BASIC TECHNIQUES
Price Patterns, Part I
by Martin J. Pring
This veteran market analyst takes a look at the principles of price formation, one of the basics of technical analysis.
In my recent articles, I have covered many basics of technical analysis, ranging from peak and trough analysis all the way to moving averages. What I haven't covered is one of the most widely used concepts of technical analysis: price patterns. This time, I'll take a look at the principles of price formations, together with some of the most common varieties. Next time, I'll examine one- and two-day patterns, because they can be extremely useful for short-term traders.
FIGURE 1: RANGES TO REVERSAL. The price rallies, settles into a range, then slips into reversal.
In most charts, you'll find that prices rarely reverse on a dime; rather, they experience clearly definable trading ranges prior to experiencing a trend reversal. Figure 1 shows such an example. In the left-hand part of the chart, the price rallies and then loses upside momentum as a battle between buyers and sellers gets under way.
Often, it is possible to construct two horizontal trendlines to mark the top and bottom of the range. Every time the price rallies to the upper line, buyers are scared off by the higher price and selling pressure increases. Then, as it falls to the lower line, buyers are attracted, but sellers, who naturally want a higher price for their goods, withdraw their offerings, so the price bounces again. Eventually, sellers win this battle as the price slips decisively below the lower end of the range. The charting activity that separates the uptrend from the downtrend can be contained by two parallel trendlines known as a rectangle.
DISCERNING BETWEEN REVERSAL
AND CONTINUATION PATTERNS
Price patterns come in two forms, reversal and continuation. In Figure 1, we see a reversal from an uptrend to a downtrend. Conversely, we could have had a reversal from a downtrend to an uptrend.
Figure 2 features a continuation or consolidation pattern. It shows the rectangle as a temporary halt in an ongoing uptrend. As the pattern is being formed, there is no way of knowing which direction the breakout will materialize, based on the price action contained within the formation itself. Other indicators such as oscillators could provide vital clues, but the normal technical principle is to assume that the previous trend is in force until proven otherwise. A trend is a trend, after all. This means that when we have determined that a rectangle is being formed, we should assume that it is a continuation, rather than a reversal rectangle, until the charts indicate otherwise.
PRINCIPLES OF INTERPRETATION
Before we consider other varieties of price patterns, examine some of the interpretive principles that apply to them all:
- The significance of an individual pattern. The importance of a particular formation is very much a function of its size and depth. For example, when the captain of a giant oil tanker decides to reverse course, the new course will likely last a lot longer than a driver of an automobile doing the same thing. The same is true of markets.
Martin J. Pring founded the International Institute for Economic Research in 1981. He is the author of several books, including the classic Technical Analysis Explained, and Introduction To Technical Analysis, the first technical analysis multimedia CD-ROM. He pioneered the introduction of videos as an educational tool for technical analysis in 1987, and was the first to introduce educational interactive CDs in this field. His Website is http://www.Pring.com, and he may be reached at info@Pring.com.
Excerpted from an article originally published in the August 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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