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| Index: |
1. The creation of the charts: types, terms, scales.
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| 1.1. Main Types of graph. |
| 1.2. Time frames. |
| 1.3. The Logarithmic Scale. |
2. Chart Patterns
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| 2.1. Reversal and Continuation Patterns. |
| 2.2. Head and shoulders. |
| 2.3. Rectangles: double and triple tops and bottoms. |
| 2.4. Triangular Formations: Congestion and Consolidation. |
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| 1. The creation of the charts: types, terms, scales. |
1.1. Main Types of graph.
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BAR GRAPH It is the most common graph used, particularly in time terms, the daily chart:
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The daily bar chart is a simple construction. Simply draw a bar whose top coincides with the high of the day and whose bottom is the low. It can be complemented with a horizontal mark on the left to represent the opening price, and on the right for the closing price.
The closing prices are particularly important with regard to breaking through support and resistance. |
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The prices are placed on the y-axis, while the time is placed on the x-axis. The daily trade volume is often added although this data is not always known.
In the case of a weekly chart instead of daily, the high and low are for the week. Similarly charts can be made monthly. Bar graphs may be more sensitive and each bar can also represent less than a day, even hours, 15 minutes, 3 minutes, etc.
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LINE GRAPH
This is the easiest graph, where only the closing price is considered(daily, weekly, monthly) along the time axis. It has the advantage of being simple and clean, but removes too much information when conducting technical analysis. It is therefore not advisable to use for any type of more comprehensive analysis.
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CANDLESTICK GRAPHS
This is a graph of Japanese origin which has come to be known as a candlestick or candle graph. A rectangle (known as the body)is used, whose top is the high and bottom the low in the case of a white (unfilled) candle. The rectangle may have upper and lower “wicks” which indicate the high and low for the term considered. The candle is black (filled) if the closing price is lower than the opening. Thus, information on the development of the day is clear and accessible, creating patterns of easy recognition.
In the figure on the left the rectangular body (distance between the opening and closing) is white, indicating a close above the opening. In the figure on the right the body is black, indicating a close below the opening. |
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1.2. Time frames.
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We can have several time frames for each graph. Here are some examples:
- Intraday (from tick to tick, hourly, three-hourly, at 5 min, 15 min intervals, etc.).
- Daily
- Weekly
- Monthly
- Etc
Intraday charts usually show more noise, because in such a limited term it is easier for a lack of liquidity to appear and therefore we can have gapping, in addition to high volatility. Daily and monthly charts are the most used; from monthly and up, the time frame is usually too high for nothing but very long term movement.
EXAMPLES:
Intraday 60 min - bar chart
Intraday 1 min - candlestick graph
Weekly - line graph
monthly - candlestick graph
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1.3. The Logarithmic Scale.
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By studying high volatility value evolution (e.g.in the technology and real estate sectors), graph studies need to figure a measure of percentage evolution. The study of the price logarithms evolution allows exponential series to be treated with greater precision. This is called the logarithmic scale (or semi-logarithmic scale because it affects only the y-axis), as opposed to the traditional arithmetic or linear scale.
- In practice, the semi-logarithmic scale is similar to the percentage scale. The same appreciation percentage occupies the same space on the graph, instead of the equivalent amount of euros. In the arithmetic scale, a step of 2 to 4 euros is twice that of 1 to 2 euros, while the same logarithmic scale takes up the same amount of space since both involve an appreciation of 100%.
The problem that the logarithmic scale presents is shown at higher levels. Since the logarithmic comparison is made with respect to much lower prices, the trend in higher bands can only be properly appreciated if the pace of movement is maintained.
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For example, examining the evolution of Yahoo! during the technology boom, there are two strong bullish movements, one from the area of $ 2 to $ 122 and another from $ 55 to $ 250. The logarithmic scale, as shown in the figure, heavily underestimates the movement from 55 $ to 250 $ since, compared with that between $ 2 and $ 122, there is a little appreciation. |
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For example, examining the evolution of Yahoo! during the technology boom, there are two strong bullish movements, one from the area of $ 2 to $ 122 and another from $ 55 to $ 250. The logarithmic scale, as shown in the figure, heavily underestimates the movement from 55 $ to 250 $ since, compared with that between $ 2 and $ 122, there is a little appreciation. |
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| 2. Chart Patterns. |
2.1. Reversal and Continuation Patterns.
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These patterns refer to a change in trend; and the trend rarely changes suddenly. It usually takes time. During this time the trend is not valid, of course, and the price moves sideways.
The other possibility with sideways movements is that after the interim period we have continuation of the trend. It then forms a continuation or consolidation trend shape, generally due to excessive prices which must be corrected. Once the market has corrected the excess, is prepared to continue the trend.
Knowledge of these patterns is a great aid to our analysis. With few exceptions, we must wait for the confirmation of the figure. Confirmation occurs when the price scopees certain critical level. Sometimes we expect one type more than another, for example if, after a five wave fall a reversal or consolidation figure occurs, we tend to think reversal is more likely.
Sometimes we do not need to wait for the confirmation of the reversal figure because there are many other indications of reversal. For example, in the event of breaking a steep trend line, coming back to the line with low volume, in addition to finding divergences in the indicators, the chance of reversal is very good. In this case confirmation should not be waited for, but there are few exceptions of this type.
Another exception is found in the case of panic selling or the climax of high volume purchasing, when the price returns to the same level with low volume, and offers a unique opportunity to buy or sell. In these changing trends, the distribution of stocks, contracts, etc. or the accumulation of the same occurs before trend reversal. The trend does not usually turn abruptly, but it can do at times.
- Some patterns can be both reversal and continuation. For example, triangles and rectangles.
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2.2. Head and shoulders.
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Consider one of the best known and reliable reversal patterns; confirmation is particularly important both for the pattern as well as the volume of movement. If this is not checked, it will not be a H&S
The figure below shows an ideal pattern. In the first shoulder (s1) there is an increase in volume, which is normal. At the head (H), the following high, there is a smaller volume and the price falls back to the correction level of the first shoulder (the trend is probably broken). The final recovery (s2) arises from the purchasers considering this support level as "cheap". The volume is low anyway and does not recover the previous high. Finally support is broken at the neck line (cl). A "pull back" attempt is often found at the neck line, which now acts as resistance before continuing its journey in the opposite direction.
N.B: It is interesting to note that not all markets have volume data available, which complicates the interpretation of the pattern.
The decisive factor in the pattern occurs when the price penetrates the neck line.. In support and resistance breaks the volume is important. It is never a deciding factor but it helps to clarify what is happening. If the neck line is broken with low volume, it is easy for pullback to the line to occur. In any case this pullback occurs with low volume because it is a correction against the main bearish trend. If the neck line is broken by high volume, the break is more reliable and the pullback more difficult
Symmetry and Investment in the Patterns: The Case of H&S:
We have previously proposed that the bullish and bearish movements are often studied in symmetrical fashion. The momentum of the uptrend, for example, from an Elliott standpoint, consists of five waves (three upward and two corrections in the middle). Consequently, a boost in the bearish trend will be symmetrical, five waves formed by three bearish waves with two upward adjustments in the middle. In the case of reversal patterns this symmetry also occurs. Therefore, we can say that an inverted is a reversal pattern of a bearish trend with the symmetrical aspect of the H&S. Let us say that in this case the volume is more important in the case of H&S and also the volume of lows does not coincide with the volume of highs.
The first shoulder volume (s1) increases while in its bullish correction it decreases (normal in a bearish trend). The following bearish impulse (H) the volume does not increase with respect to the previous shoulder. However, when this fall is corrected, the volume increases. The last drop (s2) has a very small volume, because there is no selling pressure but there is buying pressure. Finally the volume which breaks the neck line is very high.
It is easier to find pullback to the neck line in the case of an inverted head and shoulders. In any case, the volume should be low at pullback.
Objectives of the Shapes: The Case of H&S:
Many shapes have a minimum advance goal equal to the price range of the figure itself .
Thus, the falling pattern goal of a should be measured as the distance from the top of the head to the neck line, measured from the neck line down. Remember this is only the minimum goal. It would be done the same way but symmetrically in the case of an inverted H&S
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2.2. Rectangles: double and triple tops and bottoms.
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In a rectangle there is a balance between bullish and bearish pressure. For a while there is a sideways price movement. The technical analyst does not yet know whether the price will continue the former trend, and the pattern is either confirmed as one of continuation or it entails a shift in the trend, changing the market from bullish to bearish or vice versa.
Rectangles usually occur as continuation, but can sometimes appear as reversal patterns. The pattern, a priori, can contain evidence but never complete certainty about reversal or continuation. When the price is trending it begins sideways movement in a rectangle and the trend continues, it is a continuation pattern. If the trend is bullish, continuation is confirmed by breaking through the resistance level of the sideways movement and reversal by breaking through the support. If the trend is bearish, by breaking through the support of the rectangle continuation is confirmed, while if the resistance is broken the pattern is one of reversal.
Factors to be considered in the evaluation of the rectangle:
- During the evolution inside the rectangle price force accumulates so, that the longer the pattern lasts, the stronger and more significant the exit will be.
- The volume, as always validates rupture. A strong increase in volume makes it more consistent and reliable at exit, whether it bearish or bullish.
- The minimum measurement or goal for the subsequent movement is, as usual in charts, of the same size as the rectangle. However, if it is a reversal pattern the implications are usually much greater than the first goal which acts as temporary support or resistance.
The reason that the goals of reversal rectangles are greater is often due to the pattern appearing in an area of significant medium term support or resistance and, it then becomes a double/triple top or double/triple bottom. These formations are among the most reliable and indicate trend change, thus the goals can be extended (e.g. to the previous trend proportional correction levels).
Example 1:
In the figure we can see a temporary reversal rectangle. there is no significant support in the area and no double or triple bottom, showing price congestion. So, it only scopes minimum upward goals. Note also that the top area (resistance) of the rectangle, once overcome, becomes a temporary price support of the price.
It is very important in this example, that the chart patterns operate normally but always subject to the main trend, in this case bearish. For this reason, they may be useful in the short-term but perhaps not for longer terms as in this case. Hence, its use for charting movements and very specific objectives in all types of markets, both rising or falling.
Example 2:
In the case of the IBEX index, we can see how a pattern of major implications occurs, as it takes place in the area of all-time highs, and is therefore wide-ranging. This generates a double top with very broad bearish implications.
Note how a minimal rebound occurs in the minimum projected fall for the rectangle and later falls to much lower levels.
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2.4. Triangular Formations: Congestion and Consolidation .
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Triangular formations reflect a certain price indecision, as they indicate contrast between the forces of bid and ask. This supply and demand is not balanced as in the case of rectangles but becomes compressed and “strangles” the price. Many triangles are of continuation and reflect price consolidation, but they can eventually become reversal formations.
As in all chart patterns, continuity or reversal is indicated by the rupture of the figure bullishly rising above resistance or bearishly breaking through support. However, several types of triangle anticipate the direction of movement. Triangular formations are characterized by the movement speed and strength at exit. The price is compressed in the confrontation between supply and demand and when the market decides, it does so with force.
Major Triangle Formations (or related):
- Symmetrical triangle formed by two lines approximately symmetrical with respect to the horizontal, like two small bullish and bearish trendlines.
- The volume decreases during development and increases sharply to exit the triangle. The bullish departure must be supported by increasing volume, but in the bearish case it is not necessary and there should be an increase in volume outside the figure. In fact, if it appears too soon, it is often a sign of a false rupture.
- The pattern is much more reliable if the exit is at a distance not before 2/3 of the vertex (false rupture) or not too close to the same (likely invalidation of the pattern).
- The symmetrical triangle is more prone to false signals than other chart elements
- In 80% of cases it is a continuation pattern.
- Generally, the minimum projected goal for triangular formations is the height of the figure -measured from its start- starting from the rupture point (not from the vertex).
- Right-angled triangle: One side is almost horizontal. The horizontal line is the most prone to rupture, so this kind of triangle gives us more information about continuity or reversal. The characteristics of volume, reliability, rupture point and so on, are very similar to those of the symmetrical triangle.
- Wedges have both lines are inclined in the same direction bullish or bearish), but with different slopes.
- Their difference from the triangle is huge. In a triangle, for example, the horizontal line represents resistance which when overcome can lead to a bullish boost. However, in a bullish wedge, the upper sloping line represents variable ask which is depleted faster and faster in relation to the ask (it has a shallower slope).
- Flags: Flag formations are small, of short duration and similar to a tilted rectangle. For this reason we should consider them when talking about the triangular formations.
- Normally, the inclination of the flag is against the trend, but may be horizontal or even slightly tilted in favour of the trend.
- In general, they appear during long trends and represent minimal bullish and bearish consolidation, i.e. they are continuation patterns.
- The exit can be closer to the vertex without in any way invalidating the figure. This is logical as they are shorter figures.
- The goal of the figure is approximately the length of the trend prior to the formation of the figure, typically much larger than the small size of the flag (this sometimes happens in wedges).
- Pennants: Similar to flags but the lines converge more, i.e. the narrowing is greater. However, they are still small, which distinguishes them from triangles or wedges. As with flags, they are tilted in a direction opposite to the trend and represent minimal consolidation. They are continuation patterns.
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Technical Analysis 