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Stocks & Commodities V. 18:5 (30-36): PeaksAnd Troughs by Martin J. Pring CLASSIC TECHNIQUES Rally fails to PeaksAnd make a new high Rising peaks A and troughs T roughs B Declining peaks andtroughs now signaled The oldest ways of chart analysis had to work in the days before computers (B.C.). There’s no reason they shouldn’t worknow.Here’salookatpeaksandtroughs,aclassicform of chart analysis that worked B.C. and work now. by Martin J. Pring troughs rise, trend is up. As they fall together, trend is down. have always thought that, in general, the simplest tech- niques work the best. High up I in this category, and perhaps themostunderrated,isthecon- ceptof peakandtroughanaly- Rising peaks sis,atechniquefirstbroughtto andtroughs now ourattentionasatenetofDow signaledE theory. While the theory itself D has lost much of its luster in recent years, the peak and trough part of it has not. It is arguably the most important building block of technical analysis. C When you look at almost any chart, it’s fairly evident that F Price falls below D, prices do not go up and down in straight lines, but move in but rising peand zigzag patterns instead. During a bull trend, a rally is inter- troughs still intact ruptedbyacorrectioninwhichpartoftheadvanceisretraced. This is then followed by another rally, after whiwhen both peaks and troughs start to rise. “line” in Dow parlance, is broken quent correction follows, and so on. These are the peaks and troughs. As long as a trend experiences a series of rising peaks and rising troughs, it is considered to be intact. However, when the series of rising peaks and troughs is replaced by a series of declining peaks and troughs, the prevailing trend has reversed. Figure 1showsaseriesofrisingpeaksandtroughs.When asubsequentrallyfailstomakeanewhighforthemove(A), X Rising troughs this alerts us the trend may have changed. It is not until the rising peaksnot price slips below the previous bottom (B), however, that the price action reveals a declining peak and trough. The trend, Y according to this technique, is now deemed to be bearish. In a bear trend, prices continue their downward zigzag Rising peaks andtroughs (Figure 2) until the latest trough fails to make a new low for now broken themove(C).Thesubsequentrallytakesthepriceabovethe previous high (D), and the series of declining peaks and troughsgiveswaytoaseriesofrisingones.Theactualsignal takes place at E, when it is evident that the price has made a newhigh.Atthatpoint,wedonotknowwherethenextpeak will occur, but we do know it is likely it will bFIGURE 3: REVERSAL. An uptrend is reversed when both peaks and troughs the previous one. head south. Copyright (c) TechnicalAnalysis Inc. Stocks & Commodities V. 18:5 (30-36): PeaksAnd Troughs by Martin J. Pring Asyoucanseefromtheprice action at point F, there is noth- ingtostopthepricefromfalling below the trend reversal signal (E),butpricingwillstillbecon- sistent with a rising trend. H ALF -SIGNALS Onoccasion,weareleftindoubt whetheratrendhasreversed.In Figure 3, we see that at pointX the latest trough breaks below itspredecessor,butnotthelatest peak — and only half a signal has been given. What is now required is for a fresh rally to peak belowtheprevioustopand for the price to slip below the previous low at point Y. This is a much less timely signal be- causethepricewillhavealready fallenfromthefinalhigh;butby the same token, the probabili- ties of it being a valid reversal are that much greater. Anyone not waiting for the signal at Y wouldhaveruntheriskofbeing left out of a powerful rally such as the hypothetical one shown in Figure 4. In that instance, pricesroseandmadeanewpeak, indicating the trend had never reversedinthefirstplace.Half- signalsalsoappearwhenatrend reverses from down to up. Peak and trough analysis should be treated as only one indicatoramongmanyinatech- nical arsenal. You would not normally rely solely on a mov- ing average crossover, oscilla- torsignal,ortrendlineviolation to justify entering a trade; simi- larly,peakandtroughshouldbe used in conjunction with other indicators. Thedifferencewithpeakand trough analysis is that indicator for indicator, it generally offers astrongersignalthanmosttrend- following techniques. This is because technical analysis is very much concerned with the psychology that underlies price movements. The fact that a re- ANversal from a downtrend to an Copyright (c) TechnicalAnalysis Inc. Stocks & Commodities V. 18:5 (30-36): PeaksAnd Troughs by Martin J. Pring uptrendrequiresasuccessfultestofalowfollowedbyamove to a new high, and offers a strong psychological signal that confidence and optimism have returned to the marketplace. The same is true from a down to up reversal. L INES OR CONSOLIDATIONS X Sometimes, reactions within a trend develop as a sideways movement, where the price experiences a trading range. New high! Figure 4 shows some ranging action following an advance. (Thesamecouldbesaidinadecliningmarket.)Thesetrading ranges are also known as lines (as originally referred to in Dow theory). Whenever the price experiences a breakout from such a tradingrange,ithasthesameeffectasiftherangewerearally or reaction. This means it is possible for a breakout from a trading range to either act as a peak and trough buy or sell FIGURE 4: HALF-SIGNAL. AtX,alowertroughoccurs,butsubsequently,thehigh signal, or a reconfirmation of the prevailing trend. In effecistakenoutandthealertforadowntrendiscanceled.Half-signalsarenotasreliable when the price breaks out of a line (range), it is violating as full concordance of peak and trough movement. several minor turning points that are really supportorresistanceareas.Takentogether, they represent the equivalent of more sig- Consolidation nificant peaks or troughs. W HAT ’S A LEGITIMATE PEAK AND TROUGH ? Most of the time, the various rallies and reactions are distinct enough so that it is Consolidation relativelyeasytoidentifytheirturningpoints takes⁄3 –⁄3 of the time of as legitimate peaks and troughs. A reaction to the prevailing trend should retrace ap- the previous proximately one-third to two-thirds of the advance previous move. Thus, the rally from the troughlowtothesubsequentpeakinFigure 5is100%.Theensuingreactionshouldthen 100% 33 – 66% fall between a one-third to two-thirds cor- rection or retracement of that move; on FIGURE 5: CONSOLIDATION. As a rule, consolidation will take from one-third to two-thirds the time of a preceding advance or decline. But then — occasion, it can reach to 100%. Technical analysis is far from precise, but if a correc- tive move is less than the minimum one-third, then the peak or trough in question is suspect. A line is a fairly controlled period of profit-taking or digestionoflosses,sothedepthofthetradingrangemayfall short of the minimum approximate one-third retracement requirement (Figure 6). In such instances, the correction qualifies more on the basis of time than magnitude. It is 100% importanttonotethatwearedealingwithpsychologyhere— inthiscase,thebullishpsychologyassociatedwiththerunup in prices. That sentiment needs to be tempered, either with a price reaction or with time. Aruleofthumbyoumightwanttouseisforthecorrectionto last between one-third and two-thirds of the time taken to Retracement should be achieve the previous advance or decline. In Figure 5, the time 1 2 length between the low and the high for the move represents ⁄3–⁄ 3of the previous advance 100%.Theconsolidationpriortothebreakoutconstitutesroughly two-thirds, or 66% of the time taken to achieve the advance —IGURE 6: RETRACEMENT. The classic retracement ranges between one-third ample time to consolidate gains and move on to a new high. and two-thirds of the previous move. Copyright (c) TechnicalAnalysis Inc. Stocks & Commodities V. 18:5 (30-36): PeaksAnd Troughs by Martin J. Pring These are only rough guidelines, and in the finElXAMPLEsis, itisajudgmentcallbasedonexperienceandcommonsense,Figure 7 shows Chrysler together with a 4% zigzag†. The intuition, and perhaps most important, a review ozigzagisatoolprovidedinMetaStock,anditallowsustoplot factorssuchasvolumeandsupportandresistanceprincipthe data in a wave format. In this case, I have chosen a 4% I used an example of a rising market, but these sparameter,whichmeansthateverytimethepricereversesby ciplesworkthesamewayinadecliningtrend;ralliesshou4%, a new wave is plotted. This provides a simple objective retrace one-third to two-thirds of the previous dformat for showing peaks and troughs. In Figure 7, the bull trend was signaled when the late January 1998 low held above the early January bottom. This was confirmed in early February, when the zigzag moved THESIGNIFICANCEOFPEAKS above the mid-January high. Some doubt concerning the AND TROUGHS direction of the trend crept in as April came to a close, The significance of a valid peak/ trough reversal will depend on the type of trend. The longer the trend,peaks and troughs are created when the the greater the significance oprice moves to a new high or low for the move, peak/trough reversal will be. A se- riesofralliesandreactionsthatshowwhen a reaction to the then-prevailing trend retraces approximately one-third to two-thirds up on the hourly charts will bof the previous move. where near as significant as a reversal in a series of interme- diatepeaksandtroughs,wheretheralliesandreactionsmight lastforseveralmonths.Ifweobserveareversalinaseriesofausethelowwasbelowthepreviouslow.However,there intermediate rallies and reactions, then we would be able tolowerpeaks,sincethemid-Aprilhighwasthe infer a primary trend, where the expected decline or advancee move. This is why it does not usually pay to go could last for a year or more. with half-signals. It was not until early August that a rally Chrysler 60 55 4% Zigzag 50 Rising peaks intact 45 40 Declining troughs 35 Bull trend signaled 30 Dec 1998 Feb Mar Apr May Jun Jul Aug Sep Oct FIGURE 7: CHRYSLER. Bull and bear trends in Chrysler stand out using peak-and-trough anaor arsenal.overlay is a 4% zigzag from MetaStock’s indicat Copyright (c) TechnicalAnalysis Inc. Stocks & Commodities V. 18:5 (30-36): PeaksAnd Troughs by Martin J. Pring peak did not make a new high, and this was confirmed with greaterthesignificanceofthereversalsignalwhenitis anewlow,signalinganewbeartrend.Icannotsaythatthings given. will work out this well every time, because they will not. However, it is surprising how well this simple tool can help Martin J. Pring founded the International Institute for Eco- in improving trading results. nomic Research in 1981. He is the author of several books, including the classic Technical Analysis Explained , and I N SUMMARY IntroductionToTechnicalAnalysis ,thefirsttechnicalanaly- 1 Price trends are not usually straight-line affairs, but sis multimedia CD-R OM . He pioneered the introduction of consist of a series of rallies and reactions. videos as an education tool for technical analysis in 1987, andwasthefirsttointroduceeducationalinteractiveCDsin 2 Downtrends are signaled when a series of rising peaks and troughs gives way to declining peaks and troughs. this field. 3 Uptrends are signaled when a series of declining peaks S UGGESTED READING and troughs gives way to rising peaks and troughs. International Institute for Economic Research, http:// 4 When only a peak or trough trend is reversed, half- www.pring.com. signals are signaled. Half-signals are not as reliable Pring,MartinJ.B .reakingTheBlackBox,ACD-R OM full signals when both are reversed. Tutorial, International Institute for Economic Research. 5 Valid peaks and troughs are created when the price _____[199 I8]t.oductionToTechnicalAnalysis,McGraw- Hill Book Co. moves to a new high or low for the move, or when a reaction to the then-prevailing trend retraces approxi-_____[199 Mart.inPringOnMarketMomentum ,Interna- matelyone-thirdtotwo-thirdsofthepreviousmove.A tional Institute for Economic Research. retracement may be smaller in magnitude, provided it _____ [198T 5]c.hnical Analysis Explained, McGraw-Hill takes between one-third to two-thirds of the time taken Book Co. _____ [2000 T]e.hnician’s Guide To Day Trading, A CD- to complete the previous move. 6 The longer it takes to develop the peak and trough, the ROM Tutorial, International Institute for Economic Re- search. †See Traders’ Glossary for definition S&C Copyright (c) TechnicalAnalysis Inc.
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