by Lee Gettess

Price pattern is the single most important technical tool of which I make use of.  Now, I’m not talking about the pennants, flags, cup and saucers, or Southern Ethiopian head and shoulders stuff that I find so subjective.  I’m talking about inside days, outside days, narrow range days, wide range days, how many points and days up vs. how many points and days down.  Almost everything I use is something that can be quantified so that I can go back over past data to see how the market behaves when these patterns occur.

Right from when I first started trying to learn to trade I took a look at conventional wisdom on how markets worked and started questioning the validity of it.  Since a market that closes down one day actually has a better probability of going up the next, my initial research suggested I might be on to something.  I continued to look for things that went against the grain of normal thinking.

If you want to do your own research, which I highly recommend, this would be my best advice to you: Look at whatever “they” say normally works and see if the opposite isn’t true.  I’ve never met anyone who has a position in the “they” group, but I’ll bet “they” aren’t very wealthy!  Be like your children… question everything.

I learned a long time ago that you could work to make money or you could have money work to make you money.  There are only so many hours in a day that you can work, however, and you have to sleep sometime.  Your money never has to sleep so there is no end to how hard it can work for you.  All you have to do is put it to work for you in a fashion that you are comfortable with, and that comfort level is not the same for everyone.

I originally did all of my research on price bar charts that graphed trading activity that occurred during daylight hours in Chicago, which was a trading day that took place in about 5-7 hours.  All of the trading that takes place during these “day sessions” is tabulated by the exchanges and maintained so that market participants known what has transpired.  Every transaction (every buy and sell) is recorded and a record is kept.  This data is normally organized so that everyone can tell both the highest and lowest prices where trades took place.  There is also the very first trade that takes place when the market opens, which we very cleverly refer to as “the open”.  The market also has a last trade before they close business for the day, and that price is known as “the close”.

Now, for the sake of accuracy let it be known that those prices may not actually be the first or last trades of the day.  There are often numerous trades taking place almost simultaneously so there is not clearly just a single trade in either case.  The exchanges look at the range of trading prices around both the open and the close and then publish a price that they believe is a fair representation of what was occurring at the open and close.  It isn’t critical that you understand how or why those prices are created.  What is important is that you understand that there are opening and closing prices every day, and that we know how to make use of them consistently.

This open, high, low, and close price data is maintained in various forms, but I am particularly fond of bar charts.  A price bar is a graphic representation of the price action that essentially looks like a thick vertical line.  It is created on a scale where the low of the bar matches the low price and the high the high price.  There are also often little horizontal lines just barely jutting out of the vertical price bar which represent where the open and close are.  Normally the open sticks out a bit to the left and the close to the right.  

The price bar doesn’t really tell you everything that happened that day.  It can’t tell us how many times it went up and down, nor precisely whether the high or low was made first.  However, it does provide us with the open, high, low, and close of the day, and that information combined with the same information from previous days can offer us some valuable analytical tools.  By the way, we are discussing these price bars as representing the trading that takes place during a day.  That is the best for the purposes of our discussion.  However, price data can be organized on almost any time basis and graphed the same way.  You can create weekly bars, monthly bars, hourly bars, and even bars the represent very small increments of trading like five minutes.

When graphed consecutively, the relationship of one price bar to the next offers information for a slightly larger picture of how the market is trading.  One bar tells you that day’s open, high, low, and close.  When compared to the same information from the previous day, we can tell if the market has moved higher or lower over a two-day period.  Now sometimes a market doesn’t move either higher or lower.  We can have a high that is not as high as the previous day and a low that is not as low as the previous day.  This is known as an inside day and can have some fairly important predictive qualities. 

One of my earliest readings when attempting to learn more about markets discussed something called “key reversal” days.  I honestly don’t’ remember where I read about them, but they were discussed as major trend change indications where the market would reverse and begin heading in the opposite direction.  Essentially a key reversal day was described as a day that traded up above the previous day’s high, then turned and got weak enough to get below the previous day’s low. I have looked at a lot of pictures of price charts, and there absolutely is validity in that price pattern.  However, it didn’t seem to work nearly as often as the literature suggested.  I certainly found that price pattern at some significant highs, but I also found plenty of occurrences where the pattern set up and no reversal followed.