TechnicalAnalysisofStockTrendsExplained:AnEasy-to-UnderstandSystemfor

SuccessfulTradingbyMichaelThomsett.

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Copyright©2012.MichaelThomsett.

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PART I:INTRODUCTIONTraders have heard about“fundamental analysis” and“technicalanalysis”andoftendecide to become adherentstooneortheother.However,youcanusebothoftheseto:a. complement one anotherand improve skills in timingoftrades.b. confirm and cross-confirm

reversalindicators.c. create a wide view thatbringsinelementsofpriceaswellasfinancialtrends.

Segment1.Fundamental vs.technical analysis.(Differencesandsimilarities;using both together in acoordinatedprogram.)The differences betweenthese two approaches toanalysis are significant.Fundamental analysis isdefined as the study offinancial trends (profitabilityand cash flow), expressed inratios, and involving severalyears’ worth of status and

results. It includes manycomponents, all basedon thehistorical financial record.Among these, the mostsignificantresultsare:a.revenuesandearningsoverseveral years, aimed atspotting trends that may beeither positive or negative.For example, if revenues areerraticorflat,itisdifficulttoestimate future direction. Ifrevenues are rising but netprofit (or net return) is

declining, it isasignofpoorcontrols by management; ifnet earnings rise and netreturnissteadyorimproving,that is a signal of positivegrowth.b. debt ratio measures theorganization’s reliance onborrowings,versustheuseofequitytofundgrowth.Thisisderivedbydividinglong-termdebt by total capitalization.(Totalcapisthesumoflong-term debt plus shareholders’

equity). If the debt ratio ishigh or increasing, it meansfuture net earnings will haveto be devoted increasingly todebt service and interestexpense,and less for fundingexpansion or payingdividends.c. dividend yield is a keyfundamental, and investorsseek companies whosedividend is steady orgrowing. Those whosedividends have increased

every year for 10 years ormore (called “dividendachievers”) have tended overtime to out-perform themarket in general, and havealso been able to minimizethe year-to-year volatility infinancial results moresuccessfully than companieswhose dividend has fallen orbeenmissed.d. price/earnings ratio is anoddity because it compares atechnicalindicator(price)toa

fundamental (earnings). Apotentialproblemisthatpriceis current and earnings arehistorical. For this reason, astudy of PE should involveseveral years of the rangeofPE. Investors seekconsistency and a relativelymodest range. When themultipleofPEistoohigh,thestock is probably overpriced;when too low, it indicates alack of interest in thecompany.

e.fundamentalvolatilitygoesbeyond the study of amulti-year trend, such as that forrevenuesandearnings.It isastudy of the reliability inyear-to-year changes.Investors like predictability,such as steady revenue andearnings growth and areliable and consistent netreturn. Some results,however, tend to be highlyvolatile, with results rangingfrom high revenues and

earningsoneyear, toreducedrevenues and a net loss thenext. This makes itimpossible to predict futuretrends; so fundamentalvolatilityisakeyindicator.There are many additionalfundamentalindicators.Theseare only a few of the moreimportant ones. While thefundamentals are focused onthe financial results reportedover many years, technicalanalysisisfocusedmostlyon

price (as well as tradingvolume and momentum).Among the traditionaltechnicalindicatorsare:a. price-based movementwithin the established range,whichexpressesvolatilityandchanges in volatility. Anestablished range is setbetween resistance at the topand support at the bottom.The breadth of this tradingrange defines levels ofvolatility.

b. tests of resistance andsupport which may fail orsucceed. A failed test ofresistance or support is mostlikely to lead to pricemovement in the oppositedirection. A successful testleads to a breakout. Thebreakoutitselfmayreversesothat prices return to theestablishedtradingrange;oranewrangecanbeestablished.It often occurs that previousresistance becomes new

support in an upsidebreakout; or that previoussupportbecomesresistanceinadownsidebreakout.c. gapping price movementmay involve the often-recurring common gap, orprovide a symptom of astrong new trend in price.When price gaps areaccompanied by very strongbreakout, without a reversal,the two indicators together(breakout and gaps) signal a

movement above or belowtheprevioustradingrange.d. volume-based indicators,notably volume spikes as asignalofreversal.Thisshouldbe confirmed by otherindicators, but exceptionallyhigh volume in a singletrading session is a keyreversalwarning.e. momentum indicatorsmeasure the speed andstrength of price direction,and several valuable

indicatorsprovideoverboughtand oversold ranges that,when confirmed, addconfidence to the appearanceofapricereversal.All technical indicators needto be independentlyconfirmed; this is a basicpremise in technicalanalysis,because no indicators are100% reliable. Any of theabove five areas may beconfirmed by any others.Furthermore,reversalpatterns

are found in candlestickpatterns. Chartists may relyon candlesticks to confirmprice-based, trading range,gappingaction,volume-basedormomentumindicators;andany of these may cross-confirm candlestick patternsaswell.The value of using bothfundamental and technicalindicatorsisrelatedtothekeyreason for performinganalysis:toimprovetimingof

entry and exit. All technicalanalysis relies on indicatorsand their confirmation. Withthis inmind, even the ardenttechnical analyst may selectand qualify companies andtheirstocksbyalsoreviewingthefundamentals,asaninitialstep. The most effectivemeans for improving aprogramof analysis is touseboth fundamental andtechnical tests together. Thisrecognizes that both provide

value in different, butcomplementaryways.

Segment 2. Does technicalanalysis work? (Examplesandacasestudyshowingthevalueoftechnicalanalysis.)The question every investorshould ask about all types ofanalysisis:Doesitwork?Technical analysis drawstogetherasetofindicatorsofmanytypes,including:a. Traditional (Western)technical analysis is familiarto technicians. So-called“Western” technical analysis

includes a broad range ofindicators based on pricepatterns. These include theall-important testing of thetrading range borders(resistance at the top andsupportat thebottom).Thesetests take many forms,including price gaps,breakouts (successful andfailed), double tops andbottoms of price spikes,patterns like wedges andtriangles,andmuchmore.

b. Candlestick reversalindicators are patterns ofsingle sessions,double, tripleormore,thatsignalareversalin price. These are signalsthat,basedonmomentumandchanging strength amongeitherbuyersorsellers,createrecognizable patternsanticipating the end of acurrent trend and thebeginningofanewtrend.c. Trends are expressed inmany forms, including price

and momentum, and may betracked through movingaverages and trend lines.“The trend,” one marketadage tells you, “is yourfriend” but amore importantobservation is the extendedadage, “The trend is yourfriend, until it ends.” Trendanalysis through price,volume, and momentum,helps identify when thecurrent trend is likely to endandreverse.

d. Volume indicators arefound in many forms, alldesigned to determine whenanestablished trenddirectionis beginning to reverse. Thismay be seen in complexanalyticalsignalsor inasignas simple as a single-sessionvolumespike.e.Momentumindicatorstracknotonly thedirectionapriceis trending, but its speed.When momentum begins toslow down, it indicates that

buyers or sellers are losingcontrolof the trend,meaningtheothersidemaybeabouttotake over as the price trendreverses.All of the indicators andranges of indicators worktogether to help analystsdetermine:

how long a trend willlast.whenthetrendbeginsto

slowdown.when the specificturningpoint is likely tooccur.

The turning point is the key.Traders enter new positionsand exit old positions basedon thestudyof thesesignals.However, no one signal isenough by itself to provideconfidencethatthetrendisonthevergeofreversal.Forthis,traders rely on one of the

basic requirementsof timing:confirmation.Confirmation is theverificationofonesignalwithtwo or more additionalsignals showing the sameinformation. For reversaltiming, traders rely onconfirmationtosignalthatthefirst indicator is probablyreliable, since a second (orthird) indicator provides thesamesignals.Confirmation may take

severalforms,including:a. Two similar signalsindicatingreversal.b.Twodifferentsignals,bothsignalingreversal.c. An original signalconfirmed by another;confirmationmay occurwitheither signal providing theinitial indication, with thesecond acting as theconfirming signal. In otherwords,anyindicatormaybealeadingorlaggingindicator.

What if confirmation signalscontradictoneanother?Whataction should a trader takewhenthisoccurs?Guidelines:a. Do not act when twoequally strong indicatorscontradictoneanother.b.Assigngreaterweighttoanindicator considered strongerormoreimportant.c. Wait for a third indicatorconfirming the likelyreversal. Do not act until ithasbeenfound.

Example: Alcoa (AA)demonstrated a bearish trendin the months of February,March andApril, 2012. Thiswas not the result of anysingle indicator, but of aseries of indicators, allconfirming the bearish trend.Theseincluded:a. downtrend extending overa four-week period fromMarch12throughApril9.b.volumespikeinmid-April,a single session of

substantially larger volumethan the typical sessionsprecedingit.c. upside price gapimmediatelyafter thevolumespike, which could signal areversal and subsequentuptrend. This demandedcaution among traders, sincethe meaning of the gap wasnot clear. Some gaps dosignal reversal, while othersarelast-gaspeffortstoreversethelonger-termtrend.

d. bearish harami cross, atwo-session candlestickindicatorconsistingofablacksession (moving downward)and a doji (a session withlittle or no trading range,creating the shapeofacross,andexistingwithin the rangeoftheprevioussession).This example demonstrateshow three strong downwardindicators confirmed oneanother. The combination oftheextendeddowntrendprice

movement, thevolumespike,and the bearish harami crosswere stronger together thanthe uncertainty of the upsidepricegap.In coming segments, thespecific trends,gappingpricemovement, and candlestickindicators are examined ingreaterdetail.Thisexampleisintendedonly to showhowaset of dissimilar reversalindicators work together andact as strong confirmation of

changeintheexistingtrend.

Segment 3. Critics oftechnicalanalysis.Technical analysis has areputation among the moreconservative sector of themarket. It is perceived ashigh-risk and unreliable,appropriate only forspeculation and not as ameans for anticipating pricemovementsaccurately.Critics make their case bycitingthefollowing:a.Short-termpricemovement

ischaotic.Itistruethatshort-term price movement isunreliable and cannot bepredicted accurately. Due tomanyconflictingandcontraryprice pressures on both buyand sell sides, the currentprice picture is too complextopredict.b.TheDowTheory(seemorebelow) cautions that short-term price movement is notreliable. The Dow Theory,the basis of technical

analysis, points to the valueof intermediate and primarytrends; and discounts short-termtrendsduetothechaoticnature of immediate pricemovements.c. According to the randomwalk hypothesis, (see morebelow) any short-term pricemovement is 50-50. Therandomwalk hypothesis putsforth the idea that short-termprices cannot be predictedsince any future price

movement may move up ordown with equal probability.Thishypothesissupposesthatno influences within themarket affect this randomnatureofprices.d. An alternative concept isthe efficient market theory(see more below); this alsodisputes reliability oftechnical analysis. Thistheoryisfavoredinacademia,but contradicts the randomwalk hypothesis. It proposes

that the current prices of allsecurities are “efficient”because it expresses allinformation known to thepublic.Asaresult,allcurrentprices also are fair andaccurate.e. No indicators provide100% certainty. This is true.No indicator, by itself, canensure 100% accuracyconcerning the next move.Even strong, seeminglyreliableindicatorsmademore

convincing withconfirmation,arenever100%reliable.The facts dispute thesecriticisms.Forexample:a. Short-term price patternsprovide reliable priceinformation. Within thechaotic nature of short-termprice movement, intelligencecan be gathered by thecombination of indicators.These involvenotonlyprice,but volume, momentum, and

moving averages. These aresubtle indicators of pricestrengthorweaknessontheirownbut, through theprocessof confirmation, provideinsight about the trend andhow and when that trend iscoming to its conclusion.Combined with patternanalysis on charts, thecombinedscienceoftechnicalanalysis is designed toorganize the apparent short-termchaoticnatureofprices,

and to provide predictablehintsaboutevolvingtrends.b.TheDowTheory supportstechnicalanalysis.Thetheoryfocuses on long-term trendsand market movements.However, due to theunreliability of short-termswing movements, tradersneedtorelyontheindicatorsand confirmation thatstrengthen timing for entryandexit.c. The random walk

hypothesis is disproven byobservation of price activity.The randomwalk hypothesisis easily disproven. Anyonewho has observed pricebehavior upon any earningssurprises, for example, willnote theexaggerated reactionof price and the fastcorrection of thatexaggeration.Thismakes theprice behavior predictableratherthanrandom.d. The market is far from

efficient;toomanyinfluencesareatplay.Thebeliefinpriceefficiency is alsoquestionable. If all priceswere efficient, no over-reaction and subsequentcorrection would occur. Allprices would be efficient(meaning stable) and wouldnot react in an exaggeratedmanner. There are too manycompeting and conflictinginfluencesatplayatalltimesto expect efficient price

movement.e. There are no alternatesystems providing 100%accuracy.Noindicators--notevenfundamentals--areever100%reliable.Anysysteminuse has to rely on improvedintelligence and informationin the moment. However,traders attempt to improvetimingofentryandexitbasedon the indicators andconfirmationavailableon themarket. An expectation of

complete accuracy orreliability would not berealistic.Additional observationsconcerning the Dow Theory,the random walk hypothesisand the efficient markettheory,follow.TheDowTheory contains aseries of beliefs concerningthe stock market and itstrends. This serves as thebasis for technical analysis.The underlying tenet states

thatthemarketisinabullish(upward) trend when one ofthe averages advances abovea previously establish highindex value; and when thisadvance is confirmed byanotheraverage.Ontheotherside, when both of theaverages fall below apreviously establishedbottom, the market is in abeartrend.This theory was put forthoriginally by William Peter

HamiltonandothereditorsoftheDow-JonesCompanyandsuccessors of the originaleditor, Charles Dow.AlthoughDowhimself neverusedtheterm“DowTheory,”it has grown into a tradingsystem based on his originaleditorials.The theory contains siximportantaspects:

1. The market has three

trends. Primarymovements(ortrends)inthe market last betweenseveral months andseveral years, and maybe bullish or bearish.Secondary movements(or reactions) lastbetween a few days anda few months andrepresent retracementsagainsttheprimarytrendbetween one-third andtwo-thirds of the

previous pricemovement. Short-term,or “short swing”movements last from afewhours toa fewdaysand are likely tocontradict establishedprice direction (bullishor bearish); however,these short-term swingsare reliable aspredictions of long-termpricetrends.

2. Trends consist of three

specific phases. Everytrend moves throughthree phases. Theaccumulation phase isthe period wheninvestors withexceptional informationactivelybuy(inabullishtrend) or sell (in abearish trend). Thepublic participationphase occurs when, dueto price movementcausedbyactivityinthe

accumulation phase, thegeneral public joins inthe trend. Finally, thedistribution phaseoccurswhen speculatorsenter the market andover-buy or over-sell,and at this point theobservant investorbegins to transact in theoppositedirection.

3. All news is discountedby the market. Thismeansthatcurrentprices

absorb all news rapidlyand reflect that news inthe price. As stated inthe efficient markettheory,thebeliefthatallnews is immediatelytaken into the currentprice explains much ofshort-term pricemovement.

4. The market averagesconfirm one another.Under this belief, thethree averages

(industrials,transportation andutilities) all cross-confirm any majortrends as they develop.No trend is establisheduntil a change indirection surpasses aprevious high or lowpoint, and the samemovement is repeated ina second of the threeaverages.

5. Trends are further

confirmedbychangesinvolume of trading. Theprice direction of anindividual security isconfirmed as a majortrend if and when thetrading volume issufficiently high toindicate that themovement itself isnotareaction or secondaryfactor, but amajor, newtrend.

6. The trend will continue

until new, contradictorysignals emerge. Thetheory states that withinan existing trend, short-termcounter-movementsdonotmatteras longasthe prevailing indicatorscontinue in the samedirection. A trend endsonly when reversaloccurs in opposingmovements,confirmation, andvolume changes

indicatinganewtrendisbeginning.

The random walkhypothesis applied toinvesting states that stockprice changes having thesame statistical distributionact independently, so that sopast activity can be used topredict future price activity.In other words, pricemovement is unpredictable.Thistheoryignorestheeffect

of using technical indicators(pricevolume,momentum)toimprove the timing of entryandexitpoints.If price movement isdetermined by a series oftrulyrandomphases,itmeansthat the forces of supply anddemand are not applicable tothe stock market. It furtherassumes that observed pastprice behavior has nomeaning in future priceoutcomes. However,

investors using technicalanalysis have observed aspecific“causeandeffect”onmanylevels,whichcontradictthe random walk hypothesis.Forexample,pricemovementin reaction to earningssurprises tends to beexaggerated; and thoseexaggerated movements tendto self-correct within one tothree trading sessions. As apredictable aspect of pricemovement, this tendency is

predictableandcanbetradedupon, even though manypotentiallyrandomfactorsarealsoinplay.The randomwalk hypothesisisaninterestingstartingpointfor the study and criticalobservation of technicalanalysis.This enables traderstochallengethetheoryandtodevelop alternativeobservations of their own,based on charted pricepatterns, moving averages,

and price or volume-basednotabledevelopments.The efficientmarket theory(or, hypothesis) is the beliefthat all current pricing ofsecurities is efficient andcontains adjusted prices forall known information aboutthe security. The theoryfurther claims that it isimpossible to achieveexceptional returns oninvestments, since all currentpricesarefair.

A“weak-form” theorypointsto pricing of securities basedon publicly knowninformation as the basis forthe market’s efficient. A“semi-strong” versioncombines currently knownpublic information plus newinformation tomake thecasefor efficiency. A “strong”version of the theory adds inunknown (insider)information and claims thatall formsofdata, knownand

unknowntothepublic,createthe current pricing. Thosewhosubscribetotheefficientmarket theory admit thatfuture valuation is likely toevolve as the informationpool changes; and that as aresult, the efficiency itself isnotpermanent.A close link may be foundbetween the efficient markettheory and the random walkhypothesis. Originally, thosepromoting the random walk

alsobelieved the randomnesscaused (or was caused by)price efficiency. However,prices cannot be bothefficient and random at thesame time or for the samereasons. One school ofthought argues that theefficient market theoryapplies to individual stocksbut not to the overall stockmarket.In recentyearsanotherbeliefhasemerged,thattherandom

walk and efficient marketmodels contradict oneanother. Stocks with low PEratios tend to outperformother stocks. If the marketwere efficient, performancelevelswouldnotvaryamongdisparate PE securities. Theobservation about PE ratiosalso challenges the claimedrandomnatureofprices.

Segment 4: Assumptionsbehindtechnicalanalysis.The factors affecting pricecontain specific andpredictableattributes.Amongthesefactorsare:a. Economics. The effects ofeconomics cannot be ignoredin how they affect prices ofsecurities. Themost basic ofeconomic indicators, supplyanddemand,affectsprices intwo ways. The mostimmediate effect is seen in

the straightforwardinteraction between buyersandsellers.Thecurrentpriceofanysecurity is theagreed-upon price at which buyershavebeenwillingtobuy,andsellers have been willing tosell. This is expressed in anexpanded way in the tradingrange itself. The top of therange - resistance - is thehighest price that buyers arewillingtopay,andthebottomoftherange-support-isthe

lowest price sellers arewillingtoaccept.On a larger scale, economicsupply and demand for allconsumer and commercialproducts affects supply anddemand for every companywhose stock is traded on thepublic exchanges. As supplyfallsforaproduct,pressureisplaced on prices and profitsrise,leadingtostrongerstockprices. As demand falls,pricesareweakenedandasa

consequence,profitsfall.Other economic influencesinclude monetary exchangerates, notably for companieswhose outlets are global (forexample, for McDonald’s,Coca Cola, and Johnson &Johnson); trends inemployment andunemployment; and taxpolicies at federal and statelevels.b. Fundamentals and theirtrends. Fundamentals

including profit or loss,working capital, andcompetitive position withinan industry, affect pricesthrough historical volatilityand identification of eithervalue orgrowth investments.Theinfluenceoffundamentalvolatilityonthetechnicalsidecannotbeoverlooked,asbothaspects are part of the same,overall trend in financialstrengthandstockprices.c. Market behavior. The

market does not behaverationally or logically.Reaction is invariablyexaggerated to any and allnews and, while the DowTheory observes that themarket discounts all news,market participants tend toadd a premium to that samenews. This is importantinformation for thecontrarian investor, onewhoacts in the opposite directionfrom the crowd. The market

is dominated by emotionalreactions at three levels. Asprices rise, greed leadsinvestors to buy, often at orclose to the price top. Asprices fall, panic leadsinvestors to sell, often at orclosetothebottom.Whenthedirection of the market isunclear, uncertaintydominates and investors tendto not act even when strongindicators provides cluesaboutemergingpricetrends.

These emotional reactionslead to the common practiceof“buyhighandselllow”inspite of the sound advice to“buy low and sell high.”Contrarian investorsrecognize that marketbehavior is misdirected, andare able to trade intelligentlyand to ignore the crowdmentalityandemotionalover-reaction of the market atlarge.d. Market-wide trends and

their effect on individualsecurities. The markets areorganized around popularindexes that track movementin selectgroupsof securities.Most popular among theseare the Dow Jones IndustrialAverage(DJIA)consistingof30 stocks; the S&P 500,which tracks 500 companies;and the NASDAQComposite,whichtracksover2,700companies.One important function of

these market indexes is theiruse as benchmarks. Abenchmark is a performancemetric used by financialservice organizations tomeasure and compareperformance of portfoliosbeingmanaged, or ofmutualfundsofferedtothepublic.However,thepopularindexeshave come to represent “themarket”inthemindsofmanyinvestors and traders.Although the DJIA tracks

only 30 stocks, for example,many traders and investorstime their entry and exit intoindividualsecuritiesbasedonchanges in the average,primarily the DJIA, S&P orNASDAQ.e.Market definition in termsofindexes.Theadagethat“arising tide lifts all boats”often is cited to explain howmarket averages can be usedreliably to judge marketconditions and sentiment.As

a consequence, a broadassumption is made thatindividualsecuritiesaregoingto track market-widemovements closely. Thisbelief - that the indexesdetermine movement ofindividual stocks - ismisleading.The measurement of betareveals how broad marketmovement and individualstock price movement arerelated. Beta measures the

tendency of an individualstock and its price volatility,in relation to the broadermarket.Theentiremarketisassigneda beta value of 1. (Thismaybe applied to any index, butfor stocks it usually is usedfor the S&P 500.) If a stocktracks the market exactly -meaning it rises or fallsexactlyinlinewiththeindex-thenthatstock’sbetaisalso1. Some stocks have less

responsiveness, or volatility,thantheoverallmarket.Theirbeta will be less than 1. Forexample, ifacompany’sbetais0.5, itmeansthepricewillmove at half the rate of theindex.Ifthemarketincreases2%, a 0.5 beta stock willmove in the same direction,butonlyby1%.Somestockstend to outpace the overallvolatility of the market. Forexample, if the market risesby2%,astockwithabetaof

1.25isexpectedtorise2.5%.Investors who recognize thebeta application of theirindividual companies ascompared to the broadermarket, are using thoseindexes effectively to judgethe risk of their portfolio.However, it is a mistake toassume that market directionalways mandates the likelydegreeofmovement(oreventhe price direction) of theindividualsecurity.

The assumptions underlyingtechnical analysis are notspecific, but serve only asguidelines. No one canpredict the direction of pricemovement or duration oftrends, either for the entiremarket or for individualsecurities. However,collectively the effects ofthesefactorsallowatechnicalstudy of pricing and thedevelopment of timingstrategies that provide more

successfultimingofentryandexit.

PART 2:CHARTSSegment1.Whatisachart?Achartisthevisualsummaryif a security’s price history,spanning a series of days,hours orminutes. It providesthe analyst or trader with animmediate sense of thesecurity’s performance,current trend direction,

volatility, and any unusualbutnotablepricepatterns(forexample, sizeable price gapsor changes in the breadth oftrading).PurposeofthechartA chart does not tell youprecisely what a security islikely todonext, in termsofprice movement. As one ofthe core principles of theDow Theory cautions, short-term price swings areextremely volatile and

unreliable.Does short-term pricevolatility mean that short-term price movement isimpossible to read? No; infact, chart interpretationfocuses on a few short-termbut important signals,including:

1. Changes in trenddirection, anticipatedthrough a series of

signals.2. Combined price,

volume,movingaverageandoscillatorsignals.

3. Specific reversalpatterns in eitherWestern technicalanalysis price signals orEastern (candlestick)reversalpatterns.

HowtoreadachartThecentralportionofachartshows the price. This is

scaled according to thebreadth of trading over theperiod reported. Thus, everychart is scaled differently.The price portion shows thehigh and low of the day aswell as opening and closingprice.For example on thecandlestick chart of ChinaPharmaceutical Group Ltd.,thedailyhighand lowpricesare reflected within eachday’s candlesticks. The high

and lowareexpressedby therange of the candlestickincludingtheupperandlowerextensions (shadows).Opening and closing pricesarefoundintherectangles.Awhite rectangle reveals anupward-movingday,meaningtheopenwas thepriceat thebottom of the rectangle andthe close was at the top. Ablack rectangle occurs in adownward-movingday.Thus,the open is the top of the

rectangle and the close is atthebottom.

A number of overlays oradditionscanbeaddedtothechart. These include movingaverages, normally shown asanoverlaytopricesoyoucanspot MA crossovers,convergence and divergencepoints; oscillators, shownabove or below the centralprice area; and volume,usually shown below as aseriesofverticalbars.The same chart for ChinaPharmaceuticals, Ltd. is next

shown with a series ofadditional indicators added.Theseinclude:

1. MACD, or MovingAverage ConvergenceDivergence,anoscillatorbased on the study oftwo moving averages.Theseareshownasblueand red overlays to thepricechart.Notehowatcertain times, the two

lines converge (ormovecloser together) ordiverge (move apart).These changes betweenthetwomovingaveragesare significant, and areexplained in greaterdetailinalatersection.

2. Volume, shown as aseries of green barsbeneath the pricesection. Note theincrease indailyvolumeas it spikes in mid-June

atthesametimethattheprice gaps upward,indicating very strongbuying interest in thiscompany, which levelsout in July, and at thesame time volumebeginsdecliningback tomorenormallevels.

3. Relative Strength Index(RSI), shown at thebottom as a running redline. This is amomentum oscillator

that reveals when acompany is overboughtor oversold. Althoughthe levels can beadjusted, the indicatorusually identifies 70 astheoverboughtleveland30as theoversold level.These can be used toconfirm timing of entryto sell (when the RSIlinemovesabove70)orto buy (when the linemovesbelow30).

In this chart, the RSI leveldipped below 30 throughoutApril, May and June, allpotential buy signals orconfirmation.Aspricemovedup, the point where RSIexceeded 70 (the last threeweeks of June), was a sellsignal or confirmation of acomingbearishreversal.

Scaling is reported on theright sideof thechart, and isdetermined by the range oftrading during the periodreported.Forexample,Yahooiscalledinincrementsofone-tenth of a point. The priceactivity seems quite volatileon this scale; however, noneof the sessions is greater inrangethanahalfpoint;giventhe small increments, thechart appears more volatile

than it is, especially incomparison to charts withgreaterincrementalscaling.

For example, IBM’s chart iscalled in one-pointincrements. At first glance,thepriceactivityonthischartappears less volatile than onthechartofYahoo.However,because the scaling is 10times greater (one pointversus one-tenth of a point),IBM is actually much morevolatilethanYahoo.This makes an importantpoint concerning chart

analysis. Every company’svolatility has to be analyzedon its own merits and basedon scaling. The scaling isautomaticallysetsothatallofthe price information fitswithin the frame given thetime period involved. As aresult,thebestwaytoanalyzeand understand a company’sprice volatility is within thehistoryofthecompanyitself.It is not realistic or accurateto compare two different

companies by studying theircharts, unless the scaling isidentical.

The time period also affectsscaling.Forexample, ifpricemoves in a broader tradingrangeovertime,alongertimeperiodwillrequirechangestothepricescaleaswell.Time period is shown belowthe chart. Time periods aremost frequently daily, but itcan be summarized intoweeks, or more detailed intohoursorevenminutesorticks(changes as they occur). Aninteresting point concerning

price pattern analysis: Well-known and frequentlyobserved patterns indicatingandsignalingreversaltendtoapply with equal reliabilityregardless of the time periodofthechart.Theroleofthe“chartist”A chartist is the name giventoanyonewhoreliesonpricecharts toanticipateorpredictprice movement in threepossible directions: upward,downward or sideways. A

price trend may serve as acontinuation of the currentdirection,orasareversal.The chartist is continuallyaware of the existing tradingrangeandhowpricebehaveswithin that range. Reversalsignals can appear at anypoint;butinorderforthemtodrawachart’sattention,theremustbeatrendineffecttobereversed. Furthermore,reversal is most likely at ornearthebordersofthetrading

range. A chartist looks forsignals near resistance of apossible breakout, rally andcreation of a new, highertradingrange--orforsignalsof reversal and retreat backintotheestablishedrange.On the other side of thetradingrange,achartistseeksthe samekindsof signals forbreakout below support andestablishmentofanew,lowerrange and a downtrend - orreversalbackintotheexisting

tradingrange.ChartstovisualizevolatilityThechart iseasilyappliedasa tool for recognizingvolatility. The trading rangedefines price volatility, notonly in its breadth of points,butalsobywhetherornotthetrading range holds steadyovertime.Ifyouobservepricesmovingabove resistance or belowsupport, do those new levelshold? Or does price retreat

back into the establishedrange? The predictability ofprice change over timedefines volatility more thanprice movement within anestablished breadth fromresistancetosupport.Ifstockpricesremainswithintheir set range, chartists tendto take greater confidence inthe predictability, evenwhilerecognizing that breakoutsabove or below can occur.However, when price

regularly bolts aboveresistance or below support,without self-correcting, itmakes it more difficult topredict or anticipate futurepricemovement.Relationship of charting tothefundamentalsThetendencyamongchartistsand other technicians is toobserve price, volume andmomentum by themselves,and to ignore thefundamentals. However,

technical and fundamentalindicators are related andprice activity responds tofundamentalchanges.Fundamentalfactorsaffectingpricemovementinclude:a. News and announcementsofproductexpansion.b.Mergersandacquisitions.c. Earnings, and especiallyearningssurprises.All of these fundamentalshave immediate impact onprice, in the short term and,

often, permanently. Pricedoesnotoperatesolelyontheeffectsofsupplyanddemandwithin the market. Thatsupplyanddemandiscreatedby market perceptions aboutpotential for future profitsand price growth; and that isderived directly from thefundamentals.

Segment 2. Types of chartsin use today: line chart,OHLC, and candlestickchartsStock price charts come inmany varieties. Individualtraders may prefer one typeover another. This decisionwillbebasedon:

1. Familiarityandcomfort.2. Easeofuse.3. Underlyingpurpose.

ThelinechartThe line chart exhibitsinformation with a straightline(orlines)connectingdatavalues. For example, if avaluemovesfrom30to35,astraightlinemovesdiagonallybetweenthesetwovalues.Thelinechartwasusedinthepast to report stock prices; asingle line would usually bebased on closing prices foreach period. This format forstock charting has been

replaced more recently bymore advanced chartingmethods. With theavailabilityofonlinechartingservices that automaticallycalculate values, a morevisual formatting of prices(including open, close, highand low) is a moreinformativeformofcharting.Line charts have applicationwhen twoormore trends arebeing compared. Forexample, comparing closing

prices for two or morecompanies,or foracompanycompared to an index, isinstructive as a form ofspecializedanalysis.Structure: The line chartincludes two axes. Thehorizontalaxis (thex-axis) isa time summary; and thevertical axis (the y-axis)reports value. Each axis islabeledaccordingly.Thetimereported determines scaling,and the y-axis is scaled so

thattherangeofdataoverthetimeperiodwillfitwithinthearea. For example, the linechart of China NationalMaterials Ltd. Summarizes aseriesofdailylinesconnectedto one another, reflectingeachday’sopeningprices.

The shortcomings of thisstyleofchartinclude:a. The inability to see therangeofeachday’strading.b. The lack of both openingand closing prices; a singleline consists of either eachsession’s opening price orclosingprice(thisexampleisaseriesofopeningprices).c. Inability to spot volatilitydue to breadth of tradingrange.TheOHLCchart

An alternative to the linechart is the OHLC (open,high,low,close)barchart.Inthis type of chart you havevastlymoreinformation.Youcan tell each day’s range oftradingandspot thehighandlowlevels.Theverticalextentof each session’s bar alsorevealsthebreadthoftradingforthatsession.

ThisOHLCchartisbasedonthe same data as the linechart, but with greatlyimproved levels ofinformation. Here you canspotnotonlythetrend(whichis all you get with the linechart),butmuchmore:

each day’s high-lowtrading range,represented in theextentoftheverticalbar.

each day’s open andclose,representedbythesmall horizontal bars onthe left (open) and right(close of each session’sverticalbar.direction of trading,found by observingwhether the close islower (declining) orhigher(rising)session.

ThecandlestickchartThe most informative of all

chartsisthecandlestickchart.It reports all of the sameinformationastheOHLC,butwith greatly improved visualfeatures. This makes it easyto spot trends as well asspecificreversalsignals.Eachsessiononacandlestickchartincludes:

Directionoftrade(whitecandles indicate upwardmovement and black

indicate downwardmovementOpening and closingprices. The bottomborder of the whiterectangleistheopenandthe top border is theclose; the top border ofthe b lack rectangle istheopenand thebottomborderistheclose.The complete tradingrange. The day’s highand low are represents

by the extent of upperand lower shadows,extensions from therectangle on either sideoronbothsides.

Onthecandlestickchart,youcan very quickly spotupward-movingdaysby theirwhite candlesticks; anddownward moving days bytheir black candlesticks. Sothisenablesyoutoglanceatalong-term chart andimmediately tell how pricebehaved on each session aswell as within the longertrends.Candlestick patterns,especially for reversal, are

easily spotted. For example,on May 29 and 30, a veryclear, strong bearish signalappeared.Thebearishharamiis a two-session reversalsignal consisting of a white(upward-moving) session,followed by a black(downward-moving session).The first session’s tradingrange exceeds the second,both above and below. InJapanese, harami means“pregnant,”areferencetothe

protrusion of this secondsession,making the indicatoreasytospot.

***Thethreetypesofcharts–line,OHLC,andcandlestick–areallbasedonthesamedatabutprovideincreasinglybetterlevelsofinformation.

Whencombinedwithadditionaltechnicalsignalsforconfirmation,thesecharts(especiallythecandlestick)canhelptobetteranticipate

developingpricepatternsandthelikelihoodofreversal.

The technical ideal is not toeliminatepoortimingofentryor exit, but to improve thelikelihood of better timing.Nosystemprovidescompletecertainty. However, with theinformation you gain fromstudying charts, andconfirming the developmentsthat appear to be occurring,youdoraisethelikelihoodofbetterentryandexittiming.

Segment3.Chartproperties:timescale,pricescaleCharts come in manydifferent types. Beyond thedistinctions of line, OHLCand candlesticks, charts mayemploy varying time andpricescalingsystems.A majority of chartists willprefer using linear charts,meaning that the priceincrements and timeincrements remain consistentthroughout the period

charted. For example, a two-point move will be one-halfthesizeofafour-pointmove;and the increments of timeare applied equally for everysession.Price scales may also beexpressed and charted insemi-log, logarithmic, orKagiformats.TimescaleTime scales can be designedin any increment; under thelinear charting method, all

timeandpricedataaregivenequal weight and distance.Thus,aone-minutechartwillreportsessionsbeginningandending each minute; and adaily chart will reportopening and closing valuesforonesessionperday.All technical indicatorsworkequally well no matter whattime increments areemployed. So you willrecognize and be able to actonareversalindicatorandits

confirmation inachart timedbytheminute,justasyouwillwith one showing daily,weeklyormonthlysessions.For example, Home Depot’sone-minute chart shows 30sessions of one minute eachbetween 2:00 p.m. and 2:30p.m.This chart might beinformative for tradersinterested in spotting anoverall trend minute byminute.Note thegradual rise

inpricepeakingatminute14and then declining sharplybetweenminutes19and20.

A more popular version ofcharting is the dailysummary.This is theversionmost chartist prefer to use,sincetheparametersareeachday session from theopen tothe close. However, anysingle-line chart providesonlyonetypeofinformation.Most investors want to seethedailybreadthoftradingaswellThe next chart summarizesHome Depot’s price activity

forthemonthofJuly,2012.Monthly charts provide along-term overview of astock’s trend.Whilemonthlycharts are not especiallyuseful for a day-to-day studyof technical trendsandshort-termpricemovement,theydoprovideausefulideaofpricemovementoverthelongtermandhowvolatileithasbeen.

The next chart summarizesapproximately 18 months ofpricehistoryforHomeDepot.As with all line charts, thisprovides broad informationbutnodetails.Technicians are likely to bemore interested in a dailyview of the price range andless interested over pricehistory. Technical analysis isgenerally based on currentprices; however, themonthlychartisusefulforchecking:

1. Timing of buying ofswelling shares, basedon how price hasevolved over manymonths.

2. Long-term volatilitylevels.

3. Comparative volatilityand price movementbetween two or morestocks.

In the modern environmentwith numerous free chartingservices available online, thecandlestick chart has becomethe most popular format forchartists. In the past, beforeInternet service, constructionof a candlestick chartdemanded time.Today, theseareeasytofindandprovideawealthofinformation:

1. Opening and closingprices (horizontalbordersofeachsession’srectangle).

2. Full trading range(extension from top ofupper shadow to bottomoflowershadow).

3. Direction of trading(white in up days andblackindowndays).

The next chart reflects dailysessions for three months of

tradinginHomeDepot(HD).

PricescaleIn addition to time scales,pricecanalsobescaled.The majority of charting isbasedon linearprice scaling.Each session’s price rangehas a fixed vertical valuebasedona strict summaryofthat session, regardless ofhow sessions before or afterhave been valued. Thus,looking at a chart of manysessions, chartists are able toappreciate relative price

breadth,andtospot:

exceptionally broad ornarrowsessionswithbigpricegapstrendsbasedonthesamescalinginformation

A semi-log chart tracks thepercentage of change fromonesessiontoanother.Thisisaveryspecializedvariationofcharting and is useful for

analyzing big market moves,especially in market-wideindices or benchmarks.However, if you are focusedon analyzing a stock’s pricetrends, a semi-log chart willnot always reflect theevolving trends needed totimeentryandexit.The semi-log chart plotsdegrees of change betweensessions rather thandisplayinga fixedvaluesuchas that found on the linear

price chart. This provides a“degree of magnitude” ofprice change, rather than afixed or uniform comparisonbetween prices of differentsessions. Semi-log charts areusefulfor:

1. The study of largemarket movementsrelative to prior pricetrends.

2. Single-stock price

volatility over the longterm.

3. Sector or marketanalysis comparisonsbetween two or moresectors.

The scaling of a semi-logchart will not be equal, butexponential. Rather thanpricingof10,20,30and40,for example, a semi-logscalingsystemmaybe1,10,100and1,000.

ScalingcomparisonsLinearscalingprovidesmanybenefits for technicalanalysis:

1. It isfamiliarandscalingiswidelyunderstood.

2. Judging the significanceof trends is reliable inlinearcharting.

3. Most technicalindicators assume linearscale.

Disadvantages of linearscalingare:

1. Degrees of change donot necessarily gethighlighted, dependingonscale.

2. Scale is adjusted basedon breadth, so thatrelative volatility(betweentwocompanieswhose charts havedissimilarscaling) isnot

reliable.3. Analysis of signal

sessions (such asexceptionally largebreadth of trading in asinglesession)mightnotbe as important as itappears because scalingdistorts it in relativeterms.

Advantages of semi-log (or,logarithmic)scalingare:

1. Prices are reflected inrelative terms, sodegrees of change areprominent.

2. Big change appearslarge, but little changedoes not; this clarifiesthe nature of volatilityfor chartists viewing thelong-termtrend.

3. Distortions resultingfrom price scaling areabsorbed andminimalized.

Disadvantages of semi-logscalingare:

1. When two or moresessions areapproximately the samesize, the change is notreflectedonthechart.

2. Equal percentageplotting may cloakimportant technicaldevelopments, such astests of resistance or

support occurring withsessions ofapproximately the samebreadth.

3. Virtually all technicalindicators assume linearcharting, so thesignificance of pricepatterns may be lostwhen using semi-logscaling.

TheKagichartAnother charting system is

the Kagi chart. This is asystemdevelopedinJapaninthe 1870s to plot differencesin supply and demand. TheKagi chart follows theseprinciples:

1. Whenpricerisesaboveaprevious high(representing increaseddemand)orfallsbelowaprevious low(representing greater

supply), either the coloror the thickness of thelines changes (in thefollowingexample,coloris used instead ofthickness).

2. The lines are vertical toreflect supply anddemand, and are joinedtogether by a series ofhorizontal connectors

3. Plotting of the chartfollows a variable

period, adjusted whenthedirectionchanges.

4. Direction is plottedwhen the trend reverses,usually once movementin an opposite directionexceeds 4%; this tendsto even out short-termvolatility.

The next chart summarizedthe monthly Kagi trend forHome Depot overapproximately 14 months.

The period of increaseddemand (green areas)occurred over most of thecharted the period; and thatthe primary period ofincreased supply, or reduceddemand, were found onlyduring the first threemonths.

Notethataslongasthedirectionremainedthesame,theKagitimescalewasmonthly;butwhenit

changed,thescalingrevertedtodifferenttimecounts.Thescalingrepresents

percentageofchangeratherthanprice.Thechangefromsupplytodemanddominanceissetassuminga4%level.

***

The variety of charts givestechnical analysts a range ofselection choices. Automatedaccessvia theInternetmakeschartinganeasymatter.Pricemovement can be plottedusingmore than one system,and it is possible to gaininsight by pursuingcomparative analysis of thesame price and timeinformation using differentmethods.

However, most technicalanalystswillultimatelypreferlinear pricing and timing forreliability and application ofindicators; and will be likelyto select candlesticks overline orOHLC charts, if onlybecausethevisualadvantagesof candlesticks are so muchgreater.The difficulty of using semi-logchartsisthat,asthenameimplies, these are only

partially logarithmic. Apurely logarithmic systemwould be based strictly ondegrees of changeexponentially plottedand exponentially timebasedon degree of change. Thiswould distort the ability oftechnicians to apply well-known and highly reliabletechnicalsignals.Candlestick charts areassumed to be linear unless

otherwise stated. In thisformat they provide the bestvenue for technical study ofpricemovement,momentum,trends, andmoving averages.Being able to combine thesefeatureswithabroadviewofeach session's breadth oftrading is the most practicalsystemoftechnicalanalysis.

Segment4.ChartpatternsinWesterntechnicalanalysisChartistsseekoutpatterns inprice;changesinvolume;andgrowth or decline inmomentum. All of theseshort-term changes appear inthe form of patterns. Pricepatterns are prominent inWesterntechnicalanalysis.This section explores themost popular and recurringtypesofpricepatternsusedintechnical analysis to

anticipate price direction andreversal.ResistanceandsupportThebasisforshort-termpriceanalysis is the trading range,the price area and breadth inwhich trading occurs. Thebreadthoftrading,ordistancefrom top to bottom, defineslevelsofvolatility.The degree of volatility in astock is relative. So if theprice level varies betweenonly two points historically,

and the breadth increases tofour points, that is twice thevolatility.Ifpricelevelshaverangedbetweensixandeightpoints,andthatleveldeclinesto four, it is much lowervolatility.Two price levels define thetradingrange:

1. Resistance is the top ofthe current tradingrange.Thisisthehighest

price sellers are willingto pay for shares ofstock. At this price,selling activity is activeenough to keep pricefromrisingandfurther.

2. Support is thebottomofthetradingrange.Thisisthe lowest price sellersare willing accept forshares of stock. At thisprice, demand isassumed to be strongenoughtokeeptheprice

fromfallinganylower.

Resistance and support maybelevel,risingorfalling.Forexample, the chart for AirChina includes examples ofall threepatterns.The first isa rising range, defined as aseries of higher high pricesand higher low prices, butwiththesamebreadth.Second is adeclining tradingrange, with both resistanceand support declining but

maintaining the sameapproximate breadth oftrading.Finally,attheendofthechartprices leveled out so thatresistance and support bothmoved sideways while alsoretaining thesamebreadthoftrading.

Resistance and support are

the borders of the tradingrange. Eventually, however,price levelswillmove aboveresistance or below support.A breakout may result inprice retreating back into theprevious trading range; orprice may continue to riseabove resistance or belowsupport to set up a newtradingrange.

For example, China Railway

experienceda failedbreakoutabove resistance; pricesmoved above and thenquickly retreated back intotheestablishedtradingrange.Afailedbreakoutsuchasthisis likely to result in pricesmoving in the oppositedirection. In this case, pricesmoveddownso strongly thatthey broke through supportand succeeded in remaininglower. This set up a newtrading range with lower

resistance and support, andabout the same breadth oftrading.An interesting pattern oftenfoundwithbreakoutsiscalledthe flip. A previous level ofresistance becomes the newsupport level as prices movehigher; or the previous levelof support becomes the newre4sistance level after adownwardbreakout.Forexample,CocaColawentthrough a period in which

price levels broke throughresistance and established anew, higher trading range.The previous resistance pricebecame the new supportprice.

Headandshoulders

A very reliable patterntechnicians look for is calledheadandshoulders.Thisisaprice pattern with threedistinguishing characteristics:three peaks, with the middle(the head) higher than thefirstandthird(shoulders).Con Ed experienced such apattern in its chart. Theimportant aspect of head andshoulders is that oncetechnicians spot it, theyexpect prices to decline. The

triple attempt to drive priceshigher has failed, so thistranslatesintolostmomentumamongbuyers.

The head and shoulders can

happen on the downside aswell. The inverse head andshoulders consists of threelowpoints.Themiddle(head)is lower than the first andthird(shoulders);andlikethetop-side version, prices areexpected to thenmove in theoppositedirection,upward.The chart for Exxon Mobilprovides an example of theinverse head and shoulderspattern.After itdevelopsandsellers were unable to drive

prices lower, the trendreversed and began movingupward.

TopsandbottomsThe head and shoulders is arecognizable pattern testing

resistance on the top orsupport on thebottom.Otherpatterns also test the bordersofthetradingrange.Double or triple tops andbottoms are recurring peaksin price that approach theedge of the range. Failing tobreak through, price then isexpected to move in theoppositedirection.The chart for J.B. HuntTransportexperiencedatripletop before prices began to

decline.Thiswasasignalthatbuyerswerenotabletobreakthrough the price of $56-57.After several attempts, thesell-side took overmomentum, moving pricesdownward.

Double or triple bottomsoccurwiththesamerationale:sellers are trying to move

prices lower but the attemptfails. Then buyers take overmomentum.Forexample,KraftFoodshadthree bottom prices duringJune and July, 2012. Afterfailing to break throughbelowthe$37-38price level,Kraft’s price began trendingupward.

FlagsandpennantsA flag is a counter-move in

the current trend, usually ofvery short duration. Thebreadth of trading does notchange, but soon after theflag develops, trading thenresumes. Flags arecontinuation patterns ratherthan signals of a comingreversal.Forexample,AT&Twasinalong-term uptrend betweenMay and August, 2012.However, three consecutiveflags occurred between mid-

Juneand theendofJuly.Allwereapproximately the samebreadth of trading. But oncetheywere completed, a largeprice gap followed and theuptrendcontinued.Flags also occur duringdowntrends, when the flagwould consist of amomentary uptrend of a fewsessions.

Apennantislikeaflaginthesense that it also is a

continuation pattern. Butwhereas the flag’s range isconsistent, a pennant’sdeclines. For example, overnine months, the chart forIntel was characterized by aseries of pennants, bothupwardanddownward.The first two cases bothoccurred as disruptions of anexistinguptrend.Notethatassoon as the pennant closes,the uptrend continues. Thethird pennant is an upward-

movingshorttrendduringthecurrent downtrend. In eachcase, the pennant’s rangecloses right before theestablishedtrendcontinues.

TrianglesandwedgesDeveloping signals whose

ranges close up provideimportant intelligence forchartists, enabling them toanticipate coming pricetrends, both continuation andreversal.Triangles are found in threedistinct shapes. Asymmetrical triangle may beeither a continuation orreversal pattern and amongthe types of triangles, this isthemostdifficulttointerpret.Chartists have to rely on

confirmationsignalstodecidewhatthesymmetricaltrianglemeans. It consists of lowerhighs and higher lows, withthe trading range shrinkingand converging to the pointwhereatrendwilltakeover.

For example, Yahoo’s chartwent through a strong

symmetrical triangle patterntoward the end of July.Notice how the patternshrinksandthenpricesbreaksinto a new trend. It appearsfrom this pattern that anuptrend follows; but there isnotenoughhistorytobesure.An ascending triangle is abullish signal. It consists ofequal highs and a series ofhigherlows.Forexample,thechartofApplecreatedaclearascending triangle with

resistance at the top and arising support level. As thetriangle concluded, pricesjumped above establishedlevels.

A descending triangle is abearish signal, consisting oflevel low prices and a series

ofdeclininghighprices.Oneexample was the chart forChevron,whichbeganwithavery strong descendingtriangle.

Themeaningofthispatternisbearish, as evidenced bysubsequent price movement.Even though the price levels

jumped above the decliningresistance points, theestablished supportwas soonviolated. The lower tradinglevelcontinuedforthemonthofMay,beforepricesbeganastrong uptrend in June andJuly.A similar pattern to thetriangle is the wedge. Thedistinction is that whiletriangles tend to have fixedresistance or support, thewedgeexperiencesmovement

onbothsides.Arisingwedgeis made up of higher highsand higher lows, and isbearish. A falling wedge isbullish and is made up oflowerhighsandlowerlows.For example, the chart forTsingtao Brewery had onerising wedge and two fallingwedges. The rising wedgeaccuratelypredictedacomingprice decline. However,neither of the falling wedgeswas reliable; they signaled

possibleuptrends,butinbothcases these did not develop.This set of failed signalsmakes thepoint that youcannever rely on even strongsignals 100% -- they areindicators,notguarantees.

Gaps

Another significant pricepattern involves gaps. Thereareseveraltypesofgaps,andthey recur frequently. Thetype with no specialsignificance is called acommongap.Arunawaygapoccursasaserieswhenpricemovementoccursrapidlyandstrongly.Thebreakawaygapoften occurs when pricelevelsmove above resistanceor below support. In eithercase, prices may turn back

into the established tradingrange,orcontinuetosetupanew higher or lower tradingrange. An exhaustion gap isfound as a signal ending acurrentuptrendordowntrend.A chart containing numerousstronggaps is that ofProcter& Gamble. Gaps are noteasily to interpret, but whenthey occur this often, somesignals can be taken fromgappingpricemovement.The first two look like

common gaps because noimportant priced movementfollows. However, the thirdshows up after a sustaineddowntrendandisprobablyanexhaustion gap. The fourthgap takes place within thesubsequent downtrend. Butthe most interesting gaps onthis chart were the fifth andsixth ones, both taking placeis a strong uptrend andpotentially identifying arunaway gap pattern. The

final, seventh gap on thischart could signal exhaustionof the uptrend, especially asprice levels stopped movingupward and were beginningtoslideslightly.

Technical signals come inmanyshapesandsizes.These

aresomeofthemorepopularof the technical signals. Allsignals require independentconfirmation, however, byway of other technicalsignals, momentumindicators, or candlestickpatterns.

PART 3:JAPANESECANDLESTICKSAll chart types have thepurpose of providing fastvisual summaries of pricemovement. As primarytechnical tools, chartssummarize price, volume,momentum, and averages ofpricedevelopments.

Eachchart’sfeaturesinclude:

1. Price movement,including high and lowas well as open andclose.

2. Direction of movementover time foridentification of short-termtrends.

3. Anticipation of comingreversals based on testsand breakouts above

resistance or belowsupport.

Segment 1. What areJapanesecandlesticks?The candlestick is a form ofreporting developed in Japanin the 17th century, to trackprice movement in ricefutures. Candlestick chartsidentify specific pricepatterns that provide earlyindications of pricemovement including likelyreversal.Candlestick indicators are

found in single sessions, twoconsecutivesessions,orthreeor more sessions. Thestrength of indicators varies,but all reversal signals –candlesticks and others –should be confirmedindependently by othertechnical signs. Somefeatures add to the reliabilityof candlestick indicators,including:

1. Proximitytoresistanceandsupport.Alltechnicalsignalsaresignificantwhenconfirmedbyotherindicators,orwhenoccurringatkeypositions.Amongthesepositions,proximitytoresistanceorsupportisthemostimportant.Reversalismostlikelytooccurwhenpricemovementapproaches

thesepricelevels.Afailedbreakoutislikelytoleadtopricemovementawayfromtheresistanceorsupportlevel.Abreakoutwithstronggappingpriceactionmightalsoreverse;however,candlesticksignalsareexcellenttoolsforidentifyingthepossibilityofreversal,especiallywhen

confirmedbymomentumoscillators.Forexample,onSouthernCompany’schart,supportissignaledtoendbytheone-sessionindicatorcalledahammer(consistingofasmallrealbodyandexceptionallylargelowershadow).Thisproximityissoimportantbecausethehammerdemonstrates

thefailureofsellerstomovethepricelower;thisledtoastronguptrendincomingsessions.

2. Volatility levels of thestock. Reversal isclosely associated withthe stock’s level ofvolatility. Highlyvolatile stocks aredifficult to predict;however, usingcandlesticks andindependentconfirmation is a soundmethod for usingvolatility to understandthe likelihood of price

reversal.3. Strength of confirming

price signals. Just assome indicators arestrong while others areweaker, confirmationalso is found is manydegrees.A strong initialindicator accompaniedby an equally strongform of confirmation,increases the likelihoodofreversal.

4. Exceptionally strong

confirmation frommomentum indicators.Among the confirmingindicators, momentumoscillators are perhapsthe best and mostreliable of all signals.These identify not onlythe direction of a trendon average, but also itsstrength and speed.Oscillators are trackedby index values; andwhen the value rises

above a predeterminedlevel, the stock isassumed to beoverbought. When theindex falls below apredetermined level, itindicates an oversoldcondition. Reversal ofthese extremes is highlylikely, and this is thevalue in trackingmomentum. Suchindicators provide themost reliable forms of

confirmation forcandlestick reversalsignals. JP MorganChase had a clearsupport level until newsbroke concerning thecompany’s large lossesin derivativesspeculation. Thequestionfortraderswas,How can you tell whenthe reaction downtrendhad ended? The answerwas found in Relative

Strength Index (RSI), amomentum indicator.Note the dip in the RSIline beneath the indexvalueof30.Thisrevealsan oversold condition.The change fromdowntrend to uptrendwasalsoseeninastrongupward-moving pricegap after May 21, andanother after June 4. Atthat samepoint, theRSIindicator moved back

intothemiddlezoneandmarked thebeginningofthe uptrend.

5. Spikes in volume. Thetrend in volumeaccompanies pricemovement with highreliability. A volumespikeisareliablesignofcoming reversal. Whenvolume spikes in asingle session(especially to the extentthat it confirms acandlestick reversalsignal), it makes thelikelihood of price

reversal veryreliable. The DuPontchart provides anexcellentexampleofthistype of confirmation.Thebullishharamicrossis a two-sessionindicator consisting of ablack (downward-moving) sessionfollowed by a doji (asession with little or nodistance between openand close), with the

second session rangeentirelywithin therangeof the previous session.However, even thoughthis is a bullish signal,price levelscontinued todecline for the next fivesessions. The volumespike seen at themidpoint of this declinesignaledthatpriceswereabout to reverse andmove upward. Thisvolume spike confirmed

the bullish candlesticksignal.

6. Crossover andconvergence (ordivergence) in movingaverages. Movingaverages are tracked inmany forms, andamongthe favorites are the useof twoMAsat thesametime.A20-dayand200-day MA application isoneofthemostpopular.The theory holds thateach of these bringsvalue to the anticipation

of price movement.Convergence anddivergence of the twoMAs as well ascrossover points (whenMA crosses price) arevaluable signals ofchanges in the pricedirection. Asconfirmation tools forcandlestick signals, MAanalysis provides greatvalue. The Japanesecandlestick is a means

for spotting thelikelihood of pricedirection and change.Some indicators arecontinuation patterns,but the greatest interestisfocusedoncandlestickreversalsigns.Technicaltraders seek early cluesthat price is about toreverse due to pricepatternchanges,slowingmomentum, andmovingaveragetrends.

Segment 2. Features: openand close, high and low,pricedirectionThe candlestick provides awealth of information totraders.Whenreviewingachartforaperiod of time, candlestickformationsareeasilyspotted.Trends, acceleration of pricemovement, and volatility areallmadevisual.ValueincandlestickanalysisCandlesticks work well for

technical analysis, becausethey compliment other formsof price study. The specificreversalindicatorsintheformofone-session,two-sessionorthree-sessionpatternshelpto:

1. Support (or contradict)other candlestickindicators.

2. Identify periods ofconsolidation anduncertainty, as well as

the end of such periodsand the beginnings ofnewtrends.

3. Look for exceptionallystrong signals at or nearresistanceandsupport.

4. Determine whetherbreakouts will lead tonew trading ranges, orretreat back to thepreviously set tradingrange.

Featuresofthecandlestick

Candlesticks contain all oftheinformationaboutasinglesession that analysts require.Thisinformationincludes:

1. Direction of pricemovement. An upward-moving session isrepresented by a white“real body” (therectangular center); anda downward-movingsessionisrepresentedby

ablackrealbody.2. Opening and closing

price.Therectangle(realbody) defines openingand closing prices foreach session. Thehorizontal lines servethis purpose. On anupward-moving (white)session, the openingprice is the bottom lineand the closing price isthe top line. On adownward-moving day

(black), the openingprice is the tophorizontal line of therectangle, and theclosing price is thebottomline.

3. Trading range of thesession. It often occursthat trading within onesessionoccursaboveandbelow the open/closerangeoftrading.Thefullrange is represented bysticks appearing above

andbelowtherealbody.Thesearetermed“uppershadow” and “lowershadow” and also arecalledwicksortails.

The candlestick and itsfeatures are summarized inthefigure.

CandlesticksinconfirmationThevalueofcandlesticks forspottingreversalsisaprimaryadvantage. However, timingof entry and exit demandsindependentconfirmation.Candlestick formationsprovide reversal signals, butshould also be confirmed.The specific confirmationmaybemadewith:

1. Other candlestick

formations.2. Volume indicators or

single-sessionspikes.3. Momentum oscillators,

notably as they moveinto overbought oroversoldterritory.

4. Western technicalindicators (tops andbottoms, head andshoulders, gappingpricemovement, and manyotherpatterns).

ProximityofcandlesticksCandlestick indicators aremost significant when theyarefoundatornearresistanceorsupport.These borders of tradingrangesmaybechallengedbyprice movement. Some rulesofthesechallengesinclude:

1. Success or failure.Candlestick indicatorsmay reveal whether a

breakthrough willsucceed or fail (areversal indicatoroccurringat thepointofbreakout is strongevidence of a failedbreakout).

2. Oppositemovement.Anattempted breakout thatfailsoftenisfollowedbyprice trending in theopposite direction.Candlesticks mayconfirm this coming

pricemovement.3. Confirmationofsuccess.

Price breakouts thatsucceed often areconfirmed withcandlestick continuationpatterns.

4. The flip. Price breakoutthat establishes a newtrading range mayinclude a flip betweenresistance and support(prior support becomingnew resistance with a

breakout through thebottom; or priorresistancebecomingnewsupport with a breakoutthroughthetop).

5. Flip confirmation.Support and resistanceflips may be confirmedwith subsequentcandlestickpatterns.

Segment 3. A short list ofcandlesticksignalsDozens of candlestickindicators providecontinuation and reversalsignals. Among these, thissection displays and explainsa few of the better-knownindicators.LongcandlesThe first notable candleformation is a single session.The long candle may beupward-moving (white real

body) or downward-moving(black real body). A longsession is important becausestrength of trading is greaterwhen the distance betweenopen and close is more thanthetypicaltradingsession.The “long” nature of thissession is relative. Forexample, when a chart is setinincrementsof¼ofapoint,a two-point move is quitelong. When a chart is set in10-ponit increments, that

same two points is relativelyshort.Chart intervals are set basedonthetimeperiodandtradingrange. As a stock’s pricesexpand, the incrementalspaces are broadened so thatallofthetradingactivitywillfit on the chart. For thisreason, it is not accurate tocomparea“long” session foronesecuritytothatofanotherwhose incremental pricing isdifferent.

Thismaybeeithera reversalor a continuation indicator,depending on where itappears:

1. A white long candle

appearing within anuptrendisacontinuationindicator.

2. A white long candleappearing within adowntrend is a reversalindicator.

3. A black long candleappearing within anuptrend is a reversalindicator.

4. A black long candleappearing within adowntrend is a

continuationindicator.

DojipatternsJust as exceptionally longsessionsaresignificant,soareexceptionally short sessions.The shortest possible sessionisthedoji.ThisisaJapanesewordmeaning“mistake,”anditappearsasahorizontallineinstead of a rectangle. Thisreveals that the session’sopening and closing priceswerethesameorveryclose.

A doji can be bullish orbearish.A dragonfly doji is bullishand contains only a lowershadow,revealingthatsellersattempted to drive pricelower,butdidnotsucceed.A gravestone doji is bearish

and has only an uppershadow. This shows thatbuyerstriedtodrivethepricehigher, but that attemptfailed.A long-legged doji has bothupper and lower shadows,revealing that both buyersand sellers tried to controlprice direction, and bothfailed. This is a reversalpattern that relies on thecurrent direction. When itappearsinanuptrend,ithints

at a coming downwardreversal;whenitisfoundinadowntrend, it hints at abullishreversal.EngulfingpatternA pattern appearing often istheengulfingpattern. This isan especially strong reversalsignal.The bullish version consistsof a black session followedbyawhitesessionwhoserealbodyextendsbothaboveandbelowthatofthepriorsession

(engulfingit).The bearish version consistsof a white session followedbyablacksessionwhoserealbodyextendsbothaboveandbelowthatofthepriorsession(engulfingit).

Harami

The word harami means“pregnant” in Japanese, andthis describes the protrusionof the second session in thistwo-session indicator. Itsformation is opposite that oftheengulfingpattern.

The bullish harami beginswith a black session and isfollowed by a white sessionwhose open and close arefound completely within therangeofthepriorsession.The bearish harami beginswith a white session and isfollowed by a black sessionwhose open and close arefound completely within therangeofthepriorsession.HammerandhangingmanThis is an interesting one-

session indicator, for tworeasons. First, it does notmatter what color the realbodycontains.Second,itmaybe either bullish or bearish,depending on whether itappears at the top of anuptrend (bearish reversal) orat thebottomofadowntrend(bullishreversal).

Thefairlysmallrealbody(ofeithercolor)alsocontainsalowershadowthatislargerthantheextentoftherealbody.Thebullishversionappearsatthebottomofadowntrend;itiscallingahammerandforeshadowsareversaland

uptrend.Thebearishversionappearsatthetopofanuptrend;itiscallingahangingmanandforeshadowsareversalanddowntrend.Threewhitesoldiers

These are three-sessionpatterns that may constituteeither continuation orreversal.

The rule for the three whitesoldiers is: each session hasto open higher than the openof the prior session, and alsohastoclosehigher.Thesearemostoftenreversalpatterns (meaning the threewhite soldiers is expected toconclude a downtrend,signaling reversal). In fact,these are reversal signalsabout80%ofthetime.However, they may also befound as continuation

indicators:

1. Three white soldiersappearing within adowntrend is a reversalindicator.

2. Three white soldiersappearing within anuptrendisacontinuationindicator.

Threeblackcrows

Thesethree-sessionindicatorsmay be either reversal orcontinuationsignals.

The rule for the three blackcrows is: each session has toopen lower than the open ofthepriorsession,andalsohastocloselower.Thesearemostoftenreversalpatterns(meaningthreeblackcrows are seen at the top ofan uptrend, signalingreversal). In fact, these arereversalsignalsabout80%ofthetime.However, they may also befound as continuation

indicators:

1. Three black crowsappearing within anuptrend is a reversalindicator.

2. Three black crowsappearing within adowntrend is acontinuationindicator.

***Dozensofcandlestick

indicatorsareusedbychartiststoanalyzepricepatterns,spotreversalorcontinuation,andserveasconfirmationforother

indicators.Thissectionhasonlyhighlightedsomeofthemorepopularandrecurringcandlestickindicators.

Segment 4. Study of severalcandlestickschartsThis section providesexamplesofaselectgroupofcandlestick indicatorsintroduced in the previoussection.Each chart includeshighlighted signals showingwhatoccurredafterthesignalappeared. This is intended toshow how successfulindicators are applied;however, no indicator should

be expected to ensure suchmovements all of the time.Every indicator has apercentage of failures, soconfirmation is always a keyin addition to finding strongsignals.Longcandles

Paychex went through a

period of small pricemovementsinbothdirectionsfor the months of May andJune. The highlighted longcandle was important forseveralreasons:

1. A gap occurred bothbefore and after thesession, both in upwarddirection.

2. A bullish haramipreceded the long white

two and three sessionsearlier (black candlefollowed by a smallerwhite); this was anadditionalbullishsignal.

3. The long white candlewas the most bullishvariety, called a whitemarubozu –distinguished by lack ofupper and lowershadows.

Long candles also appear in

anticipation of downtrends.Cisco systems was such anexample. Although thehighlighted long candle wasnot extremely long, it waslarger than sessions beforeand after. It also led to amonth-long downtrend,highlightedonthechart.

DojiThe doji comes in three

primary examples. Thedragonfly is bullish; thegravestoneisbearish;andthelong-legged is a reversal thatcan be either bullish orbearish, depending on whereit appears within a currenttrend.The chart of Pearl Orientalbegan with a small butimportant dragonfly doji.Thisisanexampleofafailedindicator. The dragonfly isbullish; however, it only acts

as a reversal about half thetime;theotherhalf,itmaybepartofadowntrend,asshownintheexampleofPearl.Althoughthedojiisgenerallya strong indicator, a 50%reliabilitymakesitpracticallyuseless.Youwould expect itto act bullishly since thelower shadow represents afailed effort by sellers tomovepricelower.The 50% performancereliability has to be kept in

mind,sincethatisnotenoughto spark a trade, even ifconfirmationislocated.

The gravestone is a bearishdoji,asshowninthechartof

China Glass. This indicator,likesitsoppositedragonfly,isareversalsignalonlyhalfthetime, making it equallyunreliable.Inthisexample, itdidleadtoadowntrend.One way to judge thisgravestone is by theunusuallylonguppershadow.The longer the shadow, thestronger themeaning. In thiscase, buyers lost momentuminaneffort todrive thepricehigher.

Compared to the very smalllower shadow of thedragonflydojiinthepreviousexample, this longer uppershadowisabetterindicatorofcomingreversal.

The last type of doji is thelong-legged variety. This

contains both upper andlower shadows and itsmeaningdependsonwhereitisfoundinthetrend.Liketheother types, this leads toreversalonlyhalfofthetime.However, in the example ofGeneral Electric, the uppershadowisquitelong.Likethegravestoneexample,thislonguppershadowisasignoflostmomentum among buyers.This makes the long-leggeddoji a likely bearish reversal

signal.This is especially true notonly due to the long uppershadow,butalsoasareactiontotheverylargeupwardpricemovement preceding it. Thatwas an exaggerated trend, soa reversal should have beenexpected. Once the long-legged doji appeared, adowntrend seemed morecertain.

EngulfingThe engulfing pattern is

found often and is highlyreliable. The bullish reversesmore than 60% of the time,andthebearishreversesabout80%.Thatisahighdegreeofreliability.The chart of AlteraCorporation experienced twobullishengulfingpatternsinafive-sessiontimespan.Thisisan example of strongconfirmation; however, it isunusual.The proximity of two of the

same candlestick patternsshould not be expected tooccur often. This makes theexampleexceptionallystrong.It accurately predicted thestronguptrendthatfollowed.

ThebearishengulfingpatterninDominionResource’schartwas a good example because

it was confirmed in severalways:

1. The breakout aboveresistance was followedimmediately by thebearish engulfingpattern, making reversalverylikely.

2. The session followingthe engulfing signal hadan exceptionally longuppershadow,indicating

lost momentum amongbuyers.

3. Proximity to resistance(andthebreakout)addedstrength to the bearishindicator, making theresulting downtrend anearcertainty.

HaramiTheharamiactsasa reversal

signal,butonlyabouthalfthetime. This makes it asunreliable as the precedingdoji indicators – unless theharami appears withexceptionally strongconfirmation.Staples had an example ofstrong confirmation. Twobullish harami indicatorsshowed up in a five-sessionperiod.Itanticipatedastronguptrendforthefollowingtwoweeks.

Thebearishharamiisequally

unreliable as its bullishcounterpart – reversing onlyhalfthetime.However, in the chart ofMMM, there was a specialcircumstance that made thebearish harami exceptionallystrong and a likely case ofreversal. The price rose sorapidly and peaked with thebearharami.When a reversal indicatorappears at the very top of achart, it adds strength. This

was not an easy situation tointerpret, however. Theprecedingtrendwassidewaysafter a brief uptrend; so thebearish indicator was notespecially strong. It did leadtoadowntrend,however.Based on the low occurrenceof reversal for the harami,this examplewould not haveprovided enough informationto act on it. Beforeanticipating a downtrend, itwould make more sense to

look for independentconfirmation from volume,momentum indicators, orothersigns.The fact that thisoccurred at(and slightly above)resistance adds a degree ofstrengthtothebearishsignal.All reversal indicatorsoccurringatornearresistanceor support should be takenseriously because reversal ismore likely there thananywhereelseonthechart.

HammerandhangingmanThe hammer and hangingman are single-session

indicatorsthatareunusualfortworeasons:

1. The color of the realbodydoesnotmatter.

2. The significancedepends on whether itappearsat thebottomofa downtrend (hammer)or the top of an uptrend(hangingman).

Both of these are reliable as

reversal signalsabout sixoutof 10 times, making thembetter than random, but notby much. Before acting onthese, independentconfirmation should belocated.The hammer appeared in thechartofPeet’sCoffee&Tea.It was strengthened to adegree by the precedingdowntrend.The frequency ofdoji sessions indicated morethan average uncertainty

among both buyers andsellers.Due to this uncertainty, atrader might have givenweight to the hammer to agreater degree than itsappearance elsewhere.However, withoutconfirmation, it would nothavemadesensetoactonthehammerbyitself.

The hanging man is equallyweak as a reversal signal,

working 60% of the time.Confirmation is essentialbeforeactinguponseeingthehangingman.

The chart of Dell wasexceptionalforafewreasons:

1. The entire chartconsistedofverynarrowtradingsessions,allatorbelowonepointbetweenopenandclose.

2. Two hanging mansessions appeared ninesessions apart.Unfortunately,bothwerevery weak, seen by thesmalllowershadows.

3. The following large

downward gap was asignificant three-pointchange, especiallyconsidering the smallrange of trading in eachsession throughout.However, thisgapcouldnot have beenanticipatedfromthe twohanging man indicators.They were not strongenough to anticipatesuch a surprising fall inprice.

ThreewhitesoldiersOne of the easiest indicatorsto spot is the three whitesoldiers,consecutivesessionsof three (or more) upward-moving prices. The idealthree white soldiers consistsof each day opening withintherangeofthepriorday,andthenclosinghigher.

Thisisoneofthestrongestofall reversal signals, with an

80%reliabilityhistory.ThechartofExpediacontainsthree examples of the threewhitesoldiers:

1. The first appears after avery large upward pricegap. The immediateappearance stronglysuggests that price willnot drop back topreviouslevels.

2. Thesecondsuggeststhat

after a 2.5-monthsidewaystradingpattern,thepriceisabouttorallytotheupside.

3. The third examplefollowsapricegapverysimilar to the first. Itconfirms the hint in thesecond indicator that anupward movement wascoming; it also addsassurance that thenewlyset higher price levelwillnotretreat.

ThreeblackcrowsThis is the bearishcounterparttothethreewhitesoldiers, a bearish versionthat is also reliable 80% ofthe time. It consists of threeconsecutive downward-moving sessions, eachopening within the range oftheprevioussessionandthenclosinglower.ThechartofTheTravelers isa good example of how thethreeblack crows appears.A

strong uptrend leveled out,meaning the next move wasuncertain. The appearance ofthe three black crows settledthequestion.Even though price againhesitated and movedsidewaysafterthethreeblackcrows, the trend was clearlybearish.

PART 4:TRENDSSegment 1. Why do pricestrend?The nature or prices is tomove in one direction for aslongasmomentumcarries it;and to then use upmomentum, pause, andreverse.Inertia is an aspect of

momentum. When pricestrend inonedirection, inertiaworks to keep it moving foras long as the momentum issustained.Oncemomentumisexhausted,thetendencyisforprices to then trend in theoppositedirection.ChaosversuspredictabilityWhydo prices reveal a levelof predictability? Can pricemovement by volatile andimpossible to predict? Someanalysts – those subscribing

to the random walkhypothesis – believe thatpricemovementisrandom.Technical analysts rely ontechnical signals found in avariety of forms (price,volume, and momentum) topredict change. If a traderdoes not believe inpredictability, this is a futileeffort. However, a scientificapproach to trend analysisreveals strong historicalreliability.

Most analysts agree thatshort-term price movement(swings)ishighlychaoticanddifficult to predict. Swingtraders rely on over-reactionin short-term trading toexploit both emotional over-reaction and chaos. Longer-termtradingsciencereliesonmomentum analysis as wellas on price patterns andreversalsignals.Intermediate (reaction trendsor retracements lasting

betweenafewdaysandafewmonths)andlong-termtrends(lasting between severalmonthsandseveralyears)arefar more predictable thanshort-term price movement.Historical analysis of trendsreveals predictability in thedefining attributes of thesetrends as well as in theirtendencytoevolve.Supply and demand -- andtrendingAtrendisthereflectionofthe

current price dominance byeitherbuyersorsellers.Trends last until the side incontrol begins losingmomentum. At that point,prices tend to level out andthen to reverse. The otherside then takes over and thetrend moves in the oppositedirection.This has been observed frommanystatisticalandeconomicpoints of view. The DowTheory (expressed through

several price, volume andmomentum studies) is basedlargelyonhistrendsdevelop,how long they last, and thesignalsthattheyareending.A market adage states that“the trend isyour friend”butthe complete adage is “thetrendisyourfriend…untilitends.” This refers to theunavoidable reversal. Notrend continues forever. Atendency among traders is toride the trend too far and, in

fact,asitaccelerates,tomakedecisions at precisely thewrongtime.Awareness of this tendencyhelps traders to think likecontrarians.Acontrarianisatrader whose decisions aremade logically rather thanemotionally. Trend analysisreveals that thegreatest levelof entry into long positionsoccursatornearthetopofanuptrend;and that thegreatestlevel of selling occurs at or

near the bottom of thedowntrend.This reveals the mostimportant flaw in the“crowdmentality”ofthemarket:Thetendency is to buy high andsell low, when wise timingadvises “buy low and sellhigh.”The statistical trend and howitlevelsoutTrends are predictable notonlybecausetheyreverse,butalsointhewaythisoccurs.

An expected outcomefollowing a strong trend isretracement, thetendencyforprices to move against theprevailing trend. It is not achange in market sentiment,but an intermediatecorrection, assuming that theprevailing trend will resumeafterpriceretrace.Retracement demonstratesthat no trend continueswithout pause in onedirection. It will move,

retrace,andthenresume.A reversal is a change fromsentiment, such as a bullmarket reversing to a bearmarket, or vice versa. Aretracement is the normaladjustment of the trend as atemporary movement. Howcanyoutellthemapart?Several techniques in priceanalysis help technicians torecognize the differencesbetween retracement andreversal. Among these, two

key indicators are BollingerBands and FibonacciRetracement.BollingerBands (named forthe originator of the theory,John Bollinger) involves theuseofthreemovingaverages–high,mediumandlow.The middle band is aweighted (exponential)moving average usually setover20 tradingsessions.Thebands above and below arestandard deviations from that

average, a statisticalcalculation of likely pricevolatility.Traders use this indicator invariousways.Forexample,aswing trader may buy whenthelowaverageistouchedbyprice, and sell when themiddle band is touched; orsell when price reaches thetop and buy to close at themiddle.To many traders concernedwith volatility (including

options traders), the breadthbetweenthethreeaveragesisrepresentative of volatilitylevels. When close together,the trend implies lowhistorical volatility; and asthe breadth between thebands expands, volatility isthoughttomovehigher.Itisavisualmethod for identifyingvolatilityand for timingbothlongandshorttradeentryandexit.BollingerBandsalsoserveas

confirmation indicatorswhenother signals are found,including candlestickreversals, momentumoscillators, and volumesignals.

The chart shows how the

three moving averagesinteract with price. Note thenarrowing of breadth towardthe end of May, when pricejumps out of its resistance.The breadth remains wideuntiltheendofJune,whenitbeginsnarrowing.This reveals how multiplemovingaverageanalysis aidsin timing of entry and exit.Thetrendisbullish,butonceprice exceeds the highestaverage, it is expected to

level out.The firstweek andlast two weeks ofMay wereexceptionally volatile,demonstrated by pricemoving above the uppermovingaverage.FibonacciRetracement is amethod for determining theapproximatenumberofpointsretracement will involve.Once the retracement occurs,traders expect the prevailingtrendtobeginonceagain.Leonardo Fibonacci was a

13th century mathematician.HewroteLiberAbaci (1202)promoting the use of Arabicdigits zero to nine forcalculations of weights andmeasures, bookkeeping,interestcalculationsandotherbusinessapplications.In the same book, heintroduced what is nowknown as the Fibonaccisequence, in which eachnumber is the sum of the

previoustwonumbers:1,1,2,3,5,8,13,21,34,55,

89,144…Applied to stock priceanalysis, this sequenceidentifies degrees of likelyretracement against aprevailing trend. Analystsexpectretracementtooccuratspecific percentages againsttheprevailingtrend.Forexample, theextremes inprice levels within a trend(topandbottom)representsa

number of points ofmovement. Retracement inthe opposite direction is atemporary counter-movementofasmallernumberofpoints.Whenthenumberofpointsinthe primary movement aremultiplied by the keyFibonacci ratios of 23.6%,38.2%, and61.8%, the resultindicates likely retracementaswellaslevelsofnewly-setresistanceandsupport.

23.6% is the result ofdividing a value in thesequence by the valuethree places ahead (forexample, 34 ÷ 144 =23.6).38.2% is the result ofdividing a value in thesequence by the valuetwo places ahead (forexample, 55 ÷ 144 =38.2%).61.8% is the percentagethat each number

represents of the nextnumber in the sequence(forexample,89÷144=61.8%).

These percentages set likelyprice levels whereretracements will be mostlikelytoend,andtheprimarytrendresume.Therearethree,however (23.6%, 38.2% and61.8%).Sohowdoyouknowwhichonewillapply?The percentages represent

levels where reversalindicators are likely to befound. If a reversal signal isnot found at 21.6%, tradersidentify the 38.2% level andlook there; if there is noreversal signal, they lookonceagainatthe61.8%level.

In the six-month chart ofRadio Shack, four examplesof retracement demonstratehow closely the Fibonaccinumbering system predictstiming:

A 1.25 point drop and0.50 retracement, or40%--Fibonaccirevealsthata38.2%retracementis0.48.A 1.50 point drop and

1.00 retracement, or66.7% -- Fibonaccireveals that a 61.8%retracementis0.93.A 1.25 point drop and0.75 retracement, or0.60% -- Fibonaccireveals that a 61.8%retracementis0.77.A 1.25 point drop and0.50 retracement, or0.40% -- Fibonaccireveals that a 38.2%retracementis0.48.

Signalshelpingyoutotellthe

difference betweenretracementandreversal:

Retracement is likely toreveal no specificreversal signals withinthechart.Incomparison,a trend reversal isusually set off withstrong reversalindicators andconfirmation.Confirmation for

reversalswillbe seen inthe form of strongindicators like engulfingpatterns, white soldiersor black crows, orharamisignals.Retracement is mostlikelytooccurrightafterexceptionally strongprice movement,meaningpartofthegainor loss is reversed inresponse to over-reaction to current news

(such as earningsdisappointments) andcorrecting to theestablished trenddirection.A reversal is notidentified withimmediate news, andcanoccuratanytime.

Segment2.TheDowTheoryand tracking of technicaltrendsTrends are the essentialattributes of charting. Everychartist relies on identifyingand tracking trends; andequally important, spottingreversals.On the basis if individualstocks, the same principlesapply as those applied tomarket-wide indices likethose tracked byDow Jones.

Thekeyisinconfirmation.How the Dow identifiestrendsFor individual stocks,confirmation is found innumerous indicators. Theseinclude candlestickformations, price patternsincluding tests of resistanceandsupport,priceaberrationslike repetitive gaps,momentum oscillators, andchangesinvolumelevels.For the market as a whole,

trend establishment andreversal is more likely to bebasedontheDowTheoryandits version of confirmation.Under this definition,confirmationisthereversalina trend when found in oneindex and then confirmed byanother.Tworulesapply:

1. A change in directionrepresents a new trendonly when a second

index also changescourseandfollows.(Thebest-knowversion is theDJIA followed by thetransportationaverage.

2. New trends have to befurther confirmed byvolume. The theory isbasedontheassumptionthat high volumerepresents the truesentimentofthemarket.

Based on these rules of the

Dow Theory, market-wideprimary trends are notestablished until the changein direction is confirmed inboth of theseways.The newtrend continues under priceonceagainreversesandfindsconfirmation.ThethreetypesoftrendsThe Dow Theory identifiesthreetypesoftrends:Aprimarymovementortrendlasts between severalmonthsand several years and is the

prevailing direction of themarket. A strong upwardtrend is described as a bullmarket, and a strongdownward trend is called abearmarket.A secondary trend (alsocalledareaction)lastsfromafew days to a few months,and exists within a primarytrend but moves in theopposite direction. Once thesecondary trend is over, theprimary trend movement

resumes.A short-term trend, or shortswing, extends from a fewhours to a few days. Thesearehighlychaoticanddonotprovide any long-term value.However,suchswingstendtorepresent over-reactions tocurrent news (such asearningssurprises)andstrongmovements quickly correctthemselves.The math of trendanticipation

Many systems are used intechnical analysis todetermine the strength,duration and importance ofcurrent trends. These includemovingaverages,momentumindextracking,volumelevelsanddominance(bybuyersorsellers),andmanymore.Traders relying on specificindicators do not need tomaster the often complexcalculations involved indeveloping technical

indicators. Charting servicesprovide indicators as featuresof charts and you can selectthose you want to track. Noseparate calculations arerequired; however, it iscrucial to know the meaningof an indicator’smathematicalmoves.For example, manymomentum oscillators likeRelativeStrengthIndex(RSI)consist of an index valuebetweenzeroand100.When

the indexvaluemovesabove70, the stock may be over-bought; and when it movesbelow30,itmaybeoversold.This is useful in confirmingreversalsandtimingoftrades.Other technical indicatorsrely on a combination ofmathematicalcalculationsandmovement of either price orindicator. For example,Moving AverageConvergence Divergence(MACD) tracks two moving

averages. Significance isidentifiedwhentheMAlinesconvergeofdivergefromoneanother; when they cross thecurrentpriceaboveorbelow;or when the rate ofacceleration in the MA lineschanges,itsignalsreversal.HistoricalprimarytrendsThe confirming properties ofthe Dow Theory can beobserved over time bystudying the history of theindustrial and transportation

averagestogether.The chart shows theindustrials average as a linegraph,andtransportationsassOHLC, both summarizedwith monthly prices over afull decade. Notice that bothaverages track the long-termtrend very closely.Technicians are especiallyinterested in spottingreversals.In the moment of analysis,what one analyst sees as a

clear reversal signal may beviewed by another as asecondary trend. There israrely universal agreementamong analysts when onetrend is ending and anotherone beginning. However, astudy of the historical pricemovements of these twoindices shows how the DowTheoryworks.The first five years clearlydemonstrate a strong uptrendin the industrials; this is

confirmed by thetransportation index. By2008, however, the pricelevels began declining in theDJIA even as thetransportation index peakedtowardtheendof2008.Bymid-2009, the downtrendin the DJIA had beenestablished and upwardmovement began. Thetransportation index laggedbehind slightly, but quicklyconfirmed the upward

movement. The early 2012dip appeared to be asecondary (reaction) trend,although it was too early totell for sure based on thedurationofthischart.The overall chart containsclearly identified resistanceand support levels. Theresistance level wasapproached three times,represented by price peaks,butdidnotbreakthrough.Asthis trend continues, a move

above resistance could signalthe beginning of a strongupwardbreakout.Supportwasviolated inmid-2009 and to many, thisappearedasanewbeartrend.However, prices hasrebounded to the upsidewithin a fewmonths and theuptrendresumed,establishinga rising support trend for thelastthreeyearsoftheperiod.

ThequestionofdurationAnyprimary trend can last a

few months or a few years.There is no consistency in aprimary trend’s actualduration, and the manysecondary trends oftendeceive analysts to believethatareversalhasoccurred.Some wise guidelines fortrendanalysis:

1. Always confirm thetrend, especiallyreversals.

2. Keep an eye onresistance and supportfor the market-widetrend, and note whathappens when pricesapproachthoselevels.

3. Trackvolumeaswellasprice. Although volumewas not shown on thechartof the two indices,any spikes in volumelevels add confirmationtothepricedirection.

Segment3.Identifying trendlines and channel lines: up,downandhorizontalThis segment demonstrateshow trend lines and channellines help identifycontinuation and reversal incurrent trends; and how tospot attempted breakoutseveninvolatilepricetrends.TrendlinesAtrendlineissimplyasingleline tracking a trading rangeasitmovesinanuptrendora

downtrend.A trading range may behorizontal, defined as havinga fixed-price resistance andsupport.Oritmaymoveovertime, either upward ordownward:

When a trading range isrising,thetrendlineisastraight line drawnbeneath the price; ittracks the movement of

the trend and reflectsrisingsupport.When a trading range isfalling,thetrendlineisastraight line drawnabovetheprice;ittracksthe movement of thetrendandreflects fallingresistance.

Prices move in trends and,while the duration of a trendvaries, it canbe trackedas itevolves in either direction.

The trend line connects astarting point of the movingprice, to the point where itendsorpauses.Thetrendlineruns into a price moving intheoppositedirectionandthisalso marks the end of theshort-termpricemovement.The trend line reflects risingdemand that increases asprice levels rise; or fallingdemand accompanying adecline in the price range.Once that trend concludes

(marked by oppositemovement in price fallingbelow the rising supportlevel, or rising above thefalling resistance level) itmeanspricemaybe about toreverse and move in theoppositedirection.Theangleof the trend line isa visual representation of thestrength in the short-termtrend. The steeper the angle,the stronger the trend. Thetrend line should extend for

some period of time tovalidate the trend itself. Thelonger the trend – even if asecondary one – the moresignificance it holds. Thegreater the extension of theperiod, the greater thelikelihoodofreversal.Chartistsdonotplaceweightin extremely short-termpricemovement but rely onestablished trends to timeentry and exit. A trend linemaybebasedona“rule”that

prices may not violate theline;ortheymayignorepricespikes when those spikes donotholdbeyondaverysmallnumberofsessions.Examples – upside anddownsideTrendlinestakemanyshapesand sizes, and understandinghow these work as definingtrends improves your abilityto interpret price directionandmomentum.For example, the chart for

ShenzhenExpresswayrevealsa generally declining trend.To better understand therhythm of price movement,twodownwardtrendlinesareshown. Both lastapproximately one month,with a one-month pause ofsideways movement inbetween. The trend linesreveal the angle of pricedeclineforeachoccurrence.

Another example, the

Cummins chart, containslonger-term trend lines. Thefirst is an uptrend lasting 2.5months with a small diphalfway and then another atthe conclusion of the firstupwardtrendline.How can you tell that thisuptrend will lead to areversal? The relativelynarrowrangefoundinthelastthree weeks of Februaryindicates the loss ofmomentum among buyers.

This is a clue that adowntrendisontheway.Theverybriefcontinuationofthe uptrend ended decisivelyas the new downtrend andtrend line began. Thiscontinued to the end of thecharted period and returnedprice levels to theirapproximate level fivemonthsearlier.This downtrend was notwithout volatility. If youconsider the trend line as

decliningresistance,youfindattheendofAprilabreakoutabovetheline,whichfailed.

Trendlinesaregoodtoolsfor

gaining insight into theevolution of a trading range.The lastexamplereveals thatwhenthetrendlinelastsforaperiod of months rather thanweeks,perspectiveonsupport(moving upward) orresistance (movingdownward) is improved withthetrendlineinplace.Channel lines, expanding thetrendlineThe trend line demonstrateshow evolving trading ranges

act and helps identify theirendingandreversalpoints.Expanding on this, channellines combine a trend linewith a second line on theopposite side of the price.Thisshowshowuptrendsanddowntrends may containsharpanglesandyetmaintainthesamebreadth.A channel line is such amovement. It consists of atrend lineandachannel line,with the same approximate

breadthoftradinginbetween.In technical analysis, whenone side or the other movescloser or farther away, theresultisatriangleorawedge.These imply a change indirection or momentum, andoftenareusedascontinuationorreversalsignals.The channel lines pattern isdifferent. It remains steadyuntilitends,andatthatpointa reversal is very likely. Theparallel lines define channels

and sets the movement apartfromtrianglesandwedges. Itreveals a trend that containsidentical movement in bothresistanceandsupport.As long as the channelcontinues in its direction, itserves as a continuationpattern.However, as soon asthe dominant line (the trendline) runs into contrary pricemovement, the continuationends and that point markslikelyreversal.

For example, the five-monthchart of China NuclearIndustry demonstrates howcontinuation becomesreversal, and how thisworksin both directions. Theuptrend is marked by thelowertrendlineandtheupperchannel line, markingmovement with identicalbreadth.Although the conclusion ofthe channel occurs when thepricemovesabovethehigher

channel line, this would beinterpreted as a breakoutabove resistance. Becauseprices then moves sideways,the breakout appears weakandisunlikelytosucceed.Amarked price decline withgapsoccurstowardtheendofFebruary, followedbyaverybrief rally during the firstweek of March. Once thisends, the signal of a comingdowntrendisquitestrong.The second channel lines

pattern begins immediately,andcontinuesuntilmid-May.The continuation ends withthe very strong downwardmove below decliningsupport. Just as the previousbreakout above resistancefaltered and resulted in adowntrend, this violation ofsupport weakensimmediately.

This double channel lines

pattern demonstrates thatwhen resistance and supportevolve, a breakout can occurin the established direction;but the breakout (aboveupward-moving resistance orbelow downward-movingsupport) indicates weakeningmomentum and likelyreversal.Another example of thechannellinespatternisfoundin the 8.5-month chart ofOneida Financial

Corporation.Thisbeginswitha channel lines uptrendextending more than threemonths.Note the strongone-session spike above risingresistance. This is followedby a sideways movementwithin the establishedchannel.After completion of thischannel, an exceptionallyvolatile period extendsbetween early March andmid-May. A new uptrend is

strongly suggested by thevery strong lower shadowsession immediately beforethenewchannellinespattern.This long lower shadowindicates lost momentumamong sellers.After this, thenext two sessions form apiercing lines pattern, a two-session candlestick bullishsignal.Thisconsistsofalongblacksessionandthenalongwhitesession.Thelongwhiteopens with a gap below the

closeofthepreviousday,andcloses within the previousday’srealbodyrange.This marks the new upsidechannellines,whichmayalsobeseenasaresumptionoftheprevious channel lines. Theentire chart reflects anupward trend, and the twochannel lines confirm thatthis trend is likely tocontinue.

Bothchannel linesalsowork

as a means for betterunderstand ding short-termvolatility. In the secondchannel lines, there are twoclear instances in which thelower shadows fall belowsupport and one where anuppershadowmovesabove.Theseattempts tochange thetrend direction all failed,further strengthening theuptrend in two ways. First,theuptrendholdswithoutanyreversals.Second,thebreadth

of trading also holds,revealing that the establishedandevolving tradingrange iswherebuyersandsellershavecometoagreementabovethepricelevelandbreadth.ConclusionTrends and channel lines arelesscomplexthanmanyothertechnical indicators. Theyprovide advantages in chartinterpretationinseveralways:

1. They define currenttrends in both directionandduration.

2. Theysignalwhen trendsare ending, and thelikely continuation orreversalthatwillfollow.

3. When continuation orreversal are confirmed,trend lines and channellinesarerevealing.

4. When resistance andsupport evolve, channellines identify failed

attempts tomove out ofthe established breadthof trading; these linesalso show continuationandfinalconclusionandreversalofthetrend.

Segment 4. Short-termtrends, reaction trends, andprimary trends - analysis onstockchartsTheDowTheoryasthebasisfor technical analysis; itsemphasis is on identificationofthreetypesoftrends:

1. Short-term, or “swing”trends lasting a fewhourstoafewdays.

2. Secondary,or“reaction”

trends lasting between afew days and a fewmonths.

3. Primary trends, lastingbetween a few monthsandseveralyears.

Ashort-termtrend–chaosofthemomentThe short-term trend or“reaction swing” appliesmore to individual stocksthan to the index of themarket.

The swing representsunending reaction andadjustment between buyersand sellers. Every form ofnews and information causesa reaction in themarket, andprices adjust in bothdirections as the newinformationisabsorbed.The“swingtrader”isatraderwho acts on these chaoticprice swings. This traderrecognizes that quick pricemovements often are over-

reactions to news; and thatthe reaction is likely to becorrectedwithin one to threesessions.Short-termpricemovementismostoftenguidedbyemotionrather than rational analysis.For example, a disappointingearnings report, rumors of atakeover, or changes inguidanceforthecomingyear,all may create short-termswings. These invariablymove in the opposite

directionwhen theother side(buyer versus seller or viceversa) corrects theexaggeratedmovement.The chart of Dynasty FineWines consists of twodowntrends as marked. Notethe two swing trendsoccurringwithintheselonger-termdowntrends.Firstwas atwo-session dip below thetrend, which immediatelycorrected.Secondwasaone-session opening above the

trend line, which alsocorrectedrightaway.These are typical of thenatureofswingtrends–veryshort-term and quicklycorrected bymovement backinto the existing trenddirection.

Reactiontrends–examplesCompared to the very short-

term swing trend, a reactiontrend lasts longer and canrangebetweenafewdaysanda few months. It tends todisrupt theprimary trendandis recognized by the lack ofany specific reversalindicators, or even contraryindicators.For example, the chart ofAdobe Systems consisted oftwo primary trends (or asingle primary trendinterrupted for three weeks).

Thereactionswingwassharpbut very short-lived. Therewere no upward-movingreversal indicators. In fact,atthebeginningofthereaction,the candlestick formationseemedverybearish.

Theendofthereactionperiodwas clearly marked with an

exceptionally strong bearharami pattern. This is thetwo-session signal consistingofalongwhitedayandthenashorterblackday.Theseconddayopenedandclosedwithintherangeofthefirstday.Thiswasstrongbasedon thesize of the white session. Itmarked the end of thereaction and led toresumption of the downtrend(or beginning of a newdowntrend, depending on

howtheseareinterpreted).Primary trends – historicalexamplesTheswing trendandreactionare most often utilized toanalyze individual stocks,although they can also beappliedtothebroadermarket.Primarytrendsareestablishedby a series of specificchanges in price direction.Amongthese,expecttoseeachangeindirectionconfirmedby a second market index.

For example, the Dow JonesIndustrial Average would beconfirmed by changes in theTransportationAverage.The chart for the DJIAextending over 12 yearsconsisted of three primarytrends:

Firstwasabullish trendfrom2003to2008;Second was a bearishtrendfrom2008 tomid-

2009;Thirdwasabullishtrendfrommid-2009onward.

The bearish trend in the

middle could be interpretedas a reaction trend, but itsdurationof1.5yearsmakesitmore likely a primary trend.The downturn in price levelswas confirmed by theTransportation Average,confirming this as a primarytrend.The first primary trendrevealed numerous swingtrades, and the secondprimary trend wascharacterized by greater

volatility in the form ofreaction trends. Thedistinction in these twooffsetting price movementswas duration as well asdegreeofpricechange.The distinctions among allthree trends are a matter ofinterpretation.Youmaycallashorter-term trend eitherswing or reaction; theimportantmatter,however, istobeable tounderstandhowatrendaffectspricedirection

andyour timingof entry andexitdecisions.

PART 5:MOVINGAVERAGESSegment1.Whataremovingaverages?Themovingaverage (MA) isa tool used in technicalanalysis to better understandtrends in price. Becauseshort-term price movement

may be very chaotic,computing averages helpssmooth out the trend andbetter displays the directionandmomentum.MA is used in many of thewidely used indicators,notably momentumoscillators and volumesignals.Averaging the recentpast is a key component inanalyzing and understandingthe current trend, and inanticipating what might

happennext.Computing the movingaverage(MA)MA is a basic statisticalfunction.Itconsistsofaddingup the values in a field ofvalues, and then dividing thetotalbythenumberofvalues.A field is a collection ofvalues. For examples, 20sessions of closing pricesrepresents a field of 20values.A value is a single entry

withinthefield.The formula for the simplemovingaverageis:(V1+V2+…Vn)÷n=

MAToapplythisformula,afieldof seven values is averaged.Inthiscase,the‘n’valueis7:

113.40213.21311.64412.90512.15

612.98713.16

The first step in finding themoving average is to addthesetogether:(13.40+13.21+11.64+12.90+12.15+12.98+

13.16=89.44Next,because there isa fieldof seven values, the total isdividedby7:

89.44÷7=12.777ThesimpleMAinthiscaseis12.777, representing the

averageofthesevenvaluesinthefield.Dealing with non-repetitivespikesOne of the problems incalculating MA is theextreme volatility that occursin short-term price trends. Astatistical method forensuringthegreatestaccuracyin MA calculation, is toremove exceptional spikesfromthefield.For example, if a field of

values conforms generally toarangeofresults,butone–aspike--isexceptionallyhighor low, that value may beremoved to even out theanalysis. Because the spikewas non-repetitive, it makesthe adjusted MA moreaccurate.The “rule” is that the spikeshould be exceptional, anddoes not repeat. In the chartfor Dollar Tree, the dailytrading range was extremely

narrow.However, the secondto last session included aprice dip form the existingrangeof48-53downto38.The moving average(represented by the red line)and calculated on the dailylowprice,alsodippedslightlydue to the spike. Removingthis from the analysis wouldlevelouttheaverage.

Although the effect ofremoving the spiking day

would be minimal in thiscase, over a longer period oftimeitcouldbesignificant.In selecting theMAmethod,spikes can also be removedby picking a different pricepoint. This example wasbased on each session’s lowprice. By selecting closingprice for the MA, the spikewould be removed from theMA.Applications of the MAconcept

In chart reading, the openingand closing prices arerevealed, and may also beaccompanied by a series ofone or more MAs. Forexample, the chart forFacebook includes two MAlines, a 200-day MA and a20-dayMA.

For most MA analysts,crossover – the point whereoneorbothMAscrossprice,is a very significant sign.Notethecrossovertowardtheend of the chart. Both MAlines fell below price as theprice itself seemed stuck ontherangeof$22-24pershare.A second important signal isconvergence, thepointwhereboth MA lines meet. Thisoccurred twice on the chart.The first convergence was

found near the top of thechart, and both were abovecurrentprice.Thesecondwasfound near the end of thechart as the MA lines onceagainmoved above the pricerange.Another telling signal is theopposite of convergence, ordivergence. Note how the200-day MA moves belowprice and at the same time,away from the 20-day MAjustas theprice level falls to

anall-timelow.***

ThetheorybehindtheuseofMAinpriceanalysis,isthattheaveragesrevealalot

aboutthetrend,andhelptoidentifythestrengthor

weaknessofthattrendasitevolves.

IndicatorslikeMACDrelyonMA and in fact this one isbasedentirelyonMA trends.Likemanyindicators,thisisaweightedMA,meaningmore

importance is given to themost recent values in thefield.

Segment2.TypesofMAs

The MA is a statisticalmeasure used in manytechnical indicator. It isintended to level outotherwise chaotic short-termprice movements. This MAreflectsthetrenddirectionbyincorporating the values forseveralperiods.

MAcanbecomputedinthreeways: simple, linear and

exponential.

SimplemovingaverageThe simple moving averageassignsequalweight toallofthevalues ina field.Avalueis the component of theaverage;forexample,closingprices for a series of 20sessions represent the 20values. A field is the rangestudied.Forexample,ina20-day MA, the 20 sessionsrepresent the range (in

statistics, also called the“population”).ThesimpleMAmaybeusedby itself as a device forleveling out the selectedvalues. The values may beclosing or opening prices; anaveragebetween the two; thehighest price in the session’strading range; or its lowestprice.Charting online includesMAcalculation, enabling analyststoquicklyvisualize the trend

without needing to calculateits change. MA normally isshownasanoverlaytoprice.Inthisway,youcanseewhenMA is above or belowprice,orwhenitcrossesover.The longer theMA, the lessvolatile it is likely to be.However, longer-term MAalso tends to distort the truecurrent trend because olderdataareoutdated.Thisiswhymany indicators take twocorrectivesteps:

First, they employ two MAlines, a longer-term and ashorter-term.Second, theyweight theMAsothatthemorerecentvaluesaregivenmoreinfluence.LinearaveragingA linear weighted MA is aformofweightingintendedtoprovide more importance torecent data. There are manysystems for weighting; thelinear approach assumes aweightingfactortobeapplied

toeachnewentrytothefield.Each value is weightedaccording to its numericalcount within the field. Forexample, in a field of sevenvalues,themostrecentoneismultiplied by 7; the secondmostrecentbysix;andsoonuntil the oldest is valued atone time. Then the total isdivided by the sum of theweightingdigits.Example: a field of sevenvalues is averaged based on

the linear averaging formula.Fromearliesttolatest:113.40x1=13.40213.21x2=26.42311.64x3=34.92412.90x4=51.60512.15x5=60.75612.98x6=77.88713.16x7=92.12

Total28357.09

LinearMA:357.09÷28=12.753

In this example, theoutcome

is very close to the straightmovingaverage for the samefield(12.777).Inafieldwithgreater volatility, the linearMA approach is likely toresult in a far differentoutcome.ExponentialweightingOne method for weightingthatreliesonasetformulaisexponential moving average(EMA).Thisiswidelyusedintechnicalanalysis,notablyformanymomentumoscillators.

The calculation involves firstcalculating an exponent, andthenapplyingittothenewestentryinafieldofvalues.Thisenablescalculationevenovera long period of time, butwithout requiringrecalculation. EMA isautomatically calculated forcharts including technicalindicators.The computation of theexponentis2÷n,wheren isthe number of values in a

field.ThisexponentisusedtocalculatetheEMA.Thesteps:

1. Calculate the exponentbased on the number ofvaluesinthefield.

2. Calculate a simple MAforthefirstMAvalue.

3. Subtract the next entryto the field from theMA.

4. Multiply the differencebytheexponent.

5. Add the result to thepreviousMA.

6. Repeat for each newentrytothefield.

This process is calculatedautomaticallyononlinechartsandformomentumoscillatorsrelyingonEMA.

Segment3.Trendsandtrendreversals based on MAanalysisTrends never continueindefinitely. The purpose inMA-based analysis is toidentifywhenacurrent trendbegins to flatten out, slowturn,orreverse.MAisoneofmanyindicatorsused by chartists in anattempt to characterize pricemovement and to develop arationale for timing of entry

andexit.ThenatureoftrendsTrends are not predictable.However, some commontraits exist in trends, largelybased on MA study andanalysis.Theseinclude:

1. As trendsapproach theirend, they tend to flattenoutandplateau.

2. Exceptionallystrongandsudden trends also tend

to have equally strongandsuddenreversals.

3. Trends are inhibited byresistanceandsupport.

None of these observationsare trueallof the time.Theyarecommontraitsseenoften,andmaybeusedtoanticipatelikely price movement.Trends,likeallindicators,aremost reliable whenindependentlyconfirmed.Momentumandpeaking

Trendsbeginwithadegreeofmomentum. The stronger themomentum, the faster thetrend develops. Thismomentumiseasilyspotted.Also easily spotted is apeeking effect. A trend willnot continue to grow at thesame pace indefinitely.Eventuallytherateofgrowthin the trend slowsdown, andthen levels out. After this, aperiodofsidewaysmovementmay occur; or the trendmay

suddenly turn and move intheoppositedirection.For example, the three-yearchart of Oracle consists of aone-year uptrend, then adecline, and finally, pricesettles into a sidewaysmovement. For traders, thissituation is difficult tointerpret, because price mayresume the previous uptrendor reverse and movedownward. This is whyconfirmation is essential

following a sideways pricemovement.

Notice how the momentum

flattensouttowardtheendofthe uptrend. The beginningwas characterized byrelatively long candles, butthese declined right beforethe peak. The three smallmonth sessions signaled thecomingendofthetrend.Adifferentkindof trendwasfound in the three-year chartof Johnson & Johnson. Thethreemajor trendmovements(up, down, then up) wererelatively sudden with no

smoothing out. Finally, theprice trend flattened outtowardtheendofthechart.

The final uptrend flattened

outconsiderablybeforepricessettledintotheresistanceandsupport range. Note how therange narrowed as the trendevolved.Finding reversals with MAchangesThe likely signs of slowingmomentum and comingchangewilltakemanyforms.These include thedevelopment of triangles,volume spikes, candlestickreversal signals, and changes

in directional indication inmomentum oscillators, suchasRSIandMACD.Reversal takes many forms.Keep these guidelines inmindwhen trying to find thepointoflikelyreversal:

1. Confirmationisessentialbeforeactingonreversalindicators.

2. The likelihood ofreversal is strongest at

resistanceandsupport.3. Sideways price

movement showsindecision, buteventually either buyersor sellers will takecontrolandcreateanewtrend or a renewal of apreviousone.

Segment 4. MA applied topricechangesMoving averages assistchartists in recognizing themeaning of trends, reversals,and momentum. By trackingthe MA line next to pricemovement, trends and subtlechanges in trends becomeevident.The significance of MAcrossover (moving fromabove to below price or viceversa) is that the MA either

supportstheevolvingtrendorcontradictsit.MA changes signaling pricereversalThesingleMAlineworksasa tool for anticipating long-term price trend, itsmomentum, and comingdirectionalchange.Because theMAisa laggingindicator, it may be foundeitherabovethecurrentpricelevel or below it. That initself is not significant;

however, when the MA linecrosses price or lags farbehind (diverges away fromthepricetrend)thatimpliesareduction in the trend’smomentum.When MA crosses the price(fromabovetobeloworviceversa) that also acts as asignificant signal. However,this should be confirmedbeforeentryorexitdecisionsaremade.TheMAincludesarangeof information thathas

tobejudgedinthecontextofcurrentpriceanddirection.Gaps and their role in pricemovementTherearemanytypesofgapsobserved in technicalanalysis; many are notimportant. The common gapoccurs frequently,representing a space betweenone session’s closing priceandanother’sopeningprice.A second is the breakawaygap,whichisfoundatapoint

where price begins to trendabove or below theestablished trading range.When found in conjunctionwithamoveaboveresistanceor below support, it deservesfurtherattention.Agappingmovesuchas thismaymark thebeginningofanewtrend.Itmayalsoreverseveryquicklyandfill,meaningthe price trend returns to theestablished trading range.Gaps are key technical

signals when tracking pricetrendsandmomentum.Twoadditionalkindsofgapshold special significancewhenconfirmedbyMA.Therunaway gap is seenwhen atrend–especiallyanewlysettrend – is exceptionallystrong. It consists of severalsessions of gapping prices,oftenconsecutively.For example, the chart ofCaterpillar revealed aninteresting uptrend started

withthreeconsecutiveupsidegaps. This was a runawaygap.Confirmation was found intwoforms:

1. Althoughathree-sessiondowntrend occurredimmediately before therunaway gap, the lastblack day and followingwhite day formed abullish candlestick

pattern: the piercinglinessignal.Immediatelyafter this, three gapsappearedconsecutively.

2. More subtle but equallyimportant was thechange in the MA linethatpreceded thismove.The line moved fromabove the price line tobelow, and then begantracking pricemovement.AlthoughtheMA remained below

price, it trackedupward.ThecrossoveratJuly23was noticed because itset theMA below pricefor the remainder of thechart.Thisindicatesthatthe momentum of theuptrendremainedstrong.

A second and equally

revealing gap is found whenmomentumhasdeclined, anda reversal is about to occur.The exhaustion gap is foundnear the topof anuptrendornear the bottom of adowntrend.For example, the chart ofChina Telecom beganwith asidewaysmovementand thenmoved strongly upward overa three-week period. Theexhaustion gap formationoccurred after price dipped,

signaling the end of theuptrend.

The meaning of this changein the uptrend was signaled

by two indicatorsbeyond theexhaustion gap, bothconfirming the comingreversal:

1. A bearish meeting linessignalformedat thetop,consisting of the lastwhite session and thefirst black session. Thisformation, when foundat the topofanuptrend,often is the signal that

reversal is about tobegin.

2. The MA tracked theuptrend, but it divergedlower as the trendcontinued. In fact, itcrosses over only afterthereversalhadoccurredrightattheconclusionofthe chart. An enduringuptrendwould expect tosee the MA line trackcloser to the price trendand to cross above; this

MA never did, and it –along with theexhaustion gap –anticipatedreversal.

MA and interaction withresistanceandsupportlevelsAnalysts expectMA lines toreveal and anticipate themomentum of a price trend.At the same time, MA alsointeracts with resistance andsupport and reveals whetherthese trading range borders

arestrongorweak.Even in a dynamic tradingrange, when MA remainswithintheestablishedbordersof the trading range itindicates that those bordersarelikelytohold.The chart of Google makesthis point. It consists of adowntrend,aturn,andthenavery strong uptrend.However, the MA for thischartwasveryrevealing:

1. MAremainedwithinthetrading range bordersand tracked price veryclosely.

2. MA was above priceduring the downtrend,but crossed over andtrackedtheuptrendfrombeneath.

***ThecombinationofMAwith

other indicators – such ascandlestick reversal signals,analysis of gapping pricepatterns, and conformity tothe trading range, all makeMA a useful technicalconfirmationindicator.

PART 6:INDICATORSTechnical analysis relies onthe study of a range ofindicators. These come inmanyspecifictypesandoftenarebasedoncalculations;forthoseusingchartingservices,thecalculationsarebuiltintochartsautomatically.

Segment 1. Indicator types:price,volume,momentumThere are three broad rangesofindicators.Thesearebasedon price, volume andmomentum.Priceindicatorsidentifycauseand effect of price trends.While many chartingtechniques in both Westerntechnical and analysis andEastern(candlestick)analysisidentify reversal orcontinuation, some broader

price formulas are helpful inprovidingoverview.Volume indicators indicatechanges in the price trendbasedonaveragingofvolumetrendsandseparationbetweenbuyer-dominated or seller-dominatedvolumetrends.Momentum indicatorsmeasure the speed of changeas well as direction. Manyvaluable indicators provideconfirmation of what priceandvolumetrendsforecast.

TherangeofpriceindicatorsTwo useful price indicatorsare the average true range(ATR) andaccumulation/distribution(AD).Average true rangemeasuresvolatilityratherthanthepricetrenditself.Othersignalscanbe used to track trenddirection and momentum,whichATRisaconfirmationsignal for the price volatility(risk)withinthetrend.

ATR is an exponentialmoving average (EMA) of aspecified number of tradingsessions based on a stock’strue range. A popular periodis14days.True range is an extendedtrading breadth from theprevious day’s close to thecurrent day’s close (asopposed to a single session’strading range). ForATR, the“truerange”isthelargestof:

1. Most recent high pricelevels less most recentlows.

2. The latest sessions,highminuslow.

3. The latest session’s lowprice, minus theprevioussession’sclose.

Thefocusonrangesiscentralto ATR analysis. Rangesummarizes the degree ofenthusiasm or lack ofenthusiasm among traders.

The greatest the ATR, thegreatest the assumed level ofenthusiasmamongbuyers (inan uptrend) or sellers (in adowntrend).If therangebeginstodeclineas the trend evolves, itprovides a forecast that thetrend may be slowing down.This “early warning” oftenprecedes other reversal ormomentumsignals.The chart of Exxon Mobildemonstrates how ATR is

used as a confirming priceindicator. The long-termuptrend is not showing anyspecific weakening just in areviewofprice.However,thetrend line does end with asmallpricedecline.Confirmationof this is foundinthestrongdeclineofATR,summarized below the pricechart. This reveals a steadydecline in true ranges,concluding that the pricetrend is likely to reverse in

thenearfuture.

The second important priceindicator ofaccumulation/distribution(A/D).Thismaybeviewedasa momentum indicatorbecause itmeasures levelsofbuying or selling interest. Itcan also be termed a volumeindicator because its indexvalue is based on volumeflow.A/D serves as a pricemeasurement even though itcontains elements of

momentum and volume. TheA/Dformulais:((Close–Low)-(High–Close))÷(High–Low)x

VolumeThis calculation is applied toeach session and then addedto or subtracted from thecumulative index value. Ananalysis of the formulareveals how price, volumeandmomentumallcomeintoplayintheA/Dline.The index moves between a

rangeof+1and-1.Whentheline moves into positiveterritory, buying pressure isgreater than selling pressure;and the opposite is in effectwhen the index value movesintonegativeterritory.The chart of Garmin Ltd.Reveals selling pressure intwo instances, one near thebeginning of the chart andanotherattheend.Thefirstexamplecombinesadrop in the trading range,

augmenting the strength ofthe downtrend. It isconfirmed by a strong moveof theA/D line intonegativeterritory.The second example is moredifficult to find in the pricetrend, since it appears to beon a strong upwardmovement without pause.However,theA/Dlinemovesinto negative territory at thevery end of the chart,demonstrating the potential

for a reversal in theimmediatefuture.

Volumeindicators

Volume indicators confirmprice direction and oftenprecedeastrongreversal.Themosteasilyspottedoftheseisthepricespike.Aspikeoccurswhen:

1. Volumejumpsfarabovethe average range oftypicaltradingsessions.

2. The volume levelimmediately returns topreviouslysetlevelsanddoesnotrecur.

3. The significance of thespike is confirmed inpricechanges.

Two additional volumeindicatorsareworth tracking,and both may act as leadingindicators, signaling likelyreversalbeforethepriceitselfconfirmsthechange.

On-balance volume (OBV) isthe calculated sum of totalvolume for a session,identifiedas“up”or“down.”Up volume is given positivevalue and down volume isgivennegativevalue.Aflawin this is that“up”or“down” are applied whetherthe dominance of one side isfractional or large. So whenvolume levelsareveryclose,the OBV trend can bedistorted.

The sum of OBV over aperiodoftimeisaccumulatedtotrackthevolumetrend.Forexample, COSCO Pacificexperienced a serried ofshort-lived but stronguptrends. Based on pricealone, it appeared quitevolatile. Traders may havebeen reassured by the steadyupwardmovementofOBV.This trend provides a cluethat theupwardmovementinprice represents a reasonable

level of growth, and that aslong as this continues anddoes not begin to weaken, itreveals a likely continuationofthatuptrend.

Thesecondimportantvolume

trend is money flow index(MFI).ThisexpandsonOBVby showing overbought oroversold conditions in price,making MFI am excellentindicator for timing of entryandexit.Themovingaverageof MFI is most oftenexpressed over the mostrecent14tradingsessions.For example, Netflix, anespecially volatile companyduring 2011 and 2012,presented a difficult chart to

interpret during the summerof 2012. The price levelappeared to be trendingupward, only to drop with alarge downward price gap. Itsoon resumed the uptrend,however.Based on price alone, thevolatility was not useful totraders. The next big changecould move in eitherdirection. However, the MFIline provided insight aboutthewidetradingrangeofthis

stock.Thekeypoints inMFIare indexvalues above80orbelow20.Above80indicatesoverbought, and below 20indicatesoversold.On this chart, even withvolatile price movementthroughout the period, MFImoved above 80 only brieflyandonlyonce.Therestofthechart remained within themediumrange.This indicates that the pricerange,althoughbroad,didnot

provide any buy or sellsignals. The result: for thoseholding Netflix stock, therewas no immediate indicationtosell;andforthosethinkingof buying, there was noindication that the timingjustifiedthatdecision.

MomentumindicatorsThe final of three types ofindicators deals withmomentum, the speed andstrength of a trend. Thisattribute identifies momentswhen current trends begin toweaken,thefirstsignthatthetrendwillbelikelytoreverseinthenearfuture.

Segment2.Convergenceanddivergence, and theirsignificanceThe concept of priceconvergence (prices movingtoward averages) and pricedivergence (prices movingaway from oscillators)provides great value in thestudy of price andmomentum.Expanding on this, specificindicators are designed tostudy convergence and

divergence between twoMAlines of different duration.Like price divergence, manyuseful clues can be derivedfrom changes in these MAlines.Bullish and bearishdivergenceThe use of oscillators tosignal entry or exit iseffective as a means oftiming.Asecondandequallypowerful method is tocompare divergence between

priceandoscillators.For example, comparisonsbetweenpricemovement andchange in Relative StrengthIndex (RSI) reveals eitherbullishorbearishdivergence,signaling changes in thecurrenttrend.Bullishdivergencemeansthatan uptrend is not confirmedby the oscillator, in whichcase the uptrend is probablyweak. Bearish divergencemeansthatapricedowntrend

is contradicted by anoscillator, pointing to aweaknessinthedowntrend.The chart of Wal-Mart(WMT) provides an exampleofbullishdivergencebetweenprice and Relative StrengthIndex(RSI).Astronguptrendbegan in July and continuedthroughthemiddleofAugust.By itself, the price did notprovide any indication thatthetrendwasweak.However,thedivergenceseen

in RSI pointed to a weaktrend. Even as the uptrendbegan, the RSI line movedabove thekey indexvalueof70,pointingtoanoverboughtcondition. Shortly after, theRSIlinedeclinedandpointeddownward.The price trend appearedstrong, but RSI diverged by(a) moving into overboughtrange and (b) movingdownward,bouncingbackup,and then moving downward

once again. This signaled aweakening momentumamong buyers in spite of thestrong upward pricemovement.

Technicians look forconfirmation,butadanger inthisisthatdivergencemaybeoverlooked. In this case, thecombination of overboughtsignal and a downward RSImove served as a warningthat the trend would not lastmuchlonger.ThefailureofRSItoconfirmthe new high levels in theprice movement was therevealingsignalthatthetrendwas losing its momentum,

and that traders should beginlooking foraconfirmingexitsignal.Thatexitalertappearedatthebeginning of August in theformofacandlestickbearishreversal signal. The blacksession followed by a loweropening and lower closingwhite session was a bearishthrustingindicator.Note also that immediatelyafter this, a price gapappeared at the start of the

new downtrend. The gap,plus the bearish thrustinglines confirmed the bearishreversalfirstforeshadowedintheRSImovement.A bearish conversion worksin the same manner butmoves in the oppositedirection.ThechartofLoewsprovided a good exampleduring a very volatile pricepattern. Two examples ofdivergence were found.While the short-term price

directionwasdownward,RSImovedup.Just as the price trends werequite short, so was the RSIdivergence. This does notmean it wasn’t significant,however. The divergenceitself predicted short-termuptrends in both instances,and both uptrends followedquickly.ThesecondexampletookRSIveryclosetotheimportant70indexvaluebefore retreating.

This was worth trackingbecause the upward movewassostrongwhile thepricemovecontinueddownward.

Uses of convergence anddivergenceinanalysis

The example of divergencebetweenpriceandmomentummakes the point that thesignal contradicts apparentprice movement. Even so,this is rareenough thatwhenit does appear, it should notbeignored.

Convergence and divergenceis applied more often tocompare price trends to twomoving averages (MAs).Changes in the MA lines(specifically convergence,divergence, and crossover)are signals of changes in thepricetrend.A difficulty in interpretationmay lead to confusion aboutthe significance of price andMA trends. However, as a

general observation, a fewrules apply concerningconvergence, divergence andprice:

1. When price moves to anew high and themoving averages alsomovetonewhighlevels(convergence), MAservesasconfirmationofthepriceand itsuptrendstrength.

2. When price moves to anewlowandthemovingaverages alsomove to anew low levels(convergence), MAservesasconfirmationofthe price and itsdowntrendstrength.

3. Whenpricemakesanewhigh but theMAmoveslower (divergence), itsignals weakness in theuptrendpricemovement.

4. Whenpricemakesanew

low but the MA moveshigher (divergence), itsignals weakness in thedowntrend pricemovement.

5. MA movement oftenprovides false signals,becauseMAlagsbehindprice trends. As aconsequence, the trendmight weaken wellbefore the MNAconvergence ordivergence appears. For

this reason, rules 1through4shouldbeusedas confirming signals ofotherreversalindicators.

CrossoversMAdoesnotalwaystracktheprice trend specifically. OneorbothMAlinesmightcrosspricefromabovetobelow,orfrombelowtoabove.When crossover occurs, it isinterpreted as a significantevent, often strong reversal.

When both MA lines crossfrom above to below theprice, it is a bearish signal.Those who follow MA takethis as a sell signal for longpositions, but the indicatorshouldbeconfirmedbyothersignals.When crossover of bothMAlines occurs from below toabove,thatisinterpretedasabullish signal, and chartistsare likely to buy. However,confirmation is essential to

provide greater timingaccuracybasedonthelaggingindicatorofMAlines.The chart of McDonald’sshows how confusing andcontradictory signals are putinto context usingMA. TwoMA lines are used in thiscase, a 200-day (solid redline)anda20-day(dottedredline).The crossover between Juneand mid-July indicates astrong bullish trend.

However, the candlesticksignalsinJulyareconfusing.The first and second wereboth strongly bearish. Theengulfinganddojistarsignalsoccurred in close proximity,makingthemevenstrongerastheyconfirmedoneanother.The third was a bullishengulfing, which occurredexactlyatthepointwheretheMA lines crossed over andabove theprice level.This isan example of MA

convergencealongwithpricenew high level, a stronglybullishindicator.

Even so, price then declined

into a pennant beforedeclining further. It isnoteworthy that after thischarted period, the stocksettled into the mid-80s andthe Ma lines moved belowprice,averybearishsignal.

This isanexampleofachartwith numerous contradictoryindicators, includingconfirmation in bothdirections. This level ofvolatility is disturbing, even

thoughMcDonald’shasbeena stellar performer for manyyears. The short-termoutcome is uncertain due tothecontradictorysignals.

***Conclusion

Convergence and divergenceis most often thought of inconnection with MA trendsand as a momentumoscillator. However, it alsoserves as a check on pricestrength or weakness. When

the price and anotherindicatorrevealdivergence,itcould be a signal that thecurrenttrendisweak.The use of convergence anddivergence has manyapplications. It is strongestwhen volatility is high andwhenconfirmationofanothersignal is desirable. However,even with strongconfirmation,nosignalsoffer100% reliability. However,signals do improve your

interpretation of price andtimingofentryandexit.

Segment 3. DirectionalindicatorsIndicatorsofalltypes–basedon Western or Easternanalysis – provide clearsignals about the likelihoodoffuturemovement.Thethreetypesofmovementin price are reversal,continuation andconsolidation.ReversalsignalsThe most common signaltechnicians look for is

reversal. A majority ofimportantsignalsaregoingtobefoundatorneartheendofacurrenttrend.Reversalmayconsist of several importantattributes:

1. Specific signalsrevealingthatthecurrentprice trend is movingaway from dominanceby one side, with theexpectation that the

other side will be likelytotakeover.

2. Volume confirmation,found in the form ofspikesofunusualgrowthin daily levels; andarticulatedwithvolume-specificindicators.

3. Further confirmationfrom momentumoscillators, showing thatat the end of a trend,momentum slowsimmediately before the

pricedirectionstopsandthen moves in theoppositedirection.

For example, the chart ofConsolidatedEdisonprovidesseveral reversal indicators atthe end of an extendeduptrend.First, a double top forms,includingthesecondtopwithan exceptionally long uppershadow. This extensionindicates lost momentum

among buyers; even thoughprice was pushed up duringthesession,itretreatedintoaverynarrowtradingrange.Second, a series of blackcrows followed closely,clearly marking the reversalfromuptrendtodowntrend.Third,volumedidnotprovideanyusefulconfirmingsignalsinthiscaseotherthanaweakspike at the beginning of theblackcrows.Fourth, theRelative Strength

Indexmovedstronglyintotheoverbought section right atthepeakoftheuptrend.

Taken together, these fourreversal signals provided aclear forecast of thedowntrend and marked thereversal.ContinuationindicatorsAsecondformofindicatoristhe continuation signal. Thisis found during a currenttrend and indicates that thetrend is going to continue.These indicators are lesscommon than reversalindicators because chartist

focus is on timing of entryand exit, which implies achangeinthecurrenttrend.Continuation indicatorsinclude specific signals thatare quite different thanreversal.Theseinclude:

1. Specific signalsrevealing continuedstrength of the currenttrend.

2. Lack of contradictory

volumechanges.3. Momentum oscillators

remaining within mid-range and withoutmoving above or belowbuy/sellsignalpoints.

For example, the chart ofNew World Developmentwent through an extendeduptrendfromJuneuntilmid-August.However, thereweretwodisruptionsintheupwardmovement. How could you

know whether this was areversal or just a counter-moveintheuptrend?

Two bullish continuation

signals confirmed that thedips were not reversals. Thebullish thrusting linesconsisted of a white sessionfollowed by a black sessionclosing within the range ofthe prior day. This is areliable continuationindicator.The second was a bullishseparating lines signal. Thisconsisted of a black sessionfollowed by a white sessionopening with an upside gap.

It also confirms continuationoftheuptrend.ConsolidationmovementThe thirdforofmovement issideways. This represents aperiod following a trend, inwhich neither buyers orsellers are able to take over.Price consolidation is aperiod in which both sidesdefine their stance regardingtrading range and the forcesofsupplyanddemand.An interesting problem

involving consolidation isknowing how to recognizewhenitends.Thedecisiontocontinuetheprevioustrendorto break in the oppositedirection is difficult to spot.To manage this problem,several indicators have toappear.However, because the periodof consolidation is uncertain,the signals have to beexceptionally strong andconfirmation is absolutely

essential.Signalsinclude:

1. A specific and strongsignal of an end to theperiod of consolidation,preferably twoconsecutivesignals.

2. Confirming changes involume along withvolume indicatorssupporting the indicateddirection.

3. Further confirmation

from momentumoscillators, showing alikely building in favorofthedirectionofanewtrend.

For example, Home Depothad a month-long period ofconsolidationwithinanarrowtwo-point range. How canyou tell when this sidewaysmovement ends? The chartprovided several cluesforecastinganuptrend.

First, two candlestickindicators appeared, bothproviding a bullish signal.The upside gap filled is athree-session signal. A gapappearsbetweenthefirst twowhite sessions; and the third,blacksessionfills thatgap tocompletethesignal.

The second candlestick is atwo-sessionsignal,thebullishengulfing.This occurs below

the support of consolidation,providing a strong clue thatanuptrendwillsoonfollow.

Confirmingboth candlestickswas the overallmovement intheA/D line. It rose over anextended period includingmost of the consolidationperiod.Thisindicatedthatthenext move would be to theupside.

TheimportanceofproximityAll price patterns – reversal,continuation andconsolidation – will providesignals,andthesearegoingtotake on varying degrees ofsignificance depending onwhere they occur in thetradingrange.As a general rule, the closerto resistance or support, themore chartists pay attention,especially to reversal signals.Areversalagainstanuptrend

taking place at resistance, oras part of a breakout abovethat level, has greaterweightand likelihood of a reversal,than one occurring at mid-range.Abullishreversalfoundrightat support or as part of adownside breakout, has abetterchanceofreversalthana signal occurring at mid-range.These are the valuableaspects of proximity.

Resistance and support arethe price levels at whichreversal is not only mostlikely to occur, but alsowhere reversal will probablybestrongest.Mid-range reversal is likelyto be relatively weakcompared to reversal atresistanceandsupport.Thisistrue because these priceborders of the trading rangeare strong, representing theprice point where any

breakoutisunlikelytooccur.

Segment 4.Using indicatorswith candlestick chartreversalsignalsA key aspect to technicalanalysis is the developmentof specific signals flagginglikely reversal. TheseWestern technical signalsoften appear immediatelybefore reversal. However,before entry or exit, theseneed confirmation.Candlestick reversal signals,when added to Western

reversal indicators, are verystrong reversal confirmationtools.This section demonstrateshow three popular Westernindicators signal the end ofthetrend;andhowtheseworkwith candlestick reversalsignals to provide strongconfirmation.IndicatorpatternsOf the many Westerntechnical signals, some aremore powerful than others.

Some of the most easilyrecognized and reliablereversalindicatorsinclude:

1. Double tops andbottoms. These signalrepetitive attempts atmoving price in aspecific direction.Failure marks lostmomentum andnormally is followed byprice trends in the

oppositedirection.2. Wedges. These reversal

signals occur often andform declining breadthoftrading.Asthewedgenarrows, reversal islikely to follow in theopposite direction (afalling wedge is bullishand a rising wedge isbearish).

3. Exhaustiongaps.Amongthemany types of gaps,the exhaustion gap is

easily recognized as thelast part of a trend.Whenagapoccursaftera steady trend, it mayindicate that momentumhas been lost, andreversalisverylikely.

Recognizing trend endingswithWesternsignsA study of chart patternsreveals many types ofreversal indicators. Whilethese by themselves are not

reliable for entry or exit, thepatterns are the first step indeveloping a strategy to (a)find reversal signals, and (b)seem confirmation beforetakingaction.Double tops or bottoms areexcellent markers of turningpoints. And among the mostused reversals. The chart forCisco Systems provided aclear double bottom in twoconsecutive sessions. Notehow the downtrend

immediately reversed andmovedintoanewuptrend.

Wedges are another favorite,

duetotheirhighreliabilityasreversals. A rising wedge isbearishandafallingwedgeisbullish. As the breadth oftrading narrows, reversal isexpected.The chart of BrightoilPetroleum provided a goodexample of a rising wedge.Note how the price breadthnarrowedandconcludedwiththree consecutive long days.Immediately after, a newdowntrendslidebegan.

A third popular reversal

signal is found in theexhaustion gap. Such gapssignal the conclusion of thecurrenttrend,andaresignsofmomentum being exhaustedimmediately before thereversaloccurs.Intel Corp. showed threeexhaustion gaps. The firstwasat theendofanuptrend,and the second and thirdsignaled the conclusion of adowntrend.

Confirming reversal with

candlesticksThe popular indicators arevery strongandchartists relyon them for entry and exittiming. However, bythemselves,no indicatorscanbe relied upon withoutconfirmation.The following charts areduplicatesofthethreeshownfor the popular technicalsignals; they are furtherexpanded to revealcandlestick reversals. The

confirmingsignalsstrengthenthe indicatedreversal ineachcase.Cisco Systems had a classicdoublebottomthatended thedowntrend and began theuptrend. But by itself, wasthisenoughtomakeatrade?The highlighted bullishharami–consistingofablacksession followed by a whitesession opening and closingwithin the first day’s realbody, is a very strong

indicator confirming a likelyuptrend. Such an uptrendfollowed.

PART 7:MOMENTUMOSCILLATORSSegment 1. RSI, MACD,StochasticsandothersThis section explains howmomentum oscillators work.There are many oscillators;the following discussionfocuses on three of the best-

knownandmostwidelyused:Relative Strength Index,MACD,andStochastics.RelativeStrengthIndex(RSI)RSI is a measurement ofgainsorlossesduringatrend.It is intended to identify andhighlight overbought oroversold conditions. It isnormally calculated over a14-sessionperiod.ThecalculationofRSIis:100–(100÷(1+RS))

(RSis:Theaverageof

upwardclosingsinthepast14days,dividedbytheaverageofdownwardclosingsoverthepast14days.)Although it is useful tounderstand the calculationand how RSI is derived, theindex is added to chartsautomaticallybyselectingtheRSIoption.The index results are simplyto follow. The RSI indexrangesbetweenzeroand100.

If the index value movesabove 70, the security isoverbought. And if RSImoves below 30, it isoversold.As a confirming indicator,RSIisvaluablewhentrackingcandlestick or Westernreversal signals. However,strong movement in asustained trend can alsodistort the true meaning ofRSI, so it should be used inconjunction with other

signals.A significantmove inRSI isdivergence, when the RSIdirectioncontradictsthepricetrend. This indicates that theprice trend is weak. Whendivergence is found, RSI isacting as a leading indicator.WhenRSIconforms, it tendstoactasalaggingindicator.WhenRSI occurs alongwithprice movement, it tends toconfirm reversal signals.Because RSI is measuring

momentum in pricemovement,as trendsweaken,RSI can be used to note thedifference between atemporaryretracementandanimpendingreversal.For example, Colfax Corp.wentthroughtworeversalsintheir trends. Both weremarked with very clear andstrong candlestick reversals,and both were confirmed bymovementintheRSI.

Thefirstreversalwasmarkedbyabullishengulfingpattern

atthebottomofadowntrend.This was preceded by aconfirmingdipslightlybelowtheoversoldlineofRSI.

The second reversal signalwas foundnear the topof anextended and strong uptrend.Thebearishharamiwasaredflag that the trend wascoming to an end. It wasconfirmedasRSImovedintothe overbought area at thesame time. These two

togetherwereasellsignal.TheapplicationofRSIinthissituation demonstrates howmomentum confirms thesubtle changes in price. Itmaybealeadingoralaggingindicator,andinbothcasesitiseffectiveasconfirmationofwhatpricesignalsforecast.Moving AverageConvergence Divergence(MACD)MACD combines twomoving averages and

analyzes how they move inrelationtooneanother,andinrelation to price. It tracksmomentum and providessignificance when crossoveroccurs between the averagesand price; andwhen the twoMA lines converge ordiverge.MACD employs a netexponential moving average(meaning one is subtractedfrom the other). As theymove closer (converge) or

farther apart (diverge), theMA average takes onsignificance.Theshorterofthetwoisa12-day MA and the longer is aslower-moving 26-day MA.The chart employs acrossover line known as the“zero line.” A positiveMACD (above the zero line)tellsyou that the12-dayMAishigherthanthe26-day;andanegativeMACDshowsthatthe12-dayMC is lower than

the26-day.Positive MACD reveals thatupside momentum is on theincrease. Negative MACDreveals that downsidemomentum is increasing.These two general “rules”makeMACDeasytospotandeasytouse.Someadditional observationsaboutMACD:

1. The zero line (or signal

line) is a nine-dayexponential movingaverage of the MACD.Thisisthedividingpointbetween bullish(movement above) andbearish (movementbelow) trends. So thereare actually three MAsin play: the 12-daymove, the 26-daymove,and the average of 9dayssignalline.

2. Thefaster themoveand

the farther from thesignal line, the moresignificant it is in termsofthetrendmomentum.

3. When the trend crossesoverthesignal line, it isbullish if the 12-day ishigher than the 26-day;and bearish in thereverse moving belowthesignalline.

4. Divergence (MACDmoving away fromprice) is bullish if the

price forms a new lowbut MACD forms ahigher low.This revealsslowing of downsidemomentum. Theopposite applies indivergence above a newhigh in price; it revealsslowing upsidemomentum.

Thedetailsof theMAtrendsin MACD are complex, butthe visual observation is

easilyobserved.ThepointofMACD is to identify timeswhen momentum isincreasingordecreasing.For example, Best Buy wasquite volatile during theperiod shown on its chart.However, the volatility wasmoreclearlyunderstoodwithanalysis of MACD inadditiontoprice.

The crossovers occurred at

keypointsinthetrend.Whileprice seemed to indicateuncertainty during the mid-July to mid-August period,MACD moved stronglybelow the signal line,displaying momentum to thedownside.As theMA lines crosses andMACD moved above thesignal line, momentumshifted again and becamepositive.ThisshowshowMACDoften

anticipates likely momentumin either direction, and maydiverge from what priceappears to be revealing. Thisadds to the quality of theindicator, since MACD inboth instances led the pricetrend before price levelsturned.StochasticsStochastics is a comparisonbetween location of thecurrentpriceandprice levelsover time. Resistance and

support are importantingredientsof theStochasticstrend as the oscillator isintended to identify likelyreversalpoints.Theformulaforthisindicatoris the result of calculatingexponential moving averagesfor highest and lowest pricelevels over a specifiednumberofsessions.Itrevealsconvergence and divergencefrom the current price to thetypical price range over the

identifiedtimeperiod.When price and StochasticMA diverge, it provides ahint that the current pricetrend is weak or growingweaker.When the StochasticMA moves faster than price(known as a “Stochasticpop”) is tells you to increaseholdings (if moving in thesamedirectionasprice)or toliquidate the position ifdivergingagainstprice).For example, The chart of

Golden Eagle consisted onthree specific trends, twodown and one up. However,the value of Stochastics wasin how that indicatoranticipated the turn inadvanceofthepricechange.

In early July, the Stochasticanticipated the downtrend bymoving down, accuratelypegging the price trend thatfollowedimmediately.AtthebeginningofAugust,itappeared that the downtrendmight continue. ButStochastics moved upwardstrongly, flagging the likelyuptrend that began inresponse.BythemiddleofAugust, theuptrend appeared to be

continuing strongly. But theStochastics once againturned, anticipating comingweaknessintheuptrend.

***ConclusionMomentum, oscillators workinsimilarwaysandallhelptoidentify and even anticipatereversals based onstrengthening or weakeninginthepricedirection.The three reported here –RSI, MACD and Stochastics

–areamongthemorepopularand widely used momentumoscillators. However, thereare many more, eachdesigned to fine tune thetrackingofmomentumanditsrelationshiptoprice.

Segment 2. InterpretingmomentumchangesOscillators provide a wealthof information and insightconcerningprice.Whilepricecharts focus on direction ofmovement, oscillatorsmeasure the speed ofmovement and peg likelyreversal points. These pointsare based on distinctionsbetweenmid-rangepricesandthe extremes (overbought oroversold).

ThemeaningofmomentumOscillators may be centeredor banded. Both provideinformation concerning pricechange and the degree ofstrength within a currenttrend.Momentum tends to grow astrends continue. Thus, thelonger a trend continues, thegreater its momentum.However, the trendeventually exhausts itself. Atthis point, momentum is

expectedtobeginslowing.As momentum slows, itbecomes increasingly likelythatoneoftwothreechangeswilloccur:

1. Priceswill leveloutandmove into a sidewayspattern. After this thetrendmayresumein thesamedirection.

2. Priceswillleveloutforaperiod of consolidation,

andconcludewithanewtrend moving in theoppositedirection.

3. The trend will reversequitesuddenlyandmoveintheoppositedirection.This more suddenreversal is likely to befound at or close toresistance or support.Thereversaloccursafterfailedtestsofthesepricelevels; or after amomentary breakout

(often including gaps)that are immediatelyreversedandfilled.

CenteredoscillatorsA centered oscillator beginswith an assigned signal lineor “zero value” line, andsubsequentcalculationsmoveabove or below that line.These types are effective atjudging strength orweaknessof a trend, and spottingchangesinmomentum.

The best-known centeredoscillator is MACD. Twomovingaverages(26-dayand12-day) interact with oneanotherandalsoinrelationtoa signal line. The signal lineisanexponentialsummaryofthepastninedays.The farther the divergencebetween the two MA lines,the more significant themeaning; and the crossoverpoints of both MA lines inrelation to the signal line

further marks a change inpricemomentum.BandedoscillatorsWhile centered oscillatorsanalyze momentum from anassumed zero point, bandedoscillators employ twomoving average bandsrepresentingpriceextremes.The lower band equateswithoversold, and theupper bandequates with overbought.Typical and well-knownexamples are RSI and

Stochastics. Both rely onsignals crossing apredetermined line for thetwoextremes.RSI usually is set at 70 foroverbought and 30 foroversold,inanindexrangeofzero to 100. As long as thecalculatedRSI isbetween30and70,theextremeshavenotbeen met. However,movementapproachingeitherline may be used as earlyconfirmingsignals.

Stochastics uses a similarmethodology. However, theranges are 80 for overboughtand20foroversold.BothRSIand Stochastics are boundbetween0and100.Oscillator signals -overboughtandoversoldTheprimaryuseofoscillatorsistomonitorpricemovementnot only by Western orEastern reversal signals orvolume,butalsobyindicatedoverbought and oversold

conditions. Some signals aredesigned to lead signals,otherslag.One of the most usefulaspects to oscillators is thesignal that a current trend isweak, even if it is not aboutto reverse. Weakness signalsthe chartist to look forreversals signals in pricepatterns. Confirmation is theessential key, whetheroscillatorsleadorlag.Asecondaspecttooscillators

is the value of divergencesignals. When the oscillatorcontradics price, it signalsweakness in the trend.Divergence may signal abullish change (oscillatormoving in a bullish directionversus price in a bearishtrend).The combination ofMA with other indicators –such as candlestick reversalsignals, analysis of gappingpricepatterns,andconformitytothetradingrange,allmake

MA a useful technicalconfirmationindicator.Divergence may signal abullish change (oscillatormoving in a bullish directionversus price in a bearishtrend). Divergence may alsosignal bearish change(oscillator moving bearishwhilepricemovesbullish).These divergences aresymptoms most likely to befound as the oscillator indexapproaches or moves into

overbought or oversoldregions.Instronguptrendsordowntrends, monitoringoscillators to findoverboughtor oversold conditions mayserve as a first warning thatthetrendisabouttoreverse.However, overbought andoversold conditions may befalse, so confirmation viaother signals should belocated before acting. Theextremes may be a first signof coming change, or could

be false when notindependentlyconfirmed.For example, Aetnaexperienced a sharpdowntrend.TrackingRSI ledto an oversold signal, whichappeared confirmed by theupturn in price. However,instead of an uptrend, pricemoved into a consolidationpattern with a three-pointbreadth for more than amonth.

It is also possible in very

strongtrendsforoscillatorstomove into overbought oroversold condition andremain there for an extendedperiodof time.The extremesdo not always signal thatreversal is going to occurrightaway.

For example, SherwinWilliams displayed anuptrendbutat thesametime,RSI moved into theoverbought region and

remainedtherethroughouttheremainder of the trend.Afterapause, theuptrend resumedinspiteoftheRSIwarningofapossiblereversal.

Crossover

The tendency of oscillatorMA lines or index values tocrossthresholds(eithersignallines or extremes) marks thebeginning of change in atrend. Crossover validatesdivergence if and when theoscillatordirectioniscontrarytoprice.In this case, divergence byitselfmight not be especiallysignificant. However, if theMAcrossesthesignallineortwoMAscrossoneanotherin

acenteredoscillator, thentheimportance of the divergencemay be greater. The sameapplies to banded oscillators.Divergence within the mid-rangeisnotasmeaningfulasdivergence accompanied bymovementintooverboughtoroversoldareasoftheindex.Both of these changes fromonesideofasignallinetotheother, or from id-range tooverbought or oversold,reveal a specific change in

momentum. At such times,tracking price patterns andlooking for reversalconfirmation may strengthenthetimingofentryorexit.Momentum oscillatorsanticipate these reversalpatternsbutdonotreveal thetiming of their actualoccurrence. For the timing,rely on the price patternsshowing reversal. Oscillatorsmay also act to not confirmindicated price reversal. For

example, locating a strongprice pattern reversal seeksconfirmation. If an oscillatordoes not provide thecrossover to confirm thereversal, it could mean thepricepatternsignalwasfalse.Positive and negative ofoscillatorsBe aware of the differentpurpose and effectiveness inmomentum oscillators.Differencesbetweencenteredand banded oscillators affect

theirvaluetospotreversals.Banded oscillators are thebest signals to findoverbought and oversoldconditions.For example,RSIis a simple 0-100 indexwithclearly understood thresholdsof 70 and 30. Movementabove or below signal achange inmomentuand-onceconfirmed-signal the time forentry or exit in response. Inthis example, momentummay lead price patterns in

identifying the change in thetrend.However, these conditions inwhichtheindexmovesoutofthe mid-range are not strongenough to act upon bythemselves. They have to beconfirmed by other reversalsignals becasue they do notrevealthetimingofchangeinthe trend, only the change initsmomentum.Centered oscillators are lesseffective in identifying

overbought or oversoldconditions. These are moreeffective in anticipatingmomentum shifts frombullish to bearish or viceversa.However, because they arebased onMA analysis ratherthan calculated index values,thedegreeofchangestendstoremain relatively small. Socentered oscillators identifysentiment change and thestrength or weakness of the

trend.A danger of relying oncentered oscillators is thatthey may react in a mannersimilar to reversal when theactual condition is a short-term retracement against theprevailing trend. This iswhyconfirmation is essentialbefore acting on discoveredchanges in centeredoscillators.

***Conclusion

Momentum oscillators maylead or lag, providing initialindicators or confirmation.They should not be used bythemselves to signal entry orexit.Becausemovingaveragesandindex calculations determinethe oscillator trend, theycannot always accuratelypredict price reversal.However, when combined

with price trends and price-specific reversal signals,oscillators are excellenttechnical tools for timing oftrades.

Segment 3. Leading orlaggingindicators?Chart reading is a process ofmaking judgments. Thestrength of a reversalindicator relies not only onhow well it is confirmed byother signals, but also onwhether it is a leading or alaggingindicator.A leading indicator ispresumed to appear inadvance of a price reversaland also in advance of

confirmingsignals.Alaggingindicator confirms after adifferent signal has appearedand may also show up toolatetomakeatradedecision.LeadingindicatorsAmong the best-knownleading indicators areRelativeStrengthIndex(RSI)andStochastics.Bothrelyonformulated summaries ofmomentum to anticipateshort-termchangesinprice.Most analysis of leading

indicatorsfocusesonreversalsignalsduringstronguptrendsor downtrends.However, theleading indicator appearingduring a period of sidewaysmovement is more valuablebecause, lacking specificdirection, this provides aninitialsignalofthenexttrendexpectedtooccur.Leading and laggingindicators are both used forspotting slowed momentumduring a current trend, and

both provide excellent formsof confirmation along withotherreversalsignals,notablyin the form of candlestickindicators and tests ofresistanceandsupport.For example, sidewaysmovementmadeitdifficulttopredict what would happennext in the chart of IntelCorp. A three-monthsidewaystrendappearedtobeending as prices rose towardtheendofApril.

However, the RSIcontradicted this sign andthenfoundconfirmation.Theoverbought RSI signaloccurred toward the end ofMarch, forecasting adowntrend. Price movedupward the followingmonth.However, note the strongbearish engulfing pattern atthe last portion of the chart,confirming the earlier RSIsignal.

This bearish sign and

confirmation ended thesidewaystrendandforecastadownwardmovement.As thenext chart shows, whenexpanding the Intel chartthrough June, a downtrenddidoccuraspredictedby thebearishengulfingpattern.The downtrend ended whenRSI dipped into the oversoldarea in the third week ofMarch and again in the firstweek of June. At the sametime, a bullish engulfing

pattern predicted an uptrendand confirmed the RSI earlysignal.

Leading indicators rely on

past price movement anddominance among buying orselling activity. However,although the indicator reliesonpastmovement,pastpricelevels are consideredsecondary to the indicatedchange in momentum aleadingoscillatorprovides.Momentum measures thespeed and strength of pricemovement, not pricemovement itself. As a result,evenaseeminglystrongtrend

may lose momentum andleading indicators are likelyto anticipate the end of thetrend before it appears inpricelevels.For example, RSIsummarizesinasimpleindexthe average price advanceswith average price declinesfor the past 14 sessions. Thecurrent RSI level reflectswhether the overallmomentum during this timeframe is trending in an

upward or downwarddirection.Thisapplicationofa formulato create a range ofmomentum (in the case ofRSIbetween30and70indexvalue) summarizes theaverage of price movementand its likelymeaning.Oncethe index exceeds 70(overbought) or falls below30(oversold),theRSIactsasa leading indicator that areversalislikelytofollow.

Theearlysignalsprovidedbyleading indicators are aprimary benefit, notablyduring periods of sidewaysprice movement. These alsoanticipate price weaknesswhen divergence appearsbetween the indicator andprice. These are strongsignals for timing of entryandexit.A major disadvantage toleadingindicatorsisthatfalsesignals do occur.Awhipsaw

– short-term pricemovementand reversal – can affect theoscillator and provide a falsesignal. With this in mind,leading indicators should beviewed as the first step in atrendchange.After a leading indicatorappears, seek additionalsignals providingconfirmationorcontradiction,before proceeding. Thiscautionary approach ensuresthe most effective use of

leadingindicators.LaggingindicatorsThelaggingindicatorappearsafter price movement. As amomentum oscillator servingas a lagging indicator, thisconfirmsasignalfirstseeninprice patterns, such ascandlestick reversal or testsofresistanceandsupport.Well-known laggingindicators tend to rely onmoving average analysis andconvergence or divergence

and crossover study. Thebest-known lagging indicatoris MACD. Although it is alagging signal, it is no lesspowerful than a leadingindicator;itonlyshowsupinadifferentlocationrelativetopriceaction.Lagging indicators are mostvaluable as confirmationsignals during current trends.As confirming signals,lagging indicators mayprovide confidence to traders

that a price-specific reversalsignal is valid and likely toleaddirectlyintoareversal.For example, EmbryHoldingsendedanuptrendinFebruary and then pricesmoved sideways throughmid-April. How do yourecognize when a new trendwillbegin?TheMACDlinecrossedintobearishterritoryinthethirdweekofMarch.Thiswasasignalthatanewpricetrend

wouldsoonfollow.

TheMACDbearishcrossoverwas the first sign that thesideways movement waslikelytoend.Whenthechartis extended through anothermonth, a downtrend didappear. It seemed to have ashort life; however, at thesametime,MACDconfirmedthe bearish trend by againmovingbelow the signal lineandremainingthere.After a short period ofupward-trending days, a

strong downtrend began justas MACD had predicted. Infact, the MACD linecontinued falling in negativeterritorythroughtotheendofthe chart, indicating that thedowntrend was holdingmomentum.

Themajordisadvantageto

laggingindicatorsisthattheymightshowupafterareversalhasalreadyoccurred.However,reversalsdonotalwaysoccurquicklyorimmediately.Soaslower-developingreversalmaybespottedinapricepatternandthenconfirmed.Inthissense,laggingindicatorsarequiteeffectiveinaddingconfidencetothelikelihoodofreversal.

IndicatorsinperspectiveMomentum oscillators thatleadorlagmaynotalwaysbeas sensitive to price patternsastradersdesire.Theyarenotconsistent. This is why theyprovide only a piece of thereversalpuzzle.Confirmationis essential; but momentumindicatorsareamongthebestconfirmationsignals.If theperiodofstudyusedtocreate oscillator values isdecreased,itmaycreatemore

false signals. If the periodemployed is increased, thelevel of signalsmight be toounresponsive to momentumshifts that the oscillators areineffective. Longer averageperiods equate to reducedsignalgeneration.

Segment 4. Oscillators usedwithcandlesticksignalsMomentum oscillators giveout strong signals, but theseare not always reliable. Thekey to using oscillatorseffectively is to coordinatethem with other signals.Reversals found incandlestick price patterns areeffective as cross-confirmingtools.CausesoflowreliabilityThe low reliability of

oscillators is not universal.However, it is a problem tobe aware of, especially inspecificcircumstances.Theseinclude:

1. High volatility. Whenprice movement iserratic, especiallyaccompanying abreakoutfromapreviouspricerange,theaveragesused in oscillators are

impacted. So volatilitymay easily distortmovement of the MAsand provide falsesignals. The chart ofCOSCO Pacificdemonstrated thispoint. Price movementwas very erratic andmoved below supportbefore reversing higherto move aboveresistance. The strongupward price movement

brought MACD acrossthelineabovethesignaland into positiveterritory. But thereliability of this movewas not absolute.MACDwasdistortedbythe strong upward-trendsessions.

2. Short-term butsubstantial price

movement. If the stockprice moves rapidly, itmay lead to a specificoverbought or oversoldsignal in the oscillator.Reacting to oscillatorsignals at suchmomentsis not necessarilywise. Google’s pricemovedrapidlyupwardinthe second half of itschart. With no sign ofthe uptrend ending anytime soon, the RSI line

moved into theoverbought area.However, by the end ofthe period, the line hadretreatedbackbelowthatline. This was a falsesignal.

3. Recent substantial price

moves. When pricemoves quickly in onedirection, oscillators aregoing to move as well.At these times, findingreliable signals isdifficult and, bythemselves, oscillatorsare not entirely reliable.The signals ofoverboughtandoversoldare more significantduring times of moremoderate price

trends. MacauInvestment Holdingsexhibited two possiblefalsesignals,oneineachdirection.At the start ofthe chart, prices fellquickly, leading to adecline within thenegative side forMACD. This wasfollowed by a two-month period ofconsolidation.Attheendof the chart, prices once

more moved, this timerapidly upward. Thisbrought the averagesunderlyingMACDintoadouble crossover aswell. But given thespeedoftheuptrend,theMACDchangecouldbea false signal.

Oscillators as lead or lagconfirmationAmomentumoscillatorisnotalwaysgoing to lead, even ifit is identified as a leadingindicator.Alaggingoscillatorwillnotalwayslageither.This is the problem manychartists have in interpretingthemeaningofoscillatorsandthewaytheymove,signal,ordiverge. Every signal foundin an oscillator has to beconfirmed through traditional

signals like double tops orbottoms, gapping priceaction,orvolumespikes.In the case of Bank ofAmerica, numerous priceindicators were found at thebottomofthedowntrend:

1. A double bottom,indicatingthedowntrendhad ended and a newuptrend should beexpected.

2. A series of price gaps.(The first two wereinvisible,butanalysisofthe price pattern revealsinterday gaps betweencloseandopen.)

3. A building level ofvolume over severalsessions.

4. Avolumespike.

These confirming indicatorsfollowedtheleadingindicatorprovidedbyRSI.Ithadfallen

into the oversold category,thefirstsignofaturnaround.Then the indicator movedupward into the mid-rangearea,signalingtheconclusionoftheoversoldcondition.

Oscillators aremost effectivewhentheyindicateorconfirma separate signal, especiallyonebasedonadifferentformof information. Price patternreversal signals are goodexamples of reversalconfirmation or leadindicators.Price patterns and,specifically, reversal signals,employadifferentsetofdatathan oscillators; so when theprice pattern and oscillator

predict the same change, theindicatorismorepowerful.Examples of candlestickswithoscillatorsMany strong candlestickreversals provide generallyreliable information.However, they needconfirmation just asmuch asany other signals. Forexample, the chart of IBMfollowed a predictablepattern.First, prices were declining

and thedowntrendconcludedwithaclearbullishengulfingpattern. This occurred at thesame time the oversoldconditionended,confirmationofthebullishsignal.Second,pricesdeclinedagainand ended with a single-session hammer, predicting areversal andnewuptrend.Atthe same time, RSI dippedintotheoversoldareabeneath30, and then moved rapidlyupbutstillwithinmid-range.

Another series of reversal

signalswasfoundinthechartof Energy Partners. Severalbullish candlesticks led thisand were confirmed byMACD:

1. Thrusting lines, a two-sessionbullishsignal.

2. Meeting linesconfirming the previoussignal,eventhoughpricethenfell.

3. A delayed reaction inMACD, momentarilycrossing the signal lineinto bullish territorybeforeretreating.

4. A strongMACDdouble

crossover into bullishterritory.

5. A strongbullishharami,confirminganewbullishtrend.

6. Abullishsqueezealert,athree-sessionindicator.

7. A secondbullishharami–eventhoughpricesfellafter this for a fewsessions, the bullishreversal did occurafterwards.

ConclusionMomentum oscillators createforecasting insight, often inadvance of current pricereversal. This occurs whenoverbought and oversoldconditions appear, or whenthe oscillator diverges fromthepricedirection.Oscillators may lead or lag.However, they serve thepurpose of (a) leading thereversal along withsubsequent confirmation, (b)

fortifying a separate reversalsignalbyconfirmation,or(c)contradictinganothersignal.Contradiction is just asimportant as confirmation. Ittells you to not act untilclearerindicatorsappear.

PART 8:CONFIRMATIONSegment 1. Why isconfirmationthekeyprocessintechnicalanalysis?Manytechnical“systems”areset up and based on singleindicators. The problemwithrelianceon solitary signals isthatnothingprovidesabsoluteassuranceofreversal.

Indicators are only the firststep in a two-part (or multi-part) system.Confirmation isthe second and mostimportantpartofthatprocess.ThelackofreliabilityinpricemovementEven with confirmation, theindicated significance of asignal cannot be known at100% reliability. For thisreason, several attributes inyour technical analysisprogram are essential. These

include:

1. Diversify your entryrisks. Never place moreintoatradethanyoucanaffordtolosebecauseoffailedsignals.

2. Spread your exit risks.Don’t close the entireposition unless you arecertain that youwant totakeprofitsandleavetheposition.

3. Be always aware ofproximity. Rememberthat reversal at or nearresistanceandsupport isthe most likely place itwill occur, especially ifprice breaks throughwithgappingmovement.

4. Never trust any signalwithout confirmation.Remember, pricemovement in the shortterm is chaotic andunreliable. Confirmation

makesitmorelikelythatyour timing for entryandexitwillimprove.

5. Use multiple indicators.Expand yourconfirmationuniverse toinclude price patternsand Western indicators(especially tests ofresistance and support);candlestick signals;momentum oscillators;andvolume.

For example, in the case ofthe Walt Disney Company,the direction was unclearwhenpricealonewasstudied.However, several importantsignals appeared within ashortspanoftime:

1. The double bottomtested support but didnot create a newdowntrend.

2. Shortly after that test, abullish engulfingpatterndeveloped. However,price levels did notmove strongly rightaway.

3. Thevolumespikewasaconvincingsignalthatan

uptrend rally wasunderway.

4. MACD was in positiveterritory through thechart,andthefactthatitdid not decline wasencouraging, furthersupporting the multi-signal indicator of anuptrendinprogress.

Confirmation strengthensjudgmentEvery trader makes

judgmentsaboutthetimingofentry and exit. Looking at acurrentchartanddeterminingthe strength of signals isdifficult;lookingbacktopastpatterns, turning points areeasilyspotted.Theuncertaintyaboutcurrentsignals is reduced whenstrong confirmation is addedto an initial indicator ofreversal. The proof of likelyreversal is found in thisprocess, and the stronger the

confirmation, the moreconfidenceyougain.A very contradictory signalandconfirmationwasseeninthe chart of eBay. MACDdipped into negative territorybriefly but then quicklybounced back out. At thesametime,abearishdojistarappeared with a very largeupsidegap.Thisisconsidereda bearish signal but the biggap strengthened thisindication.

In spite of the strong bearishindicator, the price movedrapidly intoa stronguptrend.This proves the point thateven exceptionally strongsignals can be false, andprices may move in theoppositedirection.In the case of eBay, thecontradiction between thebearish candlestick and thebullish MACD should haveled a trader to wait until amoredefinitesignalcouldbe

found.

Another seemingly strong setof signals and confirmationwasseeninthechartofKraftFoods.Thisconsistedof:

1. A double bottom,indicating a cominguptrend.

2. An uptrend as expected,including a breakoutaboveresistance.

3. A bearish piercing linessignal, indicating that

the breakout was abouttofail,andpricesretreatbackintotheestablishedtrading range. Thisbearish signal was quitestrong due to theproximity of the signaltothebreakout.

4. A volume spike,supporting theinterpretation of this setofsignalsasaconfirmedsign of a downtrendabouttooccur.

5. Although MACD hadmoved into positiveterritory by theconclusion of the chart,the bearish signals werequitestrong.

But what happened to KraftFoods? Expanding the chartanothermonthshowsthatthebearish indicators, evenconfirmed, were false. Soonafter the volume spike, twoadditionalsignalsappeared:

1. The hammer, a bullishsingle-session indicatorwas quite strong notonly because of itsplacement but also dueto its exceptionally longlower shadow. Thissignaled that the bearswere not successful atdriving prices lower;momentumwasgone.

2. Another very strong

bullish signal appearedin a three-session signalcalled the bullishabandoned baby. Thetitle refers to the near-doji session in themiddle, preceded andfollowed by price gaps.As predicted, these twosignals togethercontradicted theprevious bearishconfirmation, and led toabullishmove.

A strong signal andconfirmationwasfoundinthechart of First Solar. MACDmoved into bullish territoryand at the same time, a verybullish candlestick signalappeared, the morning star.This consists of threeconsecutive sessions, blackfollowedbyadownwardgap,then a white session, anupward gap, and anotherwhitesession.Taken together, MACD and

the bullish candlestickconfirmed the likelihood oftheend to thesidewayspricemovement and the start of anewuptrend.

The more confirmation youfind,themorelikelyitisthat

thereversalisgoingtooccur.For example, First Solardelivered on the confirmedupward indicator with twostrongsignals:

1. The sustained uptrendwas convincing in itsangle and speed,representing theresponse to the previouspositivesigns.

2. Thesmalldipmidwayin

the uptrend created asecond strong bullishsignal, an engulfingpattern. This can beinterpreted as a reversalof the small dip in theuptrend, or as aconfirming signal thatthe established uptrendwasgoingtoresume.

Confirming price as well asthetrendTraderstendtofocusonpriceas the point to seek reversalsigns. However, the trenditselfanditscurvealsoservesasanimportantinitialsignal.It is possible to spot aninterruption in the trend, andthen a price resumption. Forexample, Mattel’s chartshowed an uptrendthroughout the entire period.It was interrupted by a

retracement of severalsessionsinmid-July.

Theuptrendcontinuedimmediatelyafterthe

retracement.Notealsothattheretracementendedwithalong-leggeddojisession,aclearreversalsignhintingthattheuptrendwasabouttoresume.At the very moment theuptrend continued, the RSIline moved into theoverbought area. This couldhave been interpreted as abearish warning assign and,in fact, if it had moved anyfurther, it would have

requiredcautionandpossiblyanexit.However, the RSI lineremained barely in theoverbought section and thenvery quickly retreated backinto mid-range. This meantthat themovewas causedbythe very large upward gapbetween retracement andtrendresumption.Confirming continuation aswellasreversalWiththefocusamongtraders

on reversal indication, it iseasy to overlook theimportanceofcontinuation.Thus, traders in positions arefocused on reversal signalsand may easily be deceivedby false signals. However,continuation indicators arejust as important. Amongthese are many specificcandlestick formations,including neck lines. Forexample, Hecla Miningconfirmed its ongoing

uptrend with a bullish necklineindicator.

This showed up just beforeprices appeared to begin

moving sideways; however,the trend was strong enoughto quickly resume a strongupwardmovement.Continuation patterns mayalso be bearish, and willappear during a downtrend.For example, a bearishseparating lines pattern wasfound in the chart ofChina.com.Thiscontinuationpattern was found after astronguptrend,butevensoitsinterpretation can mean one

of two things: reversalof theuptrend or continuation of abrandnewdowntrend.Theconfusionwasclearedupby a strong form ofconfirmation. The RSIindicator moved well abovethe 70 index line. It did notjust barely move higher, butwas decisive and stronglycautioned that the stock wasoverbought.In fact, price levels thenbegan a clear and consistent

descent, as predicted by thebearish separating lines andconfirmedbyRSI.

SubtleformsofconfirmationBeyond easily recognized

confirmation signals, youmayalsofindconfirmationinmoresubtle formsofchange.Theseinclude:a. Hidden gaps. Many pricegaps occur without obviousspaces between sessions.These are more difficult tospot, but just as important asvisible gaps. Some gaps are“common gaps” and occuroftenwithoutanyimportance.Others, though, are strongreversal signals and should

not be ignored. Hidden gapscome in a few differentforms. The next illustrationSummarized many forms ofhiddengapsthatcanbefoundonvirtuallyeverystockchart.These gaps are hidden in thesense that a session’s realbody overlaps the previoussession. However, the spacebetween closing price ofsession one and opening ofsession two creates a pricegap.

JetBlue Airways experiencednumerous hidden gaps on its

chart during a very stronguptrend.Infact,thespeedandangle of the uptrend shouldhave caused traders to beconcerned about the changesof reversal. The hidden gapsconfirmed this potentialproblem.Relative Strength Indexmoved into the overboughtarea.However,thiswasamidmoveanddidnot last.Sobyitself,RSIwasnotconvincingasaformofconfirmationthat

theuptrendwasover.Two other developments didmake a convincing argumentfor reversal, however. Firstwas the frequency of thehidden gaps. When thisoccursduringarapidtrend,itincreases the likelihood ofreversal.The second signal was theappearanceofthelong-leggeddoji near the top. When thisappearsafteranexceptionallystrong uptrend, it

demonstrates the strugglebetween buyers and sellers.Thesidedominatingthetrendusually loses, so in this case,buyers had lost momentumand sellers were set to takeover.Soon after the appearance ofthe long-legged doji and itsreversal significance, thetrend did reverse and adowntrend began. Eventhough the downtrend endedattheconclusionsofthetrend

line, note that after twoupward-moving days, itappearedtoresume.

b.Trendlineendings.Atrendline is a simple straight linedrawn below an uptrend orabove a downtrend. It endswhenthelinerunsintopricesmoving in the oppositedirection.However,whatappears tobetheendof thetrendmightbeamomentarypricemovethatis going to reverse. So thetrend line by itself requiresseparate confirmation. Thisoccurred on the chart of

AbbottLabs.

The trend line in this case

was interrupted by a fewsessions retracing in adownward direction.However, this was not areversal but a momentaryretracementofshortduration.The uptrend continued assoon as the downward-moving sessions failed todrivepriceanylower.c. Repetitive doji sessions.Thenarrowrangeofadojibyitselfisnotareliablereversalindicator. However, when

you find three or moreconsecutive sessionsconsistingofdojiornear-dojiranges, it reveals a conflictbetweenbuyersandsellers.The repetitive doji pattern isexceptionally strong whenshadows are lengthened. Forexample, Mongolian Miningexperienced an unusual fiveconsecutive doji sessions.The long lower shadow onthefirstofthesefiveprovideda clue that a new trend was

about to begin, but thedirectionwasnotclear.

At first, it appeared that anuptrend was going todominate the price inresponse to thedoji sessions.However, this did not lastlong and a very isolatedvolumespikemarkedtheendoftheuptrend.Thiswassoonfollowed by a long blackcandle session marking thebeginning of a strongdowntrend.ConclusionConfirmation takes many

formsandneedstobeplacedin context. Seekingexceptionally strongconfirmation might demandthe use of more than oneextraindicator.Pricemovementisunreliable.Confirmation improvesjudgment concerning thetiming of entry and exit inreaction to reversal signals.Some confirmation signalsalso provide continuationsignals, which are just as

important because they tellyoutonotexitaposition.Some confirming signals arenot easily spotted. Theseinclude hidden gaps, trendline patterns, and repetitivedoji sessions. Findingconfirmationisnotlimitedtoa singular type of indicator,but should be developed toinclude tests of manydifferentones.

Segment 2. Entry and exittimingviaconfirmationThe timing of entry intopositions and exit frompositions is the key toeffective use of technicalanalysis. Because short-termpricemovementisdifficulttopredict, traders rely onconfirmation and need todistinguish between strongandweaksignals.Swing trading, the basictimingstrategy

Traders may employtechniques of swing tradingto timeentryandexit.Underthis system, traders wait forrecognizable exaggeratedprice movement and thenenter positions. Exit occurswithin the next few sessions,when the exaggerated pricemovement is expected toretreat.ThechartofPYICorporationdemonstrates the technique.Asinglesession’sdownswing

concluded with a period ofindecision and then an easilynoticed dip. This was anopportunity to either enter along position, or to close ashortposition.MACD remained in thenegative for nearly twomonths further before anopposite signal was found.Theup swingcoincidedwithMACD confirmation as theoscillatormovedintopositiveterritory.

Thisversionoftimingmaybe

based solely on pricemovement, even withoutconfirmation – althoughfinding confirmation isalwayspreferred.Whenpricemovesaway from the typicaldaily breadth of trading,reversal likelihood is quitehigh.It is not as easy to use thistechnique in highly volatileissues, as prediction ofreversal ismoredifficult.Forexample, Agritrade provided

some interesting swingtrading opportunities. Thesingle session jumpingaboveresistancewasthefirst.When support beganaccelerating to the upside, atwo-session dip below wasanother chance to enter aswingtrade.Finally,withestablishmentofanewresistancepoint,aone-sessionshadowmovedaboveandretreatedonthesamedaybackintothetradingrange.

The swing trading approachis contrarian. While a

majorityof tradersover-reactto news, such as negativeearnings announcements ordisappointing guidance forfutureearnings,swingtradersavoidemotionalover-reactionand exploit exaggeratedmovesinprice.The approach will work inthose isolatedmomentswhenprice movement is extreme.Many systems can beemployed to time the swingbydegrees:

1. Percentage-basedsystems,inwhichexitisprogrammed after aspecifieddegreeofpricemovement.

2. Trailing stop or stoploss, automaticallygenerated trades basedonpricelevels.

3. Signalandconfirmation.

The third approach – signal

and confirmation – isprobably themost applicablefor swing trading. Thosetraders interested in veryshort-term swing timing arenot as likely as other tradersto rely on percentagemovement or special orders,given the volatile nature ofpricemovementitself.Timing in swing trading isbased on recognized pricemovement in two steps –away from the existing

breadth of trading (whenentry occurs) and then areturn to normal price levels(whenexitistimed).When price dips well belowthe typical range, theopportunity is clear.A traderbuys at this signal point andwaits for price to rebound.When it does, the position isclosed.Forexample,thechartofCAInc. provided two clearexamples of entry and exit

points. The first one movedbelowsupport,whichwastheentry point, and remainedthereforthreesessions.Onceitmovedbackintorange,theexit point was clearlyidentified.Second, after a fast uptrendbacktotheoriginalresistancelevel, the pricemoved aboveand stayed there for foursessions.Thefirstviolationofresistance was the swingsignal for entry; and the fast

retreat back into rangesignaledexit.

A problem ariseswhen price

spikes to the upside. Swingtraders are supposed to shortstock at this point, wait forthe price to retreat, and thenclose. But for many traders,shorting stock is tooexpensive and risky,especially in the marginalprofit potential of swingtrading.Consequently, many tradersdeal only with the downsideswingsandlimittheiractivityto buying stock to open, and

thensellingtoclose.Asolutiontothisistheuseoflong puts. These options arebearish just as short stock is,but market risk is limited tothe cost of the put, which isquitelow.Soforaverysmalldegree of exposure, swingtraders can play both bullishandbearishswings.For example, ChinaInformation Technologyexperienced an uptrendculminating with a one-

session jump with a stronguppershadow.Theindicationwas reversal, based on theBollinger Bands all movingbelow price levels. At thatpoint, the bearish entry wasfound; and it led to a long-termdowntrend.

Options can be used for

swing trading on both sides.For example, after adownward-moving priceswing, traders can buy calls,waitfortheswingtoreverse,andthensell.Optionssolvemanyproblemsfor swing traders, whilemaximizing leverage andenabling diversification dueto the low cost of options.Used in swing trading, longoptionsaddadvantagestothestrategy and even soon-to-

expireoptionswork.With little or no time valueremaining in the optionpremium,at-the-moneyorin-the-money contracts tend totrack stock price movementpointforpoint.Timing, the key to technicalanalysisTiming is essential forlonger-term trading as well.Swing trading and daytradingreliesonbeingabletospot very short-term

exaggerated price movementand acting quickly. It is oneapproach that does rely onconfirmationoutofnecessity.Even so, confirmation thatappears at the same time asaninitialpricemovecertainlyimprovestimingoftheswingtrade. Harbin Electricdemonstratedhowthisoccursonitsfour-monthchart.

Thegradualdowntrendended

with an exceptionally clearoscillatorsignal.RSIdeclinedto the 30 value and thenmoved clearly through it,whichtookplacerightbeforethedowntrendended.How could you be sure thetrend had turned to theupside? The three whilesoldiersconfirmedthatanewuptrend had begun. Thesesignalsoccurredinverycloseproximity.Confirmationoccurringatthe

same moment as the pricemovement may take manyforms. Another example wasseen in the chart of RossStores. In this situation, RSIprovided no clear signal ofoverbought or oversold.However, the signals forcontinueduptrendwerefoundinotherways.The trend line is actually thesame uptrend with a briefinterruption.Thefour-sessiondecline could havemarked a

reversalandatthetimeitwasnot certain what wouldhappen next. But theexceptionally large lowershadow in that first lowersession demonstrated a lackofmomentumamongsellers.Thissignalwasconfirmedbythevolumespikeonthesameday. The uptrend quicklyresumed, making this seriesof movements and volumeexchanges a clearcontinuation signal. This

strongly hinted that adowntrendwouldcomenext.

The problem of failedreversalsignalsEvery trader faces a problemof failed reversal signals.Even the strongest signalsmay mislead traders byproviding confirmed,exceptionally strong reversalsignals that do notmaterialize. The purpose ofconfirmationisnottoprovidecertaintyineverycase,buttoimprove your percentages ofwell-timedtrades.

For example, the chart ofNestle Indiamoved sidewaysforthefirsthalfoftheperiodshown.Andthentwovolumespikes appeared, and inbetweenwasastrongbearishharamisignal.In spite of strong signal andconfirmation, the pricemovedupwardandnotdown.Thisisatypicalexampleofafailed reversal. The falsesignal provided in thecandlestick sessions,

confirmed by the volumespikes,was encouraging.Buteven so, price movedoppositefromexpectations.

Because failed signals occur

even with the strongestconfirmation, it makes senseto limit exposure in any onetrade.Thisisnotthesameasdiversification.With diversification, youspread capital among manydifferent positions, eachsubject to dissimilar marketrisks. This ensures that evenin the worse marketmovement,consequenceswillnot apply to the entireportfolio.

Limiting exposure withinsingletradesisdifferent.Itisa technique for managingmarket risks within a singletrade, even when the largerportfolio is well diversified.In timing entry to whatappearsastrongreversalaftera longdowntrend,howmuchshouldyouinvest?Wal-Mart was a goodexampleofhowexceptionallystrongsignalsmightnotworkout as expected.On its chart

from mid-February throughmid-April, sidewaysmovement ended with astronguptrend.Attheveryendofthechart,aseries of upward-movingsessions concluded with abullish engulfing pattern, ahighly reliable signal. Thisbullish signal was furtherconfirmed by the move inMACDintobullishterritory.

Evenwithwhatclearlyseemslike a confirmed reversalindicator, thesignalmayfail.The chart, expanded anothermonth, makes this point.Notice that immediatelyafterthe bullish harami, the pricegappedlowerbythreepoints.At the same time, MACDquickly retreated back intonegativeterritory.

The Wal-Mart price thenreturnedtoitssidewayspricemovement, but in a lowerrangethanpreviously.If you are dealing withreversal-timed entry into aposition, limiting exposurecantakeseveralforms.Theseinclude:

1. Identifying bail-outpoints and placing stoploss orders on stock

trades. In those caseswhen price movesagainst you, cuttinglosses early is a prudentstrategy.

2. Limiting share anddollar amount to a pre-set percentage of yourcapital. For example,youmay decide to limitexposure to any onetrade to 10% and selectthe number of sharesapproximatingthislevel.

3. Using long optioncontracts in place ofstock. This techniquelimitsyourpotentiallosstothecostoftheoption.Typical,anat-the-moneyoptionwiththreemonthsuntilexpirationwillcostlessthan5%ofthevalueof 100 shares of theunderlyingstock.

Strong and weakconfirmation

Weak confirmation is foundin signals providing reversallikelihood, but not strongly.So a relatively small pricemovementoflessthancertainsignificance, coupled with aweakconfirming indicator, ismorelikelytofail.

ThePG&Echartprovidedanexample. The three black

crowsactsasbearishreversalaboutfouroutoffivetimesitappears.However, evenwiththe small uptrend, this onedid not lead to reversal, butwasafalsesignal.Making matters worse, theapparent bearish signal wasconfirmed with a volumespike and two subsequenthigh-volumedays.Inspiteofall the signs, the price nextmoved upward. This signalwas “weak” because of the

veryshortuptrend.Another weak confirmationsignal is one offering onlyabout50%certainty.Asignalthatreversesonly50%ofthetime is no better than arandom guess. So these canbe discounted as far as theirvalueofconfirmation.Typical among 50%candlestick signals are dojisignals(dragonfly,gravestoneand long-legged). Forexample ABC

Communications ended anuptrend by moving sidewaysfornearlytwomonths.During this period, fivespecific sessions were long-leggeddojidays.Butonlythelast one signaled an actualdowntrend – in other words,thedojiwasnotofanyvalueasreliabletimingforatrade.

A third situation likely toprovideweakconfirmation is

a reversal at mid-range(versus one at the edges oftherange).Yahooexhibitedavolatile trading range for alongperiodof time,andthengave out several bearishsignals. All occurred at mid-range even while the pricetrend gradually movedhigher.FirstwasthemoveofMACSinto bearish territory. Thiswas a fairly strong decline,and should have drawn

attention–especially since itwas very quickly confirmedwithabearishharamisignal.With prices then trendinghigher,thenextmoveseemedless than certain. The verylargeuppershadowwasverybearish as it indicated acompletebreakdownofbuyermomentum. Even so, theprice trendcontinuedupwardand trended above previouslevels. This mid-range setof signals was entirely false

andmisleading.

Strong confirmation consistsof very clear and precisereversal signals, and equallystrong confirmation. Theseare never 100%, but thecertaintyofsuccesscanbeashigh as 80%. For example,Caterpillarhadasetofbullishsignals appearing at thebottomof a downtrend, rightatsupport.

First was a volume spike,immediately followed by aratebut strongbullish signal,the morning star. This is athree-session signal startingwith a black session, then alower white, an upside gapand finally, a higher whitesession.After this strong bullishsignal and confirmation,prices did not move for sixsessions.However, a second,stronger volume spike

marked the start of a newuptrend. Because this actionalltookplaceatthenewlysetsupportlevel,itsstrengthwasgreater than a mid-rangesignal.Among these kinds ofconfirmation are candlesticksignals with a high level ofreliability.Examplesof theseinclude theengulfingpattern,a commonly occurring signaland one with very strongreliabilityforreversal.

Procter & Gamble providedone example of this. First,RSI trended downward andinto oversold territory.Immediately after, a bullishengulfing pattern showed up.Basedonthedownwardgapafewsessionsearlier, theoddsof reversal were greatlyincreased.Price reacted by movedmodestlyupward through theremainder of the chartedperiod.Thissignalwasstrong

based on the location of thebullish harami. Such signalsnever provide 100%certainty;butwhentheyshowup at the end of the trend,reversal chances are muchstronger.

Whenpricemoves towardor

crosses resistance or support,reversal is most likely. Sowhenyouseethisoccur,lookfor confirmation. When youfind price gaps along withcandlestick and oscillatorreversal signs, chances forprice to retreat back intorangeareattheirhighest.ForexampleMatsonInc.hada very strong sideways levelofresistanceandsupportinafairly narrow breadth oftrading. The very strong

upper shadow of the long-legged doji made the signalclearlybearish.Eventhoughdojisessionsarenot very reliable, when theyexhibit shadows like this, thesignificance cannot beignored. This revealed lostmomentum among buyers,butmoreimportantwasthatitalsomoved above resistance.This greatly increasedchancesofreversal.The reversal did follow, and

in fact was so strong that ittrended below support. Thishappensoften;onesideofthetrading range is challengedunsuccessfully, and the nextstepistomovetoachallengeoftheotherside.

ConclusionFor all entry and exit

decisions,confirmation is theessential ingredient. Beingaware ofwhat defines strongor weak confirmation helpsimprovetiming.The major influences onwhether confirmation isstrong or weak are:exceptionally strong or weaksignals, highly reliablereversals, and proximity ofreversal signals to resistanceorsupport.

Segment 3. Sources ofconfirmationThe process of confirmationincludes many possiblevariations and signals. Allevidence gathered islegitimate, although somesignalsareinvariablystrongerthan others.Chartists are leftwith the task of determiningthe strength or weakness ofparticularsignals.This judgment isgainedwithexperience. However, it can

also be acquired throughobservation, seeing the causeandeffectofspecificchangesin price based oncombinationsofinitialsignalsand confirmation; themomentum of change; andproximity of signals toresistanceandsupport.Candlestick and candlestickconfirmationOne of the strongestcombinations of signal andconfirmation occurs when

two candlestick signalsappear in close proximity toeach other. When bothforeshadow the same event(reversal, for example), thelikelihood of reversal isstrengthenedconsiderably.Television Broadcastsexhibited an exceptionallystrongdoublesignalatthetopof an uptrend, consisting oftwo bearish piercing lines.The trend halted there andimmediately reversed top the

downside.

Thetypeofcandlesticksignaldefines the strength orweakness of the signals.Certaintypesofsignals(suchas engulfing patterns, threewhite soldiers or three blackcrows,andlongcandlesticks)are normally very strong.Other signals (notablysingular dragonfly,gravestone and long-leggeddojidays)arerelativelyweak.Weaker candlesticks may beexcellent forms of

confirmationiftheyappearinthe right placement, such asatthetopofanuptrendorthebottomofadowntrend–andwhen additional candlestickreversal signals are found atthesametime.For example, G S GlobalCorp. showed two bearharami signals in closeproximity.Thefirstwasquitewealasitdidnotappearafteran uptrend. The second one,however,was at the top of a

briefuptrend,and it led rightawaytoareversal.

Candlestick and WesternconfirmationA frequent event is thecoexistence of candlestickreversals with traditionalWestern signals. Amongthese,doubletopsorbottomsoccurringatthesametimeascandlestick reversals arelikely to lead to reversal amajority of the time –especiallyiftheyarefoundatresistanceorsupport.The chart of Qualcomm

provided an example of this.The bearish doji star is athree-session signal and astrong one as well. At thesame time, the price dippedbelow support and formed adoublebottom.As expected, price turnedimmediately into a sharpuptrend lasting a full month.This often occurs whensupport is violated with aconfirmedreversalsignal.

Another example of thecombined candlestick and

Westernreversal/confirmationinvolving gapping pricemovement was found in thechart of Johnson ElectricHoldings. Very fast risingprices were characterized byrepetitive gaps, always asignal that the trend mayreverse. This also movedabove resistance at the sametime and culminated with abearishdojistar.Asthepricetrendreversed,a

similar gapping pattern wasseen on the way down,confirming that the moveabove resistance could nothold.

Candlestick and oscillators

confirmationOscillatorsby themselves arenot reliable at all times; butwhen they are found alongwithcandlesticksignals, theyare strong forms ofconfirmation.Oscillatorsmaybe the deciding factor in thetimingofentryorexitduetothisconfirmationattribute.For example, SeoulBroadcasting System formedabullishmeetinglinessignal,butplacementwasnotstrong

enough, as the precedingdowntrendwas brief and didnot cover many points. TheMACD line confirmed thereversal,however,bymovingintobullishterritory.Even so, prices continuedmoving sideways for anothermonth before the uptrendbegan as a delayed reaction.This uncertainty was alsofound in MACD, whichhoveredat the signal line forthesamelengthoftime.

Evenso,oscillatorsshouldbe

used only in combinationwith very strong reversalcandlesticksandpreferablyatthe end of an especiallystrong trend.Otherwise, falsesignalsarelikely.Showingupafter a relativelyweaktrend,anoscillatormaynot be a reliable confirmingsignal.Forexample,ComcastCorporation displayed abearish side-by-side blacklinesindicator,acontinuationpattern. As MACD also

moved down into bearishterritory, the signspointed tocontinued downwardmovement.However, these signals bothprovedfalse.Aftertwoweeksof sideways movement, theprice moved into a newuptrend, reversing thepatternin spite of the continuationsignalsandconfirmation.

Western and WesternconfirmationChartists relying on Westernindicators are likely to findmanyexamplesofsignalandconfirmation in these signalsalone. Typically, wedgesapproaching resistance(rising)orsupport(falling)ordouble tops and bottoms,accompanied by gappingprice movement, providestrong signals andconfirmation.

The chart of Apple gave agood example of this. Thefalling wedge is a bearishpattern and this developed toend with a downward moveandatriplebottom.Thiswasaverystrongbullishsignandthe next step was a stronguptrend.

Another example was foundinthecaseofFedEx.Notetheclear lines of resistance andsupport.Thefirstmovewasaprice decline below support,whichquicklyreturnedtothenarrow breadth of tradingrange.Next, prices trended aboveresistance and formed adouble top. This lackedmomentum, however, aspricesgappedlowerandbackinto the previous trading

range, where they remainedfor the rest of the periodcharted.

Western and oscillatorconfirmation

Western signals may beconfirmedaswellbytrackingmomentumoscillators.Astheoscillator moves into anoverbought or oversoldcondition, it may furthersupport a strong reversalsignal, especially at or nearresistanceorsupport.Oscillators are especiallystrong when price breaksthroughresistanceorsupport.If that occurs with gappingprice action, an oscillator

signal is compelling forimmediately reversal.Southwest Airlinesexperienced price breakoutsfirst above resistance andthen in reaction, belowsupport.By the end of the chartedperiod,priceshadreturnedtotheestablished trading range.Notice the reversal signals inbothbreakouts:firstadoubletopandthenadoublebottom.The double bottom was

confirmedbyabriefdip intobearish territory but animmediate return into thebullishregion.

Oscillator and oscillatorconfirmationLess common in chartanalysis is an oscillatorconfirmed by anotheroscillator.Most chartistswilltend to prefer one or twooscillators as confirmation ofeither candlestick orWesternsignals. However, onesituation may depend onwhether twooscillators agreeorcontradictoneanother.

The chart for Intel Corp.includes an uptrend inbetweentwodowntrends.Thesecond downtrend may haveled to uncertainty due to theshort-term duration of theprevious price moves.However, both MACD andStochastic oscillatorsconfirmedthepricedirection.

Just as significant is the casein which the initial signal isuncertain and twp oscillatorsdo not agree. This lack ofconfirmation requires moreinformation before entry orexit decisions are made. Forexample,thechartofFounderHoldingswashighlyvolatile,so checking two oscillatorsmade sense. If they agreed,then a direction could beexpectedtohold.However, MACD appeared

positivewhileStochasticwasnegative. This contradictionprovidednouseful indicationof where the price mightmove next. The price is toovolatile and the lack ofconfirming signals istroubling. Because theoscillators contradicted eachother, the prudent decisionhere would be to take noaction.

Semi-signals: Trend orchannel lines and movingaveragesTwoparticularWestern toolsused in technicalanalysisarenot indicators but patternsignals.Both are key for usein confirmation, however.These are trend or channellines,andmovingaverages.Trend lines are verystraightforward summaries oftheshapeandangleoftrends.Their value is in how they

identify the reversal in price.The chart of EdisonInternational summarizedprice movement very neatlybyidentifyingthethreetrendsinthechartedperiod.The first and third wereuptrends and the secondwasadowntrend.Ineachcase,theend of the trend is easilylocatedbecausepricereversesand the trend line is stoppedby theoppositemovement inthecandlestick.

Channel lines provide thesametypeofinformation,butwith an additional twist. Byidentifying theconsistency inbreadth of trading during adynamic and moving tradingrange,channellinesarelikelyto mark a trend’s conclusionbywayofchangesinbreadthoftrading.For example, AT&T pricesmovedsidewaysinachannelof more than one month’sduration, and ended with a

clearly identified bullishharami.Thisalsomarked theconclusionofthechannelandthestartofanewuptrend.

Moving averages oftenconsistoftheuseoftwoMAsat the same time but withdifferent duration. Chartistslook for convergence anddivergence (between MAsand in relation to price) toprovide initial clues ofcomingreversals.A single MA also providesvaluable information simplyby changing its proximitywiththecurrentprice.TrinityLtd.wasquitevolatileovera

three-monthperiod,makingitdifficult to spot reversalindicators.However, the MA lineshowed how crossover helpsin this analysis. At thebeginning of the period.MAwas above price as thedowntrend continued. Thisweakened in the middle asMA merged into the middleofpricelevels.The MA move below pricewasbriefbutitdrewattention

to a change in the climate ofthe price itself. When MAagain moved above price attheendoftheperiod,itcouldhavesignaledaresumptionofthe downtrend or at leastalerted chartists to proceedwithcaution.

ConclusionA wide range of indicatorsare employed inconfirmation. These includeany number of combinedstudiesandanalysis.Chartistsdepend on confirmation toreduce the chances of actingonfalsesignals.Even with the bestconfirmation,falsesignalsaregoing to occur. The purposein confirmation is not toremovetheuncertainty,butto

improve thechancesofwell-timedtradedecisions.

Segment 4. Confirmationtechniques used with trendchangesTechnicians employnumerous systems forresponding to confirmation.While emphasis is on exituponfindingreversalsignals,the opposite is just asimportant: deciding how toreacttoconfirmation.If a trend is expected tocontinue, should you takesome of your profits, hold

your position or add to it?This section addresses thesequestions.PartialexitA conservative method uponbuilding profits in an openposition is to take someprofits,while leaving theresttocontinuegrowing.Technicians may set pre-established price goals forpartialexit,sothatevenwithcontinuation of a trend, adisciplined approach would

be to take some profits. Thisis a dollar-based system. Forexample,atradermaydecidethat if a position’s valueincreases by $1,000, theoverall position will bereducedby$500(orclosed).Equally important is to setbail-out points based ondollar values, in order toreduce maximum losses. Forexample, a trader may alsodecidethat ifapositionloses$500, itwillbeclosed. If the

positionwill continue to losevalue, cutting losses isprudent, and those samedollars may be put to useelsewhere.The difficulty with a fixeddollar-based Another methodis the percentage system exitstrategy is its inflexibility.Percentage systems addressthisproblem.A trader may set two exitpointsforanyposition:Oneifthepricegrowsandanotherif

it declines. For example, ifthevalueofapositiongrowsby 5%, one-tenth of thepositionwillbeclosed;andifthepositiondeclinesby10%,the entire position will beclosed.Thisensuresalevelofprofits or a limited level oflosses.For example, on the chart ofthe Tom Group, Ltd., salepoints are identified at 10%intervals. This enables thetrader to sell 10% at three

different 5% increase pricepoints, so some profits aretaken as the uptrendcontinues.

Another exampledemonstrateshowthebail-out

rule works. In the case ofAluminum Corp. of China,the buy point was 3.20 andbail-out was set at a drop of10%, or 2.88. This occurredtoward the conclusion of thechartedperiod.

Stop loss and trailing stoporders

The use of specific types oforders,placedwhenpositionsare opened, helps to put exitsystems inplace.Astop lossis an order to sell an openlong position once a pricereaches a per-determinedprice. This creates a sale tominimizelosses.Forexample,astoplossordertells the broker to sell sharesif the price declines by 10%.However, the stop loss doesnotensurethatthetargetbail-

out price will be the salesprice.The stop loss is activatedonce that price is reached.However, the price maycontinuetodeclinebeforetheorder is executed.Sousingastoplossmaygenerateabail-out, but actual executioncouldoccuratalowerprice.ThechartofHewlett-Packardspecified bail-out at a 10%drop, or 19.35 based onpurchase price of 21.50. At

that point, a new bail out,10% of 19.35, was set at17.41.

Inacaseofarapidpricedecline,theactuallosscould

bemuchlower,however.Forexample,ResearchinMotion’spricedroppedwithalargegap.Thespecifiedsalespricehadbeenset,butthesalepricewaslower.Soalthoughthestop-losswassetat8.50,thiswasonlythepointwhereasaleorderwasplaced.Bythetimeitwasexecuted,thepricehaddeclinedto7.50.

Anothertypeoforderisthetrailingstop.Ifthestock’spricerises,thetrailingstopisadjustedtoaspecifiedpercentageoramountbelow.Forexample,thetrailingstopisfixedat10%beloweachday’shigh.Aslongasthestockcontinuestorise,thetrailingstopisadjusted.Assoonasitdeclinestothe10%level,asaleisgeneratedautomatically.

Theadvantageofthetrailingstopoverthestoplossisthatitadjuststoprotectprofits.Itprovidesforunlimitedprofitswhilefixinglosslevels.Forexample,abuyerofsharesinAkornseta10%declineasthepointwhere20%ofthepositionwastobesold.Thisoccurredonlyonceinthechartedperiod.Therestofthetrendcontinuedupwardthroughoutthechartedperiod.

Riskreduction–usingoptionstohedgeEven with confirmation of acontinuation or reversalsignal, you cannot be certainabout timingofentryorexit.Anopenposition is at risk ifreversal signals are ignored;and closing a positionprematurely based on a falsereversalisalsodamaging.Positionscanbehedgedwiththeuseofoptions.Thesemay

be employed to managepositions rather than tospeculate.Twoways thiscanbeaccomplished:1. Protecting unrealizedprofits in open positions. Inthis situation, a trader mayhaveanopenlongposition.Areversalsignalappears,but itis inconclusive. In this case,rather thansellingshares, thetraderpurchasesonelongputforevery100sharesowned.This creates an “insurance

put.” If the stock value falls,theputwillgainonepoint invalue for each point lost inthe stock. It costs money tobuy the put, but it is arelatively small premium fortheprotectionitprovides.If the price does decline, theput can be sold at a profit tooffset losses in the stock.Orthe put can be exercised andshares will be sold at thefixedstrikeoftheput.For example, Boeing was

quite volatile from Junethrough September, 2012.Onceatupsidegapappeared,a trader might be concernedaboutpossiblepriceretreat.At that point the trader maybuy a put. The example isbasedona75put,whichisatthe money, so its value willgrowonepointforeachpointlost in the stock. Once thepricefellto71,thetradersoldtheput and tooka four-pointprofit, but did not sell any

stock.Another price rally occurredand once again, went above75 per share. The traderbought another put at thishighpriceandheldituntiltheprice fell to 70. Selling theput generated another fivepoints of profit, all withoutneeding to sell shares ofstock.

2. Increasing potential inreaction to bullish

continuation. An open longposition is in themiddleofastrong uptrend. Acontinuation signal hasdeveloped.However,inplaceof buying more shares andincreasing the full marketrisk,atraderbuysacall.The long call will increasesone point for each point ofgrowth in the price of thestock. If the stock pricedeclines, both stock and calllose value. However, using

the call as a continuationstrategy is a relativelyinexpensive method forincreasingprofitpotential.Ifthestockrises,thecallcanbe sold at a profit to takeadvantageof thehigherpriceper share.Or the call can beexercised to buy additionalsharesatthefixedstrike.The chart ofCaterpillarwentthrough a volatile period,trending downward beforeturning to the upside. A

bullish continuation signalappeared in the form of athrustinglinesindicator.The this point, a traderbought an 85 call and heldonto it until the price hadrisen to nearly 90. At thispoint, the call was sold andprofits taken. This was anexample of increasing thelong position but withouttaking the risk of buyingmorestock.

Recognizing continuationsignalsWith emphasis on likelyreversal, traders may easilyoverlook the importance ofcontinuation. A continuationsignal may lead to taking ofpartial profits, cutting losses,orincreasingaposition.Continuation comes in manyforms, and should always beconfirmed. For example, thechart of Silver Base GroupHoldingsmarked the start of

alongdowntrendwithalargedownwardpricegap.Themeaningof thisgapwasnot known right away.However, the bearish trendwas confirmed whenMACDlines crossed from bullishdown into bearish territory.MACD remained bearishthroughout the remainder oftheperiod.

Mid-trendentrySometradersusecontinuationand confirmation to increasepositions already held. Thismid-trend entry strategy canbetimedinseveralways:a. Increase positions atrecognized likely conclusionof retracement.The tendencyisforretracementstobeveryshort-term and of predictabledegree. They may also takeon specified shapes likesflagsorpennants.

For example, the chart ofNorfolkSouthern exhibited astronguptrendthroughouttheperiod charted. However,increased position size wastimed to coincide with theend of two retracements, asmarked.The first retracement wasclear because the uptrendresumed. The secondexamplewaslessclearanditseems that buyer momentumwas beginning to stall at this

point.

b. Increase positions uponbreakout with continuationsignals. In this case, a pricebreaks out of the tradingrange. Rather than a reversalsignal, however, the signspoint to continuation. Uponseeing this, a position size isincreased to take advantageof the change in the tradingrange.The chart of Southern Co.began trading underresistance, but then broke

throughstrongly.Onceitwasestablished that a flip hadoccurred (prior resistancebecame new support), a newentry point was identified,andthelongpositionsizewasincreased.

c. Increase positions whenpriceinanuptrendfallstothe

level of themoving average.WhenMA is belowprice, asprice falls and touches theMA, if the uptrend isconfirmed, this pointmay beused to increase the size oftheopenposition.China Foods trended upwardfromFebruary through to theendofApril.Theentiretime,the moving average wasbelow price. At four points,the price dipped and touchedthe MA line. These were

identified as points toincreasepositionsize.However, once the MA linemovedthroughpriceandthenabove,itsignaledthepossibleend of the uptrend. At thispoint, the seller would belikely to sell the entireposition, take profits, andwaitfornewsignals.

The methods employed toincrease a position contradictmosttechnicalassumptionsof

fixedpositionsize.Thefixedsize assumption is useful todemonstratehowtrendsaffectvalue; however, in practice,increasing the size when apositive trend is underwaycanincreaseprofits.This applies in mostsituations to long positionsduring uptrends. However, itcanalsobeappliedtoexistingshort positions duringdowntrends.Atraderwhohasshorted stock may sell more

stock with a downsidecontinuation,or theholderofshortcallsmayselladditionalcallsifabearishcontinuationsignalisconfirmed.Techniques for increasingposition size are calledpyramid systems orpyramiding.Whiletheappealof exploiting trends iscompelling, risk should bekeptinmindaswell.Increasing position size inreaction to continuation

signals(ortimedtoenterafterretracement of convergencewith MA) is logical.However, when openpositions are increased, agreater risk of loss alsooccurs.DangersofgreedandpanicWithalltradesandstrategies,there are two inhibitingemotions within the market:greedandpanic.Greed causes traders to enterpositions during strong

uptrends,butwithoutanalysisof whether the timing issound. As an uptrend beginsto lose momentum, thetendency is for more longposition traders to enterpositions. This often leads toentry at exactly the wrongtime.Paniccausestraderstogetoutofpositionsatthewrongtimeas well. During a strongdowntrend, for example, asthe price approaches the

bottom,agrowingnumberoflongpositiontraderssell.The contrarian approach is aprofitableone.Thecontrariandoes not simply act oppositeof the timing of the overallmarket. The contrarian actsfordifferentreasons.Ignoringthe tendency to act out ofgreedorpanic, thecontrarianuses logic and analysis totimeentryandexit.Requiring signals andconfirmationleadstoahigher

degree of well timeddecisions. This often meansthe timing is made oppositeofmosttraders,whichiswhytheterm“contrarian”applies.However, it is caused by theapplicationofconfirmationofdiscovered signals instead ofemotional causes for timingofentryorexit.Understanding the technicalideal–keypointtorememberTechnical analysis is ascience, but it is not precise.

The purpose of using thesetechniques is to improve thepercentage of well-timedentryandexitdecisions.Knowing that success cannever be 100%, techniciansemployspecificstrategiesbutalso are aware of risks. Andsoawiseapproachistoneverrisk more in a single tradethanyoucanaffordtolose.Thetechnicalskillstokeepinmindandtopracticeinclude:1.Knowledgeofthebasics

Learnthedifferencesbetweenfundamental and technicalanalysis and use both toimprove your analyticalskills.Technical indicators mayinclude Western indicatorsbased on price patterns andvolume;orEastern indicators(candlesticks) that includespecific price patterns forboth reversal andcontinuation.2. Master the power of

chartingCharts develop patterns anddisplay not only trends, butmomentum as well. Chartpatterns also help coordinatemany different signals torecognizehowtrendsevolve.Technical analysis is mostoften defined as the study ofprice. More accurately,though,itisthestudyofpricepatterns, and these are foundon charts. As price evolves,recognizablepatternsareused

to signal momentum anddirectionalchange.3. Rely on the strength ofcandlesticks.Candlestick charts arepowerful technical tools.Candlestick formationsinclude dozens of reversalandcontinuation signals that,when confirmed, vastlyimprove entry and exittiming.Dozens of candlesticksignals, both reversal and

continuation, are found insingle-session, double-session, andmultiple sessiontypes.Somearemorereliablethan others, and some othersmay act either as reversal orcontinuation.However,whenconfirmed, candlestickindicatorsareamongthebesttechnical tools for timingentryandexit.4.AlwaysfollowthetrendTrends follow predicablepaths and are recognized

throughvisualtechnicaltools.Usethesetobetterunderstandthedirection,momentum,andchangeinthetrenditself.The trend involves severalattributes worthy of study atthe same time: direction,momentum, and retracementare key among these. Alltrends will contain elementsof these attributes, whichprovides strong clues aboutlikelyreversal.5. Use moving averages to

recognize coming pricechangesShort-termpricemovementischaotic,butmovingaverageshelp smooth out the longer-term trend. Specific changesin MA also foreshadowcomingpricereversals.MA can be employed as anoverlay to price. CrossoverpointsbetweenMAandpricemay accompany changes indirection and this tendency,when confirmed, aids in

recognizing how trendsdevelop patterns forcontinuationorreversal.6.Track the interaction ofpriceandvolume.Crossoveranddivergencearesignificant because theypredict reversal before pricechanges. Volume confirmspricetrendseffectively.Volume indicators or single-session spikes are among thebest signals about the nature(strengthorweakness)of the

trend. Volume signals alsoarevaluableconfirmingsignsthat,whenusedwithWesternofEasternindicators,strengthwhatthesereveal.7. Momentum is the keychangeintrendsNo trend continues forever.Eventually, the controllingsidebeginlosingmomentum,and this shows up in themomentum oscillator, whichconfirms other reversalsignals.

Momentum and other signalstake on added significancewhentheyoccuratresistanceor support. These borders ofthe trading range are mostresistancetocontinuationofatrend, so weakeningmomentum is most likely tooccur as price approachesthesepricepoints.8.More thananythingelse,rely on confirmation for allsignalsNosignalprovidesenoughby

itself to act upon withconfidence. Always seekconfirmationbeforeyouact.Confirmation comes inmanyforms, and combinations ofindicators add effectively totiming of entry and exit.Confirmation may be ofeither reversal orcontinuation. Also seekcontradiction as a means ofchallenging an initial signal.When this occurs, it mayrevealthattheinitialsignalis

false.ConclusionAll technical analysis isestimation. Technicians mayuse price to confirm whatthey have seen infundamentals, or to time dayor swing trades. Manyexperienced technicians trackprice movement by theminuteorhourratherthanbytheday.Regardlessof thedurationofa session employed in the

chart, patterns, momentumand volume all continue toprovide reliable signals andconfirmation for an evolvingtrend. Although short-termprice movement is highlychaotic, charting and signalsbring order to the process oftimingtrades.

###

AbouttheAuthorMichaelC.Thomsettisafulltimeprofessionalauthor.educatorandspeaker.Hehaswrittenover70booksontopicsofoptions,trading,investing,realestateandbusinessmanagement.HealsoteachesfiveinvestingandtradingcoursesattheNewYorkInstituteof

Finance,andoperateshisowneducationaltradingsite,ThomsettOptions.com.Asafrequentguestspeaker,Thomsettaddressesavarietyofaudiencesonmanytradingtopics.InJanuaryandFeberuary,2013,heisaguestlecturerinasix-weekcourseontradingtopicsatVanderbiltUniversityinNashville.Amonghisbest-sellingbooksaresixthathavesoldoveronemillioncopies

intotal.TheseareGettingStartedinOptions,TheMathematicsofInvesting,andGettingStartedinRealEstateInvesting(JohnWiley&Sons),BuildersGuidetoAccounting(Craftsman),HowtoBuyaHouse,CondoorCo-Op(ConsumerReportsBooks),andLittleBlackBookofBusinessMeetings(Amacom).ThomsettlivesnearNashville,Tennesseeand

writesforseveralpublishers,notablyJohnWiley&Sons,AmacomBooks,FinancialTimes/PrenticeHall,andMcFarland&Company.HealsoisanactivebloggerandcontributorofeducationalarticlesonL:inkedIn,Twitter,SeekingAlphaandtheChicagoBoardOptionsExchange(CBOE).

AboutthePublisherEthan Hathaway organisesinteractive, practical,applicable and valuableprofessionalpublic, in-houseand online business andfinancial training coursesfor business executives andbanking & financeprofessionals all over the

world.

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TechnicalAnalysisofStockTrendsExplained:AnEasy-to-UnderstandSystemfor

SuccessfulTradingbyMichaelThomsett.

PublishedbyEthanHathawayCoLtd

Copyright©2012.MichaelThomsett.

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TableofContents

PARTI:INTRODUCTIONSegment 1.Fundamental vs.technical analysis.(Differences andsimilarities; usingboth together in acoordinatedprogram.)

Segment 2. Doestechnical analysiswork? (Examplesand a case studyshowing the valueof technicalanalysis.)Segment 3. Criticsof technicalanalysis.Segment 4:Assumptionsbehind technicalanalysis.

PART2:CHARTSSegment1.Whatisachart?Segment 2. Typesof charts in usetoday: line chart,OHLC, andcandlestickchartsSegment 3. Chartproperties: timescale,pricescaleSegment 4. Chartpatterns inWesterntechnicalanalysis

PART 3: JAPANESECANDLESTICKS

Segment 1. Whatare Japanesecandlesticks?Segment 2.Features: open andclose,highandlow,pricedirectionSegment3.A shortlist of candlesticksignalsSegment 4. Studyof several

candlestickschartsPART4:TRENDS

Segment1.Whydopricestrend?Segment 2. TheDow Theory andtracking oftechnicaltrendsSegment 3.Identifying trendlines and channellines:up,downandhorizontalSegment 4. Short-

term trends,reaction trends,andprimary trends -analysis on stockcharts

PART 5: MOVINGAVERAGES

Segment 1. Whatare movingaverages?Segment 2. TypesofMAsSegment 3. Trendsand trend reversals

based on MAanalysisSegment 4. MAapplied to pricechanges

PART6:INDICATORSSegment 1.Indicator types:price, volume,momentumSegment 2.Convergence anddivergence, andtheirsignificance

Segment 3.DirectionalindicatorsSegment 4. Usingindicators withcandlestick chartreversalsignals

PART 7: MOMENTUMOSCILLATORS

Segment 1. RSI,MACD,StochasticsandothersSegment 2.Interpreting

momentumchangesSegment3.Leadingor laggingindicators?Segment 4.Oscillators usedwith candlesticksignals

PART8:CONFIRMATIONSegment 1.Why isconfirmation thekey process intechnicalanalysis?Segment 2. Entry

and exit timing viaconfirmationSegment3.SourcesofconfirmationSegment 4.Confirmationtechniques usedwithtrendchanges

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