mid-1990s. The first index, the ValueLine Composite Index (Value Line) futures contract, commencedtrading on February 24, 1982, on the Kansas City Board of Trade.Several others followed shortly thereafter. They are the Standard &Poor’s 500 Stock Index (S&P 500), the New York Stock ExchangeComposite Index (Composite), and the Major Market Index (MMI)futures contracts. There are options on futures for the S&P 500 andthe Composite Indexes.Other indexes cropped up during the 1990s, reflecting thegrowth of technology and small-capitalization stocks. Large-company indexes include the Dow Jones Industrial Average (DJIA), theRussell 3000, the Schwab1000, the Standard & Poor’s 500 Composite Stock Index, and the Wilshire 5000 (which contains about 7,000stocks). Medium-company indexes are Standard & Poor’s 400 MidCap and the Wilshire 4500. Small-company indexes are the Russell2000 and the S&P SmallCap 600.Each of these indexes reflects a different type of stock portfolio. For example, the S&P 500 and the Composite represent a broadly based portfolio. The S&P 500 includes 500 stocks, while the Composite is composed of over 1,500 stocks. Both of these indexes areweighted by capitalization. The MMI mimics the Dow Jones Industrial Average, and the Value Line mirrors stocks with low capitalization. The MMI is price weighted, and the Value Line gives equalweighting to all stocks. The Russell 2000 contains the 2,000 smalleststocks in the Russell 3000. The Russell has gained a wide following,especially among fund managers.
MD6988.065-122
9/28/01
10:55 AM
Page 114
CHAPTER 5
114
Stock Market RiskThe index contracts and their options were developed to either manage or capitalize on the risks inherent in the stock market.Basically two types of risk are associated with the stock market. The first type relates to the changes in the price level of the overall stock market. Is the stock market bullish (going up) or bearish(going down) overall? In which direction are the Dow and other indexes going?The second type of risk relates to price changes of individualstock issues relative to the level of the overall stock market. The firsttype of risk is commonly called market risk, and the second, stockspecific risk.You, as an investor, must look at individual stock prices as theycompare with the overall market. This is called volatility. If a stockis highly volatile, its price level will swing up or down in a widerrange than the overall market. Volatility is measured by use of “beta”coefficients. For example, if the price level of a given stock increasesby 1.5 percent when the overall market goes up only 1 percent, thisstock has a beta coefficient of 1.5 and is considered highly volatile.The opposite is also true. With stocks with low betas or low volatility, their price levels do not change as much as the overall market.Stock portfolio managers want to be in stocks with high betacoefficients when a bull market is in progress. The price level ofthese stocks should outperform the averages or indexes. In bearmarkets, the portfolio managers want to be in low-beta stocks or outof the stock market completely.
Index Trading StrategiesThe investor or portfolio manager can combine actually trading thestock market with the use of stock indexes and options trading. Let’ssay you expected the overall stock market to go up, but you are notsure what to expect from a specific stock or group of stocks you areholding. Remember, a specific stock does not necessarily move inthe same direction as the overall market or with the same volatility.Therefore, you could hold onto the stock and purchase a stock index futures contract or option to take advantage of the expected upward move. If you’re bearish, you could short the futures market orpurchase a stock index put option.
MD6988.065-122
9/28/01
10:55 AM
Page 115
Overview of Some of the Active Markets
115
This is hedging a stock or a portfolio. You can select the futurescontract that most closely resembles your stock portfolio. Use theS&P 500 or Composite for broad-based portfolios, the Russell 2000or Value Line for small stocks, and the MMI for portfolios similar tothe Dow Jones Industrial Average.
Price DeterminantsNaturally, you can speculate about the direction of the stock marketthrough the use of stock index futures and options without owningany specific stocks. But like all other futures markets, you need tohave an opinion about whether the market is going up or down andwhen.There are at least two technical approaches to analyzing thestock market index futures contracts. The first utilizes the analysisof charts and chart formations, including several types of movingaverages, algorithms, oscillators, and relative strength indicators.The second technical approach uses several stock market indicators,such as short interest, specialist short interest, advance-decline ratio, and odd-lot buying and selling.Other stock market analysts use fundamentals, such as:1. Corporate profits. Higher corporate profits usually equate tohigh stock prices and an increase in the indexes.2. Interest rates. Higher interest rates usually mean lower corporate profits and lower index levels.3. Economic conditions. Here’s a catch-22. Better economicconditions lead to higher corporate profits and eventuallyhigher interest rates. The indexes go up for a while andthen down.4. Public expectation. If the public is optimistic about the nearterm future, the indexes usually go up. Pessimism drivesthem down.
Traders NotesYou’ll notice that most of the volume and open interest in the stockmarket index contracts is in the nearby contract months. This indicates most traders are looking at the short-term situation and avoid-
MD6988.065-122
9/28/01
10:55 AM
Page 116
CHAPTER 5
116
ing the long term, which is difficult to trade because the market isso emotionally charged.DEBT MANAGEMENTOVERVIEW OF INTEREST RATES
Simply put, interest rates are the cost of money. Just as you must pay(buy, rent, lease) to have the use of any other tangible product or service, you must pay a price to have the use of money. Also like anyother product or commodity, the cost of money varies with changesin the supply-demand equation.Interest rates impact every commodity traded on the futuresmarket directly or indirectly. For example, low interest rates makeit easier for farmers or manufacturers to expand. This gives us morecorn, soybeans, cattle, etc. Abundant supplies drive down farmprices. When manufacturers expand because of low interest rates,their earnings increase. This enhances the value of their stock, andthe futures contract in the S&P 500 moves higher, and so on.Interest rate changes have a direct impact on the debt instruments traded on the exchanges. When interest rates go up, debt instruments go down, and vice versa. Thus, when you trade debt instruments, you are taking a position on whether you believe interestrates are going up or down. Debt instruments traded on the futuresand options on futures exchange encompass Treasury bonds, bills,and notes.
Fundamental FactorsUnderstanding exactly where within an economic cycle the countrystands is probably the single most important fundamental factor.Studies have verified the fact that interest rates follow the level ofgeneral economic activity. When the economy is expanding, the demand for (and therefore the price of) money increases. In periods ofrecession, the supply of money exceeds demand, causing interestrates to fall.Herd psychology also must be taken into play. Once a periodof expansion is well under way, the demand for money continuesafter the actual expansion has subsided. Momentum carries demand forward, as reflected in high interest rates. The same is true
MD6988.065-122
9/28/01
10:55 AM
Page 117
Overview of Some of the Active Markets
117
in the late stages of recessions. Interest continues to decline, even asexpansion is beginning.The fact that the transition in the economic cycle, from boomto bust and back again, precedes major changes in interest ratesemphasizes the need to closely monitor the economy. The Department of Commerce issues three important indexes that should bewatched. They are the Index of Leading Indicators, the Index of Coincident Indicators, and the Index of Lagging Indicators.Interest rates must pick up momentum, meaning demand formoney, before they make a major impact on the indexes. For this reason, they most closely follow the Index of Lagging Indicators, butfor purposes of forecasting, you’ll want to monitor the other two indexes because you need to wait 3 to 6 months for a trend change inthe economy to be verified. For trading purposes, you use the oldgrade-school-race starting sequence: On your mark (check the Leading Index), get set (verify with the Coincident Index), go (trade theLagging Index).To find out more about the three indexes, check out a free website, the Dismal Scientist (www.dismal.com). It provides data on andanalysis of the three indicators.
Bank ReservesThere is a strong, well-documented correlation between interest ratetrends and the level of free or net borrowed bank reserves. When reserves go down, so do interest rates. A move from free or low netborrowed reserves to higher net borrowed reserves coincides withhigher interest rates. Therefore, the reserve position of banks is anindicator of the supply-demand situation. The Bank Reserve Position Report is issued each Friday by the Federal Reserve.
The FedThe Federal Reserve has three valves it can manipulate to controlbank reserves and, in turn, interest rates. The first is the discountrate. When the discount rate is increased or decreased, the reservesof bank members are reduced or expanded, respectively.The second valve is the reserve requirement, which is the percentage of various deposits that banks are required to hold in reserve.It, like the discount rate, is seldom used, except in emergencies.
MD6988.065-122
9/28/01
10:55 AM
Page 118
CHAPTER 5
118
The dominant tool used by the Federal Reserve is the openmarket option. This is the purchase or sale of government securities.If the Fed wants to drive interest rates down, it buys government securities from dealers. This injects funds into the system, increasingsupply. If it wants to push interest rates up, it sells government securities, thereby draining funds from the system, reducing the supply of money in the marketplace.Some interference or government control over the economymay be unavoidable in this day and age. But when this power isused to artificially control inflation, it only compounds the demandfor the area under control. Eventually the economy is distorted morethan if it were left to freely react to economic pressures.
Forecasting Price TrendsTracking the economy and the Federal Reserve is your first step. Thereal challenge lies in determining correctly the impact on interestrates of these two forces. Will a certain action taken by the FederalReserve to reduce or slow down interest rates throw the economyinto a recession?The United States, and the world economy for that matter, is likea battleship. It takes a good bit of ocean and a few hours to turn itaround. It always has a lot of momentum. In other words, when youare dealing with interest rates, time and patience are importantvirtues.
Technical AnalysisDebt instrument futures are very popular among both institutionaland individual traders. This has given rise to much research on thetechnical side. Particular attention has been paid to price chart formation analysis and cycles. You must study these two areas thoroughly.FOREIGN CURRENCYOVERVIEW OF THE FOREIGN CURRENCYFUTURES MARKETS
When the Smithsonian Agreement came apart in March 1973, it setall currencies floating freely. This action provided momentum to the
MD6988.065-122
9/28/01
10:55 AM
Page 119
Overview of Some of the Active Markets
119
futures markets that began in 1972 at the International MonetaryMarket (IMM), a division of the Chicago Mercantile Exchange. TheIMM is still the world’s largest currency futures market.The initial markets traded were the British pound, the Canadian dollar, the West German mark, the Japanese yen, the Swiss franc,and the Mexican peso. Later additions have been the French franc,the Australian dollar, the South African rand, the New Zealand dollar, the Brazilian real, and the euro.Futures contracts go through a physical delivery process inMarch, June, September, and December. Contracts all have the sameamount and the same expiration and delivery time. When a contractis traded, a margin, or minimum payment that is set by the exchange,must be made. Unlike forward contracts that don’t change in value,futures contracts do, and their value can shift minute by minute.Skeptics of the Foreign Futures Exchange (Forex) marketsdidn’t see any need for the futures contracts because there wasalready a well-established bank forward market for foreign currencies. However, the bank forward market had some drawbacks. First,access was limited to large banks and corporations with excellentcredit. Small firms and retail speculators were barred. Second, onlylarge denominations of $1 million and above were traded on thebank forward market. Additionally, the market was set up primarily for traders to take or make delivery. It’s expensive and difficultto liquidate a position before expiration of the contract.Since futures contracts negate all these drawbacks, they immediately found a place in the foreign currency market. Volume hassteadily grown over the years.The complexion of foreign exchange trading will change somewhat in 2002 with the full implementation of the European Union’smonetary union and its single currency, the euro. The euro went intoeffect January 1, 1999, when 11 of the 15 European Union currencieshad their parity rate set to 1 euro. The 11 currencies that originallywent with the euro are the Belgian franc, German mark, Spanishpeseta, French franc, Irish pound, Italian lira, Luxembourg franc,Dutch guilder, Austrian schilling, Portuguese escudo, and Finnishmarka. The Danish opted out of the first round of the euro. Austriaand Greece had not met all the criteria to become charter membersof the single currency.Britain, although a member of the European Union, did notjoin the single currency initially, so the pound continues as an indi-
MD6988.065-122
9/28/01
10:55 AM
Page 120
CHAPTER 5
120
vidual currency. Although the Labor government elected in 1997was more inclined to join the single currency, it has been cautiousbecause of the strong feelings in the United Kingdom about scrapping the pound. Switzerland has opted to stay out of the EuropeanUnion completely, so the Swiss franc continues to trade separately.The euro immediately began trading as a currency and is being used in financial transactions between companies and countries.Actual circulation of the euro as a currency won’t begin until January 1, 2002. At that point, the individual currencies will cease toexist.These developments will take the German mark and theFrench franc out of currency futures trading arena, and the euro willbecome the key European Union player. Analysts are watching theeuro trade to see if it eventually challenges the U.S. dollar as theworld’s dominant currency. A weak euro could, in the long term, enhance the Swiss franc’s reputation as a “flight of quality” currency.Under the European Monetary Union, the European CentralBank conducts monetary policy for the euro, but each individualcountry continues to conduct its own budgetary and taxation policies. Skeptics point to this split control as a recipe for trouble whencountries grow at different rates. A country that is growing slowlywill need lower interest rates to boost growth. A country that isgrowing rapidly may be facing inflation, which will require higherinterest rates.
Arbitrage and HedgingDevelopers of the foreign currency futures contracts made it easyfor banks and other commercial users of the bank forward marketto arbitrage between it and the futures market. In the beginning thisincreased volume when it was dearly needed. It also helped keepthe price range of some of the thin futures currency markets in linewith the more liquid bank forward market. In time, the banks tookthe lead and began arbitraging for their commercial clients, thuskeeping additional profits for themselves.Agricultural firms are another group of U.S. commercial firmsthat are major users of the foreign exchange futures markets. Theyneed to hedge their foreign exchange exposure since the very largegrain deals often take several months to complete.
MD6988.065-122
9/28/01
10:55 AM
Page 121
Overview of Some of the Active Markets
121
Since the “commodity” discussed in this group is money, thereisn’t any real supply-demand equation in the classic sense. Granted, countries can increase or restrict the supply of their currencyfrom time to time, but the value of or demand for a currency depends more on other factors.
Price DeterminantsForeign exchange rates, or the price of money, are commonly expressed in their relationship to the U.S. dollar. Foreign currencies arequoted on the futures market in the number of U.S. dollars that mustbe paid for 1 unit of the foreign currency. Therefore, to determinethe value of another currency, the financial or economic situation ofthat currency must be compared with that of the United States. Theimpact of a variety of trends, factors, and events on the relationshipof the currency being compared with the dollar must be assessed.Some of the most important influences on this relationship are balance of payments, interest rates, economic growth, inflation rates,and political conditions.Balance of payments is a measure of the number of dollars flowing out of the United States compared with the flow of foreign currencies into the United States. Over the years, this concept has become more complex as economists have tried to measure differenttypes of inflows and outflows. For example, merchandise, services(together these are the balance of trade), direct investments, stockissues, bank claims and liabilities, and government assets abroadeach tell something different about the U.S. financial situation.When more money flows out of the United States than flowsin, there is a deficit position. A balance of payments surplus is theopposite. As a rule of thumb, a surplus causes the dollar to becomestronger relative to foreign currencies (the dollar value of foreigncurrency declines) because there are fewer dollars in foreign countries. A deficit, on the other hand, causes the dollar to weaken compared with foreign currencies (the dollar value of foreign currencyincreases) because there are more dollars in foreign countries.High interest rates in the United States compared with those inforeign countries usually attract capital. Money flows into the country. The dollar becomes stronger. Bankers call this worldwide poolof money that flows to the best deal as “hot money.”
MD6988.065-122
9/28/01
10:55 AM
Page 122
CHAPTER 5
122
Economic growth has been a double-edged sword for the dollar. A strong U.S. economy has sometimes led to balance of payments deficits, thus weakening the dollar. At other times, a strongU.S. economy has been seen as an indication of political stability inan unstable world. This perception has led to a strong dollar.High inflation rates in the United States make American products more expensive relative to foreign goods. This increases imports and decreases exports. A deficit and a weak dollar result. Atother times, inflation has created higher interest rates, leading to aninflow of capital and a stronger dollar.Awareness of political conditions is another must. If there ispolitical instability in foreign countries, wise investors move theirfunds into the United States. This strengthens the dollar. The opposite can also be true.The price determinants discussed must be carefully evaluatedbecause the impact can be either positive or negative for the relationship between the dollar and the other currencies. You must learnto read the psychology of the market as the events occur.
Trader’s NotesThe rapid growth of futures contracts in foreign currencies testifiesto their usefulness and popularity, but some of these markets arestill somewhat thin. This can be very dangerous. It is advisable toavoid trading Friday afternoon after the London markets close because of the lack of liquidity at this time.
MD6988.123-162
9/28/01
10:55 AM
Page 123
C H A P T E R
6
Understanding Analysis
Key Concepts◆ How Good Is Fundamental Analysis?◆ How Is Technical Analysis Performed?◆ Four Basic Approaches to Technical Analysis◆ Four Structural Analysis Methods◆ Character-of-Market Analysis
Now that you have a general feel for the futures markets and havedetermined that you are financially and psychologically suited totrade, you need to consider the area of price-trend forecasting. Futures trading requires you to make a simple decision of whether togo long or short. Do you think the price of whatever commodity youwant to trade is headed higher or lower? If you can’t do this, there’sno point in considering an individual trading account.There are basically three methods of forecasting price trends.You can use fundamental or technical analysis. Or you can use acombination of the two.WHAT IS FUNDAMENTAL ANALYSIS?
Fundamental analysis is the study of basic, underlying factors thatwill affect the supply of and demand for and therefore the price ofa futures contract. In theory, it is quite simple. When the supply of
Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use.
123
MD6988.123-162
9/28/01
10:55 AM
Page 124
CHAPTER 6
124
F I G U R E
6.1
Supply-Demand Equation• Existing stocks• Plus production• Less usage• Equals supplyFundamental analysis is based on an analysis of the comparative strength ofthe opposing forces of supply and demand. If supply exceeds demand, pricesusually decline. If demand outstrips supply, prices usually rise.
a commodity becomes scarce, the price goes up. When it is plentiful, the price goes down. (See Figure 6.1.) Unfortunately, it doesn’talways work this way. For example, some of the toughest factors toaccurately quantify are those of supply and demand. How much ofa given commodity is enough? Where is it, and is it in a usable form?Agricultural commodities illustrate this point very well because most people are familiar with them and because they are veryresponsive to supply and demand factors. To make an accurate priceprojection for corn, for example, here’s what you’d need to know fora given crop year: existing stocks (on-farm and commercial inventory), production (projected acres/yields), and usage (food, feed,and seed). This sounds much easier than it is.First, keep in mind you’re doing this on a global basis, andmany of the countries from which you need vital information willbe uncooperative. The developed countries may share only the information that suits their side of the supply-demand equation. Ifthey expect to be corn buyers, they might provide inflated figureson the supply they have on hand or expect to produce. Their objective is to drive prices down. Undeveloped countries may do thesame thing, or they may not have an established infrastructure togather, process, and evaluate what information they have on theircrop.As you attempt to piece together all the facts on productionand usage, you quickly come to the conclusion that much of the information is unreliable for a variety of reasons. With agriculturalproducts, the weather is always a major uncertainty. Too much ortoo little rain, even over a short period of time, can drastically impact prices. Other groups of commodities are equally influenced byseemingly uncontrollable factors that are virtually impossible to
MD6988.123-162
9/28/01
10:55 AM
Page 125
Understanding Analysis
125
predict. Consider what wide swings in political unrest or interestrates can do to the price of precious metals.The point is simply that the accuracy of fundamental analysisoften hinges on fast changing information, much of which is not easily obtained, nor can it always be accurately interpreted.HOW DO YOU DO FUNDAMENTAL ANALYSIS?
For years, number crunchers have attempted to quantify supplyand demand statistics. It’s been like the search for the Holy Grail.Who wouldn’t want a mathematical formula that can accuratelyforecast prices 3, 6, or 9 months into the future? For that matter whowouldn’t want one that would be good for tomorrow’s prices?Statisticians have tried linear and nonlinear regression analysis, double exponential smoothing, probability and trigonometriccurves, multivariable analysis, and just about every other techniquethey could think of. Hopes were raised with the advent of computers. The Wharton School of Business and Chase Manhattan Bankwere two well-known leaders in the field of econometric modeling.Their models were sophisticated computer programs that attempted to account for just about every variable affecting price.However, to date, fundamental analysis has not been particularly successful in day-to-day trading of the futures markets forthree reasons: (1) Projections have been marred by unexpectedevents. (2) Variables never seem to be taken into consideration. Oneor more critical ones always seem to be missing (or misinterpreted)after the projections are made. (3) This type of analysis is long termin nature, while most futures trading tends to be short to mediumterm.If you combine all this with the fact that fundamental analysisis not self-correcting, you can begin to get a feel for the problem. Forexample, if a fundamental analyst determines that $2.00 is a cheapprice for corn and goes long, what happens when the price drops to$1.50? Should the loss be absorbed and buying continue? How doesthe analyst justify the position with what the market is doing?IS FUNDAMENTAL ANALYSIS USELESS?
No, definitely not. Some CTAs have found it very effective. They often use a particular aspect, weather for example, to make projec-
MD6988.123-162
9/28/01
10:55 AM
Page 126
126
CHAPTER 6
tions. They are position traders who take long-term approaches tothe market.More often than not, the CTAs who use it do so by combiningit with technical analysis. Fundamental analysis can provide theoverview and the long-term trend. Technical analysis is used to signal the short-term entry and exit points. Since fundamental analysis deduces its conclusion from external or underlying factors influencing supply or demand, it is unique to each commodity.WHAT IS TECHNICAL ANALYSIS?
Technical analysts confine their prognostication of future pricetrends solely on the analysis of price activity. The price of a futurescontract, they contend, reflects the impact of every single bit of fundamental information known by anyone who can even remotely affect the price of the commodity. Every fact that is known about supply, demand, and, most importantly, the psychology of the publicends up on the price charts. Therefore, price action is the compositeopinion of everyone involved in the markets.That is why learning to analyze price action is so important toanyone trading stocks, futures, or options. The function of technicalanalysis is to determine through the analysis of price change theprobable strength of demand compared with the pressure of supplyon a futures contract at various price levels and then to predict thedirection, length, and velocity of the next move.HISTORY REPEATS ITSELF IN PATTERNSAND FORMATION
In the commodity markets, history does repeat itself. Past price action can provide clues about future price action. On commodityprice charts and indexes, price movements tend to repeat themselves with remarkable consistency.You’ll learn that some patterns or formations indicate that demand is greater than supply. Others suggest the reverse is true. Andsome imply that supply and demand will remain indefinitely in balance.This occurs for two reasons. First, technical analysis can be aself-fulfilling prophecy. It is self-fulfilling because so many professionals use it. They all see the same patterns and often expect the
MD6988.123-162
9/28/01
10:55 AM
Understanding Analysis
Page 127
127
same results. Therefore, if enough of them act the same way to thesame chart signal, the signal fulfills its promise. This occurs regularly with the most common and widely known signals.Second, the market is anticipatory, and you can see price movement first in the charts. For example, major buyers, like the Chinese,have been known to go long the futures market before they announce a big grain deal. They enter the futures market to cover theircash sale. Therefore, the first alert that something is about to happen often occurs on the futures price charts.Entering the market causes a price movement before the fundamental facts are known. Technical analysts are alerted in advance,before the fundamental information is public. Supply and demandfactors are still the prime movers, and yet technical analysis is theearliest indicator of movement.If you use technical analysis, you don’t have to understand oracquire all the fundamental information in the world in order totrade. The impact of all the activity affecting price comes to you inthe form of price movement. If you don’t understand what is causing the price movement, you can exit the market until you do.IS IT FOOLPROOF?
There is no infallible system—technical or fundamental—for tradingthe futures markets. Chart signals, just like fundamental news, can bemisleading. You don’t always have to be right to enjoy trading futuresand options, but you need to have structure in your approach to themarkets. Technical analysis can give you that structure (see Figure6.2.). Since technical analysis is probably the only forecasting technique an individual investor can utilize, it is important to know themost common tools and signals. Fundamental analysis, because ofthe enormous amount of information necessary and the enormousamount of time required to absorb all the fundamental factors, isusually too costly and time-consuming for individual investors.There are basically four general approaches to technically analyzing commodity markets: (1) price charts, (2) trend following, (3)structural, and (4) character of market. The first two are the mostwidely used and recognized.Price chart analysis involves finding chart formations or patterns that often repeat themselves, such as reversals, support-resistance areas, head and shoulders, continuing formations, and others.
MD6988.123-162
9/28/01
10:55 AM
Page 128
CHAPTER 6
128
F I G U R E
6.2
10 Technical Analysis Trading Rules1. When a trend is established, it is likely to continue.2. The longer term the chart (15 minute, hourly, daily, weekly, monthly),the more reliable the trend line.3. The greater the volume of trading when a trend in established, thegreater its significance.4. In uptrending markets, when prices move too far too fast, trading volume decreases and prices decline.5. In downtrending markets, volume is higher when prices are decliningthan when they rally.6. Markets tend to give warnings before major trend changes occur.7. If a market is in an uptrend, volume usually drops just prior to it reversing its direction.8. Volume usually increases in downtrending markets, just before a reversal of trend.9. Before they plunge through their trend lines, markets tend to test themby making shallow penetrations. These dips are warnings of impending trend reversals.10. The steeper the trend, the more unstable it is and the more likely a reversal of trend is imminent.
Trend-following types of analysis include trend lines and movingaverages.Structural analysis presumes the market itself moves in established, recognizable patterns—seasonal, cyclical, or wave patternsbeing the most common. Once the analyst can exactly locate the current position of the market, a prediction can be made on the nextmove or price objective.Character-of-market analysis