med head
and shoulders.
For their part, the chartists cannot win the argument, either. although chart analysis is based on gen-
eral principles, its application depends on individual interpretation. the successful chart-oriented trader
might not have any doubts about the viability of chart analysis, but the “random walk” theoreticians
would dismiss his success as a consequence of the laws of probability, since even a totally random trade
selection process would yield a percentage of winners.
in short, the debate is not about to be concluded.
it is also important to realize that even if conclusive tests were possible, the conflicting claims
of the random walkers and the chartists need not necessarily be contradictory. one way of viewing
the situation is that markets may witness extended periods of random fluctuation, interspersed with
shorter periods of nonrandom behavior.
thus, even if the price series as a whole appears random, it
1 the specification of maximum price width is deliberately intended to exclude periods of wide-swinging prices
from being defined as trading ranges.
34
A Complete Guide to the Futures mArket
is entirely possible that there are periods within the data that exhibit definite patterns. the goal of the
chart analyst is to identify those periods (i.e., major trends).
the time has come to admit my own biases. Personal experience has convinced me that charts
are a valuable, if not essential, trading tool. however, such perceptions do not prove anything. the
random walkers would argue that my conclusions could be based on selective memory—that is, a
tendency to remember the successes of chart analysis and forget the failures—or just pure luck. and
they are right. such explanations could indeed be correct.
the bottom line is that each trader must evaluate chart analysis independently and draw his own
conclusions. however, it should be strongly emphasized that charts are considered to be an extremely
valuable trading tool by many successful traders, and therefore the new trader should be wary of
rejecting this approach simply on the basis of intuitive skepticism.
the following are some of the
principal potential benefits of using charts. Note that a number of these uses remain valid even if one
totally rejects the possibility that charts can be used to forecast prices.
 1. Charts provide a concise price history—essential information for any trader.
 2. Charts can provide the trader with a good sense of the market’s volatility—an important con-
sideration in assessing risk.
 3. Charts are a very useful tool to the fundamental analyst. long-term price charts enable the fun-
damentalist to isolate quickly the periods of major price moves. By determining the fundamen-
tal conditions or events that were peculiar to those periods, the fundamentalist can identify the
key price-influencing factors.
this information can then be used to construct a price behavior
model.
 4. Charts can be used as a timing tool, even by traders who formulate their trading decisions on
the basis of other information (e.g., fundamentals).
 5. Charts can be used as a money management tool by helping to define meaningful and realistic
stop points.
 6. Charts reflect market behavior that is subject to certain repetitive patterns. Given sufficient
experience, some traders will uncover an innate ability to use charts successfully as a method of
anticipating price moves.
 7. a n understanding of chart concepts is probably an essential prerequisite for developing profit-
able technical trading systems.
 8. Cynics take notice: under specific circumstances, a contrarian approach to classical chart signals
can lead to very profitable trading opportunities.
the specifics of this approach are detailed in
Chapter 15.
in short, charts have something to offer everyone, from cynics to believers. the remaining
 chapters of Part ii review and evaluate the key concepts of classical chart theory, as well as addressing
the all-important question of how charts can be used as an effective trading tool.
35
Chapter 4
Types of Charts
You don’t need a weatherman to know which way the wind blows.
—Bob Dylan
 ■ Bar Charts
Bar charts are by far the most common type of price chart. In a daily bar chart, each day is represented
by a vertical line that ranges from the daily low to the daily high. The day’s closing value is indicated by
a horizontal protrusion to the right of the bar, while the opening price is represented by a protrusion
to the left of the bar. Figure 4.1 is a daily bar chart of the July 2015 soybean contract.
The daily (or intraday for short-term traders) bar chart is most useful for trading purposes, but
bar charts for longer data periods provide extremely important perspective. These longer-period bar
charts (e.g., weekly, monthly) are entirely analogous to the daily bar chart, with each vertical line
representing the price range and final price level for the period. Figure 4.2 is a weekly bar chart for
soybean futures. The segment within the rectangle corresponds to the period depicted in Figure  4.1.
Figure 4.3 is a monthly bar chart for soybean futures, and the two rectangles enclose the periods
depicted in Figures 4.2 and 4.1.
The change in time perspective can go in the other direction as well; intraday charts can provide
greater detail of the price action than daily charts. Figure 4.4 is a 30-minute chart of the July soybean
futures that covers the same time period as the last eight daily bars in Figure 4.1.
Used in combination, the monthly, weekly, daily, and intraday bar charts provide a telephoto-type
effect. The monthly and weekly charts would be used to provide a broad market perspective and to
formulate a technical opinion regarding the potential long-term trend. The daily chart—and, for
36A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  4.1 Daily Bar Chart: July 2015 Soybeans
 FIGURE  4.2 W eekly Bar Chart: Soybeans (Continuous Futures)
Note: Continuous


r charts provide a telephoto-type
effect. The monthly and weekly charts would be used to provide a broad market perspective and to
formulate a technical opinion regarding the potential long-term trend. The daily chart—and, for
36A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  4.1 Daily Bar Chart: July 2015 Soybeans
 FIGURE  4.2 W eekly Bar Chart: Soybeans (Continuous Futures)
Note: Continuous futures will be defi ned in the next section.
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

37TYPES OF CHARTS
 FIGURE  4.3 Monthly Bar Chart: Soybeans (Continuous Futures)
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  4.4 30-Minute Bar Chart: July 2015 Soybeans
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

38A COMPLETE GUIDE TO THE FUTURES MARKET
shorter-term traders, intraday charts—would then be employed to determine the timing of trades. If
the long-term technical picture is suﬃ ciently decisive, by the time the trader gets to the daily or intra-
day charts, he may already have a strong market bias. For example, if a trader interprets the monthly
and weekly charts as suggesting the likelihood that the market has witnessed a major long-term top,
he will only monitor the daily and intraday charts for sell signals.
 The diff erence in perspective between short-term and long-term charts can be striking. For exam-
ple, in the daily bar chart shown in Figure 4.5 , the technical picture for coff ee seemed quite bearish,
with prices in late October 2013 having just pushed below a period of sideways price action while in
the midst of a longer-term downtrend that showed no evidence of abating. The weekly futures chart
(Figure 4.6 ), however, provided a strikingly diff erent perspective. Although this multiyear chart
also showed the market in an unbroken downtrend, it revealed that prices had fallen to the vicinity
of the 2008 and 2009 lows—a signifi cant price level that had supported the market in the past, and
which, in late 2013, implied the potential for a major trend reversal in that vicinity. Indeed, as the
inset chart for the December 2014 coff ee contract shows, prices subsequently embarked on a huge
rally from November 2013 into early October 2014. Although in late October 2013 it may not have
been apparent which of these confl icting interpretations would prevail, the basic point is that longer-
term charts may suggest very diff erent interpretations of price patterns than those indicated by daily
charts. Hence, both types of charts should be examined.
 FIGURE  4.5 Daily Bar Chart Perspective: December 2013 Coff ee
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

39TYPES OF CHARTS
 FIGURE  4.6 W eekly Bar Chart Perspective: Coff ee Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 ■ Linked Contract Series: Nearest Futures versus
Continuous Futures
 The time period covered by the typical weekly or monthly bar chart requires the use of a series of
contracts. Normally, these contracts are combined using the nearest futures approach: a contract is
plotted until its expiration and then the subsequent contract is plotted until its expiration, and so on.
Traders should be aware that a nearest futures chart may refl ect signifi cant distortions due to the price
gaps between the expiring month and the subsequent contract.
 Figure 4.7 provides two clear examples of this type of distortion. The top chart is a live cattle
weekly nearest futures chart; the bottom chart is a live cattle weekly continuous futures chart, which
will be defi ned momentarily. The nearest futures chart implies a large 7.175-cent (6 percent) one-
week gain in the price of cattle from the August 31 close to the September 7, 2012 close. However,
this price jump never really took place because the price gap represented nothing more than the expi-
ration of the lower-priced August 2012 cattle contract and the switch to the higher-priced October
2012 cattle contract. In contrast, the continuous futures chart, which, as will be explained shortly,
refl ects actual price movements, showed that price had rallied only 0.45 cents from August 31 to
September 7, 2012. Almost exactly a year later the same relationship between the prices in diff erent
contract months produced an even more noteworthy discrepancy: While the nearest futures chart
showed a 3.15-cent gain from August 30 to September 6, 2013, the continuous futures chart shows
cattle prices actually declined 1.125 cents between these dates.
40A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  4.7 Distortion in Nearest Futures Chart: Cattle W eekly Nearest Futures (top)
and Cattle W eekly Continuous Futures (bottom)
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 The fact that a nearest futures chart is vulnerable to great distortion, in the sense that price moves
depicted in the chart may contrast dramatically with the results realized by an actual trader (as was the
case in the cattle example), makes it necessary to consider an alternate linked-contract representation
that does not share this defect. The continuous futures chart provides such an alternative approach.
 Continuous futures is a series that links together successive contracts in such a way that price gaps
are eliminated at rollover points. Although continuous futures will precisely refl ect price swings, past
continuous levels will not match actual historical levels. (In contrast, nearest futures will accurately
refl ect actual historical levels, but not price swings.) The appropriate series depends on the intended
purpose. Nearest futures should be used to indicate the actual price levels at which a market traded
in the past. However, continuous futures should be used to illustrate the results that wo

eBooks\A Complete Guide to the Futures Market Technical Analysis, Trading Systems, Fundamental Analysis, Options, Spreads\A Complete Guide to the Futures Market Technical Analysis, Trading Systems, Fundamental Analysis, Options, Spreads.pdf


tinuous levels will not match actual historical levels. (In contrast, nearest futures will accurately
refl ect actual historical levels, but not price swings.) The appropriate series depends on the intended
purpose. Nearest futures should be used to indicate the actual price levels at which a market traded
in the past. However, continuous futures should be used to illustrate the results that would have been
realized by a trader. Continuous futures will be discussed in greater detail in Chapters 5 and 18.
 ■ Close-Only (“Line”) Charts
 As the name implies, close-only charts ignore high and low price information and refl ect only closing
values. Some price series can be depicted only in close-only chart formats because intraday data are
not readily available. Two examples are cash price series (Figure 4.8 ) and spreads (Figure 4.9 ), which
represent the price diﬀ erence between two contracts, in this case the July 2015 and November 2015
soybean futures prices.
41TYPES OF CHARTS
 FIGURE  4.8 Cash Price Chart: Crude Oil
 FIGURE  4.9 Spread Chart: July–November 2015 Soybeans
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 Some chart traders may prefer close-only charts even when high/low/close data are available
because they feel a clearer price picture can be obtained by using only the close. In their view ,
the inclusion of high/low data only serves to obfuscate the price chart. There is much to be said
42A COMPLETE GUIDE TO THE FUTURES MARKET
for the emphasis on the closing value as the embodiment of the day’s essential price information.
Nevertheless, many important chart patterns depend on the availability of high/low data, and one
should think twice before ignoring this information.
 ■ Point-and-Figure Charts
 The essential characteristic of the point-and-fi gure chart is that it views all trading as a single
continuous stream and hence ignores time. A point-and-fi gure chart is illustrated in Figure 4.10 .
As can be seen, a point-and-fi gure chart consists of a series of columns of X ’s and O ’s. Each X rep-
resents a price move of a given magnitude called the box size. As long as prices continue to rise,
X ’s are added to a column for each increment equal to the box size. However, if prices decline by
an amount equal to or greater than the reversal size (usually quoted as a multiple of the box size),
a new column of O ’s is initiated and plotted in descending fashion. The number of O ’s will depend
on the magnitude of the reversal, but by defi nition must at least equal the reversal size. By conven-
tion, the fi rst O in a column is always plotted one box below the last X in the preceding column.
An analogous description would apply to price declines and upside reversals. The choice of box and
reversal size is arbitrary.
 FIGURE  4.10 Point-and-Figure Chart: December 2014 Gold
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
43TYPES OF CHARTS
 Figure 4.10 is a point-and-fi gure chart of December 2014 gold futures with a box size of $3 and a
reversal size of three boxes, or $9. In other words, as long as a price decline of $9 or more does not
occur, X ’s continue to be added in a single column. When a price decline of $9 or more occurs, a new
column of O ’s is begun, with the fi rst O placed one box below the last X .
 As stated previously, the point-and-fi gure chart does not refl ect time. One column may represent
one day or two months. For example, Figure 4.11 is a bar chart corresponding to the point-and-fi gure
chart in Figure 4.10 . The period captured in the rectangle corresponds to the similarly highlighted
column in the point-and-fi gure chart. Note that this seven-day period occupies only one column on
the point-and-fi gure chart.
 ■ Candlestick Charts
 Candlestick charts add dimension and color to the simple bar chart. The segment of the bar that
represents the range between the open and close is represented by a two-dimensional “real body,”
while the extensions beyond this range to the high and low are shown as lines (called “shadows”). A
day on which the open and close are near opposite extremes of the daily range will have a large real
body, whereas a day on which there is little net change between the open and close will have a small
real body. The color of the real body indicates whether the close was higher than the open (white—
Figure 4.12 ) or lower than the open (black—Figure 4.13 ). Figure 4.14 shows a daily candlestick
chart corresponding to the price action displayed in Figures 4.10 and 4.11 .
 FIGURE  4.11 Bar Chart Corresponding to Point-and-Figure Chart in Figure 4.10 :
December 2014 Gold
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

44A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  4.12 Candlestick Chart: White Real Body
High
Close
Open
Low
 FIGURE  4.13 Candlestick Chart: Black Real Body
High
Open
Close
Low
 FIGURE  4.14 Candlestick Chart Corresponding to Figures 4.10 and 4.11 : December
2014 Gold
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

45
Chapter 5
 ■ The Necessity of Linked-Contract Charts
Many of the chart analysis patterns and techniques detailed in Chapters 6 through 9 require long-
term charts—often charts of multiyear duration. This is particularly true for the identification of top
and bottom formations, as well as the determination of support and resistance levels.
A major problem facing the chart analyst in the futures markets is that most futures contracts
have relatively limited life spans and even shorter periods in which these contracts have significant
trading activity. For many futures contracts (e.g., currencies, stock indexes) trading activity is almost
totally concentrated in the nearest one or two contract months. For example, in Figure 5.1, there
were only about two months of liquid data available for the Mar


hat most futures contracts
have relatively limited life spans and even shorter periods in which these contracts have significant
trading activity. For many futures contracts (e.g., currencies, stock indexes) trading activity is almost
totally concentrated in the nearest one or two contract months. For example, in Figure 5.1, there
were only about two months of liquid data available for the March 2016 Russell 2000 Index Mini
futures contract when it became the most liquid contract in this market as the December 2015 con -
tract expiration approached. This market is not particularly unusual in this respect. In many futures
markets, almost all trading is concentrated in the nearest contract, which will have only a few months
(or weeks) of liquid trading history when the prior contract approaches expiration.
Linking Contracts
for Long- T erm
Chart Analysis:
Nearest versus
Continuous Futures
46A COMPLETE GUIDE TO THE FUTURES MARKET
 The limited price data available for many futures contracts—even those that are the most actively
traded contracts in their respective markets—makes it virtually impossible to apply most chart analy-
sis techniques to individual contract charts. Even in those markets in which the individual contracts
have a year or more of liquid data, part of a thorough chart study would still encompass analyzing
multiyear weekly and monthly charts. Thus, the application of chart analysis unavoidably requires
linking successive futures contracts into a single chart. In markets with very limited individual con-
tract data, such linked charts will be a necessity in order to perform any meaningful chart analysis. In
other markets, linked charts will still be required for analyzing multiyear chart patterns.
 ■ Methods of Creating Linked-Contract Charts
 Nearest Futures
 The most common approach for creating linked-contract charts is typically termed nearest futures. This
type of price series is constructed by taking each individual contract series until its expiration and
then continuing with the next contract until its expiration, and so on.
 Although, at surface glance, this approach appears to be a reasonable method for constructing
linked-contract charts, the problem with a nearest futures chart is that there are price gaps between
expiring and new contracts—and quite frequently, these gaps can be very substantial. For exam-
ple, assume the September coff ee contract expires at 132.50 cents/lb and the next nearest con-
tract (December) closes at 138.50 cents/lb on the same day. Further assume that on the next day
 FIGURE  5.1 March 2016 Russell 2000 Mini Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
47
Linking ContraCts for Long-term Chart anaLysis
December coffee falls 5 cents/lb to 133.50—a 3.6 percent drop. A nearest futures price series will
show the following closing levels on these two successive days: 132.50 cents, 133.50 cents. In other
words, the nearest futures contract would show a one-cent (0.75 percent) gain on a day on which longs
would actually have experienced a huge loss. This example is by no means artificial. Such distortions—
and indeed more extreme ones—are quite common at contract rollovers in nearest futures charts.
The vulnerability of nearest futures charts to distortions at contract rollover points makes it desir-
able to derive alternative methods of constructing linked-contract price charts. One such approach
is detailed in the next section.
Continuous (Spread-adjusted) price Series
The spread-adjusted price series known as “continuous futures” is constructed by adding the cumulative dif-
ference between the old and new contracts at rollover points to the new contract series.
1 An example should
help clarify this method. Assume we are constructing a spread-adjusted continuous price series for gold
using the June and December contracts.
2 If the price series begins at the start of the calendar year, initially the
values in the series will be identical to the prices of the June contract expiring in that year. Assume that on the
rollover date (which need not necessarily be the last trading day) June gold closes at $1,200 and December
gold closes at $1,205. In this case, all subsequent prices based on the December contract would be adjusted
downward by $5—the difference between the December and June contracts on the rollover date.
Assume that at the next rollover date December gold is trading at $1,350 and the subsequent June
contract is trading at $1,354. The December contract price of $1,350 implies that the spread-adjusted
continuous price is $1,345. Thus, on this second rollover date, the June contract is trading $9 above the
adjusted series. Consequently, all subsequent prices based on the second June contract would be adjusted
downward by $9. This procedure would continue, with the adjustment for each contract dependent on the
cumulative total of the present and prior transition point price differences. The resulting price series would
be free of the distortions due to spread differences that exist at the rollover points between contracts.
The construction of a continuous futures series can be thought of as the mathematical equivalent
of taking a nearest futures chart, cutting out each individual contract series contained in the chart,
and pasting the ends together (assuming a continuous series employing all contracts and using the
same rollover dates as the nearest futures chart). Typically, as a last step, it is convenient to shift the
scale of the entire series by the cumulative adjustment factor, a step that will set the current price
of the series equal to the price of the current contract without changing the shape of the series. The
construction of a continuous futures chart is discussed in greater detail in Chapter 18.
1 T o avoid confusion, readers should note that some data services use the term continuous futures to refer to linking
together


s by the cumulative adjustment factor, a step that will set the current price
of the series equal to the price of the current contract without changing the shape of the series. The
construction of a continuous futures chart is discussed in greater detail in Chapter 18.
1 T o avoid confusion, readers should note that some data services use the term continuous futures to refer to linking
together contracts of the same month (e.g., linking from March 2015 corn when it expires to March 2016 corn,
and so on). Such charts are really only a variation of nearest futures charts—one in which only a single contract
month is used—and will be as prone to wide price gaps at rollovers as nearest futures charts, if not more so.
These types of charts have absolutely nothing in common with the spread-adjusted continuous futures series
described in this section—that is, nothing but the name. It is unfortunate that some data services have decided
to use this same term to describe an entirely different price series than the original meaning described here.
2 The choice of a combination of contracts is arbitrary. One can use any combination of actively traded months
in the given market.
48
A Complete Guide to the Futures mArket
Comparing the Series
It is important to understand that a linked futures price series can only accurately reflect either price
levels, as does nearest futures, or price moves, as does continuous futures, but not both—much as a
coin can land on either heads or tails, but not both. The adjustment process used to construct continu-
ous series means that past prices in a continuous series will not match the actual historical prices that
prevailed at the time. However, a continuous series will accurately reflect the actual price movements
of the market and will exactly parallel the equity fluctuations experienced by a trader who is continu-
ally long (rolling over positions on the same rollover dates used to construct the continuous series),
whereas a nearest futures price series can be extremely misleading in these respects.
 ■ Nearest versus Continuous Futures in Chart Analysis
Given the significant differences between nearest and continuous futures price series, the obvious
question in the reader's mind is probably: Which series—nearest futures or continuous futures—
would be more appropriate for chart analysis? T o some extent, this is like asking which factor a
consumer should consider before purchasing a new car: price or quality. The obvious answer is
both—each factor provides important information about a characteristic that is not measured by the
other. In terms of price series, considering nearest futures versus continuous futures, each series pro-
vides information that the other doesn't. Specifically, a nearest futures price series provides accurate
information about past price levels, but not price swings, whereas the exact reverse statement applies
to a continuous futures series.
Consider, for example, Figure 5.2. What catastrophic event caused the instantaneous 165-
cent (24 percent) collapse in the nearest futures chart for corn from July 12 to July 15, 2013?
Answer: absolutely nothing. This “phantom” price move reflected nothing more than a transition
from the old crop July contract to the new crop December contract. Figure 5.3, which depicts
the continuous futures price for the same market (and by definition eliminates price gaps at con -
tract rollovers), shows that no such price move existed—corn was actually little changed from
July 12 to July 15. Clearly, the susceptibility of nearest futures charts to distortions caused by
wide gaps at rollovers can make it difficult to use nearest futures for chart analysis that focuses
on price swings.
On the other hand, the continuous futures chart achieves accuracy in depicting price swings at
the sacrifice of accuracy in reflecting price levels. In order to accurately show the magnitude of past
price swings, historical continuous futures prices can end up being very far removed from the actual
historical price levels. In fact, it is not even unusual for historical continuous futures prices to be
negative (see Figure 5.4). Obviously, such “impossible” historical prices can have no relevance as
guidelines to prospective support and resistance levels.
The fact that each type of price chart—nearest and continuous—has certain significant intrin-
sic weaknesses argues for combining both types of charts in a more complete analysis. Often these
two types of charts will provide entirely different price pictures. For example, consider the nearest
futures chart for lean hogs depicted in Figure 5.5. Looking at this chart, it would be tempting to
49LINKING CONTRACTS FOR LONG- TERM CHART ANALYSIS
 FIGURE  5.2 Corn Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  5.3 Corn Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

50A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  5.4 RBOB Gasoline Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE   5.5 Lean Hog Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

51LINKING CONTRACTS FOR LONG- TERM CHART ANALYSIS
 conclude that hogs were experiencing a period of severe price dislocation and volatility in 2013,
peaking sometime in early July. Now look at Figure 5.6 , which shows the continuous version of the
same market. This chart shows that hog prices were in a consistent uptrend that began in April and
peaked at the end of October. It is no exaggeration to say that, without the benefi t of the chart labels,
it would be virtually impossible to recognize that Figures 5.5 and 5.6 depict the same market.
 ■ Conclusion
 In summary, the brevity of liquid trading periods for futures contracts in many markets makes the use
of li


s that hog prices were in a consistent uptrend that began in April and
peaked at the end of October. It is no exaggeration to say that, without the benefi t of the chart labels,
it would be virtually impossible to recognize that Figures 5.5 and 5.6 depict the same market.
 ■ Conclusion
 In summary, the brevity of liquid trading periods for futures contracts in many markets makes the use
of linked-contract charts essential. Continuous futures charts, which remove the distortions caused by
price gaps at contract rollovers, are probably the most meaningful type of longer-term chart and, on
balance, are far preferable to the more conventional nearest futures chart—although the latter can still
be a useful supplement in identifying long-term support and resistance levels. Continuous futures are even
more critical for testing trading systems—a topic that will be discussed in Chapter 18 . Figures 5.7 through
 5.16 provide comparisons between long-term nearest and continuous charts for various futures mar-
kets. Note how strikingly diff erent nearest and continuous futures charts for the same market can be.
Readers are reminded that continuous futures charts generated in the future will show diff erent price
scales than those shown in the following pages (although the price moves will remain the same), since
it is assumed that the scales will be adjusted to match the prevailing current contract.

 FIGURE  5.6 Lean Hog Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

52A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE 5.7 10- Y ear T -Note Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  5.8 10- Y ear T -Note Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

53LINKING CONTRACTS FOR LONG- TERM CHART ANALYSIS
 FIGURE 5.9 Soybean Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 5.10 Soybean Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

54A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE 5.11 Soybean Meal Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 5.12 Soybean Meal Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
55LINKING CONTRACTS FOR LONG- TERM CHART ANALYSIS
30
28
26
24
22
20
18
16
14
12
Feb
VIX nearest futures (VX), daily
MarNov Oct
2013 year
2014 year
2015 year
14 15Apr MayJ un JulA ug Sep Oct No vF eb 16 FebMar Apr MayJ un JulA ug Sep Oct Nov
 FIGURE 5.13 VIX Nearest Futures
Chart created using TD Ameritrade’s thinkorswim.
 FIGURE 5.14 VIX Continuous Futures
Chart created using TD Ameritrade’s thinkorswim.
30
32
34
36
38
28
26
24
22
20
18
16
14
12
Feb
VIX continuous futures (VX), daily
MarNov Oct
2013 year
2014 year
2015 year
14 15Apr MayJ un JulA ug Sep Oct No vF eb 16 FebMar Apr MayJ un JulA ug Sep Oct Nov
56A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE 5.15 Live Cattle Nearest Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 5.16 Live Cattle Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
57
Chapter 6
The trend is your friend except at the end when it bends.
—Ed Seykota
 ■ Defining Trends by Highs and Lows
One standard definition of an uptrend is a succession of higher highs and higher lows. For example,
during the May 2014–March 2015 period in Figure 6.1, each relative high (RH) is higher than the
preceding high, and each relative low (RL) is higher than the preceding low . In essence, an uptrend
can be considered intact until a previous reaction low point is broken. A violation of this condition
serves as a warning signal that the trend may be over. For example, in Figure 6.1, the late April
penetration of the early April relative low confirmed the end of the nearly yearlong rally, after
which the market entered an extended trading range (see weekly chart inset). Figure 6.2 provides
an intraday example of an uptrend defined by successively higher highs and higher lows. It should be
emphasized, however, that the disruption of the pattern of higher highs and higher lows (or lower
highs and lower lows) should be viewed as a clue, not a conclusive indicator, of a possible long-term
trend reversal.
In similar fashion, a downtrend can be defined as a succession of lower lows and lower highs (see
Figure 6.3). A downtrend can be considered intact until a previous reaction high is exceeded.
Uptrends and downtrends are also often defined in terms of trend lines. An uptrend line is a line
that connects a series of higher lows (see Figures 6.4 through 6.6); a downtrend line is a line that con-
nects a series of lower highs (see Figure 6.7). Trend lines can sometimes extend for many years. For
example, Figure 6.8 is a weekly chart with a trend line reflecting a multiyear uptrend in the E-mini
Nasdaq 100 futures that included the daily timeframe uptrend from Figure 6.4. Figure 6.9 illustrates
a trend line defining a 33-year uptrend in 10-year U.S. T -note futures.
Trends
58A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  6.1 Uptrend as Succession of Higher Highs and Higher Lows: Dollar
Index Continuous Futures
 Note: RH = relative high; RL = relative low .
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.2 Uptrend as Succession of Higher Highs and Higher Lows: December
2014 10- Y ear T -Note
 Note: RH = relative high; RL = relative low .
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

59TRENDS
 FIGURE  6.3 Downtrend as Succession of Lower Highs and Lower Lows: Euro
Continuous Futures
 Note: RH = relative high; RL = relative l


ghts reserved.
 FIGURE  6.2 Uptrend as Succession of Higher Highs and Higher Lows: December
2014 10- Y ear T -Note
 Note: RH = relative high; RL = relative low .
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

59TRENDS
 FIGURE  6.3 Downtrend as Succession of Lower Highs and Lower Lows: Euro
Continuous Futures
 Note: RH = relative high; RL = relative low .
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.4 Uptrend Line: E-Mini Nasdaq 100 Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

60A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  6.5 Uptrend Line: Copper Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.6 Uptrend Line: June 2016 E-Mini Dow Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

61TRENDS
 FIGURE 6.7 Downtrend Line: WTI Crude Oil Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.8 Uptrend Line: E-Mini Nasdaq 100 Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

62A COMPLETE GUIDE TO THE FUTURES MARKET
 It is not uncommon for reactions against a major trend to begin near a line parallel to the trend
line. Sets of parallel lines that enclose a trend are called trend channels. Figure 6.10 shows an uptrend
channel on a daily chart, while Figure 6.11 shows a downtrend channel on a weekly chart.
 FIGURE  6.9 Uptrend Line: 10- Y ear U.S. T -Note Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.10 Uptrend Channel: Soymeal Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

63TRENDS The following rules are usually applied to trend lines and channels:
 1. Declines approaching an uptrend line and rallies approaching a downtrend line are often good
opportunities to initiate positions in the direction of the major trend.
 2. The penetration of an uptrend line (particularly on a closing basis) is a sell signal; the penetra-
tion of a downtrend line is a buy signal. Normally, a minimum percentage price move or a
minimum number of closes beyond the trend line is required to confi rm a penetration.
 3. The lower end of a downtrend channel and the upper end of an uptrend channel represent
potential profi t-taking zones for short-term traders.
 Trend lines and channels are useful, but their importance is often overstated. It is easy to overesti-
mate the reliability of trend lines when they are drawn with the benefi t of hindsight. A consideration
that is frequently overlooked is that trend lines often need to be redrawn as a bull or bear market is
extended. Thus, although the penetration of a trend line will sometimes off er an early warning signal
of a trend reversal, it is also common that such a development will merely require a redrawing of the
trend line. For example, Figure 6.12 shows an uptrend line connecting the November and December
2012 lows in the Russell 2000 Mini futures. Prices remained above this line until February 2013,
when prices closed below it, signaling an end to this move. Figure 6.13 extends Figure 6.12 by two
months and shows that the February penetration of the original (dashed) trend line was a pullback
that preceded a rally to a higher high. Prices remained above the revised (solid) trend line connecting
the November and February lows until early April, at which point the market posted a more signifi -
cant correction. Figure 6.14 , however, shows the larger uptrend extended for almost another year,
prompting three additional revisions to the uptrend line, each of which was necessitated by a closing
penetration of the preceding trend line.
 FIGURE  6.11 Downtrend Channel: Soybean Oil Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

64A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  6.12 Uptrend Line: Russell 2000 Mini Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.13 Uptrend Line Redefi ned: Russell 2000 Mini Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

65TRENDS
 Figure 6.15 provides a similar example for a downtrend. The initial downtrend line connecting
the December 2014 and March 2015 highs (gray dotted line) was penetrated to the upside in June,
but after a few weeks of sideways price action, the market resumed its decline. The revised trend line
(thicker dashed line) connecting the December 2014 and June 2015 highs extended until November
2015, when prices again pushed higher—enough to require a third revision to the downtrend line
(solid line), but not enough to end the longer-term downtrend.
 FIGURE  6.14 Uptrend Line Redefi ned: Russell 2000 Mini Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.15 Downtrend Line Redefi ned: Oat Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

66
A Complete Guide to the Futures mArket
The preceding examples are meant to drive home the point that the penetration of trend lines
is more the rule than the exception. The simple fact is that trend lines tend to be penetrated,
sometimes repeatedly, during their evolution, which is equivalent to saying that trend lines are
frequently redefined as they extend. The important implications of this observation are that trend
lines work much better in hindsight than in real time and that penetrations of trend lines often
prove to be false signals.
 ■ TD Lines
In his book The New Science of T ec


lines tend to be penetrated,
sometimes repeatedly, during their evolution, which is equivalent to saying that trend lines are
frequently redefined as they extend. The important implications of this observation are that trend
lines work much better in hindsight than in real time and that penetrations of trend lines often
prove to be false signals.
 ■ TD Lines
In his book The New Science of T echnical Analysis,1 Thomas DeMark accurately notes that the drawing
of trend lines is a highly arbitrary process. Presented with the same chart, different people will draw
different trend lines. In fact, presented with the same chart at different times, even the same person
might well draw the trend line differently.
It is easy to see the reason for this lack of precision. A trend line is typically intended to connect
several relative highs or relative lows. If there are only two such points, the trend line can be drawn
precisely. If, however, the trend line is intended to connect three or more points—as is frequently the
case—a precise line will exist in only the rare circumstance that the relationship between all the points
is exactly linear. In most cases, the trend line that is drawn will exactly touch at most one or two of the
relative highs (or lows), while bisecting or missing the other such points. The trend line that provides
the best fit is truly in the eye of the beholder.
DeMark recognizes that in order for a trend line to be defined precisely and unambiguously, it must
be based on exactly two points. DeMark also notes that, contrary to convention, trend lines should be
drawn from right to left because “recent price activity is more significant than historical movement.”
These concepts underlie his approach of drawing trend lines. DeMark’s TD methodology for defining
trend lines is explained by the following definitions:
2
Relative high. A daily high that is higher than the high on the N prior and N succeeding days,
where N is a parameter value that must be defined. For example, if N = 5, the relative high is defined
as a high that is higher than any high in the prior five days and succeeding five days. (An analogous
definition could be applied for data expressed in any time interval. For example, in a 60-minute
bar chart, the relative high would be a high that is higher than the high on the prior or succeeding
N 60-minute bars.)
Relative low. A daily low that is lower than the low on the N prior and N succeeding days.
TD downtrend line. The prevailing downtrend line is defined as the line connecting the most recent
relative high and the most recent preceding relative high that is also higher than the most recent relative
high. The latter condition is essential to assure the trend line connecting the two relative highs slopes
down. Figure 6.16 illustrates the prevailing TD downtrend line, assuming an N = 5 parameter value is
used to define relative highs.
1 Thomas DeMark, The New Science of T echnical Analysis (New Y ork, NY: John Wiley & Sons, 1994).
2 The following definitions and terminology differ from those used by DeMark, but the implied method of identify-
ing trend lines is equivalent. I simply find the following approach clearer and more succinct than DeMark’s presen-
tation of the same concept.
67TRENDS
TD uptrend line . The prevailing uptrend line is defi ned as the line connecting the most recent relative
low and the most recent preceding relative low that is also lower than the most recent relative low . Figure 6.17
illustrates the prevailing TD uptrend line, assuming an N = 8 parameter value is used to defi ne relative lows.
 By basing trend line defi nitions on the most recent relative highs and relative lows, trend lines will
be continually redefi ned as new relative highs and relative lows are defi ned. For example, Figure 6.18
 FIGURE  6.16 TD Downtrend Line ( N = 5): E-Mini Nasdaq 100 Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.17 TD Uptrend Line ( N = 8): Copper Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

68A COMPLETE GUIDE TO THE FUTURES MARKET
shows the succession of TD uptrend lines that would be implied as new relative lows are defi ned
( N = 10) until a trend reversal signal is received. In this chart it is assumed that a trend reversal signal
is defi ned as three consecutive closes below the prevailing uptrend line. In similar fashion, Figure 6.19
 FIGURE  6.18 Succession of TD Uptrend Lines ( N = 10): U.S. Dollar Index
Continuous Futures
 Note: Lines 1–3 are successive TD uptrend lines that use N = 10 to defi ne relative lows (RL).
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.19 Succession of TD Downtrend Lines ( N = 10): June 2015 Euro Futures
 Note: Lines 1 and 2 are successive TD downtrend lines that use N = 10 to defi ne
 relative highs (RH).
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

69TRENDS
 FIGURE  6.20 Succession of TD Uptrend Lines ( N = 10): August 2015 Gasoline
 Note: Lines 1–3 are successive TD uptrend lines, using N = 10 to defi ne relative
lows (RL).
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
illustrates TD downtrend lines that would be implied as new relative highs are defi ned ( N = 10) until
a trend reversal signal is received (again, based on three consecutive closes beyond the trend line).
 Diff erent values for N will yield very diff erent trend lines. For example, Figures 6.20 through
 6.22 contrast the TD uptrend lines implied by three diff erent values of N for the same chart. The
lower the value of N , the more frequently the trend line is redefi ned and the more sensitive the
line is to penetration. For example, contrast the 21 trend lines generated by the N = 2 defi nition
in Figure 6.22 , versus the me


eld very diff erent trend lines. For example, Figures 6.20 through
 6.22 contrast the TD uptrend lines implied by three diff erent values of N for the same chart. The
lower the value of N , the more frequently the trend line is redefi ned and the more sensitive the
line is to penetration. For example, contrast the 21 trend lines generated by the N = 2 defi nition
in Figure 6.22 , versus the mere three trend lines that result when an N = 10 defi nition is used in
Figure 6.20 .
 In analogous fashion, Figures 6.23 through 6.25 contrast the TD downtrend lines implied by three
diff erent values of N for the same chart. Similar to Figures 6.20 through 6.22 , these charts also show
that when the value of N is low , the prevailing downtrend line is redefi ned frequently and tends to be
very sensitive. In Figure 6.23 , which shows TD lines for N = 10, there are only three downtrend
lines. For N = 5 the number of trend lines increases to fi ve during the same period (Figure 6.24 ).
Finally, for N = 2, 18 diff erent trend lines are generated (Figure 6.25 ). As these illustrations make
clear, the choice of a value for N will make a tremendous diff erence in the trend lines that are gener-
ated and the resulting trading implications.
 DeMark’s basic defi nition of trend lines is equivalent to the aforementioned defi nitions with
N = 1. Although he acknowledges that trend lines can be defi ned using higher values of N —“TD
lines of higher magnitude,” in his terminology—his stated preference is for trend lines drawn using
the basic defi nition. Personally, my own preference is quite the opposite. Although it is a truism that
70A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE 6.21 Succession of TD Uptrend Lines (N = 5): August 2015 Gasoline
 Note: Lines 1–6 are successive TD uptrend lines, using N = 5 to defi ne relative
lows (RL).
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.22 Succession of TD Uptrend Lines ( N = 2): August 2015 Gasoline
 Note: Lines 1–21 are successive TD uptrend lines, using N = 2 to defi ne relative
lows (RL).
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
71TRENDS
 FIGURE  6.23 Succession of TD Downtrend Lines ( N = 10): Gold Continuous Futures
 Note: Lines 1–3 are successive TD downtrend lines, using N = 10 to defi ne relative
highs (RH).
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.24 Succession of TD Downtrend Lines (N = 5): Gold Continuous Futures
 Note: Lines 1–5 are successive TD downtrend lines, using N = 5 to defi ne relative
highs (RH)
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

72A COMPLETE GUIDE TO THE FUTURES MARKET
using an N = 1 defi nition for trend lines will yield earlier signals for valid trend line breakouts, the
critical trade-off is that such an approach will tend to provide very tight trend lines that are prone to
far more false breakout signals. As a general principle, I think it is far more critical to avoid bad signals
than to get the jump on good signals; hence, I strongly favor using higher values of N (e.g., N = 3 to
N = 12) to defi ne trend lines.
 There is, however, no “right” or “wrong” choice for a value for N ; it is strictly a matter of subjective
preference. The reader is encouraged to experiment drawing trend lines using diff erent values of N .
Each trader will feel comfortable with certain values of N and uncomfortable with others. Generally
speaking, short-term traders will gravitate to low values of N and long-term traders to higher values.
 As a fi ne-tuning point, which becomes particularly important if trend lines are defi ned using N = 1,
it is preferable to defi ne relative highs and relative lows based on true highs and true lows rather than
nominal highs and lows. These terms are defi ned as:
T rue high . The high or previous close, whichever is higher.
T rue low. The low or previous close, whichever is lower.
 For most days, the true high will be identical to the high and the true low will be identical to
the low . The diff erences will occur on downside gap days (days on which the entire trading range is
below the previous day’s close) and upside gap days (days on which the entire trading range is above
the previous day’s close). Although such gaps are much rarer (and, generally, smaller) than in the days
 FIGURE  6.25 Succession of TD Downtrend Lines ( N = 2): Gold Continuous Futures
 Note: Lines 1–18 are successive TD downtrend lines, using N = 2 to defi ne relative
highs (RH).
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
73TRENDSbefore nearly 24-hour electronic trading, they do occasionally still occur, and can thus impact the
identifi cation of relative highs and lows. The use of true highs and true lows yields relative highs and
relative lows that are more in line with our intuitive concept of what these points should represent.
 For example, in Figure 6.26 , using an N = 3 defi nition, bar A would be identifi ed as a relative low
based on the nominal low . This point is identifi ed as a relative low , however, only because of the upside gap
that occurred three days earlier; it hardly fi ts the intuitive concept of a relative low . In this case, using the
true low instead of the nominal low would eliminate the low of Bar A as a relative low .
 ■ Internal Trend Lines
 Conventional trend lines are typically drawn to encompass extreme highs and lows. An argument can
be made, however, that extreme highs and lows are aberrations resulting from emotional excesses
in the market, and that, as such, these points may be unrepresentative of the dominant trend in the
market. An internal trend line does away with the implicit requirement of having to draw trend lines
based on extreme price excursions. An internal trend line is a trend line drawn


s. An argument can
be made, however, that extreme highs and lows are aberrations resulting from emotional excesses
in the market, and that, as such, these points may be unrepresentative of the dominant trend in the
market. An internal trend line does away with the implicit requirement of having to draw trend lines
based on extreme price excursions. An internal trend line is a trend line drawn so as to best approxi-
mate the majority of relative highs or relative lows without any special consideration being given to
extreme points. In a rough sense, an internal trend line can be thought of as an approximate best-fi t
line of relative highs and relative lows. Figures 6.27 through 6.34 provide a wide range of examples of
internal uptrend and downtrend lines. For comparison, most of these charts also depict conventional
trend lines, which are shown as dashed lines. (T o avoid cluttering the charts, only one or two of the
conventional trend lines that would have been implied in the course of a price move are shown.)
 FIGURE  6.26 Nominal Low versus True Low: Lean Hog Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

74A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  6.27 Internal Trend Line versus Conventional Trend Line: Euro
Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.28 Internal Trend Line versus Conventional Trend Line: E-Mini S&P 500
Index Continuous Futures
 Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

75TRENDS
 FIGURE 6.29 Alternate Internal Trend Lines: Coff ee Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.30 Internal Trend Line: Soybean Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

76A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE 6.31 Internal Trend Line versus Conventional Trend Line: Wheat
Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE 6.32 Internal Trend Line versus Conventional Trend Line: Live Cattle
Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

77TRENDS
 FIGURE 6.33 Internal Trend Line versus Conventional Trend Lines: Platinum
Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.34 Internal Trend Line versus Conventional Trend Lines: Soybean Oil
Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

78
A Complete Guide to the Futures mArket
One shortcoming of internal trend lines is that they are unavoidably arbitrary, perhaps even
more so than conventional trend lines, which at least are anchored by the extreme highs or lows. In
fact, there is often more than one plausible internal trend line that can be drawn on a chart—see,
for example, Figure 6.29. Nevertheless, in my experience, internal trend lines are far more useful
than conventional trend lines in defining potential support and resistance areas. An examination
of Figures 6.27 through 6.34 will reveal the internal trend lines depicted in these charts generally
provided a better indication of where the market would hold in declines and stall in advances than did
the conventional trend lines. Of course, this sample of illustrations does not prove the superiority of
internal trend lines over conventional trend lines, since it is always possible to find charts that appear
to validate virtually any contention, and such a proof is certainly not intended or implied. Rather, the
comparisons in these charts are intended only to give the reader a sense of how internal trend lines
might provide a better indication of potential support and resistance areas.
The fact that I personally find internal trend lines far more useful than conventional trend lines
proves nothing—the anecdotal observation of a single individual hardly represents scientific proof.
In fact, given the subjective nature of internal trend lines, a scientific test of their validity would be
very difficult to construct. My point, however, is that internal trend lines are a concept that should
certainly be explored by the serious chart analyst. I am sure that by doing so many readers will also
find internal trend lines more effective than conventional trend lines, or at least a worthwhile addition
to the chart analyst’s tool kit.
 ■ Moving Averages
Moving averages provide a very simple means of smoothing a price series and making any trends more
discernible. A simple moving average is defined as the average close of the past N days, ending with
the current day. For example, a 40-day moving average would be equal to the average of the past 40
closes, including the current day. (Typically, moving averages are calculated using daily closes. How-
ever, moving averages can also be based on opens, highs, lows, or an average of the daily open, high,
low , and close. Also, moving averages can be calculated for time intervals of data other than daily,
in which case the “close” would refer to the final price quote in the given time interval.) The term
moving average refers to the fact that the set of numbers being averaged is continuously moving through
time. Figure 6.35 illustrates a 40-day moving average superimposed on a price series. Note that the
moving average clearly reflects the trend in the price series and smooths the meaningless fluctuations
in the data. In choppy markets moving averages will tend to oscillate in a general sideways pattern, as
illustrated in Figure 6.36.
One very simple method of using moving averages to define trends is based on the direction of
change in a moving average’s value relative to the previous day. For example, a moving average (a


ts the trend in the price series and smooths the meaningless fluctuations
in the data. In choppy markets moving averages will tend to oscillate in a general sideways pattern, as
illustrated in Figure 6.36.
One very simple method of using moving averages to define trends is based on the direction of
change in a moving average’s value relative to the previous day. For example, a moving average (and
by implication the trend) would be considered to be rising if today’s value was higher than yesterday’s
value and declining if today’s value was lower.
Note that the basic definition of a rising moving average is equivalent to the simple condition that
today’s close is higher than the close N days ago. Why? Because yesterday’s moving average is identical
79TRENDS
 FIGURE  6.35 Moving Average (40-Day) in Trending Market: Canadian Dollar
 Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
 FIGURE  6.36 Moving Average (40-Day) in Sideways Market: Oat Continuous Futures
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.
to today’s moving average with the exception that yesterday’s moving average includes the close N days
ago and does not include today’s close. Therefore, if today’s close is higher than the close of N days
ago, then today’s moving average will be higher than yesterday’s moving average. Similarly, a declin-
ing moving average is equivalent to the condition that today’s close is lower than the close N days ago.
80A COMPLETE GUIDE TO THE FUTURES MARKET
 The smoothing properties of moving averages are achieved at the expense of introducing lags in
the data. By defi nition, since moving averages are based on an average of past prices, turning points in
moving averages will always lag the corresponding transitions in the raw price series. This character-
istic is readily evident in both Figures 6.35 and 6.36 .
 In trending markets, moving averages can provide a very simple and eff ective method of identify-
ing trends. Figure 6.37 duplicates Figure 6.35 , denoting buy signals at points at which the moving
average reversed to the upside by at least 10 ticks and sell signals at points at which the moving
average turned down by the same minimum amount. (The reason for using a minimum threshold
reversal to defi ne turns in the moving average is to keep trend signals from fl ipping back and forth—
“whipsawing”—repeatedly at times when the moving average is near zero.) As Figure 6.37 shows, this
extremely simple technique generated good trading signals. During the 24-month period shown, this
method generated only seven signals. The fi rst signal (long) was exited with a small profi t in August.
The short position triggered at this point captured a signifi cant portion of the July 2014–March 2015
decline. The April 2015 buy was exited with a small loss in June 2015, but the ensuing short trade
was exited profi tably in October. The subsequent buy was reversed in late November at a loss, and the
fi nal short trade was exited with a profi t in February 2016.
 The problem is that while moving averages will do well in trending markets, in choppy, sideways
markets they are apt to generate many false signals. For example, Figure 6.38 duplicates Figure 6.36 ,
indicating buy signals at points where the moving average turned up by at least 10 ticks and sell sig-
nals at points witnessing equivalent downside reversals in the moving average. The same method that
worked so well in Figure 6.37 —buying on upturns in the moving average and selling on downturns
in the moving average—proves to be a disastrous strategy in this market, yielding six losses and one
essentially break-even trade.
 FIGURE  6.37 Moving-Average-Based Signals in Trending Market: Canadian Dollar
Continuous Futures
 Notes: Buy (B) = 10-tick rise in moving average off its low . Sell (S) = 10-tick decline in
moving average off its high.
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

81TRENDS
 There are many other ways of calculating a moving average besides the simple moving average
described in this section. Some of these other methods, as well as the application of moving averages
in trading systems, are discussed in Chapter 16 .
 FIGURE  6.38 Moving-Average-Based Signals in Sideways Market: Oat Continuous
Futures
 Notes: Buy (B) = 10-tick rise in moving average off its low . Sell (S) = 10-tick decline in
moving average off its high.
Chart created using TradeStation. ©TradeStation T echnologies, Inc. All rights reserved.

83
Chapter 7
Trading Ranges
There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall
Street fool, who thinks he must trade all the time.
—Edwin Lefèvre
 ■ Trading Ranges: Trading Considerations
A trading range is a horizontal corridor that contains price fluctuations for an extended period. Gen-
erally speaking, markets tend to spend most of their time in trading ranges. Unfortunately, however,
trading ranges are very difficult to trade profitably. In fact, most technical traders will probably find
that the best strategy they can employ for trading ranges is to minimize their participation in such
markets—a procedure that is easier said than done.
Although there are methodologies that can be profitable in trading ranges, the problem is that
these same approaches are disastrous for trending markets, and while trading ranges are easily iden-
tifiable for the past, they are nearly impossible to predict. Also, it should be noted that most chart
patterns (e.g., flags, pennants) are relatively meaningless if they occur within a trading range. (Chart
patterns are discussed in Chapter 9.)
Trading ranges can often last for years. For example, the silver market remained in a trading range
for much of the 1990s (see Figure 7.1). Figures 7.2, 7.3, and 7.4 show a multiyear crude oil trading
range represented in c


ould be noted that most chart
patterns (e.g., flags, pennants) are relatively meaningless if they occur within a trading range. (Chart
patterns are discussed in Chapter 9.)
Trading ranges can often last for years. For example, the silver market remained in a trading range
for much of the 1990s (see Figure 7.1). Figures 7.2, 7.3, and 7.4 show a multiyear crude oil trading
range represented in continuous futures, nearest futures, and the December 2014 contract. These
three charts illustrate that the trading range boundaries and periods will differ depending on whether
depicted as continuous futures, nearest futures, or an individual contract, although there will typi-
cally be significant overlap between these alternative representations. Trading ranges also show up in
shorter-term charts. Figure 7.5 shows an example on a 15-minute chart of euro futures.
84A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  7.1 Multiyear Trading Range: Silver Continuous Futures
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 FIGURE  7.2 Multiyear Trading Range: Crude Oil Continuous Futures
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85TRADING RANGES
 FIGURE  7.3 Multiyear Trading Range: Crude Oil Nearest Futures
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 FIGURE  7.4 Multiyear Trading Range: December 2014 Crude Oil Futures
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86A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  7.5 Intraday Trading Range: December 2013 Euro Futures
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 Once a trading range is established, the upper and lower boundaries tend to defi ne support
and resistance areas. This topic is discussed in greater detail in the next chapter. Breakouts from
trading ranges can provide important trading signals—an observation that is the subject of the
next section.
 ■ Trading Range Breakouts
 A breakout from a trading range suggests an impending price move in the direction of the breakout.
The signifi cance and reliability of a breakout are often enhanced by the following three factors:
 1. Duration of the trading range. The longer the duration of a trading range, the more poten-
tially signifi cant the eventual breakout. This point is illustrated using a weekly chart example in
Figure 7.6 and a daily chart example in Figure 7.7 .
 2. Narrowness of range. Breakouts from narrow ranges tend to provide particularly reliable
trade signals (see Figures 7.8 , 7.9 , and 7.10 ). Furthermore, such trades can be especially attrac-
tive since the meaningful stop point implies a relatively low dollar risk.
 3. Confi rmation of breakout. It is rather common for prices to break out from a trading
range by only a small amount, or for only a few days, and then fall back into the range. One
reason for this tendency is that stop orders are frequently clustered in the region beyond a
87TRADING RANGES
 FIGURE  7.6 Downside Breakout from Extended Trading Range: W eekly
Heating Oil Continuous Futures
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 FIGURE  7.7 Upside Breakout from Extended Trading Range: December 2010 Coff ee
Continuous Futures
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trading range. Consequently, a move slightly beyond the range can sometimes trigger a string
of stops. Once this initial fl urry of orders is fi lled, the breakout will fail unless there are solid
fundamental reasons and underlying buying (or overhead selling in the case of a downside
breakout) to sustain the trend.
88A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  7.8 Downside Breakout from Narrow Trading Range: Japanese Y en
 Continuous Futures
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 FIGURE  7.9 Downside Breakout from Narrow Trading Range: Australian Dollar
Continuous Futures
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89TRADING RANGES In view of these behavioral considerations, the reliability of a breakout from a trading range as a
signal for an impending trend is signifi cantly improved if prices are still beyond the range after a num-
ber of days (e.g., fi ve). Other types of confi rmation can also be used—minimum percent penetration,
a given number of thrust days (discussed in Chapter 9 ), and so on. Although waiting for a confi rma-
tion following breakouts will lead to worse fi lls on some valid signals, it will help avoid many “false”
signals. The net balance of this trade-off will depend on the confi rmation condition used and must be
evaluated by the individual trader. The key point, however, is that the trader should experiment with
diff erent confi rmation conditions, rather than blindly follow all breakouts.
 FIGURE  7.10 Upside Breakout from Narrow Trading Range: U.S. Dollar Index
Continuous Futures
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91
Chapter 8
In a narrow market, when prices are not getting anywhere to speak of but move in a narrow
range, there is no sense in trying to anticipate what the next big movement is going to be—up
or down.
—Edwin Lefèvre
 ■ Nearest Futures or Continuous Futures?
For any application of technical analysis in which the accurate representation of price moves is essen-
tial, continuous futures, as opposed to nearest futures, are the only viable choice for depicting price
series that extend across multiple contracts. However, in the case of support and resistance, actual
past price levels, which are accurately represented by only the nearest futures, are also important.
This consideration raises the question of which type of longer-term chart—nearest or continuous


continuous futures, as opposed to nearest futures, are the only viable choice for depicting price
series that extend across multiple contracts. However, in the case of support and resistance, actual
past price levels, which are accurately represented by only the nearest futures, are also important.
This consideration raises the question of which type of longer-term chart—nearest or continuous
futures—should be used to determine support and resistance levels. There is no correct answer.
Insofar as the accurate measurement of prior price moves is important in determining support and
resistance, continuous futures charts should be used. Insofar as past actual price levels are important
in determining support and resistance, nearest futures charts should be used. Essentially, strong
arguments can be made for using both types of charts for defining support and resistance levels.
Traders need to experiment with whether they find nearest or continuous futures charts more useful
in identifying support and resistance levels, or, for that matter, if they find consulting both of these
charts the most effective method.
Support and
Resistance
92A COMPLETE GUIDE TO THE FUTURES MARKET
 ■ Trading Ranges
 Once a trading range is established (at least one to two months of sideways price movement on the
daily time frame), prices will tend to meet resistance at the upper end of the range and support at
the lower end of the range. Although chart analysis is best suited as a tool to signal trend-following
trades, some agile traders adopt a strategy of selling rallies and buying declines in a trading range
situation. Generally speaking, such a trading approach is diﬃ cult to pull off successfully. Further-
more, it should be emphasized that fading minor trends within a trading range can lead to disaster
unless losses are limited (e.g., by liquidating the position if prices penetrate the range boundary by a
specifi ed minimum amount, or the market trades beyond the range for a minimum number of bars,
or both).
 After prices break out from a trading range, the interpretation of support and resistance is turned
on its head. Specifi cally, once prices witness a sustained breakout above a trading range, the upper
boundary of that range becomes a zone of price support. The extended lines in Figures 8.1 and 8.2
indicate the support levels implied by the upper boundaries of the prior trading ranges. In the case
of a sustained breakout below a trading range, the lower boundary of that range becomes a zone of
price resistance. The extended lines in Figures 8.3 and 8.4 indicate the resistance levels implied by the
lower boundaries of preceding trading ranges.
 FIGURE  8.1 Support Near T op of Prior Trading Range: Euro Stoxx 50 Continuous
Futures
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93SUPPORT AND RESISTANCE
 FIGURE  8.2 Support Near T op of Prior Trading Range: British Pound Continuous
Futures
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 FIGURE  8.3 Resistance Near Bottom of Prior Trading Range: Palladium Nearest
Futures
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94A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.4 Resistance Near Bottom of Prior Trading Range: Platinum Continuous
Futures
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 ■ Prior Major Highs and Lows
 Normally, resistance will be encountered in the vicinity of previous major highs and support in the
vicinity of major lows. Figures 8.5 , 8.6 , and 8.7 illustrate both behavioral patterns. For example, in
Figure 8.5 the late 2003 low acted as a support level for subsequent lows in 2004, 2007, and 2008,
while the 2005 high provided a resistance level for the 2009 highs. In Figure 8.6 the late 2009 and
early 2010 highs formed near the resistance level of the 2008 high, while the late 2011 low provided
support for the 2012 and 2013 lows. Subsequently, the 2014 high functioned as resistance for the
2015 highs, while the early 2016 low formed just above the support level of the early 2015 low .
Although the concept of resistance near prior peaks and support near prior lows is perhaps most
important for weekly or monthly charts, such as Figures 8.5 and 8.6 , the principle also applies to
daily charts, such as Figure 8.7 . In this chart, the June and August 2013 highs occurred near the March
2013 peak.
 It should be emphasized that a prior high does not imply subsequent rallies will fail at or below
that point, but rather that resistance can be anticipated in the general vicinity of that point. Similarly,
a prior low does not imply that subsequent declines will hold at or above that point, but rather that
support can be anticipated in the general vicinity of that point. Some practitioners of technical analysis
treat prior highs and lows as points endowed with sacrosanct signifi cance: If a prior high was 1,078,
then they consider 1,078 to be major resistance, and if, for example, the market rallies to 1,085,
they consider resistance to be broken. This is nonsense. Support and resistance should be considered
approximate areas, not precise points. Note that although prior major highs and lows proved highly
95SUPPORT AND RESISTANCE
 FIGURE  8.5 Resistance at Prior High and Support at Prior Low: Euro Bund Nearest
Futures
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 FIGURE  8.6 Resistance at Prior Highs and Support at Prior Lows: Cocoa Nearest
Futures
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96A COMPLETE GUIDE TO THE FUTURES MARKET
signifi cant as resistance and support in all three of the preceding charts, reversals mostly occurred
before price reached a given level or after penetrating it by a notable amount (although usually not
clo


or Highs and Support at Prior Lows: Cocoa Nearest
Futures
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96A COMPLETE GUIDE TO THE FUTURES MARKET
signifi cant as resistance and support in all three of the preceding charts, reversals mostly occurred
before price reached a given level or after penetrating it by a notable amount (although usually not
closing beyond it); reversals that occur very near the precise levels of prior highs or lows are the
exception rather than the rule.
 The penetration of a previous high can be viewed as a buy signal, and the penetration of a
prior low can be viewed as a sell signal. Similar to the case of breakouts from trading ranges, to
be viewed as trading signals penetrations of highs and lows should be signifi cant in terms of price
magnitude, time duration, or both. Thus, for example, as should be clear from the preceding dis-
cussion regarding Figures 8.6 and 8.7 , a one-period (one-day for daily chart, one-week for weekly
chart, etc.) penetration of a prior high or low would not prove anything. A stronger confi rmation
than a mere penetration of a prior high or low should be required before assuming such an event
represents a buy or sell signal. Some examples of possible confi rmation conditions include a mini-
mum number of closes beyond the prior high or low , a minimum percent price penetration, or
both requirements.
 Figures 8.8 and 8.9 illustrate examples of penetrations of previous highs as buy signals, assum-
ing a confi rmation condition of three closes above the high. Similarly, Figures 8.10 and 8.11 provide
examples of penetrations of previous lows as sell signals, using an analogous confi rmation condition.
In Figure 8.9 price turned lower in late 2012 a little above the resistance level of the early 2012 high.
In January 2014 the market posted its third weekly close above the late 2012 high (dashed line),
 triggering a buy signal. Incidentally, this chart also provides a good example of a prior low (formed in
2013) holding as support more than two years later.
 Following a sustained penetration of a prior high or low , the interpretation of support and resis-
tance is turned on its head. In other words, the area of a prior high becomes support and the area of
 FIGURE  8.7 Resistance at Prior High: Cotton Nearest Futures
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 Resistance at Prior High: Cotton Nearest Futures

97SUPPORT AND RESISTANCE
 FIGURE  8.8 Penetration of Previous High as Buy Signal: Russell 2000 Mini Nearest
Futures
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 Penetration of Previous High as Buy Signal: Russell 2000 Mini Nearest
 FIGURE  8.9 Penetration of Previous High as Buy Signal: Live Cattle Nearest Futures
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a previous low becomes resistance. For example, in Figure 8.12 the resistance level from Figure 8.9
subsequently became support in April 2014 when the market pulled back temporarily before rallying
to new highs. In Figure 8.13 , which extends the support line of Figure 8.10 , the September 2011
98A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.10 Penetration of Previous Low as Sell Signal: Silver Nearest Futures
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 FIGURE  8.11 Penetration of Previous Low as Sell Signal: Mexican Peso Nearest Futures
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low provides a support area for the December 2011 and June 2012 lows. When this support level
is subsequently penetrated in April 2013, this same level then proves to be a resistance area for the
June–August 2013 rebound. Figure 8.14 shows a remarkably similar pattern unfolding on the daily
silver chart: The late June 2013 low provided support for subsequent lows between November 2013
99SUPPORT AND RESISTANCE
 FIGURE  8.12 Previous Resistance Becomes Support: Live Cattle Nearest Futures
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 Previous Resistance Becomes Support: Live Cattle Nearest Futures
and June 2014. This support level subsequently functioned as resistance in January and May 2015
after the market rallied off its late 2014 lows. In Figure 8.15 , the support level that was penetrated
to the downside in August 2015 functioned as resistance for the October 2015 rebound as well as the
rally that peaked in March 2016.
 FIGURE  8.13 Previous Support Becomes Resistance: Silver Nearest Futures
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 Previous Support Becomes Resistance: Silver Nearest Futures

100A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.15 Previous Support Becomes Resistance: Live Cattle Nearest Futures
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 FIGURE  8.14 Previous Support Becomes Resistance: Silver Nearest Futures
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101
SUPPORT AND RESISTANCE
 ■ Concentrations of Relative Highs and Relative Lows
 The previous section dealt with support and resistance at prior major highs and lows—single peaks
and nadirs. In this section we are concerned with support and resistance at price zones with concen-
trations of relative highs and relative lows rather than absolute tops and bottoms. Specifi cally, there
is often a tendency for relative highs and relative lows to be concentrated in relatively narrow zones.
These zones imply support regions if current prices are higher and resistance areas if current prices
are lower. This approach is particularly useful for anticipating support and resistance areas in long-
term nearest futures charts, which, as the reader wil


and bottoms. Specifi cally, there
is often a tendency for relative highs and relative lows to be concentrated in relatively narrow zones.
These zones imply support regions if current prices are higher and resistance areas if current prices
are lower. This approach is particularly useful for anticipating support and resistance areas in long-
term nearest futures charts, which, as the reader will recall, accurately refl ect past price levels (in
contrast to continuous futures, which accurately refl ect past price swings ). Figures 8.16 through 8.21
provide weekly chart examples of support or resistance occurring at prior concentrations of relative
lows and relative highs (or relative lows alone). In Figure 8.21 , a support zone initially defi ned by
multiple relative highs from 2007 to 2010 subsequently functions as a resistance zone in 2013–2014
after the market sells off .
 The approach of using concentrations of prior relative highs and lows to defi ne support and resis-
tance can also be applied to daily continuous or nearest futures charts of suﬃ cient duration—for
example, two years. (The life span of most individual futures contracts is too short for this method
to be eff ectively applied on such charts.) Figures 8.22 through 8.24 provide daily chart examples of
support and resistance occurring at prior concentrations of relative highs and relative lows. Figure
 8.24 is similar to Figure 8.21 in that a support zone transforms into a resistance zone.
 FIGURE  8.16 Support Zone Defi ned by Concentration of Prior Relative Lows and
Highs: Swiss Franc Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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 Support Zone Defi ned by Concentration of Prior Relative Lows and

102A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.17 Support Zone Defi ned by Concentration of Prior Relative Lows and
Highs: Gasoline Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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 FIGURE  8.18 Support Zone Defi ned by Concentration of Prior Relative Highs and
Lows: Soybean Meal Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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103
SUPPORT AND RESISTANCE
 FIGURE  8.19 Support Zone Defi ned by Concentration of Prior Relative Highs and
Lows: British Pound Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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 FIGURE  8.20 Support Zone Defi ned by Concentration of Prior Relative Lows: Copper
Nearest Futures
 Note: /uni2191 = relative low .
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104A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.21 Support and Resistance Zones Defi ned by Concentration of Prior
Relative Highs and Lows: Australian Dollar Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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 FIGURE  8.22 Support Zone Defi ned by Concentration of Prior Relative Lows and
Highs: Cocoa Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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105
SUPPORT AND RESISTANCE
 FIGURE  8.23 Resistance Zone Defi ned by Concentration of Prior Relative Highs and
Lows: Mexican Peso Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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 FIGURE  8.24 Support and Resistance Zones Defi ned by Concentration of Prior
Relative Highs and Lows: Sugar Nearest Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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106A COMPLETE GUIDE TO THE FUTURES MARKET
 Although best suited to longer-term charts, the technique of using prior concentrations of relative
highs and lows as support and resistance zones can also be applied to shorter-term charts. Figure 8.25
provides an intraday example: a support zone defi ned by a series of prior relative highs and lows on
a 30-minute chart.
 ■ Trend Lines, Channels, and Internal Trend Lines
 The concept that trend lines, channel lines, and internal trend lines indicate areas of potential support
and resistance was detailed in Chapter 6 . Again, as previously discussed, based on personal experi-
ence, I believe that internal trend lines are more reliable in this regard than conventional trend lines.
However, the question of which type of trend line is a better indicator is a highly subjective matter,
and some readers may well reach the opposite conclusion. In fact, there is not even a mathematically
precise defi nition of a trend line or an internal trend line, and how these lines are drawn will vary
from individual to individual.
 FIGURE  8.25 Support Zone Defi ned by Concentration of Prior Relative Highs and
Lows: Euro Continuous Futures
 Note: /uni2191 = relative low; /uni2193 = relative high.
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107
SUPPORT AND RESISTANCE
 ■ Price Envelope Bands
 A price envelope band can be derived from a moving average. The upper band of the price envelope
is defi ned as the moving average plus a given percentage of the moving average. Similarly, the lower
band of the price envelope is defi ned as the moving average minus a given percentage of the moving
average. For example, if the current moving average value is 600 and the percentage value is defi ned
as 3 percent, the upper band value would be 618 and the lower band value would be 582. By selecting
an appropriate percent boundary


a given percentage of the moving average. Similarly, the lower
band of the price envelope is defi ned as the moving average minus a given percentage of the moving
average. For example, if the current moving average value is 600 and the percentage value is defi ned
as 3 percent, the upper band value would be 618 and the lower band value would be 582. By selecting
an appropriate percent boundary for a given moving average, a trader can defi ne an envelope band
so that it encompasses most of the price activity, with the upper boundary approximately coinciding
with relative highs and the lower boundary approximately coinciding with relative lows.
 Figure 8.26 illustrates a price envelope band for the Australian dollar continuous futures using
a 20-day moving average and a 2.5 percent value. The price envelope provides a good indication of
support and resistance for much of the period captured in the chart, especially when the market is
moving sideways (e.g., February–April 2015 and September 2015–January 2016). An alternative way
of expressing the same concept is that the price envelope indicates “overbought” and “oversold” levels.
Price envelope bands can also be applied to data for other than daily time intervals. For example,
Figure 8.27 illustrates a 1.25 percent price envelope band applied to 60-minute bars of the March
2016 E-mini S&P 500 contract.
 FIGURE  8.26 Price Envelope Band as Indication of Support and Resistance in Daily
Bar Chart: Australian Dollar Continuous Futures
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108A COMPLETE GUIDE TO THE FUTURES MARKET
 FIGURE  8.27 Price Envelope Band as Indication of Support and Resistance on
60-Minute Bar Chart: March 2016 E-Mini S&P 500 Futures
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 It should be noted, however, that the price envelope is not as eff ective a tool as it might appear to
be. Although it provides a reasonably good indication of when the market may be nearing a turning
point, prices can continue to hug one end of the price envelope during extended trends. This pattern,
for example, is evident at the beginning of Figure 8.26 (November–December 2014), as well as the
middle of the chart (July and August–September 2015). Thus, while it is true that price excursions
beyond the price envelope band tend to be limited and temporary, the fact that prices are near one of
the boundaries of the envelope does not necessarily mean that a price turning point is imminent. On
balance, the price envelope provides one means of gauging potential areas of support and resistance,
but it is also susceptible to multiple false signals.
109
Never confuse brilliance with a bull market.
—Paul Rubink
 ■ One-Day Patterns
Spikes
A spike high is a day whose high is sharply above the highs of the preceding and succeeding days.
Frequently, the closing price of a spike high day will be near the lower end of the day’s trading range.
A spike high is meaningful only if it occurs after a price advance, in which case it can often signify
at least a temporary climax in buying pressure, and hence can be viewed as a potential relative high.
Sometimes spike highs will prove to be major tops.
Generally speaking, the significance of a spike high will be enhanced by the following factors:
 1. A wide difference between the spike high and the highs of the preceding and succeeding days.
 2. A close near the low of the day’s range.
 3. A substantial price advance preceding the spike’s formation.
The more extreme each of these conditions, the greater the likelihood that a spike high will prove to
be an important relative high or even a major top.
In analogous fashion, a spike low is a day whose low is sharply below the lows of the preceding and
succeeding days. Frequently, the closing price on a spike low day will be near the upper end of the
day’s trading range. A spike low is meaningful only if it occurs after a price decline, in which case it
can often signify at least a temporary climax in selling pressure and hence can be viewed as a potential
relative low . Sometimes spike lows will prove to be a major bottom.
Chart Patterns
Chapter 9
110A COMPLETE GUIDE TO THE FUTURES MARKET
 Generally speaking, the signifi cance of a spike low will be enhanced by these three factors:
 1. A wide diff erence between the lows of the preceding and succeeding days and the spike low .
 2. A close near the high of the day’s range.
 3. A substantial price decline preceding the spike’s formation.
 The more extreme each of these conditions, the greater the likelihood that a spike low will prove to
be an important relative low or even a major bottom.
 Figures 9.1 through 9.4 contain several examples of spike highs and spike lows on daily and
weekly charts. The massive spike high in Figure 9.3 marked a multiyear top in the Swiss franc futures.
Figure 9.4 contains two examples of spike lows that marked swing bottoms.
 The preceding descriptions of spike highs and lows listed three essential characteristics that
typify such days. However, the defi nition of these conditions was somewhat imprecise. Specifi cally,
how great must the diff erence be between a day’s high (low) and the highs (lows) of the preceding
and succeeding days in order for it to qualify as a spike high (low)? How close must the close be to
the low (high) for a day to be considered a spike high (low)? How large must a preceding advance
(decline) be for a day to be viewed as a possible spike high (low)? The answer to these questions is
that there are no precise specifi cations; in each case, the choice of a qualifying condition is a subjec-
tive one. However, Figures 9.1 through 9.4 should provide an intuitive sense of the types of days
that qualify as spikes.
 FIGURE  9.1 Spike High: Cotton Continuous Futures
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