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Channels persist because the crowd sees and acts upon themPARALLEL PRICE CHANNELS Parallel price channels (PPCs) build across the highs and lows of relative price movement. They print two sets of trendlines at an equal distance to each other and can persist for long periods of time. PPCs have greater predictive value than simple trendlines and work with many different strategies. They form on either arithmetic or log scale charts, but not both at the same time. They owe their existence to Fibonacci proportion within trend development. PPCs can display all the psychotic tendencies of regular trendlines. They exhibit vanishing phenomena that can persist for years. They will often criss-cross into complex mosaic patterns that box price in all directions. Frequently, small channels embed themselves into larger ones. At times, swing traders may find three or four sublevel PPCs on a single major trend. These multiple-time frame PPCs have a great advantage over trendlines. Complex trading systems, such as Elder’s Triple Screen, can be applied with great ease when they appear. Channels persist because the crowd sees and acts upon them. This unique formation demonstrates considerable potency, although modern PPCs print more violations than in the past. While other common patterns whipsaw participants into oblivion, channels print their classic mechanics more consistently. It may be that this stable Fibonacci structure cannot be easily altered by the insider manipulation that weakens other patterns. How can four chart points connect so easily into parallel lines in our random walk world? They present a strong argument for technical analysis all by themselves. While logic suggests that these formations rarely occur, the opposite is true. PPCs print more often than clean trendlines on most charts. Their frequency probably generates due to self-fulfilling prophecy. Market participants naturally target a fourth strike after the chart draws the first three points. If a reversal does appear at that level, the pattern confirms and improves the odds that the next test will also succeed. The formation then strengthens with each strike and persists until a greater force overcomes it. PPCs offer more versatility than trendlines in finding low risk entry. The two primary lines display natural reward targets and focus attention on clear violation levels. Harmonic parallel lines often form between the two extremes. These intermediate S/R levels target short-term swings, especially when they intersect with moving averages. Violation of any harmonic line raises the odds that price will continue to the next parallel support level. When the broader formation prints with embedded countertrend PPCs, swing traders access a complete pattern mosaic that guides price development. Channels extend the reach of classic technical analysis. These unique lines reveal vital information on a trend’s underlying mechanics. Channel traders maintain their edge over the competition since few books examine them in detail and the crowd remains unaware of their true power. Unfortunately, clean trendlines don’t print often in modern markets. Insiders know exactly where these lines set up and repeatedly violate them to trigger volume. But those same players never see PPCs and enable low-risk positions just below the radar. PPCs demonstrate Fibonacci behavior that allows visual traders to make accurate predictions without using a calculator. Many channel strategies closely follow trendline and S/R concepts. Choose setups based on the channel’s time frame persistence. The longer a pattern endures, the more likely that it will support the trade. Always search for other S/R to cross-verify PPC extremes. When moving averages, Bollinger Bands, or Fibonacci retracements cross parallels, risk decreases and potential reward increases. Channels may take months to form and last for years. Due to broad movement over long periods of time, locate monthly and weekly PPCs with log scale charts rather than arithmetic ones. Observe all the S/R information on these large and complex formations and then drill down to very short time periods to build detailed insight on embedded price movement. GAPS Gaps reveal sudden and important shifts in crowd sentiment through a single price bar. They can print anywhere within the charting landscape but tend to occur in several distinct patterns. Each type predicts specific characteristics in regard to persistence, response during retracements, and the impact on trend. Gaps cut through many time frames and trends, but they represent very different phenomena in each one. For example, a breakout move in one time frame may print an exhaustion event in another. Gap importance relies upon location, extension, and volume. They can print in the major trend direction or against it. When a major gap opposes the current market momentum, it represents the only chart phenomenon that signals trend change without a common top or bottom pattern. A short or long price bar can stand at the far end of a gap move. Long bars tend to predict a quick followthrough in the direction of the gap. Short bars suggest sideways action or a pullback test into the violated space. The gap’s location reveals both the character and mechanics for subsequent price action. Sharp gaps through clear S/R signify important breakouts and breakdowns. Pressure can build so strongly at these levels that the opening tick prints far from the last close. Emotional bursts can trigger multiple gaps as active trends build momentum. Gaps that print within congestion display far less persistence and may fill with little warning or volume. And high intensity gaps that occur late in strong rallies or selloffs often signal the end of a trend. Participation will limit or fuel gap strength. Certain S/R events only verify when strong volume accompanies them. For example, breakout gaps without adequate volume invite a strong reversal even if they print at a perfect location. This relationship between gaps and crowd participation relies upon complex interactions. For example, a high-volume gap may end price movement in that direction if it uses up the last available supply for that trend. But another gap with less volume may leave enough on the table to ensure new surges of momentum. Old traders’ wisdom advises that gaps get filled. This simple expression describes the mechanics of retracement found throughout most market trends. However, some gaps never fill. This knowledge dictates a fresh approach to these specialized patterns. Swing traders must learn the characteristics of each gap to apply the strategy that aligns best with its behavior. Start by identifying the location of the event on the trend-range axis. Edwards and Magee popularized gaps 50 years ago in Technical Analysis of Stock Trends. These old masters describe three types of trend gaps found in most stock charts. Breakaway gaps appear as a market breaks out into a new trend move, up or down. Continuation gaps print about halfway through trends when enthusiasm or fear overpowers reason. Exhaustion gaps burn out trends with one last surge of emotion. Breakaway and continuation gaps should print volume that sharply exceeds the 60-bar VMA. Both events provide excellent trades in the gap direction when the trend first pulls back to test them. They hold S/R the vast majority of the time and identify low-risk, high-reward entry. Markets retest most breakouts very quickly after they occur. If successful, price often moves sharply away from the pullback level. But many bars can pass before price retraces to a continuation gap. Crowd intensity tends to carry the trend well past the gap before it yields to any substantial test. Exhaustion gaps print as trends and indicators reach extremes. This last burst may occur on very high volume, but a lack of participation does not negate the pattern. Exhaustion gaps fill easily and warn that the trend is over. Price fills the gap and often pulls back to the hole from the other side before a correction proceeds in the closing direction. Congestion patterns may form through wide gap ranges before yielding to substantial movement. Keep in mind that an exhaustion gap may turn out to represent a hidden continuation gap in the next-larger time frame. This odd phenomenon requires a sharp eye and often does not reveal itself until the larger trend ends. Use the dark cloud cover or bearish engulfing candlestick patterns to uncover these dual gap candidates. Gap creation aligns with Elliott’s five-wave trend theory. The breakaway gap corresponds with the initiation of a dynamic first- or third-wave impulse. Runaway emotions emit the continuation gap at the center of the third wave. Then the trend sequence ends through the fifth-wave exhaustion gap. The continuation gap routinely marks a halfway point for the entire trend. Swing traders use this knowledge to target major reversals. Visualize the gap as soon as possible after a third wave completes. Draw an extension from the edge of the first wave to the new gap. Then double the distance and wait for a last thrust to push price into it. Consider fade entry with a tight stop loss when the target strikes, as long as substantial cross-verification supports the trade. The first test of a continuation gap often occurs after the closure of an exhaustion gap. Markets retrace five-wave trends according to Fibonacci proportion. Pullbacks often fill the primary fifth wave completely through a first rise/first failure pattern. Without strong support, the countertrend thrust then continues until supply-demand equalizes and reawakens the underlying trend. The continuation gap marks the natural 50% retracement, providing the support needed to force a reversal. Watch for false gap fills. Modern market action closes many continuation gaps for a bar or two before price thrusts sharply back in the direction of support. This likely reflects growing common knowledge of this fascinating S/R point. Don’t let this whipsaw phenomenon negate these profitable trade setups. Entry at the far side of the gap offers very low risk as long as volume remains flat. Less aggressive traders can wait for price to remount the hole and then execute as the gap reopens. Continuation gap trades provide high probability entry, but keep in mind that the subsequent swing will likely fail before it again tests the exhaustion gap. Deep pullbacks face an extended period of price discovery as trend volatility dissipates. Longer-term positions can survive this process, but swing trades may not. Use trend mirrors to target an acceptable reward before choosing to execute a gap trade. Exit quickly on the first reversal thrust unless patience allows an extended position. Always distinguish between gaps in the direction of the prevailing trend and those going against it. Countertrend gaps often flag major reversals without a long series of price bars. The most important shock events occur right near major highs or lows. A sudden break in the wrong direction after a strong rally generates fear among the crowd and may ignite herd behavior that leads to considerably lower prices. This hole-in-the-wall gap has many swing trading applications, which are discussed in detail in Chapter 11. Opening gaps fascinate participants but require solid execution skills. Market insiders know that fresh cash seeks opportunity at the start of the day and paint the tape to encourage execution. This premarket manipulation encourages supply-demand imbalance because many traders see these numbers and place ill-advised orders well above or below the market. The resulting friction sets the stage for a violent reversal just minutes into the new session. Most morning gaps face a testing period before filling or yielding to a trend thrust. Fades can begin as early as the opening bell. But price often moves first in the direction of the gap to gather volume before it reverses by the third 5-minute bar. This classic reversal zone originates from the era when most public participants had to view the markets through a 15-minute delay. Insiders held opening price firm to give this retail crowd a chance to act before fading them. Gaps encourage execution tactics that favor or fade the open. The highest-risk tactics enter a new position at the open in the direction of the break. As with other momentum plays, price can fade sharply without a clear signal that the trade should be terminated. Execution against the gap after a two-bar thrust offers lower risk but more anxiety. This countertrend tactic requires defensive management after execution and a very quick exit or tight stop as price moves into a profit. The setup also demands cross-verification with central tendency tools. The opening bars must thrust well outside short-term Bollinger Band extremes before consideration of a fade position. Look for a bounce at the prior closing bar if price breaks opening congestion and reverses to fill the gap. As the market pulls back, the opposite end of the hole now presents a new barrier. A reversal off this level sets the stage for price to fail and thrust well back into the prior closing range. Gaps that stay unfilled signal powerful support or resistance. Price should eventually push out of the morning range into higher or lower levels when this occurs. Early congestion identifies signposts for safe gap entry. These range extremes provide important information on the strength or weakness of the morning move. Gaps that fill quickly should be avoided in the direction of the trend. Use classic swing strategies to prepare execution after they test and hold. In other words, buy pullbacks in up gaps and sell bear rallies in down gaps. Also consider breakout strategies at the high or low for the session. For example, look for a second test of a shortterm top and enter in expectation of a breakout. Long entry into a big market gap down terrifies many swing traders. But this profitable opportunity must be mastered to achieve consistent performance. Learn to set aside fear and stand against the crowd when the right conditions present themselves. Reprogram your natural reaction to stomach churning down gaps by stepping in the shoes of those trapped on the other side of these shock events. Imagine taking a questionable long position into a volatile close and spending the night wondering how the next morning will affect profit or loss. Many participants with large positions cannot sleep when they carry that much risk. Images of lottery jackpots and painful losses both creep into the irrational mind. Then the next day finally arrives and the worst-case scenario occurs. The early spread shows the position many points into the hole. The resulting pain quickly drives out rational thought, and fear-driven instinct takes over. In total shock, you sell into the open, happy to be relieved of the heavy burden. Immediately the stock reverses and rockets above your entry price. Market professionals use fear to generate profits. Many opening gaps allow large players to benefit their own accounts by fading the crowd. When overall conditions favor strong buying interest, these shock gaps actually represent low-risk entry for the swing trader. Learn to interpret this market sentiment correctly and capitalize on misinformed sellers. But extreme caution is advised. Only an experienced swing trader with a solid history of risk management should execute a long position into a down gap. Poorly timed gap entry can be very deadly to an equity account. Avoid execution right at the open whenever possible. Instead, watch for cross-verification near the third-bar reversal and find a small pullback for immediate entry. Also check the news first to evaluate the severity of the shock event. The best opportunities come when no obvious reason drives the selloff. Important news events don’t always eliminate gap-down opportunities. Bad news offers insiders a chance to enter ongoing rallies at a bargain price. When everyone expects a selloff, insiders play on their fears and knock down opening bids sharply. These mechanics often produce a significant bounce after the open in strong markets. But swing traders should never expect a complete gap fill in these volatile conditions; they take whatever profits the market gives them and move on to the next setup. Risk-averse traders can also find profitable opportunities on these fearful mornings. Watch for a first rise pattern back to the closing hour high of the prior session. This price action signifies a filled gap and the first stage of a reversal that should carry higher. Treat this simple price test as a double top and watch for a long opportunity on the next pullback or third rise into the extreme. Countertrend gap entry requires solid interpretation of the numbers, skilled reading of the emotional crowd, and excellent timing. Seasoned swing traders recognize many redundant features in these morning setups. Neither market makers nor specialists rely on original strategies most of the time. They will play the same classic price games as often as they can get away with them. Experience with their tactics over time builds confidence when warning signs of their activity start to appear. |
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