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Trends and Trendlines by
Albert Yang
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Copyright Notice
All contents copyright © 2008 by Albert Yang. All rights reserved. No part of this document or the related files may be reproduced or transmitted in any form, by any means (electronic, photocopying, recording, or otherwise) without the prior written permission of the author.
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Legal
Limit of Liability and Disclaimer of Warranty: The author has used his best efforts in preparing this book, and the information provided herein is provided "as is." The author makes no representation or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaims any implied warranties of merchantability or fitness for any particular purpose and shall in no event be liable for any loss of profit or any other commercial damage, including but not limited to special, incidental, consequential, or other damages. Trademarks: This book identifies product names and services known to be trademarks, registered trademarks, or service marks of their respective holders. They are used throughout this book in an editorial fashion only. In addition, terms suspected of being trademarks, registered trademarks, or service marks have been appropriately capitalized, although the author cannot attest to the accuracy of this information. Use of a term in this book should not be regarded as affecting the validity of any trademark, registered trademark, or service mark. The author is not associated with any product or vendor mentioned in this book.
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High Risk Investment Warning Trading in any financial market involves risk. This ebook, the website www.priceactionforex.com and its contents are not intended to be and shall be deemed not to constitute either a solicitation, or an offer to transact in any financial market. The contents of this ebook are for general information purposes only. The term "contents" as used herein shall be deemed to include the contents of the ebook, the contents of the website www.priceactionforex.com and any email correspondence or newsletters related to the website). Trading foreign exchange carries a high level of risk, and may not be suitable for all investors. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. No one was compensated for their testimonial in connection with this ebook. Further, testimonials are not indicative of future performance or success. Unique experiences and past performances do not guarantee future results! Testimonials disclosed in the ebook are not intended to be representative of all clients; certain accounts may have worse performance than those indicated in any testimonial or other illustrative example. Trading stocks, options and spot currencies involves substantial risk and there is always the potential for loss. Your trading results may vary. Because the risk factor is high in the foreign exchange market trading, only genuine "risk" funds should be used in such trading. If you do not have the extra capital that you can afford to lose, you should not trade in the foreign exchange market. No "safe" trading system has ever been devised, and no one can guarantee profits or freedom from loss. The content on this website is subject to change at any time without notice, and is provided for the sole purpose of assisting traders to make independent investment decisions. Although every Page 4 of 39 http://www.priceactionforex.com This ebook may not be copied, sold or redistributed without prior written permission.
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attempt has been made to assure accuracy, we are not providing any express or implied warranty as to the accuracy of the content. We do not accept any liability for error or omission. Examples are provided for illustrative purposes only and should not be construed as investment advice or strategy. No representation is being made that any account or trader will or is likely to achieve profits or loses similar to those disclosed in the ebook. Past performance is not indicative of future results. By purchasing the ebook, subscribing to our mailing list or using the website you will be deemed to have accepted these terms in full. Price Action Forex, www.priceactionforex.com, Albert Yang, the website, ebook, and their employees, officers, directors, shareholders and representatives are not intending to either provide investment advice or invite customers to engage in investments through this ebook. We do our best to insure that the website is available 24 hours per day but we shall not be responsible for any damage or loss of any third party if for any reason the site is not available at any particular time, or at all. The information provided on this ebook is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject us to any registration requirements within such jurisdiction or country. Hypothetical performance results have many inherent limitations, some of which are mentioned below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example the ability to withstand losses or to adhere to a particular trading program in spite of the trading losses are material points, which can also adversely affect trading results. There are Page 5 of 39 http://www.priceactionforex.com This ebook may not be copied, sold or redistributed without prior written permission.
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numerous other factors related to the market in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. We reserve the right to change these terms and conditions without notice. The content of www.priceactionforex.com and this ebook are copyright and may not be copied or reproduced. No parts of the ebook or any of its components may be resold. They are for individual use only and may not be passed on in any form. Affiliated sites, linked sites and advertisements This website expects its partners, advertisers and affiliates to respect the privacy of our users. Be aware, however, that third parties, including our partners, advertisers, affiliates and other content providers accessible through our site, may have their own privacy and data collection policies and practices. For example, during your visit to our site you might click a link to, or view as part of a frame, page, certain content that is actually created or hosted by a third party. Also, through this website you may be introduced to, or be able to access, information, Web sites, features offered by other parties. We do not accept any liability for any actions or policies of any such third parties. You should check the applicable privacy policies of those third parties when providing information on a feature or page operated by a third party. While on our site, our advertisers, promotional partners or other third parties may use cookies or other technology to attempt to identify some of your preferences or retrieve information about you. For example, some of our advertising is served by third parties and may include cookies that enable the advertiser to determine whether you have seen a particular advertisement before. Other features available on our site may offer services operated by third parties and may use cookies or other technology to gather information. We do not control the use of this technology by third parties or the resulting information, and we do not accept responsibility for any actions or policies of such third parties. You should also be aware that if you voluntarily disclose personally identifiable Information on message boards or in chat Page 6 of 39 http://www.priceactionforex.com This ebook may not be copied, sold or redistributed without prior written permission.
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areas, that information can be viewed publicly and can be collected and used by third parties without our knowledge and may result in unsolicited messages from other individuals or third parties. Such activities are beyond our control and we do not accept any liability for any consequences resulting from any such activities.
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Sharing this Document
A lot of work that went into putting this document together. I can't tell you how many countless hours were spent putting together the information. That means that this information has value, and your friends, neighbors, and co-workers may want to share it. The information in this document is copyrighted. I would ask that you do not share this information with others-you purchased this book, and you have a right to use it as you see fit. Another person who has not purchased this book does not have that right. It is the sales of this valuable information that makes it possible for me to continue to write and sell ebooks at a cheap price. If enough people disregard that simple economic fact, future ebooks will be at ridiculous prices, assuming there are future ebooks at all. If your friends think this information is valuable enough to ask you for it, they should think it is valuable enough to purchase on their own. After all, the price is low enough that just about anyone should be able to afford it. If you can’t afford this book, you shouldn’t be trading, simple as that! It should go without saying that you cannot post this document or the information it contains on any electronic bulletin board, website, ftp site, newsgroup, discussion board, forum, bbs or any sharing items like bittorrent, emule, edonkey etc. The only place from which this document should be available is the website http://www.priceactionforex.com.
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Table of Contents Copyright Notice ......................................................................................................2 Legal.............................................................................................................................3 High Risk Investment Warning ..........................................................................4 Sharing this Document .........................................................................................8 Table of Contents.....................................................................................................9 Introduction and Forward by the Author .....................................................10 Forex .......................................................................................................................... 11 Base Theory of Price ............................................................................................12 Reading a Price Chart ..........................................................................................13 Opens and Closes..................................................................................................14 Price Fractal Theory..............................................................................................15 Slope Theory ...........................................................................................................16 Definition of a Trend.............................................................................................17 Price Trendline Definition ...................................................................................18 Obvious Trends, Trendlines for Obvious Trends ........................................34 Unanswered Questions........................................................................................37 FGA’s (Frequently Given Answers) .................................................................38 Conclusion ................................................................................................................39
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Introduction and Forward by the Author
Thank you for buying this ebook. This is an ebook that will introduce you to trends and trendlines unlike any other presentation before. Please do not let the terse content fool you; you should never judge a book by its cover, nor should you just an ebook by its byte-size. A lot can be said for brevity, I have thought through most of this, and have distilled it down to its fundamentals. This book will help those who are trend traders, and every other type of trader out there. It has been my frustration that so many books talk about “trend trading” yet never define a trend. I liken it to the Infinity car commercials when they first came out, they advertise a car but never showed the car. I use to give the authors the benefit of the doubt, perhaps they had some sort of goal, for us to understand and discover what a “trend” is on our own. Perhaps it is the thousands of hours I have poured over their books; or the email conversations with quite a number of them that I have become a cynic, in deep belief that they don’t share it because they don’t know it! Next time you meet a trader who tells you to give them your hard earned money so they can trade for you, ask them to define a trend, and watch them pontificate on this and that, not giving you a straight answer because they themselves do not know. You might not agree with the contents of this book, but I assure you there are very few books (as of this writing, I know of none) that even makes a digestible attempt at not only defining a trend, but giving you a mathematical basis in which to draw trendlines, and a good deal of confidence in the trendline you draw. I hope you enjoy reading this book as much as I enjoyed writing it.
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Forex
I have written this for the Forex (Foreign Exchange) market, but the information contained herein is not exclusive to Forex. Everything I cover in this book is applicable to every market. In fact, I will go ahead and admit something that most of you will find ridiculous. Because I am a 100% technical analyst, I actually don’t care if I am trading EUR/USD, corn, gold, pork bellies, Microsoft stock, or anything else. It is the chart that I look at, and nothing else. Most of the time, I trade without even knowing what underlining item I’m looking at. This reduces my bias, and makes me a 100% technical analyst. I have tested all of this with stocks, bonds, futures, and of course Forex. So this is applicable to any and all underlining items. But please understand that as with the warnings I posted above, if you have no clue, what you are doing, then you should not be trading, regardless of instrument. Forex offers demo accounts and I highly recommend trading with them until such time your skills and judgment have reached the realm of profitability.
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Base Theory of Price Regardless if you agree with the current price or not, regardless if you feel the market is efficient or not, the price currently is what you can buy or sell at, take it or leave it. That means then, current price discounts EVERYTHING. If you say your BMW is worth $60,000, but the only price people are offering is $20,000, then the sad reality of the fact is that your car is worth $20,000. This is what I coin “Price Reality Theory”. This is why I personally do not believe in fundamental analysis. Yes, the Buffetologists will not scoff at me, and tell me how wrong I am. But when all is said and done, even Warren Buffet, when he buys, has to buy AT CURRENT PRICE. If you cannot accept this fact to be true, then I highly recommend you stop reading now. Inside trading aside, this is the basis of the rest of this book. Assuming you can accept what I just wrote above, let’s move on to the application of this theory.
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Reading a Price Chart A basic price chart should then be read from right to left, not left to right. Reading left to right gives weight and priority to the past. Reading right to left gives priority and weight to the current price. If that is the case, then it stands to reason that ANY indicators based on moving average, gives weight to past prices, and simple MA gives equal weight to past prices as does current prices, therefore, any indicator based on MA is not a reliable source of information. One other important part of note, in any price chart, depending on how far we zoom in or out, we are not guaranteed how far back the chart goes, but we are always guaranteed on a live chart, that the current price is available.
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Opens and Closes Given that price bars are a snapshot of a price in a block of time, if a price bar is offset, then more than likely, the highs and lows will remain the same; but the open and close values will change. Given this to be true, then open and close values are untrustworthy indicators. Given that local highest highs and local lowest lows will probably remain the same for quite a few bars, you can then see why Donchian created Donchian Channels. His theory and mine are the same; that local highs and local lows will remain fairly consistent in a given timeframe, but opens and closes will not. So therefore, open and close values will not be used in the evaluation of price. That said, it also proves that this theory is held by Tom Demark, who thus created the definition of local highs and local lows. Any offset in charting of the bars, will not alter neither DC’s nor TD’s. And while DC’s have no lag, TD’s technically have no lag, but require 2 more bars for confirmation. So of all the price information available to us; current price, and previous highest high, and previous lowest low will be the only items used in determining market trendlines. A higher timeframe is nothing more than a bunch of bars from lower timeframes smashed together. Therefore, the highest high and lowest low will remain, but the opens and closes will be useless.
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Price Fractal Theory Because price charts are fractal in nature, it stands to reason that any definition given for slope and trend direction or trend bias, should be relative, and not absolute. That means, any definition should be given based on the bars available for the chart that is currently viewed, and that the definition should change as the views are zoomed in or zoomed out. It is quite possible for 2 people; one to say the EURUSD is trending up, and the 2nd person to say it is trending down, and for both to be correct; if both are view different timeframes, or different “zoom’ness” in terms of the chart. This requirement might sound strange at first, but if a math model is to follow the price only, it must then be fractal in nature also.
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Slope Theory This is where we get into the math. Given slope as defined by y=mx+b Then, an upward trend HAS TO HAVE slope > 0. Corollary: A downward trend HAS TO HAVE slope < 0 The two statements above, HAVE TO BE TRUE by mathematical definition. Only 2 points are needed to determine a slope. Because we believe that current price discounts everything, current bar’s high and low then will always be used as one of the end points. The other endpoint then will be the absolute high and absolute low on the chart, thus giving us 2 points in which to base our trendline drawings. (Remember, price is fractal, especially with respect to charts showing past price, so the other end point will depend purely on how zoomed in or zoomed out you are on the chart.)
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Definition of a Trend Because a trend is defined as that which has a slope that is non-zero; we can then write the most simple of definitions for a trend. Uptrend ~ An uptrend is when the price makes higher highs, and higher lows. Downtrend ~ A downtrend is when the price makes lower highs and lower lows. We know this definition to be correct because without the higher high, a slope will never be > 0, and without a lower low, we know that a slope will never be < 0. An uptrend then, leaves a set of higher lows in its wake, thus giving us support lines. A downtrend leaves us a set of lower highs in its wake, thus giving us a resistance line.
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Price Trendline Definition If the current price discounts everything, then it is one of the end points. l
If a trendline is to be drawn, it is to be drawn from historical data, to current data. This is because trend is established in the past, and we assume is carried into the present.
l
If a trendline is to be drawn, by definition of slope, an uptrend must have one end point at the lowest low point in the graph. Otherwise, an upward slope is impossible.
l
If a trendline is to be drawn, by definition of slope, a downtrend must have one end point at the highest high point in the graph. Otherwise, an upward slope is impossible.
No “correct” trendline which is drawn up to the current price, can cross a price between the two points used to draw the line. If a price bar is already crossed by the time it gets to the current price point, how can it then be considered a “trend”?? This is worth reading a few times, and highlighting with a marker. This is the mathematical crux of drawing a correct trendline. Because a trend is defined as slope, we have to then assume that the correct trendline is the slopeline drawn in which is defined as: The least steep line in which links a highest high or lowest low to the current price point, without crossing any bars between the two points.
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More importantly, it is the line which connects the highest high, to the current high of the current bar, and the lowest low to the low of the current bar without bisecting any bars in between. Because we do not deal with opens and closes, this definition above, yields us the same line, even if there’s a shift in time. Given this definition then, the only correct way to draw a trendline is: For downtrends, to take the point of highest absolute high price on the graph, to the highest point on the current bar. If drawing such line bisects any of the bars in between the two points, then the contact end point (on the current price side) needs to be regressed (moved to the left) until such time that such is false.
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Example:
Here, point A is the highest high in the graph, and B is the high of the current price bar. The highest high in the graph is drawn to the high of the current bar, note that it crosses through a few bars, therefore violating the definition of a trend. We leave point A where it is, and regress point B back to the point such that:
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Trendline A-> B does not cross through any bars. When we do this, then the correct trendline looks like this:
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Another example.
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Given line C-D.
There are bars that are being bisected between line C-D, therefore, D needs to be regressed to a low in which no bars are bisected between line C-D. The results look like this.
Given current price, and highest high on the chart (point A) and lowest low on the chart (point C), these are then the ONLY correct trendlines you can draw for this screenshot. Remember that prices are fractal, and thus you can only talk in terms of what you see on the chart, thus meaning that altering the zoom’ness of the chart will alter your trading, which is true and should remain true.
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I will give more examples, and go into more details about them.
This will be the chart we will be working with in our example. Let us first identify, the highest high, and lowest low on this chart. I have marked them as “A” and “X” respectively.
Let us then draw a line, from A to the high of the current bar, and a line from X to the low of the current bar. You will note that with all my charts, there are only highs and lows, no opens and closes.
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Note that the line going from A to the high of the current bar, bisects a few bars. Note also the line from X to the low of the current bar, also bisects a few bars. I have highlighted the bars which have been bisected in red boxes.
Because this violates the definition of a trend, we will leave the anchor point A, but move the other anchor point, from the high of the current bar, to the highs of previous bars, until such a point, that A to endpoint crosses no bars. I shall do this for you in successive screenshots. While A remains the same anchor point, I will move the other end point back, to highs of each bar, until such time, our condition is met. Page 24 of 39 http://www.priceactionforex.com This ebook may not be copied, sold or redistributed without prior written permission.
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I will zoom in on the chart for easier viewing (zoomed in portion marked in red box)
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The original A line.
We will now move that line to the high of every bar, and we keep doing so until such point in time that no bars are bisected by that line.
A -> High of one bar back. We still bisect lines in between.
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A-> high of 2 bars back. We still bisect bars in between. Next, I will give you the series of progression without comments.
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Here, we have finally regressed the end point such that point A, and our other end point do not bisect any bars in between them.
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The end point we ended up with, is marked with a red arrow.
With training, you can do this really quickly.
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I will go back to our reference chart with the A line correctly drawn, but the X line incorrectly drawn.
I will now draw the X line correctly.
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I have marked the two anchor points which are used, with red arrows.
In this example, because the X line is “further back in time” than the A line, X would be considered the “longer term” trend, and A would be considered the “shorter term” or “temporary” trend. Sometimes, A is also called the “pullback”. That means in this chart, we have an uptrend (X line) with a downtrend pullback (A line).
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The examples I have given, should be sufficient for you to understand how to draw a trendline, quickly, and accurately. While I have no way of proving that these two lines are indeed correct to the current trend, I do know that these two lines do not violate (mathematically) what we know about trends (on the chart we are viewing), something that cannot be said for about 95% of all trendlines drawn on almost all charts I see. Without falling into an obvious “Black Swan” fallacy, and acknowledging that both are completely different, we can NEVER know that what we have drawn is a correct trendline, but we can know quite a lot. We know: The highest high and lowest low on any given chart, will always be a reference point, because of the definition of trends. We know: Highest high and lowest low, will vary, according to the zoom’ness of the chart, and every person’s trendline will be altered by their chart and their timeframe and their perspective on the chart. This is due to the fractal nature of prices. We know: Any trendlines we draw for the current bar, will not violate the definition of a trend, i.e. that the trend line will not have broken previous bars. As said from a discussion with a trader who shall remain anonymous, when you draw a trendline extending to the current bar, trend “virginity” should not have been breached. No lines you draw should bisect any bars between your two contact points.
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Obvious Trends, Trendlines for Obvious Trends What if you have an obvious trend? What is an obvious trend? Well, an obvious trend is anytime you have the current price as either the highest high, or the lowest low on the chart. Example chart:
The current price IS the highest price, so the trend is UP! easy!
That was
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Now let us draw a trendline for it. Using the same principle, I have marked the lowest low on the chart as “L”. I have drawn a trendline such that the trendline does not violate what we know about trends. I have marked the other endpoint used with a red arrow.
Please note that no bars are bisected between L and the red arrow. In this case, there is only ONE trendline on this chart, because the current price is the highest high.
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Same can be said for obvious downtrends. Current price is the lowest low, so we have an obvious downtrend.
I have marked the anchor point as “H” (Highest High point on the chart), and marked the other anchor point with a red arrow.
Please note that no bars are bisected between H and the red arrow. In this case, we have again, only one trendline, because the current price is the lowest low.
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Unanswered Questions
The unanswered question I anticipate arising: Question: “How do you then know when a trend has been breached if no trendlines you draw, will ever bisect a bar previous to it? The definitions you give, seem to render trendlines fairly lobotomized.” Answer: This I answer this in the 2nd book. In the 2nd book, I will go into more details about trend biases and previous trend breaches. I will also cover things like trend fans.
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FGA’s (Frequently Given Answers)
Question: “By your definition, doesn’t this mean we have to redraw a new trendline with every new bar?” Answer: Yes and no. This partially answers one of the previously unanswered questions when you ask this question, if you haven’t figured that out.. Yes, you need to reevaluate the current trend, with every new bar. Because we regress the bars when we draw the trendlines, it might be possible that we need not redraw the line at all, that our old line still holds true. BUT, assuming the trend has changed, if you never erase the previous trendlines you drew for previous bars, you will then know when the current price breaches a previously drawn trendline. In the 2nd book, I will give a better definition for it how to deal with and draw breaches, and how to deal with trend breaks. Question: “I feel suckered. By not answering the question above, you are trying to get me to buy your second book aren’t you?” Answer: Did you learn something from this book? If so, how can you be suckered? The reason I have broken this book into two parts, is because of the anticipated length of time it will take me to generate the 2nd half. If this book was postponed to wait for the 2nd half to be finished before it is released, the release date would be pushed back probably by 6 months to a year, even accounting for Hofstadter's law. So I made the decision to break the book up, so the first parts I have finished can be released early to help as many people as possible. UPDATE: I have finished the 2nd book called “Trendfans and Trendline Breaks.” It is available for purchase at http://www.priceactionforex.com
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Copyright © 2008 Albert Yang.
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Conclusion
What started out as, me; being sick and tired of typing the same thing and answer emails, has resulted in a book that explains the basics of trends. However, not reading the 2nd book does not preclude you from thinking for yourself!! In fact, I HIGHLY recommend you question everything I have written, and think for yourself. Chances are, with some effort, you will be able to think of most of the contents from the 2nd book for yourself. I encourage you to think more. Until we meet again, may all your trades be fruitful and profitable ones. “Reading, after a certain age, diverts the mind too much from its creative pursuits. Any man who reads too much and uses his own brain too little falls into lazy habits of thinking.” -Albert Einstein Please frequent my website http://www.priceactionforex.com, the 2nd volume of Trends and Trendlines, called “Trendfans and Trendline Breaks” has been released. Also, come to the website as I often offer free ebooks! Thank you for your time.
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