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March 25, 2019
During the formation of an ascending triangle, the price builds energy while trying to break above the horizontal line.
Part of market geometry or pure price action, confluence areas are a simple technical analysis concept that considers two types of support and resistance: classic and dynamic.
Classic support or resistance levels always form on the horizontal. It is when market hesitates around a level, that makes support turning into resistance and resistance to support after the level breaks.
A dynamic level, on the other hand, follows the price action. For dynamic support or resistance to form, it must not appear on the horizontal. Instead, it forms around a trendline or channel.
However, the principle remains the same: once broken, support turns into resistance, and the other way around.
For dealing with price action as the purest form of technical analysis, traders need a bit of imagination. Like any technical analysis concept, the idea is to use levels from the past (or from the left side of a chart) to project levels in the future (or on the right side of the chart).
The process, called forecasting, gives traders an educated guess about where the price might hesitate. Hence, it provides an idea where to close potential trades, or even where to look for a top or bottom.
Because price action requires a naked chart (a chart with no indicators and nothing on it but the historical price action), we’ll start with one. This is the Xetra, or the German index, on the monthly chart.
Typically offered as a CFD (Contract for Difference), the Xetra follows the price evolution of the largest thirty companies in Germany, the biggest Eurozone economy. Hence, it is a benchmark for the state of the Eurozone economy and acts as a bellwether or benchmark for other European indices too.
Before doing anything, consider the timeframe in place: the monthly chart. In the case of support and resistance, but not only, the bigger the timeframe is, the bigger the implications are for future price action and how the market will react around levels.
Moreover, the chart shows the price action for the last twenty years. It means that it incorporates all kind of economic events that we already know and, at that time, caused a lot of troubles and hesitation among traders (e.g., 2008 financial crisis, Greek debt problems, Brexit, etc. only to name a few from the last decade).
The obvious thing that pops to the trained eye (the elephant in the room) is that the price hesitated for almost a decade around a horizontal level: the 8200 mark.
Not only that it did that, but all the pullbacks in the meantime (including the one caused by the 2008 financial crisis), weren’t able to break the previous higher-low. Or, this is the definition of an ascending triangle.
During such a pattern’s formation, the price builds energy while trying to break above the horizontal line. And, the series of higher lows expresses that energy-building. Eventually, the price broke higher, and the 8200 level, the resistance, turned into support.
However, in today’s financial markets, a level isn’t enough to define support and resistance. Instead, we need an “area” to show where the market hesitates. Hence, using a shape to describe horizontal support and resistance levels work best.
Now that we have the classic resistance turned into support, it was only reasonable that the market will bounce from the area. Or, put it more precisely, the bounce was predictable as chances were the market it’ll react.
Remember the timeframe? This is the biggest one possible, and traders go to the lower timeframes when the price reaches such support on the monthly.
There, on the lower timeframes, they check for reversal patterns like head and shoulders, hammer or bullish engulfing, piercing or Doji, morning star, falling wedge, double or triple bottom, tweezer bottom, and so on. When you have an ally on such a big timeframe, trading the reversal patterns on the lower ones makes sense.
How about projecting dynamic levels? Before anything, an ascending triangle is a continuation pattern. Hence, it has a measured move.
The measured move of any continuation pattern shows that future price action confirmed the pattern. But, by all means, it isn’t a sign of a trend reversal.
In the case of the Xetra ascending triangle, the measured move represents the length of the most extended leg in the triangular formation, projected by the time the price broke higher. Or, projected from the horizontal support and resistance level.
Now that the price broke higher and horizontal resistance was broken, the way to go is to project dynamic levels. To do that, we connect the previous two higher lows before the break of the horizontal resistance and project the line from the last swing.
See the result below.
The blue line shows the measured move for the ascending triangle as a continuation pattern. While the price hesitated the first time it met the projected trendline, the measured move wasn’t confirmed yet.
Hence, the dip into horizontal support area was an excellent opportunity for a trade back into the dynamic resistance. The bounce came, and with it, the measured move came too.
At this point, the best thing to do is to sit back and have a look at the original chart. The one that had only the price action on it, no trendlines, triangles, measured moves, projections, and so on.
The ability to build an analysis like the one above doesn’t require much of knowledge. Instead, it uses common sense, a pattern recognition approach, and attention to details.
But this timeframe is too big for trading. Scalper or swing traders typically keep positions open for a short period. Hence the monthly won’t help.
However, investors may find it useful. And even scalpers and swing traders will take their clues from a timeframe like this one, to place a trade on lower timeframes.
That’s technical analysis in its purest form.