Sunday, September 13, 2009

The trend is your friend!

This is written after reading the Jul 09 edition of Technical Analysis of Stocks & Commodities.

The old saying that the trend is your friend is important for every trader. A trend reversal does not occur immediately with the blink of an eye. In most cases, a trend slows down and stops before reversing; a pause occurs in its movement as a transition period, after which the trend continues or reverses.

During the transition, certain price formations/chart patterns emerges. These reflect mas psychology of the people playing the market. And since they are based on human psychology which does not change much over the years, we could predict with reasonable probability.

1) The condition of any model is the existence of the previous trend.
The previous trend is an important requirement for a model/chart pattern/price formation. You need to know the trend before being able to determine whether a reversal or a continuation would occur. If there were no trends, or if you could not identify any trend, then any possible price formations/chart patterns could likely be a false alarm. So, to be able to differentiate models, one of the key thing to know is to be thorough in your knowledge of areas within a trend structure.

2) The first signal of the oncoming reversal in the existing trend is often a breakthrough of an important trendline.
The breakthrough of the downward trendline by EW International in Mar shows the reversal that led to the multi-month rally till now. However, the breaking of the main trendline does not always signify a trend reversal. It's probably just a change in trend dynamics. Whther it will turn out to be a reversal or price consolidation will only become clear on hindsight. Of course, breakthroughs could mean completion of a price model formation as well (Head and Shoulders, double top, double bottom, etc).

3) The larger the model, the more significant the following movement.
"Larger" refers to the height, the width, the extent, of the price model. Height is proportional to the volatility of the price movements, while width represents the time duration the model took to complete or form. The longer it takes for the pattern to be formed, the more important the movement, and the more significant and powerful the following price patterns and movements.

4) A price breakthrough must be strong and vigorous.
In other words, the price should literally "fly" through the trendline, breaking it like a piece of tofu. Not hesitate around it.

I made a small mistake in selling UOB as soon as STI broke through my main trendline weakly. Indeed, STI rose and pushed itself into the trendline again after a few days.

5) Increased volume at breakthrough indicates movement.
Increases in market volume shows interest of market participants. More and more want to enter (or exit). The rule of the thumb is, volume should rise in the direction of the current price trend. In an upwards breakthrough, volume should increase as price increases, whereas in a downwards breakthrough, volume should increase as price decreases.

These classical form of technical analysis should help in determining the trends, trends reversal, or Elliott Waves. With a strong knowledge in different forms of analysis (including candlesticks and fibonacci), one can count with reasonable accuracy the waves and predict with even greater probability the subsequent price movements.

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