The Anatomy of a Stock Chart
By Martha Stokes, c.m.t.
Stock charts are a window into the marketplace providing a detailed graphical
view that enables a chartist to understand the dynamics behind the price
action. Whether you trade stocks, options, currencies, or commodities, you
need to be using charts for your trading analysis.
Most people however jump into stock chart reading without getting the
essential training they need to optimize and expedite their chart analysis. So let’s
start with the essentials of chart analysis using a stock chart. For new chartists
this will be a place to begin. For advanced traders, this may be a review in places
but reviewing is something all professionals in any industry do on a regular basis.
Honing skills to the highest professional level should be a life-long pursuit.
First, let’s dispel a common myth: Charts do not predict the future. However,
when used properly, charts do tell us a great deal about how to trade, when to trade,
and what to trade.
Charts tell you:
1. When to buy or sell, based on your trading style and risk tolerance.
2. What is a reasonable price to pay for a stock, option, etc, based on your
trading style and trading parameters.
3. Which stocks are forming Trendline Patterns that fit your trading style.
This tells you what trading strategies will work best at that time.
4. Where to place your stop loss based on price patterns rather than the
outdated ‘percentage stop loss’.
5. The angle of ascent or descent which tells you whether the current price
action is sustainable, how long the trend is likely to move in that direction,
if a change of trend is imminent, and where you are in the trend cycle.
6. When to exit a stock based on your trading style, hold time, and financial
goals.
7. Which of the 8 levels of Market Participants are actively trading.
8. Which of the 4 positions currently dominate the price action: buyers,
sellers, sell shorters, or buy to cover traders.
9. Whether small lots or large lots are in control of price.
10. The direction of the long term, intermediate term, and short term trend
and whether the 3 trends are in harmony or opposition to each other. This
defines the overall cycle.
Catch that Trend!
Directional Strength and How to
Find It
By Barbara S tar , Ph.D.
Traders usually favor moving averages to help them determine price trend.
However two other popular indicators, the Moving Average Convergence/
Divergence (MACD) and the Average Directional Index (ADX), can help
traders detect not only trend direction, but trend strength as well.
The MACD, created by Gerald Appel, is a momentum indicator that often
identifies price direction as it rises and falls above or below its trigger line and its
zero line.
The ADX, part of the Directional Movement system developed by Wells
Wilder, is designed to detect the strength of price movement. ADX values in the
20 to 30 range indicate mild to moderate trending behavior while values above 30
usually signify a strong trend. A rising ADX indicates that prices are trending, but
does not reveal the direction of that trend.
Plot the ADX 14 period indicator above the MACD on the same price chart
as shown in Figure 1, and patterns emerge that show both trend strength and trend
direction.
Figure 1
The ADX indicator rises when
it detects a growing trend, but
does not indicate the direction
of the trend. Add the MACD
however, and the trend direction
becomes easier to see.
27
Catch that Trend! Directional Strength and How to Find It
Three Patterns
Three distinct, and profitable, patterns frequently appear. These patterns
do not detect tops and bottoms, but can help traders confirm a trend. They are
especially useful for those traders who prefer shorter-term trades.
Confirming Pattern: The confirming pattern occurs when both the ADX and
the MACD rise and fall in unison with price. When the indicators rise together
they identify up-trending price movement that presents bullish traders with an
opportunity to enter the long side of the trade. The strongest and most ideal
trading configuration takes place when the ADX begins to rise and the MACD
rises above its trigger line and also above its zero line. The level from which
the ADX rises does not matter. In the Confirming pattern, when prices change
direction to the downside so do both the ADX and MACD to indicate a loss of
momentum and/or a potential trend change.
The Confirming pattern was evident on the daily Allegheny Technology price
chart. Both indicators rose in April confirming the price move from the $30 to $40
level. Both indicators declined in May as prices dipped, but rose once more in June
when price moved toward $45. The indicators declined in late June to reflect the
falling to sideways price action.
Diverging Pattern: The diverging pattern identifies down-trending price
movement. Here, the indicators move in opposite directions. The ADX rises to
indicate that it has found a trend, but the MACD declines which indicates that the
direction of the developing trend is down. Its mirror-image formation makes it an
easy pattern to spot visually.
This is a good pattern to follow for traders who are bearish and want to short
a stock. It also serves to warn those traders who might wish to enter a long position
that they should wait for a more favorable time.
Figure 2
When the ADX and MACD
rise and fall in unison with price,
it creates a confirming pattern.
An up trend is in progress when
both indicators rise together.
28
Barbara Star, Ph.D.
The strongest pattern occurs when the ADX rises while the MACD falls
below its trigger line and also below its zero line. Two distinct Diverging patterns
appeared on the chart of Abbott Labs in Figure 3 as prices took a nosedive from
February to March and again in April.
Converging Pattern: This pattern has an upward bias that comes after a steep
decline. The ADX rolls over and begins to decline, signifying that the strength of
the trend has weakened. At the same time the MACD, which had been below its
zero line, begins heading up to its zero line. Visually, the declining ADX and the
rising MACD seem to be converging toward each other. Although this pattern
sometimes marks the beginning of a new up trend, more often than not it is a
countertrend rally that produces a partial retracement of the price decline.
Figure 4 shows the Converging pattern on a daily chart of Honeywell
International. Following the price decline in the February time period that took
the stock below the $25 level, price began moving up in March where it was able to
retrace much of its loss. The MACD responded to the increase in price by crossing
above its trigger line and rising to (and in this case, through) its zero line as the
Figure 3
When the ADX rises but the
MACD declines, look for falling
prices.
Figure 4
The converging pattern
occurs after a decline. The
ADX moves down and the
MACD moves up as price
retraces some of its losses.
29
Catch that Trend! Directional Strength and How to Find It
ADX stopped rising and moved down to complete the Converging pattern.
This is an enticing pattern, but often not as profitable as the others because its
moves tend to be short-lived and, even though the MACD rises, prices may move
sideways instead of upward.
A Trading Example
Traders could have profited from many of the patterns signaled by the ADXMACD
duo on the CH Robinson Worldwide price chart in Figure 5.
Area A marked a decline with a Diverging pattern that was followed by a
Converging pattern as price rose in area B. That Converging pattern gave way to a
Confirming pattern (Area C) as price continued to rally another ten points. A new
Confirming pattern appeared in Area D which reflected the decline that filled a
prior price gap before reversing to the upside.
Could you have benefited from any of the four areas identified by the ADXMACD
patterns?
Summary
The patterns displayed by the ADX and MACD combination appear on charts
of commodities, indexes, and mutual funds as well as stocks. Not only do the
patterns have profit potential, they signal changes in price which can help avoid
trading pitfalls. This dynamic duo may be worth adding to your trading arsenal.
Barbara Star, Ph.D., (818) 224-4070, is a former vice-president of the Market Analysts of Southern
California. She is a frequent contributor to the magazine, Technical Analysis of Stocks and Commodities.
A former university professor, Dr. Star currently provides individual instruction and consultation to
those interested in learning technical analysis. Her e-mail address is star4070@aol.com
Figure 5
Many trading opportunities presented
themselves during a four
month period as all three patterns
appeared at various times on the
C H Robinson Worldwide price
char
30
Shawn Lucas
Recognizing Shifts in Volatility
By Shawn Lucas
Have you ever experienced that foreboding feeling of intense worry during
periods of relative calm – a sort of disturbance in the force or calm before the
storm? It is the same kind of sense that a mother has when, in the midst of the
normally chaotic play of children, she exclaims in horror, “Something’s wrong!”
Sometimes the sense actually precedes the event when the mother rushes to the
door just in time to see the child dive off the bed or the bookshelf come crashing
down. This type of perceptual awareness is a seemingly unconscious capacity for
insight, intuition or knowledge – or is it?
Traders – like their mothers – can also exhibit a predisposition to perceptual
awareness. You will often hear a trader exclaim, “It feels like this market is going to
reverse” or “Things are about to get a little crazy!”
At no time does perception have a greater impact on performance than it does
in recognizing volatility shifts. Volatility shifts are natural changes in the tempo
and magnitude of price fluctuations in the market. It is important to note that a
volatility shift is not necessarily a change in the direction of a trend, but in the
speed and distance of the trend.
In reality, recognizing a shift in volatility does not need to be a supernatural
feeling or intuition. In fact, volatility shifts fit into one of nine patterns easily
recognizable on the chart.
In this article you will see how to measure average volatility on a price chart
and identify the nine volatility shift patterns that tell you whether volatility is
increasing or decreasing.
How to measure average volatility from a price chart
A volatility shift is a change in the average price movement over time. There
are two variables you need to establish before you can measure volatility shift: the
average price cycle and the average time cycle.
Average price cycle employs the same underlying concept that is used to
calculate the Average True Range (ATR). The ATR can be used to give you an
approximation of the magnitude (distance between the high and low) of each bar
on a price chart. For example, if the range for each price bar for the last three
periods is 1.25, 1.50 and 1.25, then the average range for each price bar is 1.33.
The average price cycle measures the same thing – only instead of measuring the
price bar it measures the price cycle (distance between short term pivot lows and
pivot highs).
To calculate the average price cycle you must first measure the last several
price cycles. A price cycle is easily measured by subtracting the last pivot from the
previous pivot as shown in the diagram below:
31
Recognizing Shifts in Volitility
The average time cycle is also needed to calculate volatility shift since, unlike
the ATR where time period is fixed, the duration of each price cycle varies. To
calculate the Average Time Cycle you take an average of the last “x” number of
time cycles. The time cycle can be easily calculated by counting the number of bars
required to complete one price cycle. This is displayed in the diagram below:
Volatility Shift Patterns
R = Resistance
S = Support
R = Resistance
S = Support
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Shawn Lucas
Once you have calculated the average price cycle (APC) and the average time
cycle (ATC), you can begin to set up a model for calculating volatility shift. There
are 9 different volatility shift patterns: 1 pattern for normal volatility, 4 patterns for
increasing volatility and 4 patterns for decreasing volatility.
Normal volatility is the condition where the current price and time cycle is
equal to the APC and ATC respectively, as shown in the diagram below:
If the volatility is increasing it is called a positive volatility shift. There are four
conditions where volatility is increasing.
1. If APC is increasing and ATC is decreasing then volatility is increasing.
2. If APC is constant and ATC is decreasing then volatility is increasing.
3. If APC is increasing and ATC is constant then volatility is increasing.
4. If APC is increasing and ATC is increasing then volatility is increasing.
A negative volatility shift occurs when there is a decrease in volatility. There
figure 1 figure 3
figure 2 figure 4
R = Resistance
S = Support
33
Recognizing Shifts in Volitility
are four conditions where volatility is decreasing.
1. If APC is decreasing and ATC is decreasing then volatility is decreasing.
2. If APC is constant and ATC is increasing then volatility is decreasing.
3. If APC is decreasing and ATC is constant then volatility is decreasing.
4. If APC is decreasing and ATC is increasing then volatility is decreasing.
Learning to recognize volatility shifts is an important element to a successful
trading routine. You can imagine how challenging it can be when you prepare for a
normal market condition and get a volatility shift. It’s like preparing for a concert
by Beethoven and getting the Beatles! It can be a major source of frustration to
traders who are not accustomed to changing market conditions. By comparing the
average price and time cycles to the current cycle you can actually see volatility
shifts as they happen on the price chart and be prepared for any inclement change.
figure 1 figure 3
figure 2 figure 4
34
Shawn Lucas
Shawn T. Lucas is a leading expert in the field of technical and economic analysis of the financial
markets. He has traveled extensively throughout the United States, Canada, and Asia providing
lectures, training, consulting and expert testimony to companies and individuals on the art and science
of financial analysis.
The APC and the ATC calculations are available in an indicator format in the Proform Robot
plug-in for MetaStock. For more information go to: www.proformrobot.com
