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Two technical analysis one must understand.

Updated on December 27, 2011

Price action

EURUSD (Weekly chart)
EURUSD (Weekly chart)

Two set ups

Technical analysis combines the price, its patterns and the "market patterns" in view to make better

trading or investment decisions. It uses technical trading tools such as MACD, RSI, moving averages

and the Bollinger bands to identify critical warnings. This article will feature two technical set ups one must know.

Double top

The first phenomenon is the double top market capitulation.

After an up trend, the bullish momentum finally ends. The price fails to present a new higher high.

A double top appears. "Elliott wave" fanatics have counted five waves and the fifth wave fail to exceed the third wave’s top. Most bulls are now willing to take profit at this juncture.

The stock is now declining. Many bears saw what is taking place and could not stop salivating like Pavlov’s dog. They join the bearish momentum just before the price reaches the first and nearest support level. However, something unexpected happens. In normal conditions if the bearish strength is indeed compelling, the price must drop below support levels. In this instance, as the price dip below the first support level fooling many, it immediately returns above it.

To make matter worst, a rise in bullish momentum was substantial. Soon the original bearish momentum evolves into a positive momentum. Consequently many sellers exited their positions. The price is now above the double top and did not turn back to retest the double top. Those brave traders who have moved their stop loss could not know why it all quickly changes.

Double bottom

The second phenomenon is the double bottom trading capitulation or the AB base capitulation.

It is the inverse of AB top capitulation. These scenarios are numerous on the daily and sometimes on the weekly chart. A financial instrument has displayed five waves in a downtrend; the momentum was bearish. All screens were flashing red. Those who cut their losses at early stages thank their creator for having done the right thing. Some who sold their holdings were happy.

No one cares who loses or who went under. It is all fair play. Now the volatility is settling at a reasonable level. A perfect double bottom pattern was in place. Analysts mark up the price, and the mood is becoming confident. Sellers were no more enthusiastic after the five "Elliott waves" and the AB base. They know their time is over. They have to try another day. As the bulls were buying, the price continues its growth.

It is now half way near what I want to call the nut (refer to chart). Those who bought it early can now move their stop loss to break even. No one wants to miss out, and it is not too late. More buyers are buying. The price is now retesting the nut. Some bold investors bought it at this level which is in fact a resistance level. Buy orders littered above the nut, waiting for a breakout. In a significant bullish surge, the price will easily break above the nut and continue the move to the upside. Will it end above it or will it stop? asked some eager investors who placed buy orders above the nut. As every one was expecting, the price breaks above the nut. All buy orders were quickly filled and the price is surging.

The next day, the price gaped down to retest the nut’s position. Many were satisfied that it was only a retest. More new buyers join the bullish party, and it was a bullish day. The next day the price started its upbeat progress during the London session, but as soon as New York opens; a fresh wind blew. The market sold out at the opening bell. S & P 500, NASDAQ 100, DOW 30 and all major indexes fell. The tune has change. The price is now below the AB base. This is a classic bullish "capitulation".

As a "trader" or investor, one must always use stop loss and exercise a tested money management rules in all cases. It does not matter whether is a high probability set up or not. One can protect portfolios against these sudden changes by buying a put option when one is buying or a call option when one is bearish.

"Market capitulations" can generate both fortune and misfortune, but one can also benefit if one fully understands these two technical evaluations.


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