Markets Technical Analysis and Algorithmic Trading Chapter 4: Consolidation formation

1. DoğuAkdenizÜniversitesi Faculty of Business and Economics Department of Banking and Finance Markets Technical Analysisand Algorithmic Trading Chapter 4: Consolidation formation SaeedEbrahimijam Fall 2013- 2014 FINA417

2. Contents • Flags • Pennants • Head and shoulders • Symmetrical Triangles • Rectangles Fundamental of Technical Analysis and Algorithmic Trading

3. When consolidation forms? • While the share price fast up/down trend stops because of supply and demand equilibrium. In this situation one of three states are expected to happen: 1- Reversal trend 2- prices can decline or rise to a support level before building up steam again. 3- prices can move sideways, and then continue it’s previous trend (consolidation formation) Fundamental of Technical Analysis and Algorithmic Trading

4. Consolidation formations • Consolidation formations occur when security prices move up or down too fast and reach a level at which the demand or supply that produced the move is completely absorbed. • the temporary oscillation of the price during an up/downward trend which stops Fundamental of Technical Analysis and Algorithmic Trading

5. Flags • Discussions of flags go back to the classic works on technical analysis by Schabaker and Edwards and Magee. Little progress has been made since then. • The price trend oscillate between two parallel lines and then, again continue it’s previous trend, which looks like a flag. Fundamental of Technical Analysis and Algorithmic Trading

6. Flags Fundamental of Technical Analysis and Algorithmic Trading

7. Typical Price Action A flag pattern, • It represents a pause in a quick, almost vertical, up or down move in prices. Prices move sideways forming a flag like pattern, break out from that pattern, and then continue in the same direction as before. Fundamental of Technical Analysis and Algorithmic Trading

8. Flags Typical Volume Action Volume • Typical Volume Action Volume is extremely heavy before the flag formation begins. As the pattern develops, volume diminishes to a relatively low level. Finally, volume explodes as prices complete and break out of the flag pattern. Fundamental of Technical Analysis and Algorithmic Trading

9. Frequency of Occurrence Flags • Frequency of Occurrence Flags appear regularly on daily charts, but because of the short time they take to develop (typically less than four weeks), they are rarely seen on weekly charts, and are nonexistent on monthly charts. Fundamental of Technical Analysis and Algorithmic Trading

10. Technical Significance Flags • typically appear at the halfway point of an up or down move. Therefore, one can expect prices to move about the same distance after the breakout from the flag pattern as they did just prior to the pattern. • Swing traders should learn to identify the flag because it is a highly reliable pattern with very strong profit potential. Fundamental of Technical Analysis and Algorithmic Trading

11. Technical analysis signal of flags • If a share’s uptrend started from 10$ and the flag forms on 18$, the investor’s expected price after oscillation will be to increase around 26$. Fundamental of Technical Analysis and Algorithmic Trading

12. Fundamental of Technical Analysis and Algorithmic Trading

13. Pennants Fundamental of Technical Analysis and Algorithmic Trading

14. Typical Price Action Pennants • have the same characteristics of flags, except that a pennant is formed by converging, rather than parallel, boundary lines. Pennants slant down in uptrends and up in downtrends. As with fl ags, pennant consolidations are characteristic of fast up and down moves in prices. Fundamental of Technical Analysis and Algorithmic Trading

15. Pennants volume • Typical Volume Action Volume is extremely heavy before the pennant formation begins. As the pattern develops, volume diminishes to a relatively low level. Finally, volume increases significantly as prices complete and break out of the pennant pattern. Fundamental of Technical Analysis and Algorithmic Trading

16. Frequency of Occurrence Pennants • Frequency of Occurrence Pennants should take less than four weeks to complete and break out. Therefore, like flags, they are more identifiable in daily charts than in weekly charts and never appear on monthly charts. They occur most frequently in the last phase of bull markets and in the second stage of bear markets. Fundamental of Technical Analysis and Algorithmic Trading

17. Technical Significance Pennants • typically appear about midway through an up or down move. Therefore, expect prices to move about the same distance after the breakout from the pennant pattern as they did just prior to the pattern appearing. Fundamental of Technical Analysis and Algorithmic Trading

18. Fundamental of Technical Analysis and Algorithmic Trading

19. HEAD-AND-SHOULDERS CONTINUATIONPATTERNS Bullish Bearish Fundamental of Technical Analysis and Algorithmic Trading

20. Typical Price Action Head-and-shoulders continuation patterns • Typical Price Action Head-and-shoulders continuation patterns are inverted relative to the direction of the price trend before they appear. • When prices are trending lower, a head-and-shoulders continuation pattern appears similar to a head-and-shoulders top. (Refer to Lesson 3 for a complete description of head-and-shoulders tops and bottoms.) • In an uptrend, a head-and-shoulders continuation pattern appears like a head-and-shoulders bottom. Fundamental of Technical Analysis and Algorithmic Trading

21. Typical Volume Action For the head-and-shoulders continuation pattern, • volume decreases instead of increasing (as with the head-and-shoulders top) on the left shoulder and head, as well as on the right shoulder. Volume does resemble that of head and- shoulders tops and bottoms on breakout from the continuation patterns; it is relatively heavy. Fundamental of Technical Analysis and Algorithmic Trading

22. Frequency of Occurrence HS continuation patterns • Frequency of Occurrence Head-and-shoulders continuation patterns occur occasionally. • Technical Significance The measurement characteristics that apply to head-and shoulders tops and bottoms sometimes work with head-and-shoulders continuation patterns, but not with enough regularity to warrant reliance on them. • Technical significance is limited to notation that prices are continuing an uptrend or downtrend upon a breakout from the head-and-shoulders continuation pattern. Fundamental of Technical Analysis and Algorithmic Trading

23. SYMMETRICAL TRIANGLE • Typical Price Action Prices swing in a narrowing fashion between downslantingupper and upslanting lower boundary lines that are fairly symmetrical. There must be a minimum of four reversal points in the triangle. A breakout can occur at any time between two-thirds of the way to the apex and the apex. Fundamental of Technical Analysis and Algorithmic Trading

24. SYMMETRICAL TRIANGLE Fundamental of Technical Analysis and Algorithmic Trading

25. Typical Volume Action • Volume diminishes as prices approach the apex of the triangle. On a valid upside breakout, volume is heavy; on a valid downside breakout, volume is often light at first and then picks up significantly after a few days. • Beware of upside breakouts on light volume and downside breakouts accompanied by heavy volume. They could be a warning of false moves. (No break out) Fundamental of Technical Analysis and Algorithmic Trading

26. Frequency of Occurrence Symmetrical triangles appear regularly on price charts. • Technical Significance On a valid upside breakout, you can expect prices to continue upward until they reach a line drawn parallel to the lower boundary line. The opposite is true for a valid downside breakout. Fundamental of Technical Analysis and Algorithmic Trading

27. Rectangle Pattern • The rectangle is a classical technical analysis pattern described by horizontal lines showing significant support and resistance. Markets Technical Analysis and Algorithmic Trading

28. Rectangles: Markets Technical Analysis and Algorithmic Trading

29. Rectangle’s Typical Price Action • The area within the lines is also known as a trading area or range. • Rectangles are formed when there is a consistent supply of a security at a certain price and a demand at a certain lower price. When the price reaches the lower price, the security is purchased, driving up the price until it reaches the upper boundary, and people are ready to sell and drive the price back to the lower boundary. This occurs repeatedly until one side or the other gives way, and the pattern is broken. • A closing price outside the upper- or lower-boundary line suggests the direction of the trend. If the closing price is above the upper-boundary line, the probability is that prices will move higher. On the other hand, if the closing price is below the lower-boundary line, prices are likely to fall. Markets Technical Analysis and Algorithmic Trading

30. Rectangle’s Typical Volume Action • Volume action can give a clue as to whether the rectangle formation will ultimately be broken to the upside or downside. • If volume is relatively higher on upward price swings than on moves to the downside, it is likely that the breakout will occur on the upside. • On the other hand, if volume is relatively higher on downward price swings than on moves to the upside, it is likely that there will be a downside breakout of the rectangle Markets Technical Analysis and Algorithmic Trading

31. Volume and break out point Markets Technical Analysis and Algorithmic Trading

32. Rectangle technical Analysis signal • If the close price of a share was higher than upper line or lower than bottom line of rectangle, it can be considered as strong probability of up/downtrend respectively. Markets Technical Analysis and Algorithmic Trading

33. Trading with the Rectangle The following are two basic strategies for trading a rectangle: • The first, is to buy at support and sell at resistance (one can also sell short at resistance and cover the short sale at support). To mitigate risk, in case the stock breaks down from support, a very tight stop can be employed of perhaps 3%. For example, if one bought ImClone at $37.50, the stop-loss would be 3% lower than $37.50 or $1.12. The trader would exit the position if the stock hit $36.38 ($37.50-$1.12). • Second, method to trade the rectangle is to wait for the breakout. As with all technical patterns, this breakout should ideally occur on above-normal volume. To know when to consider exiting the trade, the trader could use the measuring principle described below. (Learn more about volume in Gauging Support And Resistance With Price By Volume.) Markets Technical Analysis and Algorithmic Trading

34. Rectangular Price Target Measuring • To calculate the minimum target, first establish the height of the pattern. In the case of ImClone Systems Figure shows the calculation as follows:Top: $47.50 Bottom: $37.50 Height: 10.00 points For a bullish breakout, once the height of the pattern has been established, add the difference to the breakout level. Since the breakout level is $47.50 and the height 10 points, the minimum target is $57.50. Of course, it may take some time to reach the target, so the trader must be patient. As well, the measuring principle is a statement of probability, not a guarantee. The trader will carefully monitor the technical picture of the stock despite the target. Markets Technical Analysis and Algorithmic Trading