Finding the Clues

FIND THE CLUES!  

From a strict chart-reading perspective, finding the clues as to when a trend is nearing completion is a matter of watching the relationship of the close of the time period for which you are trading to past highs and lows. If you study the chart in Figure 2.3, you will see the first leg or run-up in the market from September 2004 until the first lower closing low occurred in March 2005. The market never made a lower closing low during that time period. Once it did, the market entered a consolidation phase. That was the first conditional change. The sequence of higher highs, higher lows, and higher closing highs stopped; and a new conditional change occurred the market made a lower closing low and closed below the open twice in a row. The chart in Figure 2.4 zooms in on that specific area to help highlight what occurs when a trend pauses or exhausts itself.

As traders, we are searching for information that will give us clues to an advantageous entry spot to go long, whether it is at the beginning stages of a bottom or breaking out of a congestion phase or a sideways channel. Determining the market condition, whether it is bullish, bearish, or neutral, is what will help us in our trading decisions. There are many forms of technical analysis studies to help us achieve that. The best form of trend analysis is the simple trend-line approach; you start with the lowest low point and then draw the line up until the next corrective low point. Figure 2.5 demonstrates the most common way to draw a supporting trend line. After a long hard crash in IBM, a low was made on 4/17/2005 at 71.85 (the Weekly Pivot Point S-1 targeted a low of 72.50). Drawing a line from that low and extending it out to the second reactionary low and extending forward illustrated a rising trend. As the market kept bouncing near that support line (S-1), it advanced higher. Using this form of simple analysis will help you identify the market’s condition and, therefore, develop a trading plan or keep you focused to buy breaks.

As for determining a bearish or downward trend, you need to draw a line from a peak, or top, in the market, as shown in Figure 2.6. You have a series of lower highs to draw a resistance trend line. Start with the first peak, extend the line downward to the next high, and then extend the line forward. This will help you remain focused that the market is bearish, and therefore you want to focus on selling opportunities.

As the trend line is drawn from the top and extended down to the next high, notice that the highs are touching the newly drawn resistance line as the market pushes away from the trend line. Also notice the sequence of events that occur. It is the opposite of what we saw in a bull trend: Prices are making lower highs and lower lows and closing below the opens (as indicated by the dark candles); but more important, prices continually close below the prior time period’s low. In addition, the downtrend does not end until late November, when prices reverse these negative conditions. The conditional changes that occur on the way down reverse at that time with higher highs, higher lows, higher closes than opens, and, once again, the most important feature of all, higher closes than a prior period’s high.