TA Basics Part Three

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Analysis

Technical Analysis Basics III

When the markets are volatile and substantial price swings are the norm, attempting to grasp the overall picture as viewed through a deluge of warnings, prospects for a slowdown, rate cuts and earnings season is far from easy. Instead of getting bogged down in the myriad variables that could potentially drive prices, why not let the market tell you what could take place?

Patterns

I have never been a big fan of patterns whether it is a head-and-shoulders, cup and saucer, or bare naked lady. They all appeared to be too general in nature and seemed to fail to fulfill their objectives as often as they worked. Over the years my preference has focused on looking for aggressive/impulsive patterns off lows or highs and then more importantly how the market trades on the pullback.

Pullbacks

As mentioned, the pullbacks should be overlapping or sloppy, not impulsive. That's the easy part. The far more difficult question is how far back the decline will typically reach. What should be looked for are either congestion areas on the chart, technical levels such as moving averages/trendlines, or retracement levels. The latter is a percentage reversal of the move (in this case rally) that is typically set at 38%, 50% and 62%. While the patterns tell the story, if supports hold and bullish indicators (such as stochastics) are present, it should boost your confidence that this will develop as suggested.

Risk/Reward

Another positive to playing the market in this way, whether viewing intraday or daily charts, is that there is an obvious area to use as a stop. Once again looking at the 5-minute bar, a trader could enter the market on the long side on a penetration of the initial pullback low at 2406 with the critical support at the bottom of the 3 legged pullback at 2376 with the initial objective at the top of the first move.

Hindsight

Hindsight is always 20/20 with it more difficult to pull the trigger on a trade in real time (some pullbacks are also very complex). However, what this example shows is that once the market or individual stock has developed a solid move in one direction and then drifts back in a choppy fashion the probability is raised that another move in the same direction as the first run will be seen.

Big Picture

While the argument as to whether valuation levels are now compelling, why the Fed moved, when they will move again and by how much continues, why not listen to the market through the patterns for indications of whether moves in either direction will likely be sustained.

Jim Schroeder

MARKET PLACE