Chart Patterns and Market Cycles

• ragheehorner
• September 30th, 2009

A the heart of my trading are two things:  First that news and fundamentals are already discounted into price action and second, that my entries must be dictated by market cycles.  After all, I am a chartist.

Chartists believe that news and fundamentals are already baked into the cake.

I first read about market cycles from Charles Dow’s Theory and it really just clicked for me.  I knew that for each market cycle I would need a specific entry strategy.  Chart patterns were a perfect compliment to this because there are chart patterns that are appropriate for trending and non-trending markets.  Subsequently I needed a tool to identify market cycles without having to wait on touchpoints in order to draw trendlines (which by the way are notoriously late at identifying trends).

I wrote about the 34ema “Wave” (I sure do wish I had called it something else!) in my first book back in ’03 and had been using it for over a decade before that so I trusted it and believe me, NEVER underestimate how important it is to trust your tools.  It’s your confidence in your trading tools that allows you to recognize a set up and react to it and then do it all over again.

Confidence doesn’t come without a price.  You have to put in the time to first learn (comprehend) the trading style/entry, test and confirm it in the live market and then you will s-l-o-w-l-y begin to have a feeling of confidence.

Comprehension + Confirmation = Confidence

So basically what I am going to show you here is only going to be of help to you if and as you comprehend what I am about to tell you, confirm it in the live market and gain confidence in your analysis and subsequent trades.

So you may or may not already be familiar with market cycles but essentially it’s understanding that prices go through cycles that represent moving higher (mark up), moving lower (mark down), moving sideways with lower volatility (accumulation), and moving sideways with higher volatility (distribution). I order to recognize not only these cycles but see the transition between them I use a trio of exponential moving averages:  The 34 period ema on the high, on the close, and on the low.  For you Fibonacci fanatics out there, you know that “34″ is a Fibonacci number.

My “Wave” is the 34 period ema on the high, on the close, and on the low.

Using the angles at which the three lines travel I can determine in real time the current market cycle direction and the strength of a trend, the support or resistance in a trend, and the volatility or lack of volatility of a non-trending market.  Once I know this information, choosing an entry strategy become easy because I know what I want to do at support and resistance.  Realize the only reason the market works the way it does is because some people think a ceiling or floor will be broken while other are fading it:  For every buyer there must be a seller.  We may see the same support, resistance, 200sma, etc., but it’s our action (buying or selling) at that level that dictates our entry style.

If I have an uptrend I will focus on patterns like up channels and rising wedge.  Alternatively for a downtrend I will focus on down channels and falling wedges.  In sideways, non-trending markets like accumulation and distribution I will look for triangles, rectangles, double tops, double bottoms, and flags.

So the idea here is to pair up the appropriate entry with the current market cycle and chart patterns make this quite easy.  Let’s look at a few set ups I am watching and/or in in as this evening’s Asian session approaches.

(I post charts on Chart.ly throughout the morning until the London close and sometimes in the evening if I am trading the Asian session.)

Here is an example of a mark down cycle with a downtrend chart pattern — a falling wedge — on the 30 minute USD/CAD.  The trigger here is a breakdown through wedge support.

Here’s another downtrend, but this time the trigger will be a corrective entry or what I consider a “swing” play.  As prices head up towards the resistance at the 34ema low, the 38.2 Fibonacci retracement level, and the downtrend line of the falling wedge I will look to enter short on this EUR/JPY 240 minute chart.  This entry also has the added benefit of being below the 132.00 major psychological number.

Next is a an example of a distribution market.  This is the sideways market where prices are more volatile and this means that typically break up through resistance and down through support do not have good follow-through.  It’s a perfect market for fading breakouts and breakdowns especially when the ceiling is a “00″ like the 1.0400 in this set up.  I will continue to fade this until either the distribution market transitions into accumulation or begins to trend higher or lower.

The next example is of a momentum play.  A triangle pattern has formed in an accumulation cycle.  I would love the Wave to smooth out here a little more and show that the market has quieted down and is ready to begin coiling for an eventual breakout.  I have to admit that finding a good current accumulation cycle and decent momentum play, right now, was not readily available.  Watch this one:  It’s not quote “ripe” yet…

OK, so what you have here is a pretty good look at some charts I am watching and are good examples of what it means to pair up your entry strategy in accordance to the underlying market cycle.

- Raghee, http://www.twitter.com/ragheehorner

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: $EURJPY, USDCAD

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