In the last lesson we discussed that price moves in waves, and it can be said that it does so about 2/3 of the time. As a rule of thumb, price moves up 1/3 of the time, down 1/3 of the time, and moves sideways 1/3 of the time.
Price draws a Line
When not moving up or down, prices will stall, moving sideways in a narrow range. This action was also elaborated on by Dow, Hamilton & Rhea. I quote Rhea again:
A Line is a price movement during which period the price variation move within a range of approximately 5%. Such a movement indicates either accumulation or distribution. Advances above the limits of the line indicate accumulation and predict higher prices; conversely, declines below the line imply distribution with lower prices likely to follow.
To elaborate further here, when we see a line being drawn post a impulsive move in either direction, it indicates a stalemate between opposing market forces. Buying and selling is equally offsetting with neither bulls or bears able to gain the advantage. This tug of war will eventually be resolved and what you will find is that the greater the struggle during the drawing of the line, which can be exhibited by duration as well as traded volume, the more violent the move out of the consolidation pattern.
The one critical point we have to highlight, is that markets never remain static, and as such very few observations hold true for a century. While back in Rhea's time buying or selling breakouts was considered "novel" or going against the herd, today everyone has read these playbooks and it is no longer the market secret it used to be.
So now what you tend to see is a lot of head fakes and whipsaws as traders try to fade the breakout players. This means prices will pop above or below the lines to fool traders into entering, only to then reverse course and continue the consolidation pattern. Be wary of these traps.
Another name we use for a "line" is a Rectangle, and that is a charting function which allows us to highlight the line. Lets take a look:
Strategy when you see this type of action can be:
1- Stay on the sidelines until a confirmed breakout occurs, concurrent with other signals. Exit on head-fakes, but then you absolutely must be able to get back in. Do not get discouraged, it's not a "loss" - it's simply a tactical move to protect your chip stack. If you are worried about whipsaws then you can mitigate the bleed by either A) Selling Covered options to generate some yield or B) If your indicators are in Unity, and you are committed to the position, then buy protective options that are 4-6 months out in duration - You can then sit back and let the freaks in the casino rip each other up while you patiently wait for the breakout.
The reason we like buying the long dated options for protection is that the Time decay during the first 30-60 days is very minimal, so even if your analysis is wrong & you are sitting around waiting, it wont cost you much.
2- You can play this box by selling when price approaches the upper limits, and buying when it approaches the lower limits.
3- Most importantly, understand & expect the Algo gaming and stop running taking place around the breakout levels. Everyone is watching them, especially the machines, so use proper betting tactics and don't get caught out of position during these head-fakes.
Horizontal Lines - Support and Resistance
As you spend more and more time analyzing price history, you will notice there are certain price points where there is a large concentration of relative lows and highs. As price coalesces around these levels, they build a kinetic energy around them, where it now acts as a force on price.
This force can either repel price, stopping a impulsive move in it's tracks, or it can propel a price movement, adding velocity to it's current trajectory. Traders love watching prior highs and lows in price action, and to them it adds significance when price either makes a new low or high, violating those prior levels - This goes back to observations our trading forefathers made decades ago, and again it is why we tend to see almost immediate fading of these breakouts as the machines try to take your money 1 dollar at a time. So it is this action that creates "zones" or Lines that act as a Force on Price.
All technical indicators, including Horizontal price lines, can be observed and used in your preferred time frame. The longer the time frame, the more power the indicator has, while the shorter time frames offer you the ability to be nimble and move quickly - however there is much less force behind the signal.
Remember, when we draw these Horizontal lines, you need to think of them in terms of areas or "zones". In the futures markets, over a period of months or years, no single price level will be sacrosanct - There are too many variable impacting price for this to be the case. The general price zone is what you want to be focused on.
Almost all standard charting software has a "Horizontal Line" drawing function. Let's take a look at an example where price action creates these lines that can act as both a Repelling and Accelerating force.
The above chart shows the price action in Silver from May 2016 - May 2017. We can see that the 18.50 range undoubtedly evolved into a powerful price force for Silver. Bulls and Bears have been battling here for 12 months, adding to the significance of this price zone. Aware traders would be wise to:
A - Use this as a profit booking zone on longs purchased into the decline to $16 - You know other traders will be selling there, so locking in some gains is a prudent move.
B - If your indicators are telling you that this will be the "Big Breakout" and you want to stay in for more upside you can Sell calls against your position as it approaches that level. If price continues higher you still have upside, but if it declines, you will be profiting from the option premium you sold.
C - If Bearish on Silver you can look to re-establish short positions as we approach 18.50.
In conclusion there are 2 types of lines we want to be monitoring in the Futures Markets - Lines of Accumulation/Distribution, as well as Lines of Resistance and Support. The longer the time duration of these Lines being drawn, as well as the more "touches" and reaction to those lines, the greater the potential force on price will be.
Ensure you are completely open to either scenario as you approach those areas, and use all of your indicators to create a consensus for action.