Reading The Bar, Identifying The Trend

03/18/10 08:47:12 AM

by Alan R. Northam

It is easy to get trapped in relying upon technical indicators to identify the direction of the trend when all necesssary information is embedded within the trading bar. By properly reading the bar it is possible to identify the trend of a market without the delay that comes from relying upon most technical indicators.

Security: GDX
Position: N/A

Each bar on a bar chart represents all we can know about the performance of a stock or market over a specific period of time with the exception of volume. The bar chart can represent time periods from one minute to as long as one year. However, the monthly chart normally represents the long-term time period lasting from several months to several years, the weekly chart represents the intermediate term time period lasting from several weeks to several months, and the daily time period represents information from several days to several weeks. Each bar, whether it is a monthly bar or a daily bar, gives us specific information about the price action of an individual stock or even a complete market. In this study we will learn how these individual bars can help us determine the long-term trend.

Figure 1 shows the monthly bar chart for the Market Vectors Gold Miners exchange traded fund (ETF)(GDX). According to Dow theory, a trend is identified by a series of bars making higher highs and higher lows for an uptrend and a series of lower highs and lower lows for a downtrend. Note the word "series." What this means is that a bar, such as a monthly bar, that is making a new lower high and a new lower low does not constitute a change in trend from up to down. There must be a "series" of bars making lower highs and lower lows before a change in trend from up to down can be determined. Charles Dow's theory does not specify a minimum number of bars required to determine a trend so we must assume that at least two bars is required with three being more preferable. Dow theory also does not give us a clue as to how long a trend will last. So a trend can last from as short as two bars.

FIGURE 1: GDX, MONTHLY

Graphic provided by: AmiBroker.com.

Figure 1 shows that there was a series of monthly bars making higher highs and higher lows from late 2008 until late 2009. These bars have been identified by upward pointed green arrows. Note that by the end of January 2009, GDX had formed two bars that made a series of higher highs and higher lows (two bars, to be exact). Therefore, a new upward trend had been identified. Note also that the uptrend lasted until late 2009, and therefore it only took two bars to identify a reliable change in trend. This is important information, one that should be noted. I have noted this in a note on the chart.

Note that all the bars from late 2008 until late 2009 formed higher highs and higher lows, with the exception of March, April, and July. In March, the market made a higher high but also made a lower low, drawing the uptrend into question. Following March, April formed a lower high and a higher low, again drawing the uptrend into question. Please note that these questionable months do not reverse the trend but just questions it. Technically, questionable months (or bars) represent weakness in the prevailing trend. In July, GDX experienced a month in which price formed a lower high and a lower low. This also does not reverse the trend, as a series of lower highs and lower lows have not been identified. Again, July draws the uptrend into question and is a sign of weakness in the prevailing uptrend.

Now I'd like to draw your attention to the beginning of 2010. January and February formed monthly bars that made lower highs and lower lows. These two bars constitute a series of bars making lower highs and lower lows and therefore signal a trend reversal from up to down. Recall that it only took a series of two bars to signal a reliable change in trend from down to up in late 2009, and therefore, we can assume that the current series of two bars forming lower highs and lower lows will also signal a reliable trend change from up to down.

We can make this assumption until proven otherwise. As a result, we can assume that the trend is now in the downward direction until proven otherwise. Now look at what is happening in March. While the month is only half over, it has formed a higher high; it is yet unknown if the month will also form a higher low. What we know from this information is that the new downtrend is now in question, but it does not matter how the month ends; it will not constitute a change in trend from down to up. Therefore, the prevailing trend remains down until proven otherwise, which will take another month.

In conclusion, if March ends by forming a higher high and a higher low, it will not constitute a new uptrend, as there does not yet exist a series of monthly bars forming higher highs and higher lows. In addition, if March ends by forming a higher high and a lower low, it will not constitute a new uptrend but only draw the current downtrend into question and signal its weakness. Therefore, it doesn't matter what March does; it will not reverse the trend from down to up. As a result of this bar chart study, GDX remains in a long-term downtrend until proven otherwise. By applying these same principles to the weekly and daily bar charts, the intermediate-term and short-term trends of GDX can be determined.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.