Swing Charts – Part 1
In the previous article, we had a closer look at the ABC zigzag correction. One of the more difficult aspects of pattern recognition in the financial markets is determining where each swing begins and ends. Patterns seem easy to identify after the fact, but the key to successful trading is finding a potential pattern before it is complete. In this article we are going to find out how to filter through all the “noise” and help us to find important highs and lows through the use of swing charts.
In the world of technical analysis, there many ways to construct a swing chart and for the purposes of our discussion, we will construct a swing chart based on price and time. Many technical analysis software packages include a zigzag indicator. This indicator will draw a line between each of the significant highs and lows. There are never two highs or lows plotted in a row, it is always alternating high, low, high, low, etc. How does the software calculate when to draw a new line between a new high or low? The zigzag indicator will usually have a sensitivity setting. A highly sensitive zigzag indicator will plot many zigzag lines and a less sensitive setting will plot fewer lines. The sensitivity setting of the zigzag indicator focuses on the change in price by a variable percentage. For example, let’s imagine we plot a zigzag indicator on a chart of the EUR/USD and the sensitivity is set to 1%. The EUR/USD has rallied from 1.4000 to 1.4500 without a retracement of more that 1% (140-145 Points.) In this case the zigzag indicator will plot a line between 1.4000 and 1.4500. Now we see a decline in the EUR/USD from 1.4500 down to 1.4400. The previous line in the zigzag indicator will still be displayed and a new line will not be displayed from the 1.4500 high to the 1.4400 low. Why? When the sensitivity is set to 1%, you are telling the software to only show you new lines when there is a one percent change in price. The assumption is unless there is a one percent change in price, the current trend is still in effect. So in the above example, we believe that the trend at this point is still up because the market has not reversed by at least 1% in the opposite direction. Only if the EUR/USD moves down from 1.4500 to 1.4355 (1.4500-.145) would a new line be plotted. The previous example allows us to construct a swing chart based on price only. In the next article we will add time to our swing charts.
Ross Beck, DMS, FCSI