Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner Form And Pattern As A Trading Tool by Robert Miner P attern recognition has been the topic of much technical literature. From the Elliott wave theory to Edwards and Magee, traders have been told that some fairly well-defined chart patterns indicate the market's position and the most likely outcome of the ensuing market activity, as indicated from a particular chart pattern. While it is important for every trader to be familiar with traditional chart patterns that have been found to be reliable indications of the market position, it is also important for the trader to analyze any individual market for the way in which it unfolds in bull or bear cycles and for patterns unique to that market. A trader will find that for every unique market there is often a form in which a cycle will unfold and there is a chart pattern of activity that develops at important junctures. MASTER OF THE GAME If a trader is to be successful, he should master every market he intends to trade by relentlessly analyzing that market from every perspective for as far back as data are available. There is no excuse not to be intimately familiar with a market and its peculiarities, as the data for every market as well as charting and analysis software are easily available. The trader must always keep in mind several concepts to make the right decision: 1. Market activity must be viewed from all perspectives and relationships: time, price, position and pattern. No single aspect of market activity can be viewed out of context of the other dimensions. 2. The trader must have a firm idea of the market's position in comparison with the long-, intermediate- and short-term trends. The trader must recognize whether the market is in a position of strength or weakness or near a termination of a trend. 3. The trader must have a well-defined trading plan that reflects his trading goals. 4. The trader must have specific trading strategies to take advantage of his knowledge of the market and its position to fulfill his trading plan. Article Text Copyright (c) Technical Analysis Inc. 1 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner Now look at the Treasury bond market to discover how an analysis of the form and pattern of that particular market would give us usable information to make profitable trading decisions. First, look at the history of the Treasury bond market to see what we would learn from the history of the market's form and pattern as they unfold. Note the form and pattern of the 1981-86 bull market (Figure 1). From the September 1981 low, the market made a strong advance into the May 1983 high. Note the nature of market activity at that high. The initial high was made in November 1982. Six months later, in May 1983, the market exceeded the November high slightly and then sharply declined, closing the month near monthly lows and resulting in an outside reversal month. Then, the market continued to decline into the July 1984 low. From the 1984 low, the market made two relatively short advancing swings, making the highs in January and June 1985. The June 1985 swing high topped slightly above the swing high of May 1983 before consolidating for four months. In November 1985, price broke decisively above the resistance level, with a monthly close above the prior swing highs of June 1985 and May 1983 and closing near the high of the month. The market continued to advance strongly into the extreme high of April 1986. TRIANGLE CONSOLIDATION From the April 1986 high, the market consolidated for 11 months in a triangle pattern, never able to exceed either the extreme April 1986 high or even the first corrective high of August 1986. In March 1987, the market made an attempt at the August 1986 swing high but closed down near the low of the month in an outside reversal month. From that decisive failure to advance, the market declined sharply the following month below swing and consolidation support levels, confirming that April 1986 was likely to be the termination of the bull campaign and that the market was likely to either correct the advance from the July 1984 low or the entire bull market from the September 1981 low. If we examine the activity from the weekly chart perspective, we see that there really was little difference between the campaign and the monthly chart. It is important to review the market activity at this point to see what can be learned of the nature of the bond market for this bull campaign: (cid:1) The first rally swing was strong, more so than a normal corrective countertrend swing if the bear market was to continue (9/81 - 11/82). (cid:1) The extreme top of the initial advance was made after a six-month consolidation period, with the final high (5/83) only slightly exceeding the prior high on an outside reversal month — that is, the market attempted once more to continue to new highs after a prolonged period of consolidation but failed and began to decline sharply. The failure to fulfill the higher prices expected after a prolonged period resulted in a capitulation of those expectations and sharply lower prices. (cid:1) From the 1984 low, price made two relatively short advancing swings into the obvious resistance level of the prior swing high. Once again, price slightly exceeded the perceived resistance (6/85), only to fail and then enter a consolidation of several months near that resistance level. Price had now made Article Text Copyright (c) Technical Analysis Inc. 2 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner three attempts at the same resistance level. (cid:1) On the fourth attempt (11/85), price broke out sharply above the triple top in a breakout that resulted in a sharp advance to new highs. Keep in mind my rule of four: "At the fourth attempt of support or resistance, a major decision will be made. A failure to continue the trend will usually result in a sharp countertrend move. A successful breakout will usually result in an accelerated, high momentum trend swing." To a lesser extent, this is true on the third attempt or the challenge of a double top or bottom. (cid:1) Following the April 1986 high, price again underwent a fairly tight triangular consolidation period of almost a year, never able to exceed the extreme high. Expectations and frustrations were again building over time. (cid:1) The final capitulation was again preceded by an outside reversal month, which topped just short of the prior swing high. What is the pattern here? Advance, prolonged consolidation, failure to move through resistance, dramatic decline at the failure of expectations or dramatic advance at the successful test — a familiar theme. Note the form of the activity from the October 1987 low. While not an exact repetition of the prior bull campaign, the general characteristics are similar: Initial strong advance into the February 1988 high, sharp reversal into the August 1988 low, two minor advancing swings, sharp advance on the breakout and final top made on an outside reversal month of August 1989. The only real difference of the October 1987 - August 1989 bull campaign from the monthly chart perspective is that the market did not undergo the prolonged consolidation periods at each important resistance level prior to a countertrend move or trend breakout. If we examine the activity from the weekly chart perspective, we see that there really was little difference between the form and pattern of the 1981 to 1986 bull campaign and the 1987 to 1989 bull campaign (Figure 2). From the February 5, 1988, swing high, the market consolidated at high levels for four weeks, making two more weekly attempts at the high but falling short of that high and closing each week below midrange, a sign of weakness. The capitulation came when the market made a strong decline below the minor swing low, closing near the low of the week. From the corrective low of August 16, 1988, the market made two minor advancing swings, the weeks of 11/1/88 and 1/27/89. The second advancing swing only slightly exceeded the resistance of the first on an intraweek basis. The third attempt at this resistance level was made the week of May 19, 1989, on a strong break of the double top with a close above the resistance swing highs and near the high of the week. Following this breakout of important resistance, the market accelerated the advance in the same manner as the breakout in November 1985 (Figure 1) following two minor advancing swings. A new high for this bull swing was made August 1, 1989, on a very wide range reversal week with a close at the low of the weekly range. The ensuing price activity should look familiar, as it underwent the same general form as the activity after the April 1986 top. CLEAR RECOGNITION Now take the analysis up to the latter part of 1989. At that point, the trader should have clearly recognized that the bull campaign from the October 1987 low was unfolding in the same general pattern as the bull campaign from the 1981 low into the 1986 top. The bond market exhibited similar pattern characteristics at important resistance levels. Article Text Copyright (c) Technical Analysis Inc. 3 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner In the latter part of 1989, we can suspect the market was in a position similar to the market following the 1986 high. If the form of the market activity was to be fulfilled in the same manner as the activity following the 1986 high, the trader could anticipate the August 1989 high would not be exceeded and, once the market did finally break below the consolidation levels, a sharp decline would probably follow that would either correct the advance from the August 1988 low or from the October 1987 low. However, markets do not always fulfill our expectations, which is why we must have trading strategies that incorporate the shorter-term price patterns as well as the time dimension. The daily chart clearly demonstrates the blowoff top into the August 1, 1989, high (Figure 3). This top was preceded by a sharp advance to new highs that culminated in an exhaustion gap on August 1 and a close below the gap two days later that confirmed the top. The market then made a typical ABC-type correction, followed by another sharp rally that tested the August 1 high. The nature of the test of the August 1 high on October 16 was an important clue to the position of the market. On October 16 the market made a very wide range day, exceeding the August 1 high intraday, but closed near the low of the day, well below the prior swing high resistance level, an indication of weakness at this high price level. For the next two months, the market traded in a tight trading range. While we have identified the market activity at this point as being very similar to the pattern from a longer-term perspective of the market activity going into and following the April 1986 campaign high, we can never be certain whether this is a distribution period whence prices will eventually make a significant correction or an accumulation period at major resistance that will be followed by a breakout to significantly higher levels. STRATEGIES AND MEASURES The trader must use disciplined trading strategies to take advantage of the situation, no matter how it should unfold. The one thing we can be reasonably sure of is that the bond market is likely to make a very significant move out of this consolidation period. If the market is unfolding in the same manner as the bull campaign into the 1986 top, which appears to be the case, we should look for opportunities to short the market at resistance as well as at the breakout below the trading range/consolidation. If the market continues higher, it will probably do so dramatically, as it exceeds a level of resistance that has been tested several times in the past four to five months. If that scenario were to unfold, we would buy a confirmed breakout of resistance or a close above the August 1 swing high. The trader will take advantage of whatever situation unfolds regardless of what he believes should unfold. As of late December, the market had made three attempts at resistance: August 1, October 16 and November 16. The rule of four states that the fourth attempt is likely to result in a dramatic change, breakout or failure. TIME ANALYSIS The time analysis has indicated that the week of December 19 (12/17-18 = weekend) is an important projected turning point period (PTPP), which has a high degree of probability of change. I use a technique called Time Cycle Ratio (TCR) analysis to project turning point periods. This analysis is based on Fibonacci ratios of day counts between past turning points in the market. I count the number of days between turning points, multiply the result by a number from the Fibonacci series and add this amount to the last turning point. This period had a large cluster of important time factors, including: December 17 = 1.618 TCR 10/19/87L-8/16/88L Article Text Copyright (c) Technical Analysis Inc. 4 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner December 17 = 1.5 TCR 8/1/89H-9/26/89L December 20 = 60 trading days (TD) 9/26/89L December 21 = 2 TCR 8/16/88L-1/27/89H December 22 = 1.618 TCR 8/1/89H-9/26/89L December 23 = 144 calendar days (CD) 8/1/89H The trading strategy involves entering the market counter to the short-term trend going into the PTPP if the market is at a support or resistance level and the daily price activity indicates reversal. In short, when time, price and pattern coincide, action should be taken. Going into the PTPP of the week of December 19, the short-term trend was clearly up. The market was making a fourth attempt at a very strong resistance zone. On December 20, price exceeded the immediate trading range high of November 16 intraday but closed below this resistance level near the low of the day, a sign of weakness. Note how often bonds approach or slightly exceed important resistance levels at final tops, yet fail to close above that resistance level. But in this case, time, price and pattern have coincided to indicate change. The trading strategy was to sell bonds on the close on December 20 at this important coincidence, with a stop and reverse just above the intraday high. TIME, PRICE AND PATTERN Why a stop and reverse? With such a strong coincidence of time, price and pattern activity from a long- and short-term view indicating important change, a failure to complete the pattern by continuing to advance would indicate a very strong rally swing was likely to develop. Taking advantage of the market's failure to unfold as indicated is a powerful trading strategy that allows the trader to position him- or herself for whatever may develop in the market. Keep in mind that action should be taken at an ideal setup of the coincidence of time, price and pattern. The trader can never be certain what the ensuing market activity will be. We have positioned ourselves for the most likely outcome, however, and will quickly reverse positions to take advantage of whatever might unfold. Three days later the market gives us the first confirmation that our analysis and trading strategy is likely to pay off, possibly in handsome returns, as the market makes a wide range decline with a close below the trading range low. If the market is to move as anticipated, a significant correction of either the August 1988 or October 1987 to August 1989 bull swings will unfold. The final capitulation comes on January 12 as the market again makes a wide range decline and closes below the next support level. At this point we know that our analysis of all dimensions of market activity and appropriate trading strategies will pay off. AFTERWORD It is always easy to analyze a market after the fact and illustrate the relationships and profitable trading strategies. I have illustrated how the market can be analyzed beforehand to prepare the trader. The long- and short-term pattern of the bond market activity going into late December 1989 indicated well in advance that the market was making an ideal setup for a major decline based on the characteristics of previous tops. The market's failure to unfold as expected would be likely to result in a breakout to new highs and a significant advance, but whatever might happen, the trader was able to position to take Article Text Copyright (c) Technical Analysis Inc. 5 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner advantage of a probable major move by being prepared for when change was likely. The strategy, in fact, took advantage of our knowledge of the position, pattern, time and price analysis of the market activity. A key to successful trading is to have the patience and discipline to take action only when the market activity from all perspectives clearly indicates the most probable forthcoming action. Never initiate a trade without a thorough knowledge of the peculiarities of the particular market. When the time, price and pattern of market activity coincide to indicate change, the trader has the best opportunity for profits. Taking advantage of the market's failure to unfold allows the trader to position himself. Every trade will not be profitable, but every trade cab be successful. A trade may result in a loss, but as long as that loss is minimal and action was taken with reason and purpose in accordance with our trading plan, the trade is still successful. Robert Miner is a private trader and the author of the W. D. Gann Trading Techniques Home Study Course, Gann/Elliott Educators. Edwards, Robert D., and John Magee [1966]. Technical Analysis of Stock Trends, John Magee Inc. Miner, Robert [1991]. "Price as a trading tool," Technical Analysis of STOCKS & COMMODITIES, Volume 9: April. ___ [1991]. "Time as a trading tool," Technical Analysis of STOCKS & COMMODITIES, Volume 9: March. ___ [1989]. "Time, price and pattern," Technical Analysis of STOCKS & COMMODITIES, Volume 7: May. Figures Copyright (c) Technical Analysis Inc. 6 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner FIGURE 1: During May 1983 the bond market tested resistance a second time and failed to hold the gains, thus signaling a top. In November 1985 the fourth attempt at resistance was successful and a powerful bull market was underway. Figures Copyright (c) Technical Analysis Inc. 7 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner FIGURE 2: The market successfully broke through the November 1988 and January 1989 tops on its third attempt (May 1989). The price move above the double top did not run its course until August 1989. Figures Copyright (c) Technical Analysis Inc. 8 Stocks & Commodities V. 9:5 (197-201): Form And Pattern As A Trading Tool by Robert Miner FIGURE 3: The August 1989 selloff and the October 16, 1989, reversal day forewarned of the potential top. Figures Copyright (c) Technical Analysis Inc. 9