(Editor's Note:   Mr. Young publishes a weekly newsletter called the JEY Analytics.  This material from Volume 1 Issue 3 is published by permission.  To subscribe to JEY Analytics call 905-450-6102 or e-mail  info@jeyassociates.com  for subscription rates.  His web site is www.jeyassociates.com.)

As I promised in the last issue this week I will present two additional definitions of Technical Analysis and the three basic premises, (assumptions), on why TA works.

These additional definitions are provided to show that the one presented in the first issue, while true, just may not be all-inclusive.  These additional definitions cover the thought from a different point of view.  Definition two is by Martin Pring in his book "Technical Analysis Explained", ‘is to identify trend changes at an early stage and to maintain an investment posture until the weight of the evidence indicates that the trend has reversed’.  Martin likens Technical Analysis to an Art, by this he is placing emphasis on the ability of the chart reader to identify the trend correctly.  He is implying that not all readers of the same chart will see the same thing.

Our next definition comes from Robert Rotella in his book, ‘The Elements of Successful Trading’.  In his book he breaks his definition into two parts, (a) Technical analysis is the study of past market behavior to determine the current state or condition of the market, and (b) … can be used in both a reactive or predictive way to analyze the market.  The first part is where market technicians research past data and observe what happens to the market when various patterns are noted.  Then, when a similar pattern appears he would expect a similar result.  Not much different than what a doctors does, you tell what’s wrong, symptoms, and he comes up with a diagnose.  In the second part a reactive method is where one responds to a situation.  It’s raining outside, therefore an umbrella would be useful, while a predictive method is where one tries to anticipate what may happen.  There are very large, dark clouds on the horizon one would take an umbrella for protection from the rain.

In our future issues we will be showing many examples that pertain to all three definitions.

The three basic premises of technical analysis are:

• Market action discounts everything;

• Prices move in trends; and

• History repeats itself.

The statement, "market action discounts everything", is, according to John Murphy, probably the corner stone of technical analysis.  A technician believes that anything that could possibly happen to affect the price of a financial instrument is already reflected in its price.  On a more technical basis a technician is just studying the actions of supply and demand as a result of economic demands for goods.  If demand exceeds supply then price will rise whereas if supply outstrips demand price will retreat.  The technician then, is just interpreting what the chart is saying about the psychology of the market players.  Therefore, it follows then that if everything that affects market price is ultimately in market price, then the study of market price is all that is necessary.

The realization that prices move in trends is the key to technical analysis, per Martin Pring’s definition.  It is a known fact that prices move in three trends, but what escapes most observers is that prices spend less time in trends, thirty percent, than in any other mode.  There are several very important quotations that traders and investors should commit to memory or even place above their computers.  The first is an adaptation of Newton’s first law of motion, ‘A trend in motion is more likely to continue than to reverse’, or ‘Let the trend be your friend’ this one is based on the notion that one should follow a trend for a long as possible.

In the daily close only chart of the TSE-100 in Figure 1 you can observe several enumerated trend lines.  Trends 1, 2, 5, and 6 are acting as support, while trends 3 and 4 are acting as resistance.  The region at Trend1 shows a period of accumulation while during trend 2 we see a mark-up of price.  Trend 3 therefore shows distribution and a markdown of price due to an over supply and so it continues with the other trends.

Chart Courtesy of Ensign Software

The final premise history repeats itself is actually the study of human psychology.  It is the actions of humans that cause the chart bars to form the various patterns to form.  These patterns are none other than the reaction of humans driven by fear, greed, hope, and ego.  Some of us may learn from our mistakes while others will not and they will leave, making room for new players.  These new players will in turn make the same mistakes until they learn to observe the charts and the messages contained within.

At the same time there is the concept of the crowd as written about by Tony Plummer in his book, ‘The Psychology of Technical Analysis’, ‘Natural forces encourage people to indulge in group behavior.  Groups behave as single organisms: they therefore respond in a predictable way to information shocks, they have metabolic (emotional) cycles, and they follow a definable path of growth and decay.  Unlike any other crowd, however, the behavior of financial market crowds is clearly reflected in simple, and specific indicators.  These are the price movements themselves…’  This, then, can explain why we see the many different patterns on the charts.

Commodity of the Week:

The Chart of March Oats is particularly interesting in that the price decline out of the symmetrical triangle stopped right on the 38% Fibonacci retracement of the Aug Low at $1.26 to the Nov High at $2.25.  It then bounced of the $1.87 level to climb 0.215 cents for a value of $1,075 less commission.  This trade is even more spectacular when you add other Fibonacci retracement levels on the immediate past two trends.  Trend A-B shows us that at 21%, $1.91¼ it is very close to the opening price $1.88¾ while using trend B-C the 79% retracement level is right on the opening.  Therefore by placing the FR tool on the BC trend and an alert one tick above we could have been well prepared.  All that would have remained is to make that all-important call.

Chart 1 - March Oats Daily

Chart Courtesy of Ensign Software

The daily Chart 1 of March Oats contains a Symmetrical Triangle BZC, PyraPoint tool, several instances of Fibonacci Retracement for trends A-B, C-B and E-D.  These cause a cluster of retracements to be defined which define a price level with a stronger probability of acting as support and resistance.  The PP tool that is based on W.D. Gann’s square of nine produces automatic S/R based on degrees of 360 and diagonal S/R on 45-degree angles.  It can be seen in the above chart that there is very strong support at the $1.87 from both FR and the PP tool.  Close examination will also show the opening price of the bar at "X" was equal to 79% of the CB trend and the high of $2.09 was equal to 79% of the BA trend and the PP tool at "Y".

Chart Courtesy of Ensign Software

This Weekly Oats continuation chart 2 shows the relationship of the last weeks low to the 38% Fibonacci retracement and the false breakout to the downside.

It is the ability to plan trades like this well in advance that separates the winners from the losers.  With margin at $675.00 you figure out the potential offered in a trade of this type.  Don’t forget to allow for commission and some slippage for poor fills.

Chart 3 - Sugar #11 Weekly

Chart Courtesy of Ensign Software

The weekly continuation chart 3 of Sugar #11 has support at 127% retracement.  However there are two clusters immediately below.  The first one is a cluster of three with 262% the lowest at about $5.02.  The next set are at $4.40 - $4.50.  Terminating at 262% would agree with the length of a Wave 3 retracement.  

Initial Stop:

1. Upon entering the market Long, place a stop-loss below the low of the V or W bottom turn.
2. Upon entering the market Short, place a stop-loss above the high of the V or W top turn.
3. The stop is placed to avoid exiting a correct position during a normal retest of the turn.

Stop Adjustment (assuming a Long position):

1. On the 5th bar from the turn, move your stop-loss to your entry price so that your position becomes a 'no-risk' trade.  If the low of the 5th bar is below your entry price, then place the stop at the low of the 5th bar instead of at your entry price.
2. On the 8th bar, raise your stop to the low of the last 5 bars.
3. On the 13th bar, raise your stop to the low of the last 4 bars.
4. On the 21st bar, raise your stop to the low of the last 3 bars.
5. On the 34th bar, raise your stop to the low of the last 2 bars, and adjust with each succeeding bar.

Exiting A Position:

1. Using the strategy for the protective stops, the exit will take care of itself.

The illustration shows theoretical stop adjustments numbered according to the strategy statements given for the stop adjustment.  X marks the turning point the bar counting is made from and the initial stop placement.   Disclaimer:  This stop strategy has not been sufficiently researched.  It might be worthless.