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Is there a way to guage when a market will break out and which way?

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John Forman - The Essentials of Trading author

A couple of weeks ago I introduced a new video course: Reading market strength and weakness. One of those who watched the video asked this question:

I just finished watching the support and resistance video you put together.

I can say that it definitely helped me. …

The one thing that I really found enlightening was the attraction points theory. That will definitely be helpful as I will have some “targets” now.

One question that came out of watching the video though is this: When a forex pair/stock/etc is ranging, is there any way to identify when its going to break out and in which direction? As of now I’m just waiting for the breakout to occur (ie close outside the range) and then placing an order a bit above/below the high/low of that bar.

My response to this inquiry is that there certainly is. One of the principles of reading the underlying strength or weakness is that the chart methods can be employed over different timeframes and between timeframes. By the latter I mean we can look at shorter timeframes to help assess longer ones.

Here’s what I mean.

If USD/JPY (to provide a forex pair in line with the questioner’s focus) is showing a range on the daily chart, then we can look at the hourly chart, for example, to assess the strength or weakness of the market in that timeframe. That then can help us develop a picture of the likely action at the next higher timeframe level.

This multiple timeframe analysis, by the way, is a method technical traders use in many ways. Many of them will look to the longer-term chart to identify general trends (or the lack there of) to bias their trading in the short-term. Obviously, since the short-term happens before the longer-term, we can also flow the information the other way as I’ve suggested above.

Latest Guest Post

The Great Manic Depressive: The Markets

This post was contributed by Billy Williams

The markets are a lot like a manic depressive in that there are moments of incredible euphoria and then, almost in the blink of an eye, incredible feelings of despair and hopelessness. These emotional extremes are also contagious to those who are participating in the markets and as individuals suffer these extremes they eventually reach a point where they are paralyzed into inaction just as the markets begin to turn in their favor or detriment.

When the markets are healthy and the future for the economy looks bright the market is incredibly euphoric and like a manic depressive experiences incredible highs in emotional well-being that often result in caution being thrown away while riding the incredible sense of euphoria as the markets rise ever higher. Unfortunately, as night follows day, markets will eventually go down but the investors swept up in such a strong emotion as euphoria feel too connected to its source (the market rising) to ever consider that it may be time to lock in gains or protect a position. They are blind, like addicts that cannot admit their addictions they cannot admit that now is the time to leave the market for that has become there drug of choice.

After awhile, however, as the emotional high subsides in the market and suddenly it crashes as it discounts the future of the economy which faces a slow down or recession which causes an ever increasing sense of despair and hopelessness among the investors as they hold on during every decline and hope thru every short term rally only to feel there emotional well-being crash lower as the decline continues. The markets become more and more depressed to the point of no return for the investing faithful who have been bleeding losses since the crash and, in there final act of their investing death thro, they liquidate their holdings for a fraction of what those holdings were once worth.

The last of these sellers often result in a climatic sell off resulting in sharp move down in the markets as a violent convulsion down squeezes out the last of the investors that had been holding on. The market stands at the abyss on death’s knell causing much of Wall Street and Main Street to feel the dull pain of impending death of what they have understood to be modern day capitalism. Doom and dread is everywhere….on TV, cable financial news, in the newspapers, in the classrooms, on the cover of magazines, and in every barbershop and hair salon everyone talks of the end of the markets.

Then, as the last of the sellers receive their stocks sell slips a stirring begins again in the markets. Suddenly, volume begins to pick up and a huge rally takes place but is discounted as short-covering by the short sellers. A few days later, another rally takes place on higher volume and again is ignored. New stock leaders begin to see new levels of volume pour into their shares as big institutions and money managers begin to take positions but, still, the individual investors stay away out of fear.

Over the coming months, the pessimism of Wall Street gives way to caution with all the talking heads giving glowing commentary again about the huge prospects for the economy and hot IPO’s (initial public offerings). Institutional money is still pouring into new leaders in the stock market and smaller investors begin to wonder if the rally is for real. Those that do decide they will participate but only when stocks “get a little cheaper” but they never do.

Soon, the new leaders are rocketing higher and higher while investors feel they are missing the boat and begin to buy without noticing that the general market appears to be stalling and coming under distribution. A few weeks later, as investors are now back in the market the market appears to decline again with investors caught in the crosshairs again.

This cycle is played out over and over again as the general market’s manic condition creates an emotional whirl storm that investors get caught up in and allow themselves to become victim to.

Average investors allow themselves to fall victim to this cycle of extremes because they come into the market with no plan or method to trade. They buy on tips from there brother-in-law or because a stock is reputed to be a “good company”. These are not plans or methods they are gambling.

A fundamental key to winning then is to realize that successful trading is counter-intuitive compared to how the general public approaches the markets. Having a method or system that allows you to exploit an advantage helps but, ultimately, even the greatest trading method ever devised helps no one trade successfully if they don’t realize there are certain underlying truths to making big gains in the market that are counter-intuitive to the way most people attempt to win at trading.

Now, that you can see a little how these cycles form and are repeated we will journey together to learn how not to be swept up in a tsunami of negative emotional turmoil due to unnecessary losses by following the crowd and/or our own faulty reasoning in future posts.