Price Models. Part I
During the previous lectures we discussed the fundamentals
of technical analysis, three main points forming its basis. We have already
specified such basic aspects as “support”, “resistance”, “trend line”, “channel
line”. Now we can move forwards and begin studying graphic models. A postulate of technical analysis runs that the
price movement is subject to trends. Even at a glance at a price graph the
price distinguishing feature can be seen – price is moving most of the
time. The phrase “Trend is your friend”
is very important for every trader, as it is movement that gives us an
opportunity to make some money.
Analysts have noticed one more specific feature of price
movement: any trend reversal does not occur in instantaneously, with a wave of
a wand. Not at all! In most cases any trend slows down and stops at first. A
pause occurs in the movement, the so called transition period, after which the
trend continues or reverses. During the very transition periods various price
configurations occur, which allow prediction of the further movement. Such
price formations are called price figures, or models. Thus, price models are
figures or formations which regularly emerge in price graphs and reflect market
participants` mass psychology. And as they are based on human psychology, which
does not change with years, the figures may be divided into certain groups and
used to predict the market further dynamics.
Before detail discussion of main models individually, let us
consider some general points.
1. The condition for any model appearance is the previous
trend existence. The previous main trend is the most important requirement for
any model. If there is some reversal, there should be at least something to
reverse (trend, Fig.1). For continuation, a trend is needed as well. Sometimes
some formation resembling one of the reversal models can be seen in a price
graph. However, if there were no trend preceding the model, it means that no
reversal may occur, so it is a false alarm signal. Therefore one of the key
elements in the skill to differentiate the models is knowledge of such areas in
a trend structure, where one or another model can appear with higher or lower
possibility.
2. The first signal
of the oncoming reversal in the existing trend is often a breakthrough of an
important trend line (Fig.1). However, you should remember that any distortion
of the trend main line does not always signal to the trend reversal. It is
rather a signal of change in the trend dynamics. A breakthrough of the main
descending trend line may testify to formation of a horizontal price model, but
what it will appear to be – just reversal or price consolidation- will be clear
only later. Sometimes it happens that breakthrough of the main trend line
coincides with completion of a price model formation.
3. The larger model,
the more essential market movement will follow. When we use the term “larger”,
we mean height and width of a price model (Fig.1). Height determines the model
volatility level, i.e. extent of the price variation during the model
formation. Width corresponds to the time period needed for the model to be
formed and completed. The larger size a model has, the wider price range can be
seen within the model (it is volatility, or variation), and the longer time
period it takes a model to be formed, the more important the model is, and the
more powerful potential the price following movement has
.
Fig 1.
4. Price models enable us to predict the target. The maximum
target after reversal models is the previous trend beginning. The fact that any
reversal model is preceded with a trend, suggests an opportunity of qualitative
evaluation of prices further movement. Most methods of the model measurement
allow defining just minimal price guiding lines (Fig.1). The maximum guiding
line equals to the whole length of the previous trend. If, for example, the
main ascending trend has been prevailing and the main model of top is being
formed, it means that maximum price movement after the trend reversal will
equal to 100% of the distance passed by the prices during the bull market, i.e.
the price will return to the level when the ascending movement began.
5. A breakthrough of
a price model must be strong and vigorous. If to explain this expression
figuratively, price should “fly out” of the model like a cork out of a
Champagne bottle and thus prove apparent intentions of most traders to follow
this breakthrough. Note, in Fig. 1 “long” candle bodies testify to confident
breakthrough of the resistance line.
6. Growing volume at
breakthrough proves the movement. As volume proves market participants`
interest in the price movement, it means that while the volume was growing, the
movement was attended, and more and more market participants are striving to
enter the market. The volume increase proves that the pressure on prices, which
makes them change, is growing. The rule
of “proving” may be formulated as follows: the volume should rise in the
direction of the current price trend. At a breakthrough upwards, the volume
should increase as the price grows, while at a breakthrough downwards the
volume should increase as the price falls.
7. After a breakthrough, the price returning with the candle
body (closing price) inside the price model testifies to a high possibility of
a false breakthrough. As a rule, after the model completion, reversing movement
occurs, which is a short-term price surge up to the level of the price model
line. The reversing movement may not occur as well, or, say, be slight. In
order to tell “true” breakthrough from a “false” one, it is required to trace
the candle or bar closing price in the very graph scale, in which you “found”
the price model. Short-term surges as candle shadows are not so essential, but
if the candle body remains inside the price model, there is a high possibility
of a false breakthrough, and a bargain should be eliminated with minimal
losses, in order to protect yourself against weightier risks.
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