4. SUPPORT AND RESISTANCE TRENDLINES AND CHANNELS

There are two terms that define the peaks and troughs on the chart.A previous trough usually forms a support level. Support is a level below the market where buying pressure exceeds selling pressure and a decline is halted. Resistance is marked by a previous market peak. Resistance is a level above the market where selling pressure exceeds buying pressure and a rally is halted (See Figure 4-1).


Support and resistance levels reverse roles once they are decisively broken. That is to say, a broken support level under the market becomes a resistance level above the market. A broken resistance level over the market functions as support below the market.The more recently the support or resistance level has been formed,the more power it exerts on subsequent market action.This is because many of the trades that helped form those support and resistance levels have not been liquidated and are more likely to influence future trading decisions (See Figure 4-2).


The trendline is perhaps the simplest and most valuable tool available to the chartist.An up trendline is a straight line drawn up and to the right, connecting successive rising market bottoms. The line is drawn in such a way that all of the price action

is above the trendline.A down trendline is drawn down and to the right, connecting the successive declining market highs. The line is drawn in such a way that all of the price action is below the trendline. An up trendline, for example, is drawn when at least two rising reaction lows (or troughs) are visible. However, while it takes two points to draw a trendline, a third point is necessary to identify the line as a valid trend line. If prices in an uptrend dip back down to the trendline a third time and bounce off it, a valid up trendline is confirmed (See Figure 4-3).


Trendlines have two major uses.They allow identification of support and resistance levels that can be used, while a market is trending, to initiate new positions. As a rule, the longer a trendline has been in effect and the more times it has been tested, the more significant it becomes.The violation of a trendline is often the best warning of a change in trend.

Channel lines are straight lines that are drawn parallel to basic trendlines. A rising channel line would be drawn above the price action and parallel to the basic trendline (which is below the price action). A declining channel line would be drawn below the price action and parallel to the down trendline (which is above the price action).Markets often trend within these channels.When this is the case,the chartist can use that knowledge to great advantage by knowing in advance where support and resistance are likely to function (See Figure 4-4).

3. HOW TO PLOT THE DAILY BAR CHART

Price plotting is an extremely simple task. The daily bar chart has both a vertical and horizontal axis.The vertical axis (along the side of the chart) shows the price scale, while the horizontal axis (along the bottom of the chart) records calendar time. The first step in plotting a given day’s price data is to locate the correct calendar day. This is accomplished simply by looking at the calendar dates along the bottom of the chart. Plot the high, low, and closing (settlement) prices for the market. A vertical bar connects the high and low (the range).The closing price is recorded with a horizontal tic to the right of the bar. (Chartists mark the opening price with a tic to the left of the bar.) Each day simply move one step to the right. Volume is recorded with a vertical bar along the bottom of the chart (See Figure 3-1).

Charts Are Used Primarily to Monitor Trends

Two basic premises of chart analysis are that markets trend and that trends tend to persist. Trend analysis is really what chart analysis is all about.Trends are characterized by a series of peaks and troughs.An uptrend is a series of rising peaks and troughs. A downtrend shows descending peaks and troughs. Finally, trends are usually classified into three categories:major,

secondary, and minor.A major trend lasts more than a year; a secondary trend, from one to three months; and a minor trend, usually a couple of weeks or less.

2a. Charts Reveal Price Trends

Markets move in trends. The major value of price charts is that they reveal the existence of market trends and greatly facilitate the study of those trends.Most of the techniques used by chartists are for the purpose of identifying significant trends, to help determine the probable extent of those trends, and to identify as early as possible when they are changing direction (See Figure 2-1).

Types of Charts Available

The most popular type of chart used by technical analysts is the daily bar chart (see Figure 2-1). Each bar represents one day of trading. Japanese candlestick charts have become popular in recent years (see Figure 2-2). Candlestick charts are used in the same way as bar charts, but present a more visual representation of the day’s trading. Line charts can also be employed (see Figure 2-3).The line chart simply connects each

successive day’s closing prices and is the simplest form of charting.

Any Time Dimension

All of the above chart types can be employed for any time dimension. The daily chart, which is the most popular time period, is used to study price trends for the past year. For longer range trend analysis going back five or ten years,weekly and monthly charts can be employed.For short-term (or daytrading) purposes, intraday charts are most useful. [Intraday charts can be plotted for periods as short as 1-minute,5-minute or 15-minute time periods.]

2. WHAT IS CHART ANALYSIS?

Chart analysis (also called technical analysis) is the study of market action, using price charts, to forecast future price direction. The cornerstone of the technical philosophy is the belief that all of the factors that influence market price—fundamental information, political events, natural disasters, and psychological factors— are quickly discounted in market activity. In other words, the impact of these external factors will quickly show up in some form of price movement, either up or down. Chart analysis, therefore, is simply a short-cut form of fundamental analysis. Consider the following:A rising price reflects bullish fundamentals, where demand exceeds supply; falling prices would mean that supply exceeds demand, identifying a bearish fundamental situation. These shifts in the fundamental equation cause price changes, which are readily apparent on a price chart. The chartist is quickly able to profit from these price changes without necessarily knowing the specific reasons causing them. The chartist simply reasons that rising prices are indicative of a bullish fundamental situation and that falling prices reflect bearish fundamentals.



Another advantage of chart analysis is that the market price itself is usually a leading indicator of the known fundamentals. Chart action, therefore, can alert a fundamental analyst to the fact that something important is happening beneath the surface and encourage closer market analysis.

1. WHY IS CHART ANALYSIS SO IMPORTANT ?

Successful participation in the financial markets virtually demands some mastery of chart analysis. Consider the fact that all decisions in various markets are based, in one form or another, on a market forecast.Whether the market participant is a short-term trader or long-term investor, price forecasting is usually the first, most important step in the decision making process.To accomplish that task, there are two methods of forecasting available to the market analyst—the fundamental and the technical. 

Fundamental analysis is based on the traditional study of supply and demand factors that cause market prices to rise or fall. In financial markets, the fundamentalist would look at such things as corporate earnings, trade deficits, and changes in the money  supply. The intention of this approach is to arrive at an estimate of the intrinsic value of a market in order to determine if the market is over- or under-valued. 

Technical or chart analysis, by contrast, is based on the study of the market action itself. While fundamental analysis studies the reasons or causes for prices going up or down,technical analysis studies the effect, the price movement itself. That’s where the study of price charts comes in. Chart analysis is extremely useful in the price-forecasting process. Charting can be used by itself with no fundamental input, or in conjunction with fundamental information. Price forecasting,however, is only the first step in the decision-making process. 

Market Timing

The second, and often the more difficult, step is market timing. For short-term traders, minor price moves can have a dramatic impact on trading performance. Therefore, the precise timing of entry and exit points is an indispensable aspect of any market commitment.To put it bluntly, timing is everything in the stock market. For reasons that will soon become apparent, timing is almost purely technical in nature.This being the case, it can be seen that the application of charting principles becomes absolutely essential at some point in the decision making process. Having established its value, let’s take a look at charting theory itself. 

INTRODUCTION

Chart analysis has become more popular than ever.One of the reasons for that is the availability of highly sophisticated, yet inexpensive, charting software.The average trader today has greater computer power than major institutions had just a couple of decades ago.Another reason for the popularity of charting is the Internet. Easy access to Internet charting has produced a great democratization of technical information.Anyone can log onto the Internet today and see a dazzling array of visual market information.Much of that information is free or available at very low cost.

Another revolutionary development for traders is the availability of live market data.With the increased speed of market trends in recent years, and the popularity of short-term trading methods, easy access to live market data has become an indispensable weapon in the hands of technically oriented traders. Day-traders live and die with that minute-to-minute price data. And, it goes without saying, that the ability to spot and profit from those short-term market swings is one of the strong points of chart analysis. 

Sector rotation has been especially important in recent years. More than ever, it’s important to be in the right sectors at the right time. During the second half of 1999, technology was the place to be and that was reflected in enormous gains in the Nasdaq market. Biotech and high-tech stocks were the clear market leaders. If you were in those groups,you did great. If you were anywhere else, you probably lost money. 

During the spring of 2000,however, a sharp sell off of biotech and technology stocks pushed the Nasdaq into a steep correction and caused a sudden rotation into previously ignored sectors of the blue chip market—like drugs, financials, and basic industry stocks—as money moved out of “new economy” stocks into “old economy”stocks.While the fundamental reasons for those sudden shifts in trend weren’t clear at the time, they were easily spotted on the charts by traders who had access to live market information—and knew how to chart and interpret it correctly. 

That last point is especially important because having access to charts and data is only helpful if the trader knows what to do with them.And that’s the purpose of this booklet. It will introduce to you the more important aspects of chart analysis. But that’s only the start.The Investing Resources Guide at the end of the booklet will point you toward places where you can continue your technical studies and start taking advantage of that valuable new knowledge.

Charts can be used by themselves or in conjunction with fundamental analysis. Charts can be used to time entry and exit points by themselves or in the implementation of fundamental strategies. Charts can also be used as an alerting device to warn the trader that something may be changing in a market’s underlying fundamentals.Whichever way you choose to employ them, charts can be an extremely valuable tool—if you know how to use them.This blog is a good place to start learning how.

Source for this blog & Full Credit : John J. Murphy's Charting Made Easy

Not try to undertake illegaly copyrighted material only Intention to make readers aware of technical strategy and not intentioally publish the articles. I am giving full credits to the author of the book from whom i have taken the material.

We would like to express its appreciation to Equis 

International and MetaStock for use of their charts.