Last week I discussed some of the basic technical chart styles, which included line charts, basic bar charts, and candlestick charts. These are the mainstays for most traders, for both those who are just starting out and those who have a great deal of experience. Today I am going to discuss a more advanced charting type that is completely different from these basic charts. These are the Point and Figure charts. These are different from most of the charts you will normally see for this reason – they do not plot time. For example, with a line chart or a candlestick chart, there are specific time periods that are used for each of the bars or candles. These might include an hourly or daily bar or candlestick chart. If we take the time bars out of the equation we are only charting the price movements and momentum of the market. Lets take a closer look at these charts and how they might be used.

Point and Figure charts were written about and popularized in the United States by A.W. Cohen in the 1940s. The charts are unique in that they do not plot the price against time like the other charts do, but, instead, use X’s and O’s to plot the price direction in columns of X’s, as the price goes up, and columns of O’s, as the price goes down.

Point and Figure charts have never gained the popularity of the other charts, but is gaining popularity for longer-term trading and identifying support and resistance levels, as well as good entries and targets. The advantage of using the P&F chart is how easy it is to see the trend developing without the minor moves within the period.

The key to the P&F charts is to identify the price movement of each unit, or X and O. For example, if the unit is $0.50 and the X and O box is three units, each X or O box would only plot if the price moves $1.50. Rising prices are identified with X’s and falling prices are identified with O’s. So every time the price rises $1.50 in this example, a new X will be plotted and if the price goes down by 1.50 a new column will be plotted with O’s. These X’s and O’s are only plotted on the chart if the price moves by the movement of one unit, either up or down. There are never X’s and O’s in the same column, but a new column is drawn in the other direction. See the chart below to understand better how it looks and is created.

Figure 1: Point and Figure Chart

The P&F chart as you can see in the illustration above will plot based only on the price movement and can very easily identify when the momentum of the market is moving above the current resistance or below the current support levels. When the price moves above or below the current ranges, there may be a good entry in the direction of the price momentum.

The P&F charts more easily identify the price movements because an X or O is only plotted if the price action moves by the predetermined level, so the minor price fluctuations that happen constantly are filtered out.

I have stated in the past, and I will likely continue to do so, that over the past year or so, you can find just as many so-called experts that state the price of gold is going to rise as you can find experts who state that its price will fall. This makes a lot of sense since it seems as though these experts are only correct a little over 50% of the time. We have a 50/50 chance of it moving in either direction, so some will be right and some will be wrong; however, due to developments over the past few months, we may be getting a little more clear on the likely direction that it will take.

The US dollar is currently the reserve currency of the world, which means that many commodities that are traded between countries are done so in US dollars. I say it is “currently” the reserve currency because there will be a push to make the Chinese RB the reserve currency and it may succeed. The spot price of gold is pegged to the US dollar, so when gold suppliers that are based in various countries around the world purchase gold, they convert their home currency to US dollars to make the purchase and then they sell the gold in their home market. The stronger the US dollar is, relative to their home currency, the more expensive gold becomes for them. Of course they pass that cost along to the end user, which leads to a reduction in the demand for gold due to higher prices. Economics 101 tells us that supply and demand work together. So as the demand for a commodity decreases, its supply will increase, which means that its price will decrease as more and more of it is on the open market. To balance the supply/demand equation, gold production will decrease until supply and demand are in balance again. But, by that time, the price of gold will have to drop to balance this equation.

The US dollar has been strengthening, relative to other major currencies in the world, for the past several months after an extended period of weakening. Remember that this is important because the stronger the dollar is, the weaker gold prices will be. Enter the US Fed, which is unwinding their monthly cash infusions into our economy. They are doing this in part because they believe that our economy is stabilizing to a degree and possibly getting stronger, which means that they will most likely raise interest rates at some point next year. When this happens, money from foreign investors will flow into the US, which will further strengthen the dollar, pushing the price of gold even lower. The more money that flows into the US and the higher US interest rates go, the stronger the dollar will get, ultimately pushing the price of gold further and further down.

This is not only true of gold prices; most other precious metals will follow this same scenario, which isn’t a bad thing, it is just a normal economic cycle. There is a normal ebb and flow to an economy, just as there is normal ebb and flow to currencies relative to other currencies. In a way, it is very surprising that the US dollar has held its value as well as it has and it is even more surprising that it has been strengthening. This may speak more to the other choices that are available right now because most other major economies are in about the same, or even worse, condition than ours is from a health and strength standpoint. The US dollar may actually be strong because it is the least bad choice of a bunch of bad choices that are available right now.

Technical traders spend most of their time looking at charts and indicators; sometimes, way too many indicators, making for too complicated charts. Today I am going to describe three different types of charts that you may use to trade the markets.

Line Charts
Line charts are the most basic charting type. Line charts, because they are so simple, are very good at showing support and resistance levels, consolidations and price patterns. Many traders don’t use line charts because they have not been exposed to them, or they may think they are too simple or not sophisticated enough compared to more complex charts with many indicators. However, sometimes simple can be very effective. Oftentimes, you can make your trading too complicated and can get into “analysis paralysis” waiting for too many signals. With a line chart, the overall market movement really can be obvious and jump off the page at you, especially as the market consolidates and then moves out of a trading range. See Figure 1 below and notice how easy it is to identify when the market breaks out of a trading range.

Figure 1: Line Chart – note the consolidation and support and resistance levels

Bar Charts
Bar charts are different than a line chart, but are still basic. Bar charts plot the market based on time, using a bar to identify the open, high, low and close of the time frame. This type or style of chart allows you to identify the open and close ranges, as well as the high and low ranges for the period of time. The bar chart uses a single line to identify the total range of the time period between the high and low. The open and the close are represented by small “pegs” on the left of the bar for the open and the right of the bar for the close. See the illustration in figure 2 below.

Figure 2: Bar Chart – shows the range for the period, the open, and the close

A bar chart, while simple, is very effective for identifying directions or trends in the market by time frame and also quickly identifying the period ranges. For example, on a daily bar chart, you can identify the daily range and the bullish or bearish trend of the market by either a bullish bar (where the bar closes higher than the open) or a bearish bar (where the bar closes lower than the open) to quickly identify market momentum.

Candlestick Charts
Candlestick charts, also period charts like bar charts, were originally developed in the 17^th century by Japanese rice traders. They close in the bar to form a candle with both a body, which represents the range between the open and close, and the upper and lower wicks, which show the range of the period. Bearish candles are traditionally solid or filled (as seen on the left in Figure 3 below), while bullish candles are traditionally open or hollow (as seen on the right). Oftentimes, you will see bearish candles colored red and bullish candles colored green.

Figure 3: Candlestick Chart

The advantage to the candlestick patterns is, depending on the length or the candles and wicks, you can quickly identify, not only momentum and trend based on the bullish or bearish candles, but also, very easily, stalling momentum and potential reversals with a variety of candle patterns, like bullish and bearish engulfing patterns.

To sum up, these are the three most common charting styles, each with their own strengths. Regardless of the style of chart you use, it is important to keep your trading as simple as possible. Having a complicated chart, with a dozen indicators, generally gets in the way of trading success instead of leading to it!

In today’s article we’re going to spend a few minutes discussing one of the elements needed to trade successfully. This is something that is not new to most traders and is something we should look at and review periodically. Everything else that we do can depend on how deliberate the market or the chart we’re looking at is moving. A deliberate market can make our jobs as traders easier, as it allows us to have more confidence in our setups and triggers.

A deliberate market does not mean that the market is moving perfectly; it means that it’s moving in a consistent fashion. With the consistent movement of price, we can look for the setups and entry triggers we are trading and have confidence that the prices is going to react in a deliberate way. This does not mean that it will guarantee that the price will move the direction we want it to, but can gives us confidence that the probability is that the price will move in the desired direction.

As we look at each chart to define whether or not it is deliberate or non-deliberate, we want to look for a couple of different types of price action. The first type of price action that is considered non-deliberate is price action that is highly volatile, where we encounter wide, choppy swings in the market. This is the type of price action that we frequently see after major news announcements. The price begins to move so quickly and violently that we can oftentimes be in a trade and out of a trade on the same candle because the price movement is so wide. This type of volatility can cause us to become fearful, which causes us to trade poorly because of our emotions. Even though we cannot completely avoid some volatility, we can avoid the times when news is released, where we know there may be an increase in volatility.

The other type of non-deliberate price action occurs when there is very little movement happening on the charts. Often times you will find this type of price action occurs during certain times of the day where there is not a lot of trading going on and the market just chops sideways in a small, tiny range. This type of price action can be just as frustrating because our setups happen, but there’s no follow-through with the price movement. We enter into the trade and then we just sit there and watch it do nothing. This can also increase our emotional state, which can cause us to trade poorly.

As basic or as complicated as your trading strategy may be, understanding when the market is deliberate vs. non-deliberate can help you trade better in the long run. Avoiding those times where the market is non-deliberate and focusing your trading during times of deliberate price action will help you become a more consistent and profitable trader. Take some time to look at your charts and your trading system to determine how you define a deliberately trading market.

In the past, I have discussed using the Japanese candlestick patterns to help identify market sentiment and potential trend weakness, which can lead to market reversals. Today I will discuss a couple of additional double candle patterns that you can use to identify potential reversals.

For review, the Japanese rice traders in the 1600s came up with this efficient way of looking at the markets. With the advent of modern computer, software, and the Internet, these candlesticks have become a mainstay of modern market charts. The basic candle structure identifies the open, high, low and close of the individual period. For example, a daily candle represents the ranges for the day between high and low, as represented by the “shadows” or wicks, and the range between open and close, as represented by the “real body” or candle. In figure 1 below, note that if the price closes lower for the time frame, a bearish, or “filled”, candle is formed, like the candle on the left. If the price closes higher, then we have a bullish, or “hollow”, candle, like the one on the right.

Figure 1: Japanese Candlesticks – Sold Bearish and Open Bullish

Traders use these basic candles and, depending on the length of the candle bodies and the lengths of the candle shadows or wicks, they could put them together to identify different market sentiments. There are single candle patterns, like the Doji, Shooting Star, or Hammer Reversal Patterns that we have discussed in the past. Also, there are double patterns, like the bearish and bullish engulfing patterns. Today, I’d like to introduce you to Tweezer Patterns.

There are two kinds of Tweezer Patterns – Tweezer Tops and Tweezer Bottoms. These patterns help to identify, as their names imply, the potential tops or bottoms of the market. In the tweezer top candlestick pattern, you have two candles, first with a bullish (up) candle, followed by a bearish candle. What makes the tweezer top pattern unique is that the close of the bullish candle and the open of the following bearish candle are at the same price, forming a solid, two-candle top. Sometimes, there are shadows or wicks that are above the candle bodies; however, the tweezer top is using the opens and closes or just the candle bodies lining up at the top. With a tweezer bottom, you have the opposite of the tweezer top, but the bottoms of the candle bodies are at the same levels. With a tweezer bottom, you have a bearish candle closing down and the following candle, a bullish candle, opening up at the same level as the bearish close, as seen in Figure 2 below.

Figure 2: Tweezer Bottom – Close Day 1 is the same as Open Day 2

Note how in the tweezer bottom illustrated above, the close of day 1 and the open of day 2 are at the same exact price – this is the key to forming the tweezer bottom. If there are some shadows or wicks on the tweezer top or tweezer bottom, then you would ignore those and only pay attention to the tops or bottoms of the candle bodies, as seen below in Figure 3.

Figure 3: Ignore the upper or lower wicks

Look to the candle bodies (the opens and closes), ignoring the upper or lower wicks, using the tweezer tops and bottoms, can be a good way to identify changing market sentiment. These patterns can be identified on any chart and will help to distinguish potential reversals.

The stock market has been on a nearly unprecedented bull run over the past few years, which, of course, is no secret. Everyone is writing about it and talking about it and wondering when it will end or if it will end. My biggest question around all of this is why do we listen to these people and why do we care if it ends or if it continues? It should be blatantly obvious for anyone that is paying attention that to a large extent the media controls the country or at least most of the general populations thought process. I remember from my statistics classes that that if you can get approximately 11% of a given group or population to believe something or to see something in a particular way that 11% will turn the tide of the entire group or population making whatever the material it is that is being presented a reality. It becomes a reality regardless of if it is true or not. This is how advertising works and also how political campaigns work.

If a campaign for a political candidate can make enough people, approximately 11%, believe that the candidate is a good candidate and their opponent is not that’s really all they need to win because the beliefs of the 11% will permeate throughout a large percentage of the population. In this respect when it comes to advertising and campaigning this is pure manipulation and we experience it constantly on a daily basis. Based on a combination of the news stories that are reported, the advertising commercials that we see and the television shows and movies that we watch, the people or the companies that control their content actually control what we as a general population believe. If they want us to be for or against a specific event, type of people or a particular idea they can plant the seed and let it grow permeating throughout the country. The first people to be convinced of whatever the topic is talk to each other and also to others that may not have an opinion or any knowledge around the issue one way or the other but many of them will become new converts. This continues until more and more people become convinced of the same thing making it a reality.

In large part this is exactly how the equity markets work. We have a vast number of publications, online sources and seemingly an unlimited amount of media coverage around what has happened and what is going to happen in the markets, they only need to get a relatively small percentage of people that are involved in the markets to agree with what they are reporting or stating before it becomes the markets reality. This morning the Non-Farm Employment Change and the Unemployment rate were reported at 8:30am; both of these numbers came out much better than what was predicted by the analysts. The result is that the US D immediately strengthened against other major currencies and the stock market indices gapped up open. All of that is fine except that we don’t know that the numbers that were reported are accurate, are they reported in a way that makes the economy look much healthier so we as a general population feel better about the economy translating into a perceived better economy. We know that the unemployment numbers are not correct because so many people that have been out of work for extended periods of time are no longer counted which means that the drop from 6.1% to 5.9% almost has to be fabricated. The news media will report and repeat the information and hammer on it repeating the numbers over and over again until enough people believe that they are correct and believe that the country’s unemployment is actually getting better regardless of what the truth is.

 

I am a believer that regardless of if the media or the economic reports get it right or not none of this should be of any consequence to us, as traders and investors what we need to focus on is what the economic reports and the general news reports state without getting caught up in what they are actually saying; do not try to guess at the validity of what they are saying or if it is true be neutral and react accordingly. What they are saying may give us an indication of what direction the market will likely take so we can take advantage of whatever is occurring at any given time. If we are unbiased and if we can remain as detached as possible taking an objective look at the big picture, an unemployment report stating that unemployment is 5.9% or stating that it is 6.5% should not matter at all to us, it should only matter that we see the information and can react to it. The truth or the validity of the information and the perceived positive or negative of it is not the point; the point is to know how to react to whatever information comes out. Regardless of if the country is being lied to or if we are being told the truth the only difference to us should be whether we are buyers or seller. In this regard as far as we are concerned all of the information that comes out is equal, we do not need to judge or justify it or know any more about it than what is actually reported; all we need to know is how to react to whatever is reported.

Today we are going to look at what is happening with the chart of the EUR/USD on both the longer-term and shorter-term charts. We will first look at the weekly chart in order to get a big picture overview of the stronger trend as well as the support and resistance areas.

With the weekly chart of the EUR/USD you can see the strong bearish trend outlined with the down red arrow. This big move will come to an end at some point but until we see some bullish movement we will need to continue to recognize the strength of this bearish trend. You will also notice that the support area is where the price is currently sitting. If we are looking for a bullish bounce this would be the place where we might see it happen. By knowing the strength of the bearish trend we can know that we might have a hard time trading against it. By focusing on trading with this longer-term trend we can put the price action in our favor.

In this next chart we are looking at a more intermediate term time frame. The 4 hour chart is a good chart to look at to see what is happening and to look for some potential early changes in the longer-term trends.

In this chart we can also see a strong down trend where the price has been making lower lows and lower highs. This would confirm what we are seeing on the weekly charts. As we look for some possible trading opportunities we will want to watch for the times the price pulls back counter to the overall down trend. In the chart you can see that this is currently happening as the price is moving back up towards some support. Once we see this we can turn our attention to the shorter-term charts and look for opportunities to short as price move back in the direction of the trend.

This next chart is the shorter-term 15 min. chart. With this chart we can drill down to see when the best time to enter might be.

Even though we are not looking at indicators specifically on this chart, we could you some to help us identify when a good entry might occur. In this chart you can see the bullish movement that has happened more recently. Knowing that the longer- and intermediate-term charts are in a strong bearish trend, we can identify some points to look at entering a short trade. The best thing to look at is what the price is doing. If the price begins to break back down below support we could enter in at that point expecting a move back down with the overall trend.

Regardless of the pair or time frame you are trading, looking at the long, intermediate and shorter-term charts can help you see the bigger picture. This can put you in a position to take the highest probability trades you can. Take some time to practice doing this so you are comfortable with your analysis.

Today I am going to discuss what divergence is and how it works. Divergence can be applied to any market you trade – Stocks, ETFs, Options, Forex and Futures.

Divergence is sometimes referred to as a leading indicator because it can identify a potential change in momentum, even before that change appears in the price action. Divergence sets up when both the price action and the stochastics indicator diverges or move in opposite directions. When this happens and divergence is present, a potential change in direction may occur.

Now let’s discuss how to identify divergence on a chart. When a new high or low in a security occurs but is not followed by the stochastic indicator, it indicates a potential trend reversal. For example, just in the last several weeks, we have seen bearish divergence in the S&P 500 Index. Bearish divergence occurs when the price made a higher high, but the stochastic indicator made a new lower high. This is bearish divergence and shows that the upside momentum is slowing, even though prices are continuing to make new highs, and a trend reversal lower is very likely. There is both bearish and bullish divergence, let’s look at the current example of bearish divergence.

Bearish Divergence occurs when prices are making new HIGHER highs, and, at the same time, the stochastic indicator is showing LOWER highs. For example, in the S&P 500 daily chart below, the stochastic indicator is making lower highs at the same time the price action is setting higher highs. This is considered bearish divergence, which could be used to indicate a possible trend reversal with the prices moving lower. Bearish divergence is happening RIGHT NOW on the S&P 500 – see the current S&P chart below. Note the significant change in trend direction just after the bearish divergence is indicated.

Figure 1: Bearish divergence on the S&P 500 chart and the current downturn

Bullish Divergence is the opposite of bearish divergence and we are looking at the bottom of the market or the valleys. Let’s look at an example in the Forex market with the AUD/USD daily chart below as an example of bullish divergence. Notice as the price action continues to make LOWER lows at the same time the stochastic indicator in the lower window has started to move higher, making HIGHER lows, indicating a potential change in the price movement or trend before the price action shows any real sign of a reversal. Again, note the significant change in trend direction after the bullish divergence is indicated.

Figure 2: Bullish Divergence on the AUD/USD

Understanding the trend and potential reversals is one of the most important things to understand as a trader, which is very relevant to equity traders who are looking for the direction to trade. Now, having explained how divergence works, when it shows up, there may be reversal; however, how strong or long the reversal is going to be is still an unanswered question. No indicator, including divergence, should be taken in isolation, but should be looked at in context with other indicators, trends, and support and resistance levels.

In conclusion, take some time to look for these divergence signals using the stochastic indicator. They don’t happen everyday, but when they do, they are very powerful indicators of trend changes!

In our article today we are going to discuss some of the basics you can use when trading breakouts. Breakouts are simply times in the price action of the chart where price breaks above or below the prior area of consolidation. These consolidation areas are often times created after the price has experienced a strong move and then it decides to slow down and move sideways. Consolidation areas can be long or short but the typically have a short range that the price moves within. In addition, these areas of consolidation can be moving horizontal or at a slight angle up or down. Depending upon the direction of the consolidation various names have been given to them to distinguish them from each other. For example, a rectangle with be a consolidation the move horizontal while a flag consolidation will be angled slightly opposite the prior price movement. Regardless of what you call them you can trade them the same way – as a breakout from the consolidation.

When we are looking to trade a breakout we are going to want to identify several things. First we want to know the direction or the trend of the prior price action. This action that happens before the consolidation can give us clues as to what direction we will want to trade the breakout. We also need to be able to draw the resistance and support lines around the area of consolidation. This is what gives us the visual to know when a breakout is happening. Once we identify these things we can then look for the breakout trade to set up.

A setup happens when we identify the consolidation and draw our line showing the upper resistance area and the lower support area. These lines will give us the point where we go long or short. For example, if the price has been moving up and then goes into consolidation we will look to go long when the price moves above the resistance line we have drawn. This entry can be down with a buy stop entry order so we can get in when the price reaches our pre-determined entry price. Sounds easy but we need to remember that nothing guarantees we will make money when the price breaks out. We need to remember that sometimes the price will do a “fake” out instead of a break out and look like it is moving out of consolidation but in reality decides to move back down again. In this case we need to exit the trade and look for the next opportunity.

The key in trading these breakouts is to make sure you place your entry order in the right area which means you need to correctly draw your consolidation lines. This will take some practice and some patient but it is worth it once you have developed confidence in your trades. In order to avoid some fake outs consider waiting for the bar to close before entering in the trade. This mean you would need to watch for the breakouts in order to enter the trade. Take some time to practice identifying and trading breakouts to see how they might help you in your trading.