- Foundations of Technical Analysis: Using Parallels and Pitchforks / Median-Lines
- Part 1: Introduction to Basic Trendline Analysis
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In part one we discussed the use of basic trendline analysis - In this piece we’ll further build on this concept and review how parallels of these trendlines can utilized to give structure to a market advance or decline. The objective of this methodology is to attempt to identify the gradient or angle of the market trend in order to zero-in on possible levels of support and resistance. Let’s start by de-constructing a setup in order to understand how we formulate a given trade opportunity using slope analysis.
Parallels & Channels
There’s power in parallels. Most new traders are familiar with basic channels in price action- but channels are just the start! Using parallels are a simple add on that can greatly enhance your ability to identify key reaction points in the markets.
The simplest way to get started is to identify an initial trendline of support or resistance that the market has been responding to. Once that trendline has been found, a parallel (copy) of that trendline can then be extended to the other side of the move (most recent key high / low) to create a channel - this is the very basics of identifying slope. The parallel should now serve as the support / resistance structure for the trend and as the market continues to advance, look for pivots off corresponding parallels of that slope for further validation that we have identified the proper gradient or angle of the trend.
Consider the trendline (resistance) connecting the two major peaks in late-2015 and early-2016 in AUDUSD. A parallel of this slope extending off the 2016 low was critical in identifying support on the late-April decline as Aussie was in free-fall.
This rudimentary use of parallels can be extremely useful in identifying basic pivots in price- which for us as traders, means entry / exit points. But where would we look for resistance on this reversal off support? Enter the pitchfork.
Pitchforks / Median-Lines
Developed by Dr. Alan Andrews, pitchforks (also known as median-lines) are yet another form of slope analysis that can offer further guidance in trending markets. The base case scenario is that when prices comes off the lower parallel they will gravitate towards the median-line or bisector of the given range and vice versa off the upper parallel. With the same respect, once the median-line is broken as resistance it will serve as support for a rally into the upper parallel - and the opposite when the median-line is broken as support (median-line will offer resistance on a move into the lower parallel).
In the AUDUSD example above, the June rebound off the lower parallel calls for a rally into the median-line of the range. Indeed, a parallel bisecting the channel (extending off the 2015 September low) offered a clear pivot in early 2016 and was an effective target for the rally which capped out just higher later that month. This simple example illustrates how we use slope as a basis for targeting support / resistance.
Consider the same chart above. A pitchfork can be applied by using the three reference points of the most recent low-high-low into the 2016 open (blue arrows), offering an up-trend to work with. As often will be the case, the slope is IDENTICAL to the previous slope derived off the subsequent April high- meaning this formation would have alerted us much earlier to where the April rally ultimately found resistance. Note that on each subsequent rally, the advance reversed off the median-line with the final attempt in August ultimately pulling back into the lower parallel. This simple drill is meant to highlight that identifying the proper gradient, more-so than the tool used, is the most important aspect of slope analysis- obviously the earlier the better.
A Few Key Notes
Some important aspects to keep in mind when drawing pitchforks:
- In an Up-Trend: reference points should be a Low-High-Low
- In a Down-Trend: reference points should be High-Low-High
- When price approaches the median line they will:
- Reverse Or
- Price will trade through the median-line and head for the upper / lower median-line parallels
- Stress the Slope- Not the Reference Points: When applying pitchforks, the most important thing is the slope that’s produced- Has price been responding to that slope? Have we seen pivots / reactions at the touch points? These are the factors that should be considering before operating off any given trendline. That said, there will be times you will need to adjust your reference points to secondary lows/highs in order to fit the gradient more accurately.
- Once price has broken out of the formation- look to identify a new pitchfork in the opposite direction. If price breaks the lower parallel of an ascending slope- Look for a near-term high-low-high as reference points for the correction lower. If price breaks the upper parallel of a descending pitchfork- Look for a low-high-low to offer the up-slope on the reversal.
Once you have clearly identified a slope, parallels extending off key highs and lows will often times offer clear pivots in price and will be levels of interest for both targets & entries. It’s also worth noting that median-lines will be of added technical significance when they converge on other key technical indicators such as moving averages, Fibonacci levels, monthly / yearly highs & lows and sentiment.
As with any form of technical analysis, these methods take some practice and are often seen more as an art-form than a science. That said, median-lines can be extremely useful in identifying key reaction levels within market trends and once mastered, can be a crucial part of your trading strategy. In part three of this series we’ll discuss how this type of analysis can be utilized on multiple timeframes and with a combination of overlay technical indicators to create a more holistic trading strategy.
---Written by Michael Boutros, Currency Strategist with DailyFX