My Trading Secret Unveiled
Presenting My Way of Market Analysis
Everyone has a style of analyzing the markets. Frameworks are built on experience. Experience is built from many errors and successes. This article presents a framework I use to directionally analyze the markets from a purely technical-sentiment point of view.
The article is divided into three main analysis sections: price action, custom technical indicators, and sentiment analysis.
Specialized Price Action Analysis
The first tool is price action. It gives you the raw picture of what you need. Is the market ranging? trending? has it shaped some sort of interesting pattern? Is there a visible anomaly? Is there a clear trend line being respected by the market’s price at every point in time?
Price action analysis answers this very question. It is composed therefore of:
Graphical analysis: This is done by searching for visible support and resistance lines using the analyst’s discretionary tools (or if you are an advanced algorithmic trader, a graphical algorithm).
Pattern analysis: This is done by searching for historical patterns and configurations that have shown sizable market reactions in the past. I mainly use harmonic patterns (some people may prefer candlestick patterns and price patterns such as the double top formation).
Trend analysis: This may either be done visually or by adding moving averages. The main aim is to help you be on the side of the trend.
✨ Important note
A good rule of thumb is to search for bullish opportunities in a rising market and for bearish opportunities in a falling market.
Let’s discuss harmonic patterns. Harmonic patterns are a way of analyzing financial markets by looking for specific price formations that repeat themselves over time. These patterns are based on Fibonacci retracement and extension levels, which are mathematical ratios derived from the Fibonacci sequence.
The most common harmonic patterns include the Gartley, Butterfly, Bat, and Crab patterns. These patterns consist of distinct price swings that form geometric shapes on a price chart. Traders use these patterns to predict potential future price movements. For example, in a Bullish Gartley pattern, there are specific price movements that form an “M” shape on the chart. Traders believe that when the price reaches certain Fibonacci levels within this pattern, it’s likely to reverse direction and move upward.
Similarly, a Bearish Butterfly pattern forms when the price action creates a distinct “W” shape on the chart. Traders look for specific Fibonacci ratios within this pattern to anticipate a potential reversal to the downside.
These harmonic patterns are not foolproof indicators, but they can provide traders with valuable insights into potential price movements. Traders often combine harmonic patterns with other technical analysis tools to make more informed trading decisions.
One of my favorite patterns is the extreme impulse wave pattern. It is defined by two ratios:
An XA leg occurs with no preferred retracement level.
The AB leg retraces back 161.8% which forms point C.
The BC leg retraces back 161.8%% or 224.0% which forms point D (the reversal area).
The theoretical bullish appearance is as follows:
The theoretical bearish appearance is as follows:
The market starts by shaping a regular leg (XA) which retraces and forms point B with no preferred ratio. Then, the AB leg retraces back 161.8% to form point C before reversing and retracing 161.8% or 224.0% of the BC leg from where a reversal should occur (point D). The following chart shows USDJPY arriving at point D:
And the next chart shows USDJPY reacting from point D (more on these charts in my weekly newsletter here):
The following chart shows EURNZD arriving at point D. Notice how it is simple to forecast the reversal and benefit from the totality of the move. Harmonic patterns are known to be free of lag.
And the next chart shows EURNZD reacting from point D:
✨ Important note
You can see how the pattern was combined with a descending trend line. This is a textbook example of a harmonic pattern combined with graphical analysis. Two opinions are always better than one.
If you want to see more of my work, you can visit my website for the books catalogue by simply following the link attached the picture:
Custom Indicator Analysis
Technical indicators are like tools in a trader’s toolbox. They’re mathematical calculations based on historical price, volume, or open interest data of a financial asset, like stocks or currencies. These indicators are used to analyze past market behavior and attempt to predict future price movements.
There are many types of technical indicators, but they all essentially aim to do the same thing: help traders make decisions about buying or selling assets. Let’s discuss one of the latest techniques on an indicator that I have presented in a previous article.
The RSI is a popular technical indicator used by traders and investors to analyze the strength and momentum of a financial asset, such as a stock or a currency pair. It’s based on the concept of comparing the magnitude of recent gains to recent losses over a specified period of time, typically 14 periods.
The RSI calculates a number between 0 and 100 and is plotted on a graph. When the RSI value is high, usually above 70, it suggests that the asset may be overbought, meaning it’s been on a run and might be due for a price correction. On the other hand, when the RSI value is low, typically below 30, it indicates that the asset may be oversold, implying it might be ripe for a price increase.
Traders often use the RSI to identify potential buy or sell signals. For example, if the RSI crosses above the 70 threshold, it could signal a sell opportunity, indicating that the asset is overvalued and could soon reverse its trend. Conversely, if the RSI crosses below the 30 threshold, it might suggest a buying opportunity, indicating that the asset is undervalued and could potentially see an uptick in price. Take a look at the following self-explanatory chart:
A technique is a method that dictates how to use an indicator. For example, the most basic technique used on the RSI is to wait for it to reach 30 for a buy opportunity or 70 for a sell opportunity.
The technique we will see in this article is the Emergence technique which uses the neutrality level (50%) as a signal generator. The conditions are as follows:
A bullish signal is generated whenever the 14-period RSI spends at least 50 periods below 50. The bullish signal is given on the surpass of 50.
A bearish signal is generated whenever the 14-period RSI spends at least 50 periods above 50. The bearish signal is given on the break of 50.
✨ Important note
At least 50 implies that the RSI can spend more than 50 time periods above or below it.
The following chart shows how a bearish signal formed:
The following chart shows how a bullish signal formed:
It is important to use this indicator in ranging markets so as to maximize its chances for a profitable prediction. That was one example of a custom technique or indicator.
✨ Important note
The word custom here describes a non-conventional technical tool. For example, the relative strength index (RSI) is a classic indicator, while the Emergence technique on the RSI is a custom one (or a modern technique if you will).
The following chart shows a few trading signals generated by the Emergence technique:
Let’s take an example on another custom indicator, the Fibonacci moving average.
The Fibonacci moving average is a structured moving zone that uses a number of exponential moving averages using the Fibonacci sequence as lookback periods. The steps to construct the Fibonacci moving average are as follows:
Calculate exponential moving averages of the highs using the following lookback periods: {5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181}.
Calculate exponential moving averages of the lows using the following lookback periods {5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181}.
Calculate the average of the first step to obtain the upper Fibonacci moving average zone. The average is simply the sum of their values at each time step divided by 15.
Calculate the average of the second step to obtain the lower Fibonacci moving average zone.
So, what is the best way to make use out of custom indicators? By not abandoning the classic indicators such as the RSI, you can add to your conviction, signals from these custom (or modern) indicators. Take a look at the following graph:
Obviously, when the RSI is oversold (thus, giving a bullish signal) and the market is within the support given by the Fibonacci moving average, it could help your conviction.
✨ Important note
Indicators working together marginally increase the overall conviction of a trade. Seeing multiple bullish signals on an asset may improve the chances of it going up (not by impacting it, but by empirical probability measures and the addition of the number of people looking at the signal).
Sentiment Analysis
Market sentiment analysis is like taking the pulse of the financial markets. It’s all about trying to figure out how investors feel about a particular asset, like stocks or currencies. Imagine you’re in a crowded room where everyone is talking about the stock market. Some might be optimistic, saying things like, “The economy is booming!” while others might be worried, saying, “I think a recession is coming.”
Market sentiment analysis involves gathering all these opinions from news articles, social media, surveys, and other sources, and then analyzing them to get a sense of whether people are feeling positive or negative about the market. This information can be super useful for investors because it can give them an idea of which way prices might move in the short term. For example, if sentiment is overwhelmingly positive, prices might go up as more people rush to buy. But if sentiment turns negative, prices could drop as people start selling off their investments. So, understanding market sentiment can help investors make better decisions about when to buy or sell assets.
In trading, market sentiment can take on many forms. From quantitative to qualitative, and even overlapping features, a lot of tools can be used to gauge the market sentiment. Let’s take one simple example on the COT report.
The COT report, short for Commitments of Traders report, is like a backstage pass to the futures market. It’s released weekly by the Commodity Futures Trading Commission (CFTC), a U.S. government agency. This report gives a snapshot of the positions held by different types of traders in various futures markets.
Now, let’s break it down. In the futures market, there are different types of traders, like commercial traders (who actually use the futures contracts to hedge their business risks) and non-commercial traders (often large speculators like hedge funds). The COT report shows how these different groups are positioned in the market — whether they’re betting on prices going up (long positions) or down (short positions).
For example, if you see that commercial traders, who are often producers or consumers of the underlying commodity, are heavily long (meaning they’re betting on prices going up), it might suggest they’re expecting prices to rise. On the flip side, if you notice that non-commercial traders, like hedge funds, have a lot of short positions, it could indicate they’re bearish on the market.
So, the COT report is a valuable tool for investors and traders to gauge market sentiment and understand who’s doing what in the futures market.
The following example shows a quantified version of the COT where it shows overbought and oversold markets depending on the positioning from the futures markets:
In the above example, if you had a bullish view on the USD or even Nasdaq, the COT report will confirm your view as both markets rank in the extreme bearish sentiment area (which means that the sentiment may flip soon to the positive side).
To sum up, market analysis is more art than science, but still is science. This is because even though you may use fancy techniques, you will eventually have to back-test them in order to use them profitably.
This article’s key takeaway point is to show you a few angles of market analysis and how to combine them into a complete view.
You can also check out my other newsletter The Weekly Market Sentiment Report that sends tactical directional views every weekend to highlight the important trading opportunities using a mix between sentiment analysis (COT reports, Put-Call ratio, Gamma exposure index, etc.) and technical analysis.