To the untrained spectator the financial markets seem a circus of chaos – noisy, volatile, and unpredictable. Time the markets? Nonsense, they say.
To those trained in the art of charting, however, the financial markets open up to reveal a wonderland of opportunity. With the ability to identify price patterns, the chartist begins to see a method to the madness. Indeed, chart reading is championed by many to be a method which allows a better than coin toss chance of forecasting the future.
While such a practice will always entail uncertainty, many chartists contend the patterns of the past play out time and time again in similar fashion. By studying these patterns traders come to better understand the cycle of fear and greed. In fact, when crafting my own occupational description I suggest I’m involved in the identification and exploitation of emotions. Yes, I lurk in the shadows and prey on the unsuspecting victim’s emotions for profits. Unfortunately I’m susceptible to the occasional role reversal where I switch from the exploiter to the exploited.
Want to better identify when the market may be topping out? Study tops of the past. How about learning how the market tends to bottom? You guessed it. Study bottoms of the past. While each is unique, they still exhibit similar characteristics. Take the most recent two intermediate tops formed in the S&P 500 Index for example.
[Source: MachTrader]
While the first top preceded last year’s infamous Flash Crash, the second one preceded the recent Japan disaster. Both topping formations share distinct similarities:
1. The formation of a lower pivot high reflecting a subtle shift in the supply-demand status of the market. At the least this shows a weakening of the up trend. At most it signals the imminent reversal into a down trend.
2. The breaking of a key support level.
3. High volume distribution.
If you woke up on the day of the Flash Crash or the recent gap down on the Japanese news and were surprised by the market’s bearish behavior, you clearly missed these signs of weakness. In both instances the market flashed multiple warning signs that times were a changin’ – before the worst of the selling began.
If you’ve got your heart set on participating in this circus we call trading, do yourself a favor and learn the patterns of the past. They bring meaning to the seemingly random movements of the market.
This article was originally published at Investor Place.
For related posts, readers can check out:
A Forest of Tree Candles
A Missive on Charting
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