For those who hear the terms “charting” and “charting tools” first, don’t be scared. Charting is simply a way to draw lines and patterns across financial charts in order to help analysts make decisions.
The Role of Charting Tools and Indicators
Charting tools don’t add any information to the existing graphs, the merely add visualization to the things that can sometimes be lost. However, sometimes it can help uncover some valuable information for long or short term trades.
The Structure of Trends
As we have seen previously, prices move in advancing and declining waves (or swings) that are separated by swing highs and swing lows. The most basic tools of trend analysis are trend lines, which simply connect these swing highs and swing lows. On the chart below, you can see that these trend-lines give traders a good idea of the”angle” of a certain price movement.
The trend-lines connecting swing lows and swing highs usually form a trend-channel that defines the movement of an asset for the period of the trend. Because trends can be broken down into smaller waves on shorter time-frames, there are most of the times several “active” trends in motion for every asset. You can see those different trends (the lower time-frame trends drawn with red) on the chart below:
Cycles and Trend-Lines
You might ask the question that how it’s possible to spot a meaningful swing low or swing high on a given time-frame. The answer lies in cycles, which we indicated on the next chart. The swings on a time-frame tend to be roughly similar in length, giving you a good estimate for the length of the coming cycles. Using this, when a trend is established (after you identify a higher high and a higher low, or a lower high and a lower low), you simply project the length of the first wave (Cycle 1 on the chart) to get the possible points for the next swing lows (the vertical purple lines on the chart).
Trend-lines provide great value in several swing trading and other types of strategies as secondary signals. Secondary trading signals are signals that are less reliable but often come earlier, than primary signals, such as higher highs or higher lows. If the price reaches a trend-line it often means that the lower time-frame trend is close to its end, while a trend-line break is often a sign of the weakening the prevailing trend. These might provide the perfect opportunities for profit taking, switching to a more aggressive stop-loss level, or conversely, re-entering into a full position.
Let’s look at this in practice on the next chart:
Some of you might already know about trends that are not exactly like the ones we discussed so far. Trends in financial markets can’t always be described by straight lines. Why? There could be several reasons for that—the cause of the trend might not be stable, the trend might attract more and more traders causing an acceleration in the trend, or conversely, a negative trend might cause a quickly spreading panic among the holders of the asset, leading to a swift collapse.
Whatever is the reason, these so-called parabolic trends are great opportunities for traders. As the moves accelerate, profits can pile up quickly if you are positioned correctly. That said, identifying these trends is not always easy, and the jump in volatility usually causes troubles for beginners, especially if they try to trade against these powerful moves. For those reasons, we will dedicate a whole post for these trends; until then here is a recent example of a parabolic move: