

Finally, here’s a Saucer Bottom in Corn futures (the Saucer Top is the equivalent reversal of an uptrend). This is the opposite to the Spike, the price very gradually changing direction.

As technicians we much prefer to see a Saucer Bottom or Top than a V Reversal, with the slow move giving us lots of time to change skew.

Volume

One thing we haven’t mentioned much so far in this article is the role of volume in all of these patterns. Volume - the level of trading activity taking place over any period - is an essential component of technical analysis and an important part of pattern recognition.

The general principle is that volume accompanies movements with the trend. In terms of trend reversals, then, we should see the volume faltering during those final movements with the old trend, and eventually picking up as the new trend takes over.

In the case of the Head and Shoulders pattern, for example, volume should be weakest during the Third Shoulder, as enthusiasm for the dying bull market begins to evaporate.

A distinction can be made here between tops and bottoms. It is generally recognised that volume is not so important for tops as it for bottoms: at tops, market can “fall of their own weight” with buyers simply failing to show up, and volume not increasing.

Bottoms, on the other hand, generally involve mass participation, with active buyer enthusiasm being the main driving force behind the move.

Variations

There are several variations on the patterns mentioned here, in particular the Complex Head and Shoulders, the Triple Top and Triple Bottom. The Triple Top and Triple Bottom are fairly self-explanatory, while the Complex Head and Shoulders generally involves multiple shoulders on one or both sides of the Head.

The principles of volume analysis and the measuring techniques for these patterns are much the same as for the patterns already described here.

Conclusion

These patterns, without being infallible, help us to map out major changes in trend. They are generally medium and long-term patterns, with their significance and measuring targets in proportion to their size.

We incorporate these patterns into our daily analysis of the futures and FX markets. If you would like to sign up for a trial of our services, click here. For a free trial, click here.

Graham Neary MSTA (graham@futurestechs.co.uk)