In the last couple of articles we have looked at price confirmation tools. This week, we are going to look at some of the more alternative concepts in technical analysis. There are some very strange and bizarre concepts out there – some that defy logic and are hard to digest. If they work for the user though, who am I to argue against them?!
To call the concepts that I am going to look at in this week article ‘alternative’ is a little unfair. I only class them as alternative, as they aren’t in my every day world of technical analysis and trading. However, for some, these concepts are the life and soul of their trading and they would consider them to be ‘mainstream’. These alternative concepts can become a lifetime’s study. I would say, though, that they are more suitable for advanced or experienced users of technical analysis. A thorough understanding of technical analysis generally, will enable you to more easily understand these alternative concepts and deploy them in your analysis and trading.
The Development of Alternative Concepts:
Technical analysis has evolved beyond comprehension in the last ten years and this is mostly due to the increased availability of sophisticated charting and IT software. This has allowed analysts to create their own alternative concepts and applications away from the mainstream technical analysis syllabus. Most of this ‘new’ stuff is a derivative of the old, but there are some fresh, new exciting concepts starting to show through.
There are literally thousands of ideas I could have taken a look at, but here, we are going to look at just a few of the most well documented, alternative concepts that are readily available:
- Elliott Wave Theory
- Market Profile
Elliott Wave Theory:
This theory is the most ‘mainstream’ of the three we are going to take a look at. Devised by Ralph Elliott, Elliott Wave Theory (EWT) is a methodology used to measure cycles and forecast trends. Its premise is that the market behaves in an irregular cyclic fashion. Around this idea and through technical analysis, measurement techniques have been developed to help quantify it (in a very loose mathematical way) . EWT can be used in conjunction with Fibonacci and often is.
The basics of the theory build out around the concept of the ‘wave’. EWT says the market is a series of waves of various length and size. A wave is determined as a price move in one direction, as set by the reversal points that started and ended the move. The wave is further broken down into two waves: impulse and corrective. The impulse wave is in the direction of the current trend and the corrective, against it.
The impulse wave is made up of 5 subwaves, numbered 1 to 5. The corrective wave is broken into 3 subwaves, labelled A,B,C. The rules to using EWT are too complex and lengthy to be explored in this article (see further reading section below for more info).
EWT is a very useful trading tool, as it can help determine price targets and retracements. It is seen as quite a subjective tool and some would argue, works better after the event. I will leave that up to you to decide. The concept of EWT is worth further investigation, in my opinion, though.
An example using the recent down run in Cocoa (NY) to illustrate the basic principles of EWT (Chart: TradingView):
W.D. Gann was a very successful commodity trader from the early part of the 20th century. He created a concept around angles, fans, lines and grids. He also believed in cycles: seasonality etc. Gann’s forecasting and analytical methods are based on geometry, astronomy and astrology, and ancient mathematics. You can already see why some may class Gann as ‘alternative’!
Gann always believed that the most important angle was 45 degrees (as we have also seen in mainstream theory). One of the easiest concepts of his to use is the ‘fan’ – 9 plotted angles based around the 45 degree central line which can be used as a tool for anticipating reversals.
His concepts have been interpreted many ways and have become very popular. The problem is, they are hard to quantify and measure and because of this, his ideas attract many sceptics.
The Gann Box method (on the left) and Gann Fan method (on the right) very colourfully applied to a weekly WTI crude oil chart: (Charts: Trading View)
This was developed by J. Peter Steidlmayer, a Chicago Pit Trader, from his everyday practical experiences and knowledge of the behaviour of the markets. Market Profile is an intraday charting technique (price vertical, time/activity horizontal) and not a time/price series chart. Steidlmayer wanted to evaluate market value intraday. He found that being able to observe ‘fair value’ created trading opportunity.
His concept recognised the ‘normal’ Gaussian distribution. The Market Profile chart displays market price activity, recorded in relation to time, in a statistical bell curve: fatter at the middle prices, with activity trailing off at higher and lower prices. This then portrays the ease with which the market allows facilitation of trading and the manner in which it takes place.
The chart usefully, and for obvious reasons, identifies the ‘class’ of trader e.g. local or commercial. This allows traders to have a better understanding of who is controlling the price action: floor traders or long term players.
Below is a typical view of how a Market Profile chart would look on the US 10yr Treasury Note (Charts: Bloomberg):
Further reading and learning:
If you are interested in learning more about these alternative concepts, then the following reading may help:
- The Basis of My Forecasting Method (1935) W.D.Gann
- Elliott Wave Principle: Key to Market Behavior by A.J. Frost & Robert R. Prechter, Jr. Published by New Classics Library.
- Applying Elliott Wave Theory Profitably by Steven W. Poser. Published by John Wiley & Sons, Ltd.
- Market Profile: Steidlmayer on Markets, J.P. Steidlmayer, Wiley 1989
- Technical Analysis, The Complete Resource for Financial Market Technicians, Charles D Kirkpatrick, FT Press, 2006.
- Technical Analysis Explained – 5th Edition, Martin J Pring, McGraw-Hill Education, 2014
These alternative concepts – Elliott Wave Theory, Gann and Market Profile – aren’t my cup of tea, simply because they don’t fit my personality, risk or trading appetite – but they work very nicely for others. As you gain more experience and understanding in the field of technical analysis, they are certainly worth exploring further.
Next time: Technical Analysis (Part 19): Japanese Charts – Heikin Ashi