Long and short call or put options

Equal and opposite positions in the market for a fully hedged position (e.g., hedging one long position with an equally sized short position)

Figure 26.14

igure 26.13

Generally speaking, with the exclusion of late entries, the higher the price of a long entry, the more aggressive in price and conservative in time of entry it becomes

Support levels for longs and resistance levels for shorts

WCS

gure 26.8

At extremely high levels of leverage, the concept of aggressiveness and conservativeness with respect to the price on entry or exit di-minishes rapidly

gUre 25.4

Very late short or long entries with respect to support or resistance ■ Very early or premature long entries above support in a downtrend (both aggressive) ■ Very early or premature short entries below resistance in an uptrend (both

Long entries taken below resistance in an uptrend ■ Short entries taken above support in a downtrend ■ Long entries taken just below a failed support ■ Short entries taken just above a failed resistance

It should also be noted that the longer it takes for a consolidation to unfold, the larger will be the number of potential buy stop orders that lie above the resistance zone and sell stop orders that populate just below the support zone. This explains why larger consolidations tend to produce stronger and more persistent breakouts

stoplosses are es-sentially stop orders, which are trend promoting in nature

inhibiting in nature

security, index, or commodity

total short sales

Cash/asset ratio

$2 per hour over a 10‐hour period.

other third‐measure values over similar durations

ncrease in Price Fluctuations over Equal Durations Indicating Potential Rise in Volatility

over equal durations

we could not determine which stock was more volatile since the maximum amount of price change over equal durations were the same for both

exponential or parabolic

figure

Third‐Order Change

Second‐Order Change

First‐Order Change

gure 21.3

price change

Centered moving average

This is because the bands are adjusted with respect to actual price action over a certain period of observation

confirmation in the near or front month futures contract

A dominant cycle is the cycle that most influences price and market action within the observed time

igure 18.7

gure 18.5

bearish chart patterns within a falling channel and bullish chart patterns with a rising channel.

MACD

ounding tops and bottoms

gets may also be obtained based on the parallelogram itself

subside

rising channel meeting its minimum one‐to‐one downside price objective.

It cannot be projected into the future for potential barrier levels.

Many of the failed buy signals found on the chart in Figure 12.15 would have been successfully avoided or filtered out had the reversal entry breakout tech-nique been employed

Figure 12.11 is an example of tuning the fixed percentage bands to a domi-nant cycle on the four‐hour chart of GBPUSD. The trough‐to‐trough cycle period was 133 bars. Using the third formula would also yield ((2×133) +3)/4 = 67.25. Rounding to the closest integer would give us 67 periods or bars

Figure 12.4

Price below the central value is a bearish indication, but price below the lower band is considered much more bearish. Similarly, price above the central value is a bullish indication, but price above the upper band is considered much more bullish.

Notice that un-like double and triple detrending, which tends to remove lag between the oscillator and price, double and triple smoothing increases the price lag.

double detrending reduces the lag components between price and the oscillators

igure 11.22

gure 8.19

igure 11.21

seven-period

signal line

nine-period

Periods 2/Exponential Weighting Ratio 1

no lag with respect to price

THE HAnDbook of TEcHnIcAl AnAlySIS436In technical analysis, the average price is usually positioned at the last right-most bar on the chart, that is, at the current bar. This is the non-centered or end-displaced version of a moving average. It is technically incorrect to place the average price at the last bar, but in technical analysis this is done because it is being used as a barrier to price, that is, as potential levels of support and resistance, it is able to interact with price. Although there is no price lag in the centered version, the moving average does not extend to the most recent bars and therefore cannot provide a barrier to price.

Expansion

Figure 10.76

Fibonacci retracement levels (measured across the range AB)

Figure 10.69

diagonally. As a consequence, Fibonacci channel expansions will yield dif-ferent results depending on the type of scaling used on the charts.

logarithmic‐ or arithmetic‐scaled chart is employed

BC

Figure 10.51

the low of the day

Figure 10.36

Figure 10.35

Figure 10.34

even though both approaches will give the same results

Figure 10.27

Fibonacci downside extension level

Figure 10.26

Extension

423.6

261.8

161.8

127.2

38.2

23.6

61.8

78.6

⋅

extensions

Figure 10.9

Figure 9.101

Figure 9.93

This is because volume oscillators are constructed to take into account price

The rules for interpreting divergence are markedly different when it comes to vol-ume bar action, open interest, and average true range (ATR)

Figure 9.63

detrending is the MACD

signal line

nter Wave Cycle/Degree Divergence

nter peak or trough Double Divergence

current larger trend

Current and Prior Larger Trends

violating point 1

points 1 and 2

Divergence Analysis297this reason that it is referred to as standard divergence. However, reverse diver-gence involves comparing peaks in a falling market and troughs in a rising market and may be somewhat counterintuitiv

Logically speaking, comparing peaks in a rising market and troughs in a fall-ing market makes sense as market participants are psychologically more inclined to focus on new highs in a rising market and conversely on new lows in a falling market in order to make important trading and investment decisions, and it is fo

tandard Bullish

Remember that slope and reverse divergence are mutually exclusiv

thE hAnDbook of tEchnicAL AnALySiS292In general terms, basic reverse divergence occurs when: ■ Only price, and not the supporting data series, is making equal or lower peaks (based on adjacent peak to peak analysis) ■ Only price, and not the supporting data series, is making equal or higher troughs (based on adjacent trough to trough analysis).

1. Price is making higher peaks while the oscillator is making lower peaks 2. Price is making higher peaks while the oscillator is making equal peaks 3. Price is making equal peaks while the oscillator is making lower peaks

jacent peak to peak and trough to trough analysis.

peak and trough analysis

devoid of any visible peaks and troughs (F

reverse bearish

Defining Direction of the Current Larger Trend

collapse back to six

moving in opposing directions

adjacent peaks or troughs

George Lane

8.

To construct these pivot points, first find the previous day’s typical price. This represents the next day’s pivot level, PP

RS

stochastic

stochastic action

A signal line is a smoothed version of the original oscillator, that is, it is a moving average of the original oscillator values. As such, it will lag the original oscillator action. Signals are indicated as follows: ■ Oscillator crossing above its signal line is a buy (bullish) signal ■ Oscillator crossing below its signal line is a sell (bearish) signal

True Range Action of the Daily Chart of Gold. Source: MetaTrader 4

The difference between the previous close and the current high ■ The difference between the previous close and the current low

t is the difference between the MACD and its nine‐period

ignal line.

applying numerically based overlay indicators to window oscillators

We also see a projected channel bottom buy signal

Signals are indicated as follow

this coincidence of buy and sell signals by both oscillators in the chart example in Figure 8.7 above creates false consensus and may lead the trad-er into a false sense of confidence

Classification of Technical Indicators

Inside bars

the hAndbook of technIcAl AnAlysIs224inside Bars

Bullish Key Reversal Day on the Daily Chart of Apple

We shall now look at various generic bullish and bearish formations

onstruction of a Price Bar

Intrinsic

Equivolume

TRIN advances/declines / Up Volume/Down Volume=( ) ( )

Open interest is simply the total amount of outstanding contracts in the futures and options markets. Unlike stocks, all futures and options contracts eventually expire. Open interest is therefore the number of unliquidated long or short contracts.

Rising and declin-ing volume provide useful information about the level of interest or participation at various prices and indicate whether an ongoing trend is bearish or bullish

Price Barrier

It is important to note that overextensions in volume can signal either a top or a bottom. Extreme buying and selling activity generates volume and can result in either a top or bottom. That is the reason why we cannot use the terms overbought or oversold with respect to volume extremes unless we are able to associate volume with either a top or bottom formation. Therefore, although we are able to pinpoint overextensions in volume, it is only possible to identify overbought or oversold lev-els in volume after a top or bottom has already formed, that is, in retrospect

Low Volume–Based Reversals on the Daily Chart

Volume Blow‐Offs

Selling Climaxes

volume declining during a consolidation

reversal of the existing trend

irrespective

The bullish or bearish sentiment associated with volume action depends on the direction of the price

Volume Confirming a Preexisting Trend

A rise in volume indicates that market participants are interested in seeing the price go higher in an uptrend or lower in a downtrend and are willing to buy higher in an uptrend or sell lower in a downtrend in order to participate in the unfolding market action. 2. A decline in volume indicates that market participants are losing interest in seeing the price go higher in an uptrend or lower in a downtrend and are more willing to buy lower in an uptrend and sell higher in a downtrend, if not exit-ing positions in the market

Volume

open interest

5.9 trenD DireCtionaLity

ing limits the losses in either scenario by allocating a fixed percentage of original capital to narrow stops and a fixed percentage of current capital for stopsizes that exceed a fixed threshold size. The procedure for determining the proportional tradesize is as follows: 1. Do a backtest to find the average stopsize for at least 300 to 500 trades (if possible). 2. Calculate the two standard deviation value based on all the stopsizes in the sample. 3. Add this two‐standard deviation value to the average stopsize (this represents the proportional stopsize). 4. Determine the maximum percentage of current capital to risk for each trade and calculate its corresponding dollar value risk per trade. 5. Divide this dollar value risk per trade by the proportional stopsize (this repre-sents your proportional tradesize).Therefore, the trader would initiate trades based on the proportional trade-size for all trades where the stopsize is at or below the proportional stopsize. For stopsizes that exceed the proportional stopsize, calculate the tradesize by sim-ply dividing the maximum dollar value risk per trade by the stopsize. The term proportional refers to the percentage risk allocated per trade that is initiated for entries with stopsizes at or below the proportional stopsize. For such entries, the percentage of risk will vary proportionally with the stopsize, where the maxi-mum risk will always be capped at the maximum percentage risk per trade. For a more detailed description of the tradesizing issues that plague traders, refer to Chapter 28

wing points and barrier strength

Completion of the Average Period Range: One of the most reliable charac-teristics of price activity lies with its average period range, with the period being any chosen duration of observation. For example, let us assume that the average daily range of a certain FOREX pair is 120 pips per day. This would essentially mean that any price activity beyond this average range in either direction prior to the completion of the trading day will be regarded as a po-tential sign of exhaustion and a reversal may be expected. It is important to note that these averages period ranges may also be associated with underlying wave cycles in the market. Once the average range is breached prematurely, the practitioner begins to look for various signs of a reversal, paying special attention to supportive and resistive confluences. The average period range may be obtained via either of the following approaches: ■ The use of the average true range indicator (ATR) set to a reasonable look-back period on an interval chart of interest. ■ By finding the 2 standard deviation value of bar range over a certain number of periods.The practitioner should conduct a simple backtest to find the most reli-able lookback period for each of the above approaches. Note that with the latter approach, ninety percent of the period ranges will remain below the calculated value, the breach of which represents a greater degree of overex-tension or exhaustion

Decreasing Cycle Amplitudes in an Uptrend Is Bearish

Note that for bullish divergence in volume, falling prices must be accompanied by decreasing volume.

whipsaws

Phase‐Based Charts Patterns.

ntrinsically Bullish Patterns: ■ Bullish Pennants ■ Bullish Flags ■ Ascending Triangles ■ Inverted Head and Shoulders ■ Rounding Bottoms ■ Cup and Handles ■ Falling Wedges ■ Double, Triple, and Multiple BottomsIntrinsically Bearish Patterns: ■ Bearish Pennants ■ Bearish Flags ■ Descending Triangles ■ Standard Head and Shoulders ■ Rounding Tops ■ Rising Wedges ■ Double, Triple, and Multiple TopsIntrinsically Neutral Patterns: ■ Symmetrical Triangles ■ Horizontal ChannelsIntrinsically Bullish Patterns with Respect to Trend Sentiment: ■ Bullish Pennants occurring in an uptrend ■ Bullish Flags occurring in an uptrend ■ Ascending Triangles occurring in an uptrend ■ Inverted Head and Shoulders occurring in an uptrend ■ Rounding Bottoms occurring in an uptrend ■ Cup and Handles occurring in an uptrend ■ Falling Wedges occurring in an uptrend ■ Symmetrical Triangles occurring in an uptrend ■ Horizontal Channels occurring in an uptrend ■ Broadening Formations occurring in an uptrendIntrinsically Bearish Patterns with Respect to Trend Sentiment: ■ Bearish Pennants occurring in a downtrend ■ Bearish Flags occurring in a downtrend ■ Descending Triangles occurring in a downtrend ■ Standard Head and Shoulders occurring in a downtrend

In markets where the trading is continuous

The durations between active trading sessions are longer

industrial or transportation

give earlier trend change signals

The pricing of all known information need not be instantaneous or be driven by rational participants. There is also no requirement that all participants always act on all information all of the time, or that they react in the same manner.

he mechanism by which information is known to the market is that of actual participation via capital injection.

Markovian condition

Therefore, they cannot impact future prices

nstantaneously

Gradually

Efficient Market Adjusting to New Information

Conflicting Chart Pattern Signals.

Volatility Band