Technical Analysis – Trends, Support and Resistance
Kinds Of Trends
The trend shows a pending direction of the market movement. A trend may be:
- Upward (See Figure 5.7.)
- Downward (See Figure 5.8.)
- Sideways, also known as a “flat market” or “trendless” (See Figure 5.9.)
Because the markets do not move in a straight line in any direction, but rather in zigzags, it is the direction of these peaks and troughs that creates the market trend. In addition to direction, trends are also classified by time frame: major or long-term trends, secondary or medium-term trends, and near-term or short-term trends. Any number of secondary and near-term trends may occur within a major trend. The time frames for each class vary widely. The Dow Theory suggests a one-year length for a major trend. Currently, for a major trend, the market expects a time span of over one year. Secondary trends should last for a matter of months, and short-term trends for a matter of weeks.
Foreign currencies, like all the other financial instruments, do not move straight up or down, even in the healthiest of trends. Traders watch several percentage retracements, in search of price objectives.
There are three typical percentage retracements:
- Charles Dow developed the traditional percentage retracements which are 1/3, 1/2, and 2/3; or 33 percent, 50 percent, and 66 percent. A retracement past 66 percent is considered to be a trend failure.
- The Fibonacci ratios. These ratios are 0.382, 0.50, and 0.618, or approximately 38 percent, 50 percent, and 62 percent.
- The Gann percentages attach importance to the one-eighth breakdowns.
A trendline is the natural development in tracking a trend. It simply consists of a straight line connecting the significant highs (peaks) or the significant lows (troughs.) Following in the tracks of the trend directions, the trendlines may be classified as:
- Rising trendlines. (See Figure 5.10.)
- Declining trendlines. (See Figure 5.11.)
- Sideways trendlines. (See Figure 5.12.)
To draw a trendline only two points are necessary and the third one is the contact point confirmation. The currency maintains its general direction and velocity. A trendline exists until it is broken as a result of a significal move of the price up or down. Hence, even after confirmation, the breakout is still likely to be followed by a period of consolidation It is relatively rare for a trendline to suddenly reverse its direction. If a consolidation period does indeed occur, the longer it lasts, the steeper the following rally will be. Breakouts from up trendlines tend to test the strength of the former support line, now turned into a resistance line. A price filter of 3 percents serves usually to test the validity of the breakout.
The trendline and a line drawn along the opposite edge of the trend pattern about to be parallel to the trendline form the trade channel (See Figure 5.13.). Then the both lines are known as the channel lines.
Lines of Support and Resistance
The upper and bottom borders of a trade channel (See Figure 5.14.) forme lines of support and resistance. The peaks represent the price levels at which the selling pressure exceeds the buying pressure are known as resistance levels. The troughs, on the other hand, represent the levels at which the selling pressure succumbs to the buying pressure. They are called support levels. The longer the prices bounce off the support and resistance levels, the more significant the trend becomes. Trading volume is also very important, especially at the critical support and resistance levels. When the currency bounces off these levels under heavy volume, the significance of the trend increases. The importance of support and resistance levels goes beyond their original functions. If these levels are convincingly penetrated, they tend to turn into just the opposite. A firm support level, once it is penetrated on heavy volume, will likely turn into a strong resistance level. Conversely, a strong resistance turns into a firm support after being penetrated.