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The Fundamentals of Technical Analysis

As a new trader entering the world of cryptocurrency speculation, you’re faced with a bewildering array of choices: markets, time frames, methodologies, technical indicators, and the size of each trade. Without a working knowledge of the forces that drive price, your trading results are random at best.

This article is designed to build your foundation in technical analysis, taking you from novice to in the know.

A Fair Warning

Applying conservative money management and position sizing rules to attractive trade setups will be the true secret to success. However, even the most robust, market-tested methodologies – and the indicators they are based upon – experience strings of losing trades. Careful, conservative allocations of trading capital can keep you in the game for the long haul, even as such periods of drawdown occur. With a good system, over time you’ll win on average, but only if you don’t bet the farm on the first few trades right out the gate.

Leading vs Lagging Indicators

Technical indicators and tools generally fall into two distinct camps:

  1. Leading indicators – factors with some forecasting ability
  2. Lagging indicators – factors that precisely follow current price action

Neither class of technical tools is inherently superior to the other. Each can be valuable in a wide variety of market contexts.

Most important to remember is that no technical tool, indicator, system or methodology is a fail-safe diviner of future market price action, be it thirty seconds from now or thirty months. At best, they offer a reasonable method of measuring the past performance of repetitive price patterns in a variety of market scenarios.

Your goal, as an investor, should be to make these concepts your own. Adapt them to the unique way in which you interpret market price action. If you make this an all-consuming endeavor, in due time you have an excellent chance of becoming the rare trader who can always know what side of the market offers the most profit potential and with the least amount of risk. You will also know what indicators/tools to deploy and how to use them to trade the right side of the markets for maximum advantage.

Primary Market Dynamics

All significant price moves are affected by these ten primary market dynamics.

  1. Support and resistance: price levels created by large trading volumes and/or previous market reversal points
  2. Trend: a series of higher swing highs and higher swing lows, or a series of lower swing highs and lower swing lows
  3. Trend reversals: occur when a previous trending move has exhausted and a new, opposing trend direction has supplanted it.
  4. Volume: the number of shares, units, contracts transacted in a given time period
  5. Volatility: the variability of a price series over a given period of time; periods of abnormally low volatility are often followed by powerful breakout moves
  6. Price cycles: the tendency of a market to form repetitive troughs (cycle lows) and peaks (cycle highs) every n-bars
  7. Divergences: the phenomenon of price making a new high (or low), but with a given technical indicator tracking the move (RSI, MACD, etc.) failing to make a new high (or low) of its own; this disconnect between price/momentum or price/volume can set the stage for a trend reversal
  8. Fibonacci retracements: a method for measuring percentage retracements of a market swing in relation to previous swings
  9. Money flow: a method of measuring the behavior of the big money interest in a given market, normally based on formulas that rely on trading volume, price range or open interest
  10. Market profile: a technique that measures volume at price and which can identify statistical, high probability areas of supply (resistance) and demand (support) on a chart

What to Look For

Support and resistance are the most influential market dynamics of all. Next comes volume analysis (trading volume), along with market profile studies. The remaining seven market dynamics offer traders a relatively equal contribution in terms of effectiveness. When various combinations of the above dynamics are all in general agreement as to the likely direction of an impending price surge, the price is due for a swing or surge.

Individual Indicators

Market Profile (leading)

A market profile applies a bell curve statistical analysis to a chart, identifying the heaviest/lightest areas of trading volume at specific price levels.

This volume-at-price analysis method was developed by J. Peter Steidlmayer and has proved to be a go-to technical analysis tool among professional traders in the decades since its introduction in the 1980s.

Important Terms

Volume-point-of-control (VPOC): Where the price tends to stall and/or reverse.

70% Value Area: Area of heaviest trading activity. A breakout from this range tends to trend strongly in the same direction, often targeting another VPOC.

Example: BCHUSD’s 360-minute (six-hour) chart as of midday, August 13, 2018

Figure 1.) BCHUSD, 360-minutes. Market profile charts are relatively easy to interpret; breakout/swing/trend traders should focus on existing low-volume holes and exploit strong breaks into such market vacuums, as strong follow-through frequently results.

  1. Locate the heaviest and lightest zones of trading activity, represented by the horizontal peaks and valleys above.
  2. Once located, trade breakouts from high-volume areas (peaks) that lie just above/below relatively lower-volume zones (valleys).

Additional Tips

  • Take some/all of your gains as soon as you come within close range of a previously-identified, high-volume peak.
  • Only take breakout trades when there’s a surge into a previous low-volume valley.

Chaikin Money Flow (leading/lagging)

Chaikin Money Flow (CMF). is the brainchild of noted market technician Marc Chaikin and is highly useful in identifying trend strength, price/money flow divergence and trend exhaustion. Basically, it measures the location of the close on its current price bar and then also measures the difference of the current bar’s trading volume with the previous bar’s trading volume.

It will also alert astute traders when Mr. Big is selling out of his positions, and a wise trader will also begin to take some gains at that time, too, even as CMF can alert value investors that the big money is beginning to nibble on a beaten-down crypto, stock or commodity market.

Important Terms

Accumulation: When the current bar’s price closes in the upper half of its range and its trading volume is higher than the previous bar

Distribution: When the current bar’s price closes in the lower half of its range and its trading volume is lower than the previous bar

CMF Settings:  Smaller settings are geared for more rapid trading action and longer ones for market moves of progressively longer duration

Common CMF Settings: 21 (most popular), 34, 55, 89, 144

Example: 400-minute chart of CME Bitcoin futures 

Figure 2.) Bitcoin futures, 400-minutes. The interplay between the short-term and the longer-term CMF histograms, along with the slope of the 100-period simple moving average, can help provide a basis for determining trend bias.

Bullish move indicator

Price has lower lows as CMF (21) and preferably also CMF (89) histograms slope higher, moving from red to green.

Bearish move indicator

CMF (21) histogram slopes lower

Additional Tips

  • When both the CMF (21) and CMF (89) histograms are the same color (typically green if above the zeroline and red if below), favor trading in the direction of the trend, unless the trend is mature, with signs of divergence appearing.
  • If you have both CMF histograms green and the slope of the 100-perod average turning up, that’s a powerful bullish confirmation, and of course the inverse is also true for a bearish trend.
  • The CMF (89) histogram all by itself is a great trend-confirmation tool – the trend bias is bullish when green and bearish when red.

Fibonacci (Fib) Retracement Tools (leading)

This is a widely-used and revered technical tool that measures the relationship between specific market price swings in percentage terms. Unlike market profile, no volume-based supply/demand zones are considered when calculating future support/resistance price levels, and that’s why many technicians/traders also use a variety of volume, trend, momentum and statistical methods to assist in their Fibonacci-based price target work. That said, Fibonacci retracements can be used in isolation with some degree of success, although it would appear to be unwise to do so, if other indicators are available to provide additional confidence.

The Fibonacci number sequence is as follows:

1,2,3,5,8,13,21,34,55,89,144,377,610, 987, 1597, 2584, 4181 and on and on and on.

The sequence begins by adding 1 + 2, which of course equals 3. For the remainder of the sequence, the same pattern of adding the previous number to the current number continues, and the further out the sequence extends, the closer the ratio between the numbers gets to .618, which also known as the Golden Ratio.

Important Terms

Popular Fib Retracement Levels: 38.2%, 50%, 61.8%, 78.6%, 100%

Popular Fib Expansion Ratios: 61.8%, 100%, 127.2%, 138.2%, 161.8%, 200%

Example(s)

Figure 3.) LTCUSD, daily. Trading Fibonacci retracements in the context of a downtrending market; note that the spread between the two moving exponential averages is increasing, indicating strong bearish momentum at the time of trade entry at point C.

Bearish indicators

  • Price below exponential moving averages (23 day and 50 day periods)
  • Spread between averages is widening

When to Enter Short

  • When the price retraces 62% of the distance of swing AB
  • Two cycle oscillators also rise to confirm a cycle high

The risk on the trade is minimal because the downtrend is relatively new and the bearish momentum is increasing. Set a stop loss just above the red moving average as a reasonable place to exit the trade if a sudden reversal comes along that drives prices higher.

Figure 4. ) LTCUSD, daily. The same chart and trade entry point at ‘C;’ in this case a simple Fibonacci-based formula is used to calculate potential price targets for swing CD.

When to Exit Short

Calculate length of AB swing:

A = 192.89       B = 145.98

AB = A – B = 192.89 – 145.98

= 46.91

Calculate potential target prices:

Target = C-(AB*X)

C = 175.50

AB = 46.91

X = Fib

Conservative (X=0.62): 146.51

Typical (X=1.00): 128.59

Extreme (X=1.27): 115.83

As it turned out, swing CD finally terminated at 109.27, which exceeded all of the target calculations.

Moving Averages (leading/lagging)

The moving average can be used to identify future support/resistance areas and can also be used to confirm trend direction, trend strength, and even trend reversals.

Important Terms

Simple Moving Average (SMA): The sum of all closing prices divided by the number of prices used in the calculation.

Key SMAs: 10-, 20-, 50-, 100-, 150- and 200-period versions

Exponential Moving Average (EMA): Identical to a simple moving average but with more weight placed on recent price action.

Example: 480-minute (8-hour) chart for ETHUSD with four different averages applied

Use multiple averages on one chart to get an accurate view of the technical landscape on virtually any time frame chart.

Figure 5.) ETHUSD, 480 minutes. Simple technical indicators such as moving averages, when thoughtfully analyzed, can provide a dependable, rational framework upon which to base trading decisions.

In this example, we examine four trade set-ups, two longs and two shorts:

Long Trade 1: Bullish Indicators

  • Pennant chart formation
  • Price breakout through dashed resistance
  • Widening spread between the 8-, 20-, and 50-period EMAs with bullish momentum

Long Trade 2: Bullish Indicators

  • Pennant chart formation
  • Price breakout through dashed resistance
  • Widening spread between the 8-, 20-, and 50-period EMAs with bullish momentum
  • Long-term 90-period SMA began to slope higher several bars prior to the surge

Short Trade 3: Bearish Indicators

  • Price drop below the 8-, 20- , and 50-period EMAs
  • Price drop below support level defined by boundary of consolidation pattern (see: rectangle)
    • Determined by thinning spread between the 8-, 20-, and 50-period EMAs
  • Widening spread between the 8-, 20-, and 50-period EMAs with bearish momentum

Short Trade 4: Bearish Indicators

  • 90-period SMA began to downslope

Additional Tips

  • The 8-period EMA works well as a trailing stop
  • When using moving averages, always trade with the trends
  • 90-period SMA is a good trend bias filter, but always use it in conjunction with the other three moving averages to have more accurate entry signals
  • 20-period EMA may act as strong support on uptrends
    • 20-period EMAs are typically a low-risk long entry point, especially in a strong uptrend or downtrend, and more so if the trend is not showing signs of old age

Directional Movement Index (lagging)

The Directional Movement Index (DMI) was introduced in 1978 by J.Welles Wilder in his book New Concepts in Technical Trading Systems and the indicator (along with several others, including the Relative Strength Index or RSI) remains a favorite among momentum and trend traders alike.

For serious trend followers, the DMI trading system remains a winner even after forty years in action. Will you win on every trade when deploying it? No way.

However, winning trades tend to be three or even four times larger than losing trades are. So, even if you only win 40 to 50 percent of the time, you’re going to make money with the proper position sizing and money management.

The DMI is comprised of three components:

  1. The ADX line (Average Directional Index): yellow on our chart
  2. The DMI+ line: cyan on our chart
  3. The DMI- line: red on our chart

The relationship between the DMI+ and DMI- lines show whether the trend is bearish or bullish. And the ADX value tells you the strength of that bullish or bearish trend.

Ground Rules

ADX value is below 15: market is in a trendless, range bound condition

ADX drops toward 10: prepare for an explosive move in either direction

ADX rises past 25: strong trend is developing

ADX exceeds 35-40: trend strength may begin to weaken. However, in a monster trend, ADX values of 60 or even 70 are possible for brief periods of time.

DMI+ line above the DMI- line: uptrend established

DMI- line is above the DMI+ line: downtrend established.

Example

Figure 6.) Bitcoin futures, daily. Combining the DMI trading system signals with additional confirmation from a variety of exponential moving averages can lead to bigger gains and fewer losing trades.

Short Trade 1:

Entry price: $14,565 on January 11, 2018

Exit price: $10,115 on February 16, 2018

Percent gain: +30.55%

Bearish Indicators:

  • ADX line and DMI+ lines cross each other with ADX above DMI+ line
    • Bearish signal only as long as the DMI- line is above the DMI+ line
  • Price below the 8-, 20-, and 50-period ema lines AND spread between EMAs widening
  • ADX line rose steadily with no pullback until peak at 48.60 on February 6, 2018
  • Spread between DMI lines widened at various times

Closing Position:

  • 8-period EMA works well as a basic trailing stop
    • For more leeway, try a 10- or 13- period EMA
  • The trade was considered over once price closed back above the gray 20-period ema on February 16, 2018
  • Cycles and key Fibonacci retracement/expansion targets could have resulted in some more moolah on this monster trade.

Short Trade 2:

Entry price: $10,760 on March 7, 2018

Exit price: $8,010 on April 16, 2018

Percent gain: +25.56%

Bearish Indicators:

  • ADX line turning higher as DMI- line is above DMI+ line; this is a valid entry point
  • Price below all three EMAs at the time of the ADX turn-up
  • EMA spreads widen during the balance of the trade
  • DMI- and DMI+ spread widen during the balance of the trade

Closing Position:

  • 20-period EMA worked like a champ trailing the trade from start to finish

Short Trade 3:

Entry price: $7,465 on May 24, 2018

Exit price: $6,685 on July 10, 2018

Percent gain: +10.45%

Bearish Indicators:

  • ADX turns higher while DMI lines show bearish trend (DMI- above DMI+)

Cycle Oscillators (lagging)

Most liquid financial markets (including large-cap cryptocurrencies) have a repetitive price cycle that averages around 16-22 bars between significant cycle lows or troughs. At times, a cycle may extend to 24 or 26 bars, while at other times it may contract to 12-15 bars.

Knowing this, you can begin to formulate a strategy for timing more accurate trade entries and exits.

Important Terms and Indicators

Uptrend

  • Series of higher swing highs and higher swing lows
  • ADX rising above 25 with DMI+ above DMI-
  • Widening spread between two key moving averages
    • Faster moving average above slower moving average
    • 20- and 50-period EMAs are fine choices
  • Price above both key moving averages

Downtrend

  • Series of lower swing lows and lower swing highs
  • ADX rising above 25 with DMI- above DMI+
  • Widening spread between two key moving averages
    • Faster moving average below slower moving average
    • 20- and 50-period EMAs are fine choices
  • Price below both key moving averages

Key Support and Resistance

  • VPOC level
  • Key Fibonacci retracement/expansion level
  • Key Keltner channel level

Ground Rules

There are two basic tasks that you should perform before trading with cycle oscillators:

  1. Choose a definite time frame in a highly liquid (plenty of trading volume) market and then define the trend (downtrend, uptrend, or trendless).
  2. Identify key support/resistance (s/r) levels on the timeframe you chose and also on the chart one time frame higher.
    • Example: If trading a 360- or 480-minute chart, identify the key s/r levels on the daily chart, too. If trading the daily chart, identify the weekly chart key s/r levels.

After doing those tasks, wait for the price to decline into a set of cycle oscillator lows during a confirmed uptrend. Go long as the cycle oscillators once again turn higher. Stay long until either the cycle begins to top and/or the price is about to reach a key s/r level.

For short trades, simply invert all of the above.

Example(s)

Figure 7.) LTCUSD, 400 minutes. Buying pullbacks against a confirmed uptrend (or shorting pullbacks against a confirmed downtrend) is one of the lowest-risk, highest-probability trading methods available, especially for less-experienced market participants.

Bullish Indicators:

  • Spread between 20- and 50-period EMAs widening
  • Price above both EMAs
  • Long overdue to make its next cycle low
  • ADX line above 25 (actually at 40.34)
  • DMI+ above DMI- line
  • Beautiful series of higher swing highs and higher swing lows in place

Figure 8.) LTCUSD, 400 minutes. Cryptocurrencies are famed for powerful trends, in either direction. Here, LTCUSD’s mammoth uptrend stalls and then finally exhausts as price collides with key statistical resistance at the upper Keltner channel. Note how much of the maximum open gain was forfeited by exiting only after the trailing stop was breached (point X).

Entering Position:

  • Wait for gold oscillator to close above 40
  • Enter long position when high of the price bar that caused the gold oscillator to close above 40 is exceeded by one tick

Closing Position:

  • Place initial stop between 485 and 490 (just below the previous cycle low)
  • Place trailing stop with 13-period EMA (dashed line)
  • Once move gets extended (10-13 bars out) and reach the upper Keltner channel (set at 9.15 ATRs away from a 45-period EMA), close the trade
    • Low statistical probability that price will trade above upper channel for more than a few price bars

Additional Tips

  • When going long, enter a market on weakness and sell into strength
  • The extreme Keltner upper band is generally ‘the limit’ on 99% of all market moves

Keltner Channels (leading)

Keltner Channels are one of those technical indicators that’s most likely not a hot topic of discussion at the country club or the neighborhood poker game. Nonetheless, it remains a highly effective tool for locating market extremes, confirming cycle highs/lows, and identifying general support/resistance levels.

Alternatively, Keltners provide a framework to identify powerful breakout trades.

Important Terms and Indicators

As a support/resistance indicator, these are the preferred Keltner channels:

Inner channel: 4 ATRs away from a 45-period EMA   

Outer channel: 6 ATRs away from a 45-period EMA

Extreme outer channel: 9 ATRs away from a 45-period EMA

ATR: Average True Range

Example(s)

This chart shows all three Keltners applied on the daily $BRTI index, along with a 14-period Commodity Channel Index (CCI):

Figure 9.) $BRTI CME CF Bitcoin Real-Time Index, daily. Even the most powerful trending moves reach a statistical extreme at some point, and the extreme upper Keltner channel frequently coincides with such exhaustion price action; note how well the 14-period CCI works in identifying negative divergence at such overbought levels.

Things to Know

  • When price approaches extreme outer Keltner channel, prepare for imminent stall and/or trend reversal.
    • Why? The smart money has already exited, stage left. Your open gains are now at risk.
    • What to do: Take partial and/or full open profits.
  • Negative divergences in the Commodity Channel Index (CCI) when $BRTI reached a new high (near the extreme outer Keltner) also signaled trend reversal

Figure 10.) $BRTI CME CF Bitcoin Real-Time Index, daily. A simple, yet highly effective breakout/trend system using a combination of Keltner channels and a 20-period price channel indicator can be constructed in virtually any trading platform. The price channel helps filter out several false breakout buy signals generated by the Keltner channels.

Here is the exact same chart, this time outfitted with a relatively narrow set of Keltner channels:

  1. 1.5 ATRs away from 20-period EMA
  2. 9 ATRs away from a 45-period ema
  3. 20-period price channel
    1. Tracks the highest high/highest low of the previous twenty price bars
    2. Added signal confirmation tool to help filter out false bullish breakouts from the narrow-range Keltner channels

Note: This set-up is best used on volatile daily, weekly or monthly charts.

Things to Know:

  • Enter long when:
    • Price closes above both the upper blue Keltner and the price channel, AND
    • Price is above the setup bar’s high

Moving Average Convergence/Divergence (leading/lagging)

You can use the Moving Average Convergence/Divergence indicator (MACD) in many different technical scenarios including:

  1. Identification of a new and potentially powerful trending move
  2. Identification of low-risk pullback trade entries in a strongly trending market
  3. Identification of high-probability price/momentum divergence setups

The MACD measures the spread between the 12- and 26-period EMAs and then calculates the nine-period EMA of the spread.

Most traders also plot the MACD histogram as well: a separate indicator than the MACD. (MACD shown by yellow and cyan lines in chart below)

Example

Figure 11.) CME Bitcoin futures, continuous contract; 480 minutes. Four ways to deploy the MACD in rapid succession- a zero line crossover, a low-risk long pullback entry zone, a bearish price/momentum divergence and then a bullish price/momentum divergence.

Important Point #1

  • Point ‘H’ on MACD histogram
    • Use to base future price momentum comparisons

Important Point #2 (Bullish Indicator)

  • Cross of yellow MACD line over cyan MACD line
  • Cross occurs near zeroline of MACD histogram
  • Signifies market may be ready to break out of a trendless phase

Important Point #3 (Bullish Indicator)

  • Rapid increase in MACD histogram height AND higher peak than point ‘H’
    • Low-risk, high-reward swing trade setup might appear on next pullback in the MACD histogram
  • Excellent long entry position at MACD pullback zone

Important Point #4 (Bearish Indicator)

  • Lower MACD histogram high
  • Lower price lows (LL) and lower price highs (LH)
  • Downtrend confirmed with price below yellow dashed line

Important Point #5 (Bullish Indicator)

  • MACD histogram steadily rises from sub-zero lows even as final stages of downtrend play out
  • Take profits before trend exhausts and/or reverses

Additional Tips

  • MACD/MACD histogram patterns work especially well for swing/trend trading, even on intraday charts like 15 and 30 minutes

Bollinger Bands (leading/lagging)

Created by John Bollinger more than twenty-five years ago, these standard deviation-derived price bands have become an essential part of every serious trader’s toolbox. The construction of Bollinger Bands (BBs) is based on the concept of volatility contraction and expansion across an n-bar time period

They have the advantage of instant visual identification of specific price patterns: you can stand on the other side of your trading room and still have visual confirmation as to the current state of volatility on the cryptos you trade.

Bollinger Bands are constructed by taking a simple 20-period moving average and measuring two standard deviations above and below the current value of the moving average. The bands are the measure of those calculations.

Markets transition from periods of low volatility to high volatility (and vice versa) all the time, assuring you of a steady stream of trading opportunities using BBs.

Important Terms and Indicators

Price is relatively high when it touches the upper band.

Price is relatively low when it touches the bottom band.

When price breaks out of either band, the market may start a sustained swing higher/lower.

Bollinger Band Squeeze trade setup: Price explodes higher/lower out of very narrow, low-volatility BBs.

Pro tip: Markets are in trading ranges approximately 65-75% of the time.

  • Therefore, BBs are useful for mean-reversion traders seeking to capitalize on near-term overbought and oversold trade setups in trendless markets.

%B indicator: Measures the relation between price and the BBs

  • Values above 50 mean price is closer to the upper band
  • Values below 50 mean price is closer to the lower band

Bollinger Bandwidth indicator: Identifies historically high/low volatility readings

Example

Figure 12.) Square, Inc. (SQ); daily chart. Three Bollinger %B negative divergence trade setups, along with two Bollinger Band Squeeze trade setups manifested on SQ’s daily chart in less than six months during the first half of 2018.

BB Squeeze Trade Indicators and Tips

  • Periods of ultra-high volatility always revert back to ultra-low volatility states.
    • See: Boxes marked ‘squeeze’
  • Breakouts from BB Squeeze patterns typically signify start of a sustained trend of some degree.
  • Use Bollinger Bandwidth indicator (bottom of chart) to confirm how low current volatility is on a historical basis.
  • Trading BB Squeeze patterns in the direction of the 90-period SMA (sloping higher or lower in the direction of the squeeze breakout) usually produce more winning trades.

BB Mean-Reversion Trade Indicators and Tips

  • Use %B indicator (second from bottom of chart) to verify negative/positive price divergences once trend initiated by BB Squeeze trend shows signs of exhaustion.
  • Note how price closely tracked the upper band (a strong uptrend) even as %B indicator failed to make a new high with price.
  • Once price showed signs of a stall, bears drove price back down to lower band.

Relative Strength Index (lagging)

The Relative Strength Index (RSI) was introduced  to the trading world in 1978 when J.Welles Wilder published “New Concepts in Technical Trading Systems.” The math behind its construction is complex, but the main things to know about the RSI are:

  1. It’s a superb price/momentum divergence indicator
  2. It’s a fantastic trend strength confirmation indicator
  3. It’s a must-have overbought/oversold indicator

Key Terms and Indicators

Short-term RSI (3): Identifies overbought/oversold extremes

  • Only when longer-term RSI (14) is on the ‘right’ side of its 50 mid-point line

RSI (14) >= 50.01 indicate a bullish trend bias

RSI (14) <= 49.99 indicate a bearish trend bias

Example

Figure 13.) $BRTI CME CF Bitcoin Real-Time index, 480 minutes. A simple RSI trading template; this one relies on an RSI (3) and RSI (14) to generate mechanical buy/sell signals in the direction of the primary trend.

Trade #1 (Bullish Indicators)

  • Price pulls back sharply to touch 20-period EMA line (gold)
  • RSI (3) drops below 25 AND RSI (14) continues to hold above 50
  • Spread between 20- and 50-period EMAs remains wide

Trade #1 (Entry Trigger)

  • Entry at highest high of previous two price bars (8,942.55)
    • Initial stop just below lowest part of pullback into the low (8,658.27)

Trade #2 (Bullish Indicators)

  • RSI (3) pullback below 25 AND RSI (14) remains above 50
  • Price pullback toward 20-period EMA
  • EMAs maintain wide separation

Trade #2 (Entry Trigger)

  • Entry at highest high of previous two price bars (9,058.18)
    • Initial stop just below pullback low (8,829.71)

Trade #3 (Bearish Indicators)

  • Faster EMA below slower EMA
  • Price pulls back a little beyond 20-period EMA
  • RSI (3) rises above 75 AND RSI (14) remains below 50

Trade #3 (Entry Trigger)

  • Entry at lowest low of previous two bars (8,440.81)
    • Initial stop just above pullback high (8,594.57)

Additional Tips

  • Use RSI to time price/momentum divergences as well
    • Newer traders should master the art of trading pullbacks with the primary trend first, though.

Long-Shadow Candlesticks (leading)

Candlesticks were first used by Japanese rice traders more than four hundred years ago.

There are several dozen candlestick patterns that can be identified on any series of price charts, but the ones that are the simplest to employ are those that are part of cycle high/cycle low exhaustion patterns.

They go by many names such as gravestone doji, hammer, shooting star, dragonfly doji, etc., but all you need is a visual confirmation to identify any of these long shadow candlesticks.

Important Terms and Indicators

Bearish long-shadow candlestick:  Extremely long distance between the high and the upper part of the candle body.

Bullish long-shadow candlestick: Extremely long distance between the low and the lower part of the candle body.

Long shadows: Indicative of price hitting important supply/demand zones beyond which traders are unwilling to move prices any further.

Pro tip: When long shadows appear after a large swing or price divergence, high-probability trend reversal setups are often the outcome.

Example

Figure 14.) CME Bitcoin futures, 360 minutes. Forecasting a trend exhaustion point is made much easier when aspects of cycle timing, support/resistance, divergence and key candlestick patterns all come into strong agreement. Reversals can be swift and sharp after such agreement, as this 360-minute chart of CME Bitcoin futures demonstrates.

Signs of Trend Exhaustion

  • Cycle analysis  
    • Overdue for a cycle high
    • 21 bars higher since the previous cycle low
      • Most markets stall/reverse at a cycle high after an 11-13 bar run
  • Support/resistance
    • Keltner channel (6 ATRs * 45-period ema) breached to the upside
      • In most markets, such a statistical extreme price move is typically reversed within 1-4 price bars
  • Divergence
    • 10-period Detrend oscillator corresponds to the highs/lows of the 20-period price cycle
  • Long-shadow candlestick
    • Bearish with small body appearing after previous three market dynamics

Trend Exhaustion Confirmation Signs

  • Close back inside Keltner channel AND price closing below low of bearish long-shadow candle

Additional Tips

  • 50-period EMA can be a powerful support/resistance level

Detrend Oscillator (lagging)

The Detrend Price Oscillator or DPO, is an accurate cycle identification indicator and it works just as well in identifying low-risk pullback entry points in a strong trend as it does in locating high-probability cycle high/low and trend exhaustion setups.

The goal of the DPO is to isolate/remove the trend portion of the dynamics that are moving prices higher/lower, giving you an accurate view of cycle lows and highs within a strong trend.

The DPO becomes more effective when combined with other technical tools such as moving averages, cycle oscillators, candlestick patterns, and Keltner channels.

Example

Figure 15.) ETHUSD, 34000-tick chart. A working knowledge of cycle bar counts, average cycle lengths and the way in which they interact with the Detrended Price Oscillator (DPO) and other key cycle oscillators can help provide traders with a powerful edge in the markets.

Long Pullback Entry Trade in an Uptrend

  1. Price bottoms in a 15-bar cycle low (point ‘X’)
    1. ETHUSD cycle averages 14-22 bars in length on this 34000-tick chart
  2. Both WB DoubleStoch oscillators (5- and 10-period) bottom in conjunction with the 15-bar cycle low
  3. 10-period DPO bottoms and remains near zeroline
    1. Confirms uptrend still has potential to run even higher
  4. 20-period EMA (gold) serves as support during the pullback
    1. Sign of strong uptrend still in progress
  5. Price surges higher again in a two-wave pattern that allowed re-entry at the next ‘X’
    1. This was a half-cycle low based on the 10-bar cycle rather than the longer 20-bar cycle
  6. Price stalls 18 bars from original cycle low seen at the pullback (the next ‘X’) even as it has managed to breach an extreme upper Keltner channel (green line)
    1. Surges above extreme Keltner channels don’t last long
    2. Most bullish cycles in an uptrend top out in 11-13 bars or less from the previous cycle low
  7. DPO has now confirmed two things
    1. Cycle high is likely in place
    2. Agreement with both key cycle oscillators makes this a high-probability event, with a trend reversal not far off
  8. Price corrects, pausing at the 20- period EMA and then the 50-period EMA before confirming a full-scale bearish trend reversal
  9. On the lower right side of the chart, as price makes a regularly scheduled 18- bar cycle low, DPO is near the same level as it was on the previous low AND both key cycle oscillators made a higher high
    1. Combination of DPO with cycle oscillators proved prescient, with the cryptocurrency staging a nice counter-trend rally

Summary

By now, you’ve begun to realize that there actually are rational, structured technical analysis methods available within the typical trading/analysis platform to help keep a trader on the right side of the markets – most of the time. You’ve also come to appreciate the value of using a number of non-correlated indicators when it’s time to size up a potential trading opportunity.

Perhaps most importantly, you’ve begun to grasp the importance of securing your open trading profits near price levels that are getting close to statistical extremes (using extreme Keltner channels, volume-points-of-control, previous market swings or extended cycle bar counts) before the smart money steals them away from you.

Realizing this, you’ll never again be the patsy who foolishly believes that a given market will rise or fall forever, with no reversals along the way. You can now trade with a technical framework that will, first and foremost, help keep you from wiping out your account in record time even as it can help you slowly and surely build wealth over time.

You may wonder which indicator or combinations of the 12 indicators discussed offer the best performance. The only answer to that question is you need to work with all of them in a simulated trading account, taking actual trades in your favorite markets.

No two traders are alike, and whereas Bollinger Band squeeze setups might be your favorite pattern to trade, another trader may find that buying pullbacks in the direction of a strong trend is more to their liking. Yet another trader may decide that the classic MACD zero line crossover trade setup to be especially attractive.

Realize, too, that there is a certain amount of overlap among the trade signals produced by all 12 indicators (depending on the specific structure of the chart), and that an RSI pullback entry may also be confirmed by an MACD pullback entry and/or a cycle oscillator/DPO pullback entry. Therefore, I suggest that you re-create all of the trading templates in the charts, using as many of them as you wish to help confirm your trade entries and exits.

That’s the easy part. Now, the real work begins.

Once you have decided on a set of potentially profitable indicators/templates to use in your real-life trading, the most important trading education tasks of all now become your primary responsibility:

  1. Trading psychology
  2. Money management/position sizing

These are the two make-or-break disciplines that separate trading pros from the also-rans. I can tell you that I learned this the hard way over the years, as have thousands of other traders. You don’t have to be beaten to a bloody pulp by the financial markets if you obtain the right trading psychology and money management/position sizing education right now – especially before you start trading with real money.

Trading, as someone once said, is “the hardest easy money that you will ever earn.”

Intense psychological pressures will assault you as you trade the markets, especially when your system or methodology is in a losing streak. Don’t believe for a moment that any/all of the 12 indicator combinations above have some sort of magical power to shield you or anyone else from the inevitable string of losing trades.

Even the winningest set of technical tools will be hit with bad streaks. Be warned that you need to prepare in advance for the emotional pressures of the trading game even as you need to learn to trade in a calm, probability-based, almost machine-like manner.

Do some research on the topics of trading psychology and money management/position sizing for traders and begin to apply this valuable knowledge to your day to day trading regimen. You will likely be rewarded with fewer account equity drawdowns and potentially great trading profits, not to mention less stress and more confidence in your trading methodology.

Trading Software

TradeStation 10  

TAS MarketMap

ProfitTrader 7

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Donald W. Pendergast

Freelance financial markets writer/market analyst, trading educator, trading system developer, musician, songwriter, missions in Peru with my wife Gladys since 2015.

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