The Importance of Longer Range Perspective
posted under
Philosophy of Technical Analysis
by ceecabolos
Of all the charts utilized by the market technician for forecasting and trading the financial markets, the daily bar chart is by far the most popular. The daily bar chart usually covers a period of only six to nine months. However, because most traders confine their interest to relatively short term market action, daily bar charts have gained wide acceptance as the primary working tool of the chartist.
The average trader's dependence on these daily charts, however, and the preoccupation with short term market behavior, cause many to overlook a very useful and rewarding area of price charting—the use of weekly and monthly charts for longer range trend analysis and forecasting.
The daily bar chart covers a relatively short period of time in the life of any market. A thorough trend analysis of a market, however, should include some consideration of how the daily market price is moving in relation to its long range trend structure. To accomplish that task, longer range charts must be employed. Whereas on the daily bar chart each bar represents one day's price
action, on the weekly and monthly charts each price bar represents one week's and one month's price action, respectively. The purpose of weekly and monthly charts is to compress price action in such a way that the time horizon can be greatly expanded and much longer time periods can be studied.Construction of Continuation Charts for Futures.
THE IMPORTANCE OF LONGER RANGE PERSPECTIVE
Long range price charts provide a perspective on the market trend that is impossible to achieve with the use of daily charts alone. During our introduction to the technical philosophy in Chapter 1, it was pointed out that one of the greatest advantages of chart analysis is the application of its principles to virtually any time dimension, including long range forecasting. We also addressed the fallacy, espoused by some, that technical analysis should be limited to short term "timing" with longer range forecasting left to the fundamental analyst.
The accompanying charts will demonstrate that the principles of technical analysis—including trend analysis, support and resistance levels, trendlines, percentage retracements, and price patterns—lend themselves quite well to the analysis of long range price movements. Anyone who is not consulting these longer range charts is missing an enormous amount of valuable price information.
CONSTRUCTION OF
CONTINUATION CHARTS FOR FUTURES
The average futures contract has a trading life of about a year and a half before expiration. This limited life feature poses some obvious problems for the technician interested in constructing a long range chart going back several years. Stock market technicians don't have this problem. Charts are readily available for individual common stocks and the market averages from the inception of trading. How then does the futures technician construct longer range charts for contracts that are constantly expiring?
The answer is the continuation chart. Notice the emphasis on the word "continuation." The technique most commonly employed is simply to link a number of contracts together to provide continuity. When one contract expires, another one is used. In order to accomplish this, the simplest method, and the one used by most chart services, is to always use the price of the nearest expiring contract. When that nearest expiring contract stops trading, the next in line becomes the nearest contract and is the one plotted.
Other Ways to Construct Continuation Charts
The technique of linking prices of the nearest expiring contracts is relatively simple and does solve the problem of providing price continuity. However, there are some problems with that method. Sometimes the expiring contract may be trading at a significant premium or discount to the next contract, and the changeover to the new contract may cause a sudden price drop or jump on the chart. Another potential distortion is the extreme volatility experienced by some spot contracts just before expiration.
Futures technicians have devised many ways to deal with these occasional distortions. Some will stop plotting the nearest contract a month or two before it expires to avoid the volatility in the spot month. Others will avoid using the nearest contract altogether and will instead chart the second or third contract. Another method is to chart the contract with the highest open interest on the theory that that delivery month is the truest representation of market value.
Continuation charts can also be constructed by linking specific calendar months. For example, a November soybean continuation chart would combine only the historic data provided by each successive year's November soybean contract. (This technique of linking specific delivery months was favored by W.D. Gann.) Some chartists go even further by averaging the prices of several contracts, or constructing indices that attempt to smooth the changeover by making adjustments in the price premium or discount.
The average trader's dependence on these daily charts, however, and the preoccupation with short term market behavior, cause many to overlook a very useful and rewarding area of price charting—the use of weekly and monthly charts for longer range trend analysis and forecasting.
The daily bar chart covers a relatively short period of time in the life of any market. A thorough trend analysis of a market, however, should include some consideration of how the daily market price is moving in relation to its long range trend structure. To accomplish that task, longer range charts must be employed. Whereas on the daily bar chart each bar represents one day's price
action, on the weekly and monthly charts each price bar represents one week's and one month's price action, respectively. The purpose of weekly and monthly charts is to compress price action in such a way that the time horizon can be greatly expanded and much longer time periods can be studied.Construction of Continuation Charts for Futures.
THE IMPORTANCE OF LONGER RANGE PERSPECTIVE
Long range price charts provide a perspective on the market trend that is impossible to achieve with the use of daily charts alone. During our introduction to the technical philosophy in Chapter 1, it was pointed out that one of the greatest advantages of chart analysis is the application of its principles to virtually any time dimension, including long range forecasting. We also addressed the fallacy, espoused by some, that technical analysis should be limited to short term "timing" with longer range forecasting left to the fundamental analyst.
The accompanying charts will demonstrate that the principles of technical analysis—including trend analysis, support and resistance levels, trendlines, percentage retracements, and price patterns—lend themselves quite well to the analysis of long range price movements. Anyone who is not consulting these longer range charts is missing an enormous amount of valuable price information.
CONSTRUCTION OF
CONTINUATION CHARTS FOR FUTURES
The average futures contract has a trading life of about a year and a half before expiration. This limited life feature poses some obvious problems for the technician interested in constructing a long range chart going back several years. Stock market technicians don't have this problem. Charts are readily available for individual common stocks and the market averages from the inception of trading. How then does the futures technician construct longer range charts for contracts that are constantly expiring?
The answer is the continuation chart. Notice the emphasis on the word "continuation." The technique most commonly employed is simply to link a number of contracts together to provide continuity. When one contract expires, another one is used. In order to accomplish this, the simplest method, and the one used by most chart services, is to always use the price of the nearest expiring contract. When that nearest expiring contract stops trading, the next in line becomes the nearest contract and is the one plotted.
Other Ways to Construct Continuation Charts
The technique of linking prices of the nearest expiring contracts is relatively simple and does solve the problem of providing price continuity. However, there are some problems with that method. Sometimes the expiring contract may be trading at a significant premium or discount to the next contract, and the changeover to the new contract may cause a sudden price drop or jump on the chart. Another potential distortion is the extreme volatility experienced by some spot contracts just before expiration.
Futures technicians have devised many ways to deal with these occasional distortions. Some will stop plotting the nearest contract a month or two before it expires to avoid the volatility in the spot month. Others will avoid using the nearest contract altogether and will instead chart the second or third contract. Another method is to chart the contract with the highest open interest on the theory that that delivery month is the truest representation of market value.
Continuation charts can also be constructed by linking specific calendar months. For example, a November soybean continuation chart would combine only the historic data provided by each successive year's November soybean contract. (This technique of linking specific delivery months was favored by W.D. Gann.) Some chartists go even further by averaging the prices of several contracts, or constructing indices that attempt to smooth the changeover by making adjustments in the price premium or discount.
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