REAL WORLD
Flexible Market Forecasts
by Michael Kahn
It's important to be flexible in your market forecasts, as this walk through some recent trends in various markets indicate.
That repetitive price patterns exist is one of the foundations of technical analysis. The reasoning is that repetitive patterns occur because traders react to similar market conditions in a similar fashion. Unfortunately, in the real world, the term similar market conditions is subject to interpretation, as the market's price movements do not unfold in a precise, repetitive fashion. Take a look at examples of some market movements, including trends and reversals, to see how much leeway is required when you watch a technical pattern unfold, and what to do with it.
The 30-year US Treasury yield was in a downtrend (with rates falling) starting in early 1992. Figure 1 shows that in late February 1993 to late May 1993, the yield for the Treasury bond had been trading in a narrowing trading range centered at 6.9%. I have drawn an upward sloping triangle. In addition, the momentum as indicated by the nine-day relative strength index (RSI) had broken down through its own uptrend line.
In looking at Figure 1, what the analyst should do next is draw the downtrend line from the November 1992 peak. The triangle pattern drawn has a clear horizontal line at 7.07% yield. The triangle top and the November downtrend line meet one another, and since triangle patterns are generally continuation patterns, the evidence points to a downside break of the triangle, which did, in fact, occur.
Figure 2 adds the next three months of trading into the scenario. In early June, the market broke down out of the triangle pattern and continued its decline. The new short-term trend was much steeper than the longer-term trendline. Seven months earlier, this same situation occurred and the market responded by consolidating into the triangle.
