Reading The Bar, Identifying The Countertrend

03/19/10 09:23:53 AM

by Alan R. Northam

The main trend of a market determines its long-term trend. However, long-term trends are regularly interrupted by countertrends otherwise known as market corrections. By reading the bar of the next smaller time frame, you can determine if the market is trending or countertrending.

Security: GDX
Position: N/A

Yesterday, I wrote an article entitled "Reading The Bar, Identifying The Trend." I showed the monthly bar chart for the Market Vectors Gold Miners exchange traded fund (ETF)(GDX). This article described how to read the monthly bar chart to determine the long-term trend. GDX is in a long-term downtrend or bear market.

A countertrend moves in the opposite direction to the main trend. Since the main trend for GDX is a long-term downtrend, identified by reading the monthly bars, a countertrend can only be identified by looking at the next smaller time frame, the weekly bar chart. When the main trend is a long-term downtrend, a countertrend can only be identified as an uptrend on the weekly bar charts. This uptrend on the weekly bar chart can therefore be determined by reading the weekly bars.

Figure 1 shows the weekly bar chart for GDX. Note that GDX formed its last weekly bar, making a lower high and a lower low in early February 2010. The next two weekly bars made higher highs and higher lows and have been identified on the chart with two green upward pointing arrows. According to Dow theory, an uptrend is identified by a series of price bars forming higher highs and higher lows. Thus, it takes at least two weekly bars to determine a trend. These two bars identify the weekly trend as being upward or against the main trend.

FIGURE 1: GDX, WEEKLY

Graphic provided by: AmiBroker.com.

Note that the following weekly bar formed a lower high and a lower low. This bar does not reverse the trend, as at least one more bar forming a lower high and a lower low is needed to determine a new downward trend. Recall from Dow theory that a series of bars forming lower highs and lower lows is required to determine that the trend is down and not just one bar. This bar does, however, draw into question the uptrend and is a sign of weakness within the uptrend. The following two weekly bars again form higher highs and higher lows, confirming that the uptrend remains intact.

The last bar on the chart represents this week's trading, which has one more day of trading to be complete. However, it looks like this weekly bar is forming a lower high and a higher low, again drawing into question the uptrend and indicating weakness within the trend. It doesn't matter how this week turns out, because there is nothing this bar can do to change the trend. If it is able to make a higher high, then it will simply confirm the upward trend. On the other hand, if this week's trading bar makes a lower low, it will only draw into question the uptrend and signal weakness but will not reverse down the trend. Recall it takes two bars making lower highs and lower lows to reverse the trend back down.

In conclusion, by reading the weekly bars, we have learned that the weekly trend is in the upward direction, which is counter to the long-term trend of GDX as identified by reading the monthly bars. Therefore, GDX is currently in a countertrend rally, otherwise known as a market correction. For the countertrend rally to qualify as a new long-term uptrend, GDX would have to form two monthly bars, making higher highs and higher lows, which could not occur until the end of April.

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.