Most of the readers of this newsletter would be technical traders. I feel that is a fairly safe assumption. Studying charts and knowing where the old tops and bottoms are in markets of choice is required knowledge. Perhaps you remember the old adage – get to know your market like a cow knows its calf, certainly students of David Bowden’s and Safety in the Market, would remember this well.
To a technical trader, old tops and bottoms are used to represent old resistance and support levels. They let us know where the bears started clearly winning the battle against the bulls or vice versa - I like to keep it that simple.
When an old top or bottom is broken it can be basically interpreted as a sign that the old resistance or support has been broken and the market should keep on going in that direction – right? Well, not always! There is the nasty, False Break to watch out for. False Breaks are sometime referred to as Technical Break-Outs. It pays to have a filter built into your plan to avoid getting caught in these rather unpleasant trading situations – rather unpleasant is putting it mildly!
In the example chart I have here for you this week is the beloved SPI 200 contract during the last quarter of 2002 and into 2003.
You will see that four circles have been placed on the chart. The first circle relates to the top on 2 December 2002 – 3084. Here the market popped its head above the 6 November top and did manage to close once above the old top. Note the number of closes – one! The market then ran down to make a low on 16 December 2002 and spent one close below the old bottom on 12 November – again note the number of closes – one!
The traditional Christmas rally in the stock market occurred and the market ran up to the top on 7 January 2003 – breaking the old tops for November and December – and it looked like a bull year for 2003– wrong, wrong, wrong! How many closes above the old tops – none!
If you were caught buying or selling on the breaking of these tops and bottoms you would have been feeling sore and sorry being in the market these periods – let the rule be, if the market cannot at least hold for two to three consecutive closes above the old top or bottom be wary of the false break. We call this a time filter. When I refer to top or bottom, I do mean one of reasonable significance, not just every daily swing top. For that you might use a price filter.
Now from the January top the market ran down, down and kept going down. Note though, in Circle 4 when we had the two or three day close filter satisfied for the first time the market ran down for the next 8 days straight. That’s one of the best examples I could possibly give you of this valuable addition to your technical trading arsenal.
What does this mean for us later in 2003? Well ‘if’ the market can hold together and attempts to take out those tops of November, December and January once more, you will know how to handle a safer entry on the long side.
However, we should remind ourselves though – nothing in trading is infallible. With such significance around these tops you would certainly be applying a three-day filter on the closes here.
Until next edition, all the best with your trading and analysis.
Noel Campbell