FuturesTechs Blog

This morning’s reports on Silver and the FTSE would have reaped dividends for our clients, for different reasons.

Here’s the text of the FTSE Futures report:

We have posted the “all sessions” chart today because it’s actually a bit cleaner, and also shows what we’ve seen overnight; selling.

Selling to the 200 day MA as well, this well watched proxy sitting at 5771.5 today.

Yesterday’s low was 5827 in day session trade so this is a bold resistance above, and if the bulls don’t quickly retake this mark we will likely break through 5771.5 and head to 5615.5 then 5584.

If the bulls can dust themselves down from this weak open and get us back through 5816 and 5827 we then need to retake 5869.5 then fill the gap to 5912.

My gut tells me this weak open is a buying opportunity. The chart tells me otherwise…

Nice “gut feeling”!

Our Silver commentary was a bit more “nailed on”, and since we sent it out first thing this morning in the UK it traded up to 37.330 (as we tuck into our lunch in the UK, awaiting the open in the US):

Lunchtime (in the UK!) Update: We now have day session gap support at 36.400, protected by the broken resistance at 37.020, the latter having done a job in the last hour or so “on the retest”.

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Last week we posted a Blog about the potential Head and Shoulders pattern forming in the FTSE Futures. Things got interesting with respect to this yesterday, which was the crux of our morning report, reproduced below.

The fact that we’re not breaking this line PROPERLY does suggest the market’s ambilvalence is set to continue.

Towards the European close yesterday we were selling off, and we’d got through 5858, the Neckline of the Head and Shoulders pattern that we’ve been watching of late. So on the “Day only” chart that we prefer, as above, we have a slight closing break of this Neckline, and a sell signal.

Except we’re called 50 higher this morning and this will instantly tell us that the sell signal is a false one.

It looks like the market is happy in it’s current moribund range-bound confused stupor, and we’ve got to put up with this situation for a bit longer.

We’re not getting any firm signals at the moment, then, and this counts for the Individual stocks as well, making our (and your) job a rather tough one.

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We have sent an extra report to our customers this morning, outlining the POTENTIAL sell signal that’s looming in the FTSE Futures. Here is the text and accompanying chart:

We have a potential “Head and Shoulders” pattern forming in the FTSE, although the sell signal has not been given yet.

The sell signal comes if we break the “Neckline” which is at 5851, and probably on a closing basis as well (although a “clean” break on high volume would convince me enough to take the signal “intra-day”).

The target, using the traditional measuring technique for this pattern, would be 5600.

Of course this also comes off the back of the recent failure at 6095, which was very similar to the February high/failure (6086.5). The “Double Top” sell signal from this situation would only be triggered on a move through 5584.5, so a long way off yet….

5851 is on the radar, however, so “Watch this space!”

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In what may become a weekly feature of the blog, here is a summary of our coverage of the FTSE futures for the week 28th June - 2nd July.

Monday, 28th June

We said:

“The bigger picture clears things up a bit. On the line chart plotting daily closes we are shaping up to give a big “Head and Shoulder” sell signal if we saw a close below 4966… Hence we are siding with the bears, and looking for a test of these key supports below”

What happened:

We got the sixth red candle in a row with the market failing short of R1 (through not reaching 4966).

Tuesday, 29th June

We said:

“…it looks increasingly like we’re going to retest 4970, then 4883.5, then 4801… 4897.5 is “the big one” as far as the longer term skew is concerned.”

What happened:

The Futures closed at 4862.5

Wednesday, 30th June

We said:

“We think a break of 4897.5 (already done) and 4852.5 (not yet done) will trigger further selling, but we are tempering our targets to 4620, or at worst 4342.

What happened:

There was a low at 4811 and a close at 4814.

Thursday, 1st July

We said:

“Unless we get back above 4851.5 and 4897 a bit sharpish things could deteriorate very quickly, and we could be in for a couple of weeks dominated by bears”

What happened:

The market failed at 4858 and sold down to 4757.

Friday, 2nd July

We said:

….we’re still below the Neckline of our Head and Shoulders pattern, and unless today’s US employment numbers can craft us a close above 4850 we’re going to get a close that doesn’t look good from a chart point of view.”

What happened:

With the jobs data it spiked briefly up to a high at 4852.5. As of 14:45 the market is threatening to test this level again….

Let’s go back to basics: technical analysis is the study of market action, i.e. the interactions of buyers and sellers. Rather than the merits of what is being bought and sold, we analyse these interactions in search of patterns and trends that will identify profitable opportunities.

But the information available to the technical analyst does not need to consist merely of price movements; technical data is anything related to market action. The level of participation in the market, then, is also an important component of this data. We measure it by the number of stocks or futures contracts which are traded over any given period, and call it volume. The reason for the name is fairly simple: in a trading pit, it would be directly proportional to the noise!

Volume is available for nearly any market, except for Forex, whose decentralised structure makes a measurement impossible!

So what’s useful about volume?

Volume tells us where the majority of people are taking and covering their positions, so has big implications in terms of market memory.

For example, suppose that during a rally in a stock we notice that there is a price range where volume is particularly high. What does this mean? It means that there are particularly many positions originating and closing here. Going foward, then, there are lots of participants who have a “stake” in this particular price region.

If the price gets back here, people who bought in the first time might use this as an opportunity to pick up more of the stock at what they still consider to be good value. This is manifested in the price finding support here instead of falling back down.

On the other hand, what happens if sellers do come out in enough force to take us through this region? In that case, anybody who went long there is now offside and may be tempted to exit their positions. Lots of stops can get triggered, resulting in an acceleration of the decline.

So that’s the significance of volume: it tells us where most people are taking their positions. You could almost say that the market “remembers” levels in direct proportion with the level of volume seen when it trades around those levels.

Volume has long been a key component of technical analysis. One of the tenets of Dow Theory is that “Volume must confirm the trend”. High volume demonstrates mass participation in a move, and hence widespread acceptance of the new price levels. Price moves without volume were subject to suspicion, since it was possible that only a small number of rogue traders were moving the price. In that case the price  would revert back to where it came from as soon as they stopped participating.

It should be noted that sometimes, volume will be so light that the relevance of the price levels becomes negligible. This is true, for example, in the overnight session for the Agricultural commodities. Here’s a sample:

While the overnight price action will be visible to traders, some of whom may give it some small consideration, the volumes are so small that the levels can generally be ignored.

One common way in which volume is used is in the confirmation of price patterns. This is in the same spirit as Dow Theory: just as volume should confirm a trend, it should equally confirm a reversal or continuation pattern.

For example, consider the famous Head and Shoulders pattern. This begins with a series of higher highs and higher lows, a classic Dow Theory uptrend. But then we get a high below the prior high, and then a fall through the “Neckline” connecting the previous two lows.

There are definite patterns in volume which we may seek to accompany the Head and Shoulders. These may not always appear, but that’s ok: volume is only an additional piece of the jigsaw, and not the most important piece of evidence we look at when analysing the markets. Volume is always secondary to price. That said, we are encouraged when we see volume acting in a way that confirms the price action: for a Head and Shoulders pattern, that means cooling off as the market runs into resistance, and then expanding as the market decisively changes direction.

The above Head and Shoulders pattern for Silver shows volume declining on each successive peak, and then expanding as it completes the pattern with a severe breakdown.

Volume can also be incorporated into momentum indicators, usually in combination with some price information.

For example, “On Balance Volume” (OBV, see below) is a type of running sum of the volume. The trick is that we add the volume when the market has gone up, but subtract it when it goes down.

We can treat the OBV like any other indicator: adding moving averages, trendlines, etc. The trendline added to OBV above illustrated how the market was struggling.

So that’s an overview of Volume: as a core componenent of technical analysis, it confirms trends and price patterns, and can be incorporated into momentum indicators. An essential tool of the technician and trader!

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

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)