Konsep Chart Tambahan
Trend lines
Trend lines are tools that describe trends. But they can do much more, as we will see below.
Drawing the trend lines
Trend lines are usually drawn on the charts by connecting the lows in an upward trend and the highs during a downward trend. There are different approaches to drawing trend lines, but the outlined approach offers a robust charting methodology.
A confirmed trend line normally requires at least three contact points with the price. We can always connect any two random points on the charts, but the trend line is an active trend line only if we have a third contact point.
In addition, we must ensure our trend line does not excessively cut through the candlesticks. Trend lines that go through candlestick bodies should be avoided, whereas a trend line passing through candlestick shadows may be OK under specific circumstances. It is not always possible to describe a trend with a trend line and if the chart does not offer one, we should not force it.
The trend in figure 47 allows us to draw a trend line by connecting the lows. The trend line is confirmed on the third contact point and the fourth contact point provides another confirmation signal.
Trend lines are used by trend traders and reversal traders alike. Trend traders look for subsequent bounces to enter trades into the trend direction. The contact point 4 in figure 47 shows such an example.
Reversal traders wait for a confirmed breakout through the trend lines, anticipating a change in trend direction.
Figure 47: Trend lines are tools to describe trend phases. You need at least three contact points to confirm the trend lines.
Trend line angle
As already mentioned, the slope of the trend waves indicates whether a trend is gaining or losing strength.
The so-called bump-and-run formation comprises two parts: The trend progresses moderately in the initial phase, namely the lead-in phase. If the trend intensifies and the price moves away from the previous trend line, the bump phase is reached.
It is well known that trends can lose their sustainability quickly if the price rises too fast. This mechanism builds the foundation for the bump- and-run formation. If we see a significant increase in the angles of trend lines, we should be careful. The signal for a trend reversal and the run phase can be noticed when the price breaks the steeper trend line or when the price forms a new low as shown in figure 48.
Figure 48: The chart analysis shows an increasingly rapid upward trend with rising trend lines. During the bump phase, the stock has risen almost vertically, indicating bubble characteristics. If the price breaks the low and the trend line, a downward trend is likely to start.
The other trend line signal is given when trends with low or declining angles form on your charts. If the price moves slowly in one direction and the angle is extremely flat, this may indicate that market players do not fully support the trend and the ratio between buyers and sellers is more balanced. This prevents the price from rising or falling faster. Wedges are an example of this phenomenon as we have seen previously.
The left trend line in figure 49 shows a scenario wherein the upward trend rises only slowly with a small angle. This indicates that although the buyers are in control, the buying interest does not significantly predominate. A slight shift can cause a trend reversal when the selling interest absorbs all the buying interest. The break of the trend line confirms that the direction changes.
The subsequent downward trend shows how flattening trend lines can point to the end of a trend as well. The sellers are gradually losing the upper
hand and the ratio between the buyers and the sellers is becoming more and more balanced. This characteristic also builds the foundation of the wedge pattern as we have seen previously.
Figure 49: The downward trend on the right side flattens out as indicated by the trend lines and the smaller slope.
Excursus: Confluence
If two or more formations, patterns or signals such as wedges, candlestick patterns and trend lines occur together, the signal force of different concepts is combined. This is called confluence in technical analysis.
The signal strength of a trading situation normally increases when more confluence factors are combined.
When analysing chart patterns, combining individual candlestick patterns with broader chart formations has proven to be helpful. An example of this is a rejection or engulfing candlestick at the end of a double low – the spring pattern.
As already mentioned, technical analysis works, among other things, because millions of market players use it and it leads to a self-fulfilling prophecy. Not every trader will follow the Head-and-shoulders formation or use trend lines or candlestick patterns, but if several patterns and signals are clubbed together, more traders will become aware of them and then draw the same conclusions, increasing the probability of a successful trading opportunity.
Trend line breaks
A powerful trading signal is generated when an active trend line is broken. This often foreshadows a change in the trend direction and it confirms a shift in the market structure.
Figure 50 shows various confirmed trend lines with more than three contact points in each case. A break of a trend line always initiates a new trend. Interestingly, every break of a trend line is preceded by a change in the highs and lows first. When the price breaks a trend line during an upward trend, we can often notice how the trend has already formed lower highs.
The break of the trend line is then the final signal, whereupon the trend reversal is initiated.
Figure 50: Broken confirmed trend lines can be good trading opportunities. Before the breaks, we can often see that the highs and lows have already changed as marked with various Xs.
Subjectivity of trend lines
Traders can get into trouble quickly because it is not always obvious how a trend line can be drawn. If there are uncertainties in the correct application of the trend lines, it is advisable to combine them with horizontal breakouts. This makes trading more objective. Thus, do not trade at the first signal when the price breaks the trend line, but only when the price subsequently forms a new low or high as well. These signals usually occur in quick succession, and hence the trader does not have to wait too long for his/her signal, but can nevertheless improve the quality of his/her trading and, at the same time, integrate another confluence factor into his/her trading.
Support and resistance
Support and resistance are other important trading concepts that are used by most trading strategies in some form. Support and resistance are ideal tools to identify important price levels and use them as additional confluence factors.
Drawing support and resistance
Support and resistance are price levels at which the price has previously shown a reversal reaction. Thus, a resistance zone is an area in which an upward trend has previously come to a standstill and has undergone a downward trend reversal. A support level is an area where a past downward trend has not generated enough selling interest and the trend has reversed upwards.
The upper line in figure 51 represents a resistance level. The lower line is a support level.
Like the trend lines, the rule with the three contact points applies here as well. A good support and resistance zone is confirmed only when the price has returned to it three times and has shown a reaction.
Figure 51: Support and resistance levels are important reversal points on the charts.
The idea behind support and resistance
Support and resistance indicate important price levels, because if the price is repeatedly forced to turn at the same level, this level must be significant and is used by many market players for their trading decisions.
If an upward trend is repeatedly forced to reverse at the same resistance, this means that the ratio between the buyers and the sellers suddenly tips over. Not only do all buyers withdraw at once, but the sellers immediately dominate the market activity when they start the new downward trend.
Support and resistance as trend reversal
There are several options for including the concept of support and resistance in actual trading decisions.
Traditionally, support and resistance are used to identify prices which are prone to a trend reversal, even in the future. If the price is in an upward
trend and then approaches a previous resistance level, many traders will wait to trade another downward trend reversal from such a level. To increase the chances of a successful trading opportunity, do not blindly enter trades in such support and resistance areas. It is advisable to wait for more confluence factors. For example, if a head-and-shoulders formation or a double top appear at a support and resistance level, then this can increase the chances of a positive result.
Figure 52 shows how the left head-and-shoulders pattern occurred right at a long-term resistance level on the right. Point 4 on the right chart marks where the head-and-shoulders forms. Zooming in and out on your chart can often help to see the bigger picture better and enable you pick up important clues.
Figure 52: When we zoom out, we can see that the Head-and-shoulders formation forms directly at the lower end of the strong resistance level, creating additional confluence for our trade.
Support and resistance order absorption
Naturally, support and resistance do not always stop the price from continuing a trend. Breakouts can provide high probability trading signals as well.
The conventional technical analysis says: The more often the price reaches a certain level of support or resistance, the stronger it becomes. However, I cannot fully agree with this.
Every time the price reaches a support or resistance level, the balance between the buyers and the sellers changes. Whenever the price reaches resistance during an upward trend, more sellers will enter the market and enter their sell trades. If the price reaches the same resistance level again, fewer sellers will wait there. This phenomenon is also called order absorption. The resistance is gradually weakened until the buyers no longer encounter resistance and the price can break out upward and continue the upward trend.
We can observe this phenomenon when the rejections from a resistance become increasingly weaker and the price can return to the resistance level more quickly in each case. Formations such as triangles or the Cup and Handle are based on the concept of order absorption as well.
Figure 53 shows such an example. The Silver price returns sooner and sooner to the same resistance level, as the arrows indicate. This suggests that fewer sellers are interested in selling at the resistance level each time. In this case, the resistance level becomes increasingly weaker. Furthermore, just before the breakout occurred, the trend was accelerating upwards as the dotted arrow indicates. Eventually, the price broke through the resistance level and an extended upward trend emerged when no selling interest was left.
Figure 53: The order absorption phenomenon can be observed in the chart. The resistance level is gradually weakened each time the price came back to it.
Levels vs. zones
The price is an extremely dynamic concept. The classic concept of individual thin price lines that represent support and resistance is often little helpful and many traders fail using support and resistance tools for this reason. Therefore, I always recommend using support and resistance zones to get a better explanation.
Figure 54 shows a price chart with conventional price lines as support and resistance. At first glance, this looks promising and the impact and reversal points can be clearly seen.
Figure 54: The support and resistance lines look effective at defining price reversal points at first glance.
On closer inspection, it however becomes clear that the price lines are mostly not respected at all and the price tends to either miss or overshoot these lines as shown in figure 55. This regularly leads to great frustration for traders who either miss potentially profitable trades by a narrow margin or are forced to exit too early due to stop runs. If a trader misses a trade, he/she tends to be more aggressive next time. And if he/she gets taken out too soon, he/she will be too careless with the trade exits next time. Traders, who follow this pattern, are always in a reactive mode and their trading is inconsistent, which can lead to major errors and overall bad trading behaviour.
Figure 55: On closer inspection, it is noticeable that the price rarely respects the lines exactly and often overshoots or reverses early.
Figure 56 shows that a trader is better advised to mark support and resistance areas using zones to increase the explanatory value of those concepts. The zones help in filtering out noise and premature signals. The zones may appear broad at first glance, but a trader would treat such a zone as a noise corridor and stay away from trading within those zones.
This procedure is also ideal for the so-called multi-time-frame analysis, which is used to identify important price levels in the higher time frames and then go to a lower time frame to wait for further confluence factors in the lower time frame.
In this case, the trader would use the zones he/she identified on the Daily time frame and then look for trading opportunities on the intraday time frames.
Figure 56: We should form zones in order to increase the explanatory value of support and resistance and to filter out the price noise.
Supply and demand zones
The concept of supply and demand zones is similar to that of support and resistance, and even the application is analogous. However, there are a few important differences as well which enable traders to use both concepts simultaneously to find high impact price areas.
The idea behind supply and demand zones
Supply and demand zones are usually relatively narrow price corridors in which the price has initially paused briefly before it exploded in one direction and started a strong trend.
In these supply and demand zones, the ratio between the buyers and the sellers tilts so rapidly that the price moves away from these zones in an extremely impulsive manner.
Figure 57 below demonstrates the behaviour of a demand zone nicely. For example, if there is a sudden and strong upward breakout in a demand zone (1), it shows that the buyers suddenly absorb all selling interest. This imbalance usually occurs in valid demand zones without notice from one moment to the next, which confirms that buying interest in this zone has accumulated in a flash and that all sellers have withdrawn at once. If the price enters such a demand zone again (x), buying interest still exists probably because not all market players managed to enter the market during the first movement. Traders, who follow the concept of demand zones, will therefore look for clues and other confluence factors in these zones to trade during the next upward movement.
Figure 57: At point 1, we suddenly see a strong, explosive breakout, which indicates a significant overweight of buyers. We call this a demand zone. If the price falls back into this zone, the left-over buying interest is picked up and price can start a new upwards trend once again.
Drawing the supply and demand
There are several methods to identify supply and demand on the charts.
The five most important factors are:
Moderate volatility
Good supply and demand zones are usually relatively narrow and the price does not fluctuate strongly during the short consolidation phase. This indicates a proper balance.
Timely breakout
Good zones should not wait too long for the breakout and the consolidation phases are often short. The underlying idea is that the buying and selling interests suddenly tilt, but this imbalance ought not to be too long in coming.
Figure 58 shows a newly created supply area on the left. The price did not spend much time during the initial consolidation phase going sideways and the breakout was extremely strong. Those characteristics confirm the supply zone. The next time the price entered the zone, it lead to a new sell off. The X marks the point of the re-entry into the supply zone.
Figure 58: The supply zone on the left extends over only two candlesticks before the price breaks out with a strong momentum. In case of a re-entry, the open interest in selling is picked up and the price drops again (X).
Strong breakout
The strong breakout is the most important feature: The stronger the breakout away from the initial zone, the higher the probability of the price showing such a reaction in case of the next entry.
Figure 59 shows a strong supply zone on the left. The breakout away from the zone was explosive and lead to a steep downward trend. The price returned to the supply area twice, as indicated by the Xs. Each time, a new sell-off was initiated.
Figure 59: The downward breakout out of the supply zone on the left happens from one candlestick to the next without any notice or sign. This indicates a strong imbalance and marks an important supply zone. In case of a re-entry, the price again falls two times due to the great interest in selling (Xs).
Figure 60 shows a demand zone. Suddenly, at point 1 on the left, the price strongly moved upwards after a downward trend. This strong
reversal upward indicates a strong reaction and can suggest a lot of buying interest in the area.
The price returned to the demand zone twice (point 2 and 3) and completely reversed upward each time. As indicated by the initial demand zone reaction at point 1, the buying interest absorbs all selling interest immediately.
Figure 60: At point 1, the demand zone is created and the buyer overhang is so large that the price jumps up by hundreds of points. At point 2, although the zone is initially overshot, the upward reversal represents a strong reaction zone and again indicates a significant imbalance. At point 3 the pending buying interest is filled again and the upward trend starts anew.
Order absorption
The concept of order absorption, which we have learnt in connection with support and resistance, says: price levels can be weakened with each contact point.
Therefore, only the first, or at most the second, re-entry into a supply and demand zone should be traded. With each re-entry, increasingly more buying or selling interest that still exists is utilised until the zone is no longer significant.
Spring formation
This confluence factor cannot always be found in a supply or demand zone, but it can improve the quality of such a zone. A spring formation shows a failed breakout attempt, which is immediately reversed.
Figure 61 shows a supply zone with a spring pattern on the left. The price has tried to break out upward, but the breakout attempt was fended off immediately. The sellers have immediately reversed the complete trend, resulting in an explosive downward trend. The imbalance between the buyers and the sellers must therefore be particularly large in such an area. Each time the price re-entered the supply zone afterward, a new downward trend was initiated.
Figure 61: The supply zone on the left is accompanied by a spring formation; during the subsequent price movement, several sales reactions can be seen, confirming the strength of the demand zone.
Traps
Those who have a little more trading experience are probably familiar with the situation where a trade looked obvious at first, but then the opposite happens immediately. In retrospect, it is often quickly apparent that you have fallen into the same trap again and entered the market too early. Understanding how this can happen and what can be done about it is an important step on the way to become a successful trader.
Mechanisms of a buyer trap
To understand what happens in a trap, the interaction between the buyers and the sellers must be analysed precisely. The following chart situation (figure 62) illustrates this well.
-
Initially, the price moves lower in a normal downward trend. Many traders might have missed this trend and, thus, also missed the profit opportunities. Now, they are impatiently waiting for the next entry opportunity.
-
The price makes another swing low. According to classic Dow Theory, traders will now wait for a break of such a low to get into a short trade.
-
The price breaks the low and drops a little, which gives a good feeling to the traders who are now shorting. It also induces other traders to join when they see the price has fallen below the low. We can often observe that these breakouts start strongly at the beginning, which also attracts the other breakout traders and makes this trap look attractive.
-
The price suddenly turns up and the trap snaps. In case of extremely effective traps, this spontaneous reversal after the breakout usually happens in only one candlestick or with a price jump. The downward outbreak is often initiated by professional traders and as soon as they see that the trap snaps and the amateur traders place their sell trades, they enter into buying trades to position themselves for the reversal.
-
The upward trend is now accelerating and traders with the sell positions are suddenly facing large losses. However, to end their sell trades, they must buy, which then further accelerates the upward price movement.
Figure 62: The mechanisms of the price trap and failed breakouts are evident from this Crude Oil chart.
How to avoid traps
Naturally, it is not always possible to avoid a trap and occasional loss trades are quite normal. However, an experienced trader can often avoid these traps by observing the following two points.
Avoid late entries
Traps usually occur after long trend phases. Traders, who follow trends, should avoid or be careful about entering a trend late. A trend that has already formed four or five trend waves is more likely to reverse. This is especially applicable when a flattening trend or a wedge is already noticeable.
Wait for confirmed breakouts
Most traps can be avoided by trading only in case of confirmed breakouts. Do not jump on the emerging breakout attempts. It is, therefore, advisable to wait for the completion of candlesticks to make trading decisions. Waiting until a candlestick has completely broken through the previous high or low and has closed outside it, can greatly reduce the probability of falling into a trap. It tests your patience and the greed-responses kick in, but waiting the confirmation is the better strategy long-term.
However, if you realise that you have fallen into a trap, you should admit this and close your losing trade to avoid further problems.
Double bottom trap
Double tops are often ideal areas to observe and trade price traps. Many traders trade breakouts at these price levels. Owing to the general impatience of traders, which usually leads to early trade entries, traps are effective at double tops.
Traps also occur repeatedly in support and resistance zones when traders trade breakouts too early and the price falls back again. The more obvious such a potential breakout is, the more common traps are.
As already mentioned, the spring formation is an effective confluence factor that can strengthen a trap. The stronger the rejection signal of the spring candlestick, the more effective is such a trap since many trades were withdrawn from here.
Figure 63 shows such an example. The price tried to break out higher during the uptrend. The price was immediately reversed after the weak breakout attempt, creating a trap. The price then sold off because the selling interest absorbed all the buying interest, following the trap.
Figure 63: Various confluence factors announce the downward trend effectively: The failed breakout attempt takes place after a long consolidation phase and the price then also breaks through the last lows and through the trend line.
Failed breakouts
Effective trap formations can be observed around double tops and double bottoms when the patterns are accompanied by the spring pattern. In figure 64 the spring pattern is a single candle formation that indicates a failed upward breakout attempt through a previous swing high point. Ideally, the spring candle has a long upward shadow, which marks the averted breakout and confirms the rejection. The rejection shows that the price initially tries to rise, but it is then reversed by the selling interest.
More aggressive and risk-seeking traders can use the spring candle as a direct entry signal to enter their sell trades earlier. Risk-averse traders wait for additional confirmation and usually enter trades when the price breaks through the previous support and makes lower lows.
Figure 64: The spring formation is a failed breakout attempt. This indicates that there are not enough buyers in the market. The continuation of the downward trend was indicated in advance by the spring formation.