The “Voices of Volume”

Virtually all technical indicators are a mathematical derivative of price action. Volume analysis opens a completely separate dimension, which addresses the question “To what extent does participation confirm the move underway?” Here are some principles that help guide our thinking as we listen to “The Voices of Volume.”

1. Volume can Lead Price

Similar to a momentum divergence, a new high in price needs to be confirmed by at least relative increases in volume, if not new (relative) volume highs as well. If new price highs are clearly not confirmed by new (relative) volume highs, then this is a warning signal that the new price highs might not last long. The On-Balance Volume (OBV) indicator is essential for some traders due to its potential to lead price.

2. Massively Rising Prices with Massive Increases in Volume are often Unsustainable

This goes back to the principle “Trends End in Climaxes” where a sudden rush of euphoria causes all who want to join to be ‘all in’ and thus unable to push prices higher. As we know, most people are bullish at the top and bearish at the bottom, and when there’s a ‘last ditch effort’ to get into (or out of) a stock, the classic sign is some sort of price blow-off which usually is marked by a stratospheric rise in volume - don’t get caught up.

3. Price Consolidation after a long Downtrend with Increasing Volume is Bullish

This scenario represents accumulation, in that funds are meeting any selling pressure buy accumulating all available shares, and thus “they know something the mass public doesn’t” or otherwise will catch onto later which could lead to the birth of a new trend.

4. Price Consolidation after a long Uptrend with Increasing Volume is Bearish

For the opposite reason, after a long rise in price, if price consolidates for a long period of time, yet volume increases, this means that funds are distributing their shares to the numerous buyers who can’t push prices higher, and when the buying pressure eases off, the price would be more likely to fall (or start a new downtrend) than continue rising.

5. Massive Volume on a New Significant Price Low is Bullish

This signal could represent a capitulation from buyers which is being met by aggressive accumulation by funds or traders, but most likely simply represents a ‘throwing in the towel’ on the part of the buyers who can’t take the pain of lower prices any longer. Strangely enough, when volume spikes massively on a large volatility down-move in price, this often signals bottoms, especially if the price closes higher on the day or at least closes in the upper range (such as the surge on January 22, 2008).

Comparison Chart

Open Interest information is only provided by the Futures and Options Market, though they can assist volume decisions as well.

For an explanation on how to interpret this chart, visit the blog article, “Insights from Volume and Open Interest.“

It is a good idea to display volume bars or other volume indicators on your charts to allow you to go beyond the price dimension and assess participation using the principles of confirmation and non-confirmation.

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The Basics of Trendlines

Trendlines are among the most basic tools of Technical Analysis, yet are quite powerful in their interpretation.

A trendline requires at least two “touches” or price points to be drawn, similar to a ray or line in geometry. However, there are a few factors that cause some trendlines to be more “valid” than others.

1. Times Touched

A trendline that has been “tested” or touched multiple times is more valid (or significant) than one that has been tested fewer times. Trendlines gain validity each time they are successfully “tested.”

2. Angle or Slope

A trendline with a lower slope, particularly around 45 degrees, will be more valid (or significant) than one with a steeper angle. A steeper trendline will require more force to continue and is more likely to reverse.

3. Time Period

A trendline that has lasted many years is more valid than one that has lasted a few weeks or months.

Commonly Asked Questions:

“Should I trendline connect all valid points or do you allow for some points to penetrate the trendline in its construction?”

This question has inspired much debate among analysts, each having compelling arguments for both sides.

Generally, it is better to allow some “wiggle room” when drawing trendlines, particuarly using candlestick charts, and allow for intrabar penetration. Be guided by the rule “Trendlines are more valid when they are connected by more rather than fewer points.” This might mean having to draw lines that pass through some bars in favor of picking up support or resistance via other bars. Use trial and error in your analysis.

“Can I use trendlines on oscillators or other indicators?”

Absolutely! In fact, you can see signals sometimes ahead of price when you use trendlines on the RSI, On-Balance Volume, MACD, and other technical indicators. Trendlines are particularly important when looking at “Relative Strength” charts which compares one security to another.

“What is the ideal trendline?”

The ideal trendline is one which has transpired over a decent length of time, touches many price points, is not too ’steep,’ and accurately reflects support or resistance via the developing price structure.

“What happens when a trendline is broken?”

These can serve as early warning signals of a possible trend reversal ahead. At a minimum, they should give you pause that the prevailing trend might be in danger of reversing soon, though you’ll generally need further confirmation that the trend has officially reversed. The significance of the expected move depends on the above factors related to the validity of trendlines.

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The Basics of Support and Resistance

The concepts of “Support” and “Resistance” in the marketplace are as common as bread and water - scarcely a trading day goes by when you don’t encounter these concepts in some form or another. How do we accurately define these terms?

Support is known as an area where price is expected to cease declining and form a reversal, inflecting back to the upside.
Resistance is known as an area where price is expected to cease rising and form a reversal, inflecting back to the downside.

It is generally better to refer to these concepts as “price areas” rather than exact price points, and allow wiggle-room should price violate expected support by a fraction.

There are a variety of methods one can use to determine expected areas of support or resistance, from moving averages, to trendlines, pivot points, previous market highs or lows, Fibonacci levels, or chart patterns.

Ultimately, you will likely place stops and targets or enter trades at areas you believe will hold as support or resistance. If you are correct in your assessment, you will have identified a low-risk trade set-up.

Support and Resistance adhere to the hierarchy of timeframes, meaning support levels on a monthly or weekly chart will be more valid (or significant) than those on a daily or intraday timeframe.

Also, Support and Resistance adheres to the “Polarity Principle,” wherein old support levels, once broken “change polarity” and are expected to become new resistance should they be tested again (and vice versa).

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The Basics of Charting a Stock

You’re looking at a stock chart for the first time - where do you start?! What do all those lines mean?

Price data is often plotted on the vertical or Y-Axis while time data (minutes, days, weeks, months) is often plotted on the horizontal or X-Axis. The goal of reading a chart is to determine where price has traveled over a given period of time and determine potentially where it might be going through studying past and present price data.

There are a few popular methods of representing price action on a chart, including the following:

1. Line Charts often reflect the period’s close only, operating under the notion that the close is the most important piece of information, as it reflects the sentiment of all market participants willing to hold positions overnight. A line chart “connects the dots” of each period’s close and is well-suited for trendline or price trend analysis. Line charts eliminate the period’s open, high, and low and allow you to focus on how price is moving from close to close.

2. Bar Charts reflect the open, high, low, and close of the period and are drawn as vertical lines with small hash marks to reflect the open and close. Sometimes a bar chart will only show the high, low, and close. Traders find bar charts represent the data simply, yet provides more information than Line Charts. Bar charts can compress the data, which allows you to see more bars at a time and thus ascertain the trend or applicable price patterns more clearly.

3. Candle Charts emphasize the price difference between the open and the close, while also showing the period’s high and low similar to Bar Charts. Some traders believe Candle Charts have advantages over Bar Charts because the period’s action is easier to visualize, and many believe “candlestick patterns” hold a major key to seeing the balance between buyers and sellers play out over time.

There are other types of charts, including Kagi Charts, Gann Swing Charts, Point and Figure Charts, and Renko Charts - it is generally advised to begin with Line, Bar, and Candle Charts before moving on to these other forms of charting, although some traders utilize Point and Figure charts exclusively.

Indicators on Charts

Most traders want to see more information on a chart than just the period’s open, high, low, and close. They want to use indicators to help them see insights into price behavior that may be developing.

It is quite common to see Volume Bars on charts, which reflect trading activity over a given period. Generally, volume is displayed at the bottom of a price chart.

Moving Averages are usually overlaid with price data and are also scaled on the Y-Axis. These can be helpful in determining a price trend or to find possible support or resistance levels.

Oscillators and other indicators are often displayed either above or below the price data, depending on the trader’s preference. These can include simple or complex indicators which can reflect volatility, price swings, momentum, rate of change, or other derivations of price or volume.

Sometimes a chart may show more complex, hand-drawn annotations such as Elliott Wave Counts, Fibonacci Retracements, Cycle notations, or Gann angles. Generally, these are placed on a chart by the trader, and not automatically by a computer program.

I advise you to play around with the chart settings that you understand and feel adds value, but once you settle on a workable set of parameters, you need to “train your eye” to recognize these settings and not adjust them too frequently.

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Bull Flags and Bear Flags

Bull and Bear Flags are one of the simplest and potentially profitable patterns in chart analysis. Generally, this is because one can achieve a “Dual Edge” in trading the pattern, meaning the pattern tends to ‘work’ more times than not, and when the target is achieved, it yields more profit (up to two or three times as much) as the stop-loss that is incurred when the pattern ‘fails.’
Let’s look at the idealized representation of this pattern:

One cannot predict the initial impulse - known as the “flag pole” - that creates the patern, nor can one accurately predict the retracement that constitutes the “Flag” portion. The pattern derives its edge and opportunity from a price break-out above the upper trendline that forms the “Flag” portion of the move. We expect a “Measured Move” to occur which gives us a potential price projection, and location to place our stop (beneath the lower trendline of the flag) if we are incorrect.

Here are two examples of the pattern in action:



The first chart is Corn Futures on the Weekly Chart while the second example is the DIA (Dow Jones ETF) on a 5-minute chart - both selected to demonstrate the applicability of this pattern on all timeframes.

The following summary is specific trading instructions for the pattern:

Why do I like this pattern?

It is relatively simple to identify, only uses price (no complex indicators), and the stop-loss along with profit target projections are clear.

What does it look like?

Graphically, the pattern is comprised of a large volatility upward impulse move (which resembles a ‘flag pole’) which is then followed by a retracement that occurs downward in a near 45 degree angle. After this retracement is complete, a ‘measured move’ component breaks back to the upside which is roughly equal to the original flag pole portion.

The first component is the ‘pole,’ which you often can’t detect as it forms. It is the second component that creates the ‘trade.’

Once you see a clean retracement against a large, near vertical price move, this is your clue to begin looking for this trade. If the retracement is bound by near parallel channels which form a 45 degree angle, then this increases your confidence that a flag pattern is occurring.

If the retracement pulls back to the 20 period (or some other) moving average, or some other area of perceived support, this adds confidence to this pattern.

Entry

Generally, once you see price retrace about 50% of the initial ‘pole’ or price comes into a support zone, this would be your entry. If you are an aggressive trader, you can enter as price continues downward in the retracement in anticipation of a reversal. Generally, you’ll fall victim to less slippage and will get a better position if the measured move occurs.

If you are more conservative, you can actually wait for the price to break out of the upper channel and enter at that point. You’ll sacrifice initial trade location, but will put the odds a little more in your favor.

Stop and Target

Where do you place your stop and where do I play for a target? It depends on your style of trading.

The stop should go a ‘comfortable’ distance beneath the lower trend channel of the flag portion. Again, if you are conservative, you can place it just beneath the support zone or bottom trend channel.

If you’re more aggressive, you can place the stop lower than this zone, or even beneath the initial pole (of the impulse).

Keep in mind that you have a clear target once you establish your trade, and so you can easily cut that target in half to establish a clean 2 to 1 reward to risk ratio.

The target is an equal distance of the pole which is added to the bottom of the lower trend channel in the flag.

Example: If the ‘pole’ impulse is $5.00 (taking price from $40 to $45), and the retracement takes price down $2.50 to $42.50, then the ‘measured move’ target would be $42.50 + $5.00 or $47.50. Your stop could be placed where you are comfortable beneath $42.00.

Where does it occur?

This pattern occurs on any of the intraday time frames and the daily timeframe of ETFs, indexes, and futures contracts. Unfortunately, this pattern occurs less frequently on the weekly charts (though the targets are larger) and especially the monthly charts. Classic technical analysis books say that a ‘flag’ portion of the daily chart must unfold in 4 weeks time.

For a detailed explanation on how to use TradeStation specifically to project the target for a flag, visit the post “How to Project a Measured Move of a Bull Flag.“

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Double Top and Double Bottom

The Double Top and Double Bottom patterns are quite common and easily recognizable chart patterns which occur on all timeframes and in all markets. Let’s take a closer look at this classic reversal pattern.




The image on the left represents an ideal Double Top Formation (which is the mirror image of a Double Bottom) while the chart on the right represents a Real World example.

The Double Top is a Reversal pattern that is expected to occur after a lengthy upward advance in price. Buyers push prices to new highs on the first impulse up and then profit taking pushes price to a normal down-swing. Buyers step back in on the pullback but are unable to exceed the previous peak in price as sellers begin to unload their inventory, contributing to the supply/demand imbalance as price fails to make a new high and then reverses at the prior resistance level.

How to Trade a Double Top or Double Bottom

Generally, you won’t be able to act upon the pattern until price begins to reverse at the prior resistance level. You can increase your confidence that the pattern is forming if you find one or more of the following:

• Price is ‘bumping up’ against a prior resistance level from a past price
• Price is ‘bumping up’ against a key moving average on a particular timeframe
• Price has achieved a Fibonacci or other Price Projection Target
• A Negative Momentum Divergence has formed on the Second Price Swing
• A Volume Divergence has formed on the Second Price Swing (lower volume than on the first swing)

Once you believe price is experiencing a Double Top formation, enter short as closely as possible when price begins to inflect (turn down) at the previous resistance price. Place your stop just beyond the prior swing high. If the pattern resolves into a true trend reversal, you will stand to profit from the pattern as a low-risk trading opportunity.

You can obtain a Minimum Price Objective by measuring the distance from the resistance line (price at which the Double Top forms) down to the support price at the middle swing of the pattern. Take this value and subtract it from the middle-swing support price to obtain an initial target.

All rules would be reversed for trading a double bottom.

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Head and Shoulders

The Head and Shoulders Chart Pattern might be one of the most well-known and easiest to recognize patterns. It’s classically known as a Reversal Top Pattern, though the less common “Inverted” Head and Shoulders Pattern is known as a Bottom Reversal Pattern.

The Head and Shoulders Pattern (H&S) forms after a large uptrend when price is forming a “topping” pattern of declining strength. Below is a good example of the pattern which preceded the absolute top in the particular stock:


Price formed an initial rally and retracement that later became the Left Shoulder before finding support and rallying to new highs to form what later became the “Head” and then price fell back to trade at the support from the prior low. At this point, we might suspect we have a H&S pattern but we would need to wait for a lower high to form which would make up the right shoulder to complete the pattern.

Indeed price does form a lower high and comes back to trade at the neckline, or the horizontal line that connected the various price lows. Only then can we trade the pattern with any confidence.

How to Trade a Head and Shoulders

Once you see the three swings that comprise a H&S pattern, you can sell-short once price trades beneath the “Neckline” support level and place a stop above the swing high of the Right Shoulder.

What’s interesting about the H&S pattern is that it has a built-in “Measuring Objective” or “Price Projection Target” when price breaks beneath the support line of the neck. Traditionally, we would measure the distance from the Head to the Neckline and then take this distance and subtract it from the Neckline once price breaks below it for a Price Objective.

If the Head peaks at $100 and the Neckline is established at $80, then once the price breaks below the Neckline out of the Right Shoulder, we would then subtract $20 (the distance from the Head to the Neckline) from $80 (the Neckline) to give us a price projection target of $60. The blue dotted vertical lines represent the Measuring Objective on the chart above.

Volume and Psychology Insights

Analyzing Volume can help you confirm the pattern as it is developing, which can raise your confidence of having a higher probabily trade. Keep in mind that as the Left Shoulder is forming, investors are bullish and may be aggressively participating (buying) the stock, so we would expect to see enthusiasm and high volume forming on the Left Shoulder - nothing seems amiss.

The Head forms a higher high which is promising to the Buyers, but often we observe a divergence in volume and perhaps momentum oscillators as well. While price is making a higher high, fewer shares are being exchanged and the process of “Distribution” may be underway. Remember a rally needs buyers to keep it going, and price can rise with lower volume, but that is a clear warning sign that something is not right - or what is known as a “Divergence” or “Non-Confirmation.”

The Right Shoulder forms a lower swing high and often we see far less volume here than on the Left Shoulder or perhaps the Head. Investors might begin to recognize this classic pattern forming and may be preparing themselves to sell should price break the horizontal support line that has been established. There may still be bullish sentiment present, but it may be reduced over the enthusism that created the “Head” or absolute price peak.

Once price manages to break beneath the known support line (the Neck), many aggressive traders will begin shorting at this point and those holding positions will likely begin selling them, which can create a surge of volume along with a quick acceleration of price to the downside as more and more investors begin to suspect the stock has put in a top.

In short, expect to see high optimism and high volume on the left shoulder, reduced volume and high to moderate optimism on the Head, and reduced volume and skeptical if not moderate optimism on the Right Shoulder and then a flight to exit (or establish a short trade) once price breaks the neckline which should be confirmed with a spike or rise in volume.

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Rising Wedge and Falling Wedge

Rising and Falling Wedges are one of the most interesting patterns in technical analysis and pattern recognition. What distinguishes them from triangle consolidation patterns is that price forms an upward or downward sloping coil that precedes the price move. Ascending or Descending Triangles have one trendline that is parallel to the X-Axis while neither trendline is parallel in Wedge Formations.

Here are two examples of the Rising Wedge Pattern, with the first being an Idealized Representation while the second is a real-world example.



What characterizes the Wedge pattern is the converging slope of both trendlines. The trendlines converge to meet at the Apex, though price is expected to eject out of the pattern prior to reaching the full apex (point at which the trendlines converge).

Classic Technical Analysis states the following:

• Rising Wedges are Bearish Reversal Patterns
• Falling Wedges are Bullish Reversal Patterns

While this is not always the case, it is the classic interpretation of the pattern, which gives excellent risk-reward when traded.

How to Trade the Wedge Patterns

For this example, let us assume we have a rising wedge that forms after a lengthy price advance. Let us assume the pattern is a bearish reversal pattern and we are expecting a market top.

A rising wedge needs at least four ‘touches’ or tests of a trendline to confirm the pattern. Remember, a trendline needs at least two points to confirm it as valid. Generally, upon the fourth touch (or test), we would want to be waiting to enter on a breakdown of the lower trendline and place a stop above the upper trendline.

For a more aggressive method of trading rising wedges, you can enter short inside the consolidation inside the 5th swing in price to try for a better execution price. For falling wedges, you would buy on the 5th swing inside the converging trendlines and place a stop beneath the lower trendline.

Most wedges will break-out of the consolidation range anywhere from 66% to 80% of the way to the apex, though some wedges can wait until price reaches the apex for the actual breakout to occur.

Volume Confirmation

The wedge is a consolidation pattern, and as such, we would expect to see the volume trend decline (reduce) as either the Rising or Falling Wedge pattern develops, and then expand as price breaks outward from the pattern. Your confidence is decreased if we see volume surging during the formation of a suspected wedge.

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Rounded Reversal

The “Rounded Reversal” Pattern occurs most frequently on the Intraday Charts but it can also provide excellent trading opportunities on higher timeframes.

The Rounded Reversal is similar to the classic “Saucer Top and Bottom” chart pattern, both of which are trend reversal patterns that occur at tops and bottoms.
In this example, Sears Holdings (SHLD) formed an ideal “Rounded Reversal” Pattern on January 21st, 2009 into the 2:00pm lows on its 5-minute intraday chart, giving nimble traders an excellent opportunity.

A Rounded Reversal - in this case - occurs after a downtrend in price as price begins to consolidate at the lows. Often, one can draw an arc around price into the lows as price finds support and then gently begins to rise at the same angle as it declined, forming a Saucer Bottom or symmetrical price arc.

The hallmark of a “Rounded Reversal” bullish pattern is a Positive Momentum Divergence into the new price lows as price begins its initial arc to the upside. In this case and many others, price will form a doji or other reversal candle pattern on the lows combined with a positive momentum divergence.

How to Trade a Rounded Reversal

In this case, we will describe an example like the SHLD chart which represents a Bullish Rounded Reversal. Observe price as being in a downtrend and making new lows, but notice that price seems to consolidate or ‘arc’ at the lows. If price begins a gentle ‘mirror image’ swing off these lows, chances are that price is forming a simple Rounded Reversal Pattern and that you are witnessing the price lows in the making.

Increase your confidence of trading this pattern by observing a Positive Momentum Divergence with the price lows and try to confirm this development with a higher timeframe support area or accompanying reversal candle.

Enter as close as you can to the suspected price lows as price begins to swing back to the upside and place your stop beneath the price lows formed on the most recent downswing.

A Rounded Reversal does not have a built-in price measuring objective, as it is a trend reversal pattern, and traders have found success using Trailing Stops to capture the full reversal these patterns can deliver.

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Three Push Pattern

The “Three Push” Pattern is a more modern chart pattern that often needs a Momentum Oscillator to confirm its development, though with practice, you can recognize the pattern without the aid of an oscillator.


In this example, we see both a Bullish and Bearish “Three Push” Pattern Reversal on the same chart. The “Three Push” Pattern is a Reversal or Exhaustion Pattern.

To confirm the pattern, we need to see three similar price swings that resemble each other that make subsequent new lows (or new highs). However, the three swings are close together and are roughly symmetrical to each other. The defining characteristic of the “Three Push” Pattern is a Positive Momentum Divergence for a Bullish Three Push (2000-2002) or a Negative Momentum Divergence for a Bearish Three Push (2003-2005).

The particular Momentum Oscillator you use is not as important as identifying the three symmetrical price swings. For this example, I am showing the “3/10 Oscillator” which is a variant of the MACD Indicator with inputs 3, 10, and 16.

Trading the “Three Push” Pattern

In this example, we will assume we have a Bullish Reversal “Three Push” Pattern as in the first part of the chart - reverse the instructions for Bearish Reversals. Price must be in a downtrend and be making new lows. However, you may notice price swings are contracting (shrinking) and perhaps your oscillator is showing a positive divergence (where price makes a new low but your oscillator makes a higher low). Begin watching the price closely and if price makes a third narrow price low but your oscillator registers a second higher low, you have increased confidence the pattern is developing and need to take action (enter) soon.

Enter when you feel the price is beginning to reverse off the third price low and place your stop a comfortable distance beneath this low. There might not be a logical prior point on which to base your stop - aggressive traders will place a wider open stop-loss while conservative traders will prefer to place a tighter, closer stop-loss. Remember that you are trading counter-trend and try not to give too much room for price to move against you.

Since the pattern is a Reversal Pattern without a Measuring Rule (or built-in Price Objective), this pattern works well for position traders when it occurs on the higher time frames. You will need to use other methods to exit the trade, as you will have the potential to enter a trade as close to the price low preceding a trend reversal as possible. Many traders find it acceptable to use Trailing Stops when trading this pattern.

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Triangles

Though we can get caught up in specifics when analyzing triangles, it’s often best to view them for what they really are: Consolidations in Price. Whether they are continuation or reversal patterns can be misleading at times. Let’s look at a few types of triangles and see if we can get a better grasp on these common yet powerful patterns.

Definitions

Triangles are best defined as a pattern exhibiting two converging trendlines that converge at an apex.


There are three basic types of Triangle Patterns:

1. Symmetrical Triangle : When the upper and lower trendlines converge at roughly the same angle.

2. Ascending Triangle : When the upper trendline is horizontal and the lower trendline is rising with higher lows.

3. Descending Triangle : When the lower trendline is horizontal and the upper trendline is descending with lower highs.

A triangle needs a minimum of four points (price ‘tests’) to be valid - two upper tests and two lower tests, which is the same definition for establishing a valid trendline. The significance of a triangle is similar to that of trendline significance and validity.

Classic Technical Analysis teaches that Symmetrical Triangles are more frequently Continuation Patterns than Reversal Patterns, and that Ascending Triangles are “Bullish” while Descending Triangles are “Bearish.”

The logic behind this is the following

Symmetrical Triangles represent pauses or consolidations in a trend move. The expectation is that when the counter-trend movement works itself out, price will break-out of consolidation and resume the prevailing trend.

Ascending Triangles are expected to be bullish, because the assumption is that there is a level of resistance or sellers at a certain price wishing to unload inventory, and buyers continue to purchase shares at higher price levels after each downswing, and once this resistance is lifted, the bullish “valve” is opened and price can move forcefully upwards now that the selling pressure has ended.

Descending Triangles are bearish for the opposite reason - that there is a level of support wherein buyers consistently purchase shares, though sellers are becoming more aggressive on each up-swing in price and when the support is broken - or buyers have purchased all they want to purchase - then sellers will dominate in an impulse-style move down.

Keep in mind these are classic generalizations, and not certainties. One can always find triangle patterns that defy classical wisdom.

It is generally best to identify triangle patterns as consolidation patterns only and be prepared to expect an impulse out of consolidation once price has broken out of the pattern without becoming overburdened with bias or expectations regarding in which direction the break will occur.

Also, price generally does not ‘wait’ until it reaches the apex, or point at which the two trendlines converge, to break out of the pattern. Most triangles break out of the pattern between 66% and 75% of the distance from the start of the formation to the apex price.

Measuring Rule

All triangle patterns contain an inherent “Measuring Rule” or Price Projection Expectation. The rule is to take the height of the triangle - the distance between the upper and lower trendline when the pattern first began (or the highest points) and then whenever price breaks out of the pattern, add or subtract this value from the breakout price to arrive at your price projection target.


In this example, the descending triangle began at $100 per share and found support at $80 per share, giving us a height of $20. Price broke out of the pattern at $80 per share and formed a “Throwback” or “Pullback,” which is common in triangle formations. Generally, the throwback provides the highest probability of a successful trade, if it occurs. We then subtracted $20 from the support level at $80 to arrive at a price projection target of $60 per share.

When trading a triangle formation, it is best to place stops above or below the opposite trendline (in this example, it would have been best to enter short around $80 per share and place a stop above the upper trendline near $85). Always make sure your price projection target is larger than your expected stop-loss price.

Triangles can be profitable trading patterns, are often easy to recognize, and offer easy to locate targets and stop-loss prices.

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Introduction to Elliott Wave

The Elliott Wave Principle has become a dividing force among traders, with some wholeheartedly embracing the principles while others deem them impractale, imprecise, or worthless. Who is right and can someone really make money by counting five waves?

In general, the Elliott Wave Principle is one more tool you can use in your trading arsenal or one additional method to view the markets in a unique way. How you apply it is up to you, though some traders have been extraordinary successful applying the principles to their own trading.

Perhaps the Elliott Wave Principle is best in the statement “It is not about where the market is going, but about where the market is unlikely to go.” Moreover, it is a method that is useful for establishing a possible larger structure and then identifying low-risk, high probability trades that create edge over time. The Principle can be helpful for broadening your awareness of a market character and possible direction while providing you key areas to enter that allow for tight risk-control in the event that your analysis is wrong.

The principles of Elliott Wave that we reference today were ‘discovered’ by Ralph Elliott in the 1930s which were inspired by Charles Dow and others. Mr. Elliott described repetitive patterns in nature that translated into the Equity Market in terms of repetitive waves and the fractal nature of the Wave Principle. Most traders today are introduced to the Elliott Wave Principle through A.J. Frost and Robert Prechter’s The Elliott Wave Principle: Key to Market Behavior which is known as the resource for modern day traders.

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Elliott Wave Cheat Sheet 1 Basics and Introduction

First, a complete Elliott Wave pattern has 8 waves: 5 during the “impulse” phase and 3 during the “corrective” phase.


Elliott Wave is a fractal concept, so look closely at Wave (1) and Wave (2). The entire 8-wave structure that comprises the first and second wave is exactly the same as the complete 8-wave structure that completes the whole chart, which itself might be a larger Wave 1 and Wave 2 of a higher timeframe. It is important to understand that Elliott Wave is fractal.

In an impulse (an uptrend, for simplicity), Waves 1, 3, and 5 will ’subdivide’ into their own smaller 5-wave affairs. Waves 2 and 4, which move against the larger trend, have a 3-wave structure. This is an expansion of “Charles Dow Theory” which states that uptrends (bull markets) move in three phases (accumulation, realization, distribution). Elliott only adds the natural corrective waves into these three phases. Mr. Dow also made note of fractal trends (Primary, Intermediate, Minor).

In reality, Elliott Wave principles are just additions or specifications to Charles Dow Theory.

Speaking of Corrections, here are the ‘ideal’ corrective phase types:


There are actually 13 corrective patterns which are combination of these, but for simplicity, let’s focus on these four types of corrections.

The notation in parenthesis refers to the number of smaller waves in the lettered phase (corrections always use letters). With the exception of a Triangle, Wave C will always have 5 waves. Without exception, Wave B will always have 3 waves. With the exception of a Zig-Zag (my favorite correction, which resembles a ‘bear flag’), Wave A will always have 3 waves.

For specific information, view 10 Free Lessons on the Elliott Wave Principle as taught by Robert Prechter by joining Club Elliott Wave International.

Source : here

Basic Elliott Wave Labeling and Fractals

This post will discuss proper fractal wave labeling within a developing Wave Structure on all timeframes.

First, we understand that the principle is fractal, meaning a complete five-wave impulse up might just simply be part of Wave 1 or Wave 3 (or Wave 5) of a larger complete wave structure, which itself might be part of an even larger wave structure.

This image of the Sierpinski Triangle should give a visual image of how to visualize Elliott Waves as smaller and larger fractals making up a full picture:


This image from Flickr (via Meister Schlauch) shows how the complete, singular triangle is actually comprised of four identical triangles (look very closely - three filled in triangles are pointing up while a clear/hollow triangle is pointing down). And if you look at one of the filled triangles, you’ll see the exact same repetition, just on a smaller scale. And if you look inside one of the filled triangles of that fractal, you see the exact same pattern that comprises the whole, singular triangle one degree higher.

This is how to understand Elliott Wave Fractal ‘waves within waves.’

Here is how to label most waves you’ll encounter if you’re not a deep-level Elliottician:


Most likely, you won’t go above the Primary Trend or below the Minute trend on a singular chart, so this simple guide should be sufficient.

The largest wave would be circled, one degree lower would be placed in parenthesis, one degree lower would be a normal number (or letter), and then one degree below that (usually intraday) would use the Roman Numerals.

It goes without saying that, while this is the proper and accepted guideline, it’s common to see various counts depending on the analyst, but Elliott purists would consistently use this methodology.

This way, if you’re trying to read an Elliott Wave forecast, you’ll know the logic behind why the analyst used the labeling system he or she chose.

Here is an example of proper fractal wave structure labeling on the S&P 500:


As mentioned earlier, the 3rd wave will subdivide into its own 5-wave structure. However, each wave of the 3rd wave subdivides into its own 5-wave affair. I’m only labeling the 3rd wave of each respective fractal down to four degrees of a fractal count to show you how waves subdivide within waves, and to show how to label (or interpret) different degrees properly.

View 10 Free Lessons on the Elliott Wave Principle as taught by Robert Prechter by joining Club Elliott Wave International.

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The Best Trades to Take in Elliott Wave

While these might seem counter-intuitive, look very closely at these low risk, high probability opportunities as they develop. Many people who use Elliott Wave do so for key “Sweet Spots” rather than count endless waves incessantly.

They’re just looking for a “Third of a Third” or to get short after they think they see a complete 5-wave structure. Use Elliott Wave however you see fit and however it works for you - just like any of the hundreds of technical indicators out there.

The following chart shows the “ideal” trades one can take from a developing Elliott Wave structure:


First, let’s assume that we’re coming off a downtrend, or that the first green arrow up begins after a C wave down has completed. For quick reference, in order from left to right, Wave 1 is up; Wave 2 is down; Wave 3 is large up; Wave 4 is down; Wave 5 is up; Wave A is down; Wave B is up; Wave C is down - I didn’t label them in the chart to keep it from being cluttered.

Many proficient Elliotticians may disagree with me, but I believe it is either impossible or very, very difficult to ‘predict’ or label a first and second wave in real-time - especially for beginners. Elliott Wave becomes much easier once you see a large impulse - which is most likely Wave 3 - and then look backwards and see “Ok, I think I see Waves 1 and 2.” Once Wave 3 is in place, the rest of the ‘map’ is easier. There’s no guarantees, but it’s helpful for anticipating.

Wave 3’s power comes from shorts covering and longs getting aggressive - a ‘point of realization’ occurs… also known as a “Sweet Spot.” Aggressive traders can jump on board there as a trend changes from down to up. Though profitable, this is very difficult in real time.

The way I use Elliott Wave intraday and on shorter time frames is to recognize a large impulse and then wait to buy the first pullback into support. Maybe there will be divergences or price will pullback to a key Fibonacci ratio or a moving average. I don’t yet have a name for it but you’re trying to “Buy at the Bottom of Wave 4 and Trade Wave 5.”

This is a “Pro-Trend” trade and often subdivides into five fractal waves.

The top of the 5th wave often forms a momentum (or volume) or TICK (intraday) divergence into the highs, so it’s often low risk just because of that formation. Once you believe the “5th wave” has completed itself - it takes experience - then exit your long and flip short for an aggressive counter-trend trade.

If you miss the first opportunity, wait for Wave B to rise up and fail to make a new high and then enter short on that pullback. Often, the top of Wave B will form a Cradle Sell Trade and lead to a powerful Wave C trend reversal back down.

Here are the key trades to take as you perceive a possible 5-wave structure forming on any timeframe:

Buy as price crests above Wave 1 (this is during wave 3)
Buy as price comes into support after a large impulse Wave 3
Sell Short as price crests with divergences into the peak of Wave 5
Sell Short as price rises but fails to make a new high at the Peak of Counter-Wave B

View 10 Free Lessons on the Elliott Wave Principle as taught by Robert Prechter by joining Club Elliott Wave International.

Source : here

Tips and Tricks of Trading Psychology

Here, we will be compiling different “Tricks and Tips” in the field of Trading Psychology. Keep checking back for more ideas and feel free to submit your own suggestions.

Keep a Stopwatch handy.
If you are more prone to negative emotions in trading, it can be a good idea to keep a stopwatch by your desk and time how long it takes you to experience a given emotion when trading. Keep a notebook of how much time it takes you from the moment you feel the fear or the greed until the moment it passes. It may seem silly at first, but what you’ll learn that your emotions are not permanent and they always pass no matter how bad they may seem at the moment. In cataloging your experiences, you’ll likely find that it takes less time to experience each emotion and that you know that it will end, instead of being worried it will never end.

Keep an Emotions Notebook.
We know we’re supposed to keep a Trader’s Notebook or Trader’s Journal to catalog our trades and experiences, but sometimes it can be helpful to keep a specific notebook dedicated to your trading psychology experiences. If you’re more likely to experience emotion, it can be helpful to write it down and organize it, so that you can reference your experiences and gain insight from them. In essence, you’re turning your emotions into a positive source of information for the future. Write down what you’re feeling, what triggered the emotion, how long it lasted, and any additional observations.

Source : here

Controlling Greed

Greed is often more discussed in the literature of Trading Psychology because it’s an easier topic to discuss than fear. After all, we trade to make money, and it’s easy to let that impulse dominate us and get carried away, particularly if we are experiencing success. What’s so wrong with greed anyway?

Greed by itself or in moderation might not be so bad, but it’s when the greed emotion takes over and causes you to act either against your plan or your best interests that it becomes problematic.

Greed can cause us to do any number of the following ill-advised trading behaviors:

• Buying in after a long rally just because we think price will always go up
• Not looking at the risk in a trade, or identifying an acceptable stop-loss
• Ignoring the need for a stop-loss
• Taking on a larger position than normal
• Rapidly increasing our position size because we think we can’t fail

Mainly, the market has a way of making us feel humble by giving us a loss when we feel most confident. We feel most confident after a big win or a series of small wins which causes us to alter our normal trading methods and behave outside of our plan. When we feel most confident, we focus on how much the market (trading) can GIVE us instead of how much we can lose - in short, we discount the risk of the marketplace when we are experiencing excessive greed.

Source : here

Overcoming Fear

While some traders are more likely to fall victim to greed (”How much could I make?!”), others have experienced loss in the market to the point where all they can see is the fear and anxiety (”How much could I lose?” or “How much could the market take away from me?”).

Let’s look at some resources to help us cope with these fears.

I recommend beginning with Price Headley’s article “The Four Fears of Trading” which lists and explains each type of fear - it’s more than just being afraid to lose money. Headley lists the fears as the following:

1. Fear of Losing Money
2. Fear of Missing Out (on a Move)
3. Fear of Letting a Profit Turn into a Loss
4. Fear of Being Wrong (or not being right)

Furthermore, I compiled a page of helpful resources and articles on the Blogsite that lists additional resources from various authors.

When we’re in a trade that we expect to be right and make money, but the price begins moving against us, we quickly feel the fear or anxiety. We might have a stop-loss placed, but as price heads to that level, we may feel intense anxiety. Worse, if we don’t have a stop-loss, we may develop the “Deer in the Headlights” syndrome where we freeze up, unable to take action as price moves quickly against us and the loss increases.

However, fear goes beyond “Losing Money.” It can cause us to jump into a price move, ‘afraid’ that we’re missing out on the move. It can also cause us to exit a trade far too early (before it hits our profit target) under the “fear” of leaving money on the table (or specifically, “Letting a profit turn into a loss”). To overcome it, we’ll hit the exit button on a trade that is showing a small profit when if we had more confidence and executed our plan, we would have gained a larger profit.

When we feel the fear, we might take sudden steps to overcome it, whether that results in jumping out of, or into a trade. It’s critical not to let the fear lead to unhealthy behaviors, habits, or harmful coping mechanisms such as alcohol abuse.

Source : here

LEARNING MENU

1. BASIC

• The Voices of Volume
• The Basics of Trendlines
• The Basics of Support and Resistence
• The Basics of Charting a Stock

2. CHART PATTERNS

• Bull Flags and Bear Flags
• Double Top and Double Bottom
• Head and Shoulders
• Rising Wedge and Falling Wedge
• Rounded Reversal (Scallop, Saucer Bottom, or Cup and Handle)
• Three Push Pattern
• Triangles

3. ELLIOTT WAVE

• Introduction to Elliott Wave
• Elliott Wave Cheat Sheet 1 : Basic and Introduction
• Basic Elliott Wave Labeling and Fractals
• The Best Trades to Take in The Elliott Wave

4. TRADING PSYCHOLOGY

• Tips and Tricks of Trading Psichology
• Controlling Greed
• Overcoming Fear