Self-Test Answers Test Your Chapter 1 Knowledge 1. Which is the preferred chart type in LOCKIT? The preferred chart type in LOCKIT is the candle chart because candle patterns are part of the decision-making process in LOCKIT. 2. When do we have to use a semi-logarithmic scaling on the price chart? Starting with a visible price move of more than 50%, it is useful to start using semi-logarithmic scaling. Equal distances on the price axis will then represent the same percentage price change. Drawing linear trend lines on a linear scale when there are big price moves may be impossible. 3. How does volume normally relate to price? In general rising volume confirms the ongoing trend. During consolidation phases or correction moves, volume will usually decrease. 4. Where do you find price resistance or support and how does a resistance line change to a support line? Price resistance and support is found at price pivot points and at windows (gaps). Price reaching a resistance level and bouncing back confirms that resistance. If the closing price breaks the resistance level, this resistance level becomes a support level for future prices.
358 Capturing Profit with Technical Analysis 5. In LOCKIT we use trend lines and we consider three sorts of trend line evolution; can you describe them? In LOCKIT we consider breaking a trend line as one of the rules for buying or selling a stock. We keep in mind three sorts of trend line evolution. The first one is no change in acceleration. Breaking the trend line here means a new medium-term trend has started. The second one is an accelerating trend. A lot of the times this is a three step process. Breaking the sharpest uptrend announces the medium-term trend change. The third one is a decelerating trend. To take into account the slowing of the up move, we use support (resistance) lines or a trailing stop. 6. What is and why do we use an inverse trend line in LOCKIT? An upward inverse trend line is drawn from price tops and a downward inverse trend line is drawn from price bottoms. LOCKIT uses the inverse trend line when it is not possible to start a normal medium-term trend line. A parallel line with the inverse trend line starting at a previous low (high) will create a medium-term trend channel that most likely represents the future medium-term price inclination. 7. What do we use a centerline for in LOCKIT? A centerline from a top to a bottom or a bottom to a top pivot point is used as a reference line for action-reaction lines. 8. What is the use of the multi-reversal line in LOCKIT? The multi-reversal line touches the bottoms as well as the tops of the price bars. Multi-reversal lines are mostly used as a reference for action-reaction lines but also for future support or resistance in relation with future price projections. 9. What is the use of trend channels in LOCKIT?? Trend channels are parallel lines containing a smaller or larger price move. The unparallel lines of a triangle formation are also a trend channel. Trend channels represent support and resistance and can be used within LOCKIT to find price targets. Price channels within price channels are a very nice tool within LOCKIT to find price targets related to time. 10. Why do we look specifically at the 20-, 50-, and 200-day simple moving averages in LOCKIT? The 20-day average gives direction to the shorter period price move and often runs parallel with a short-term trend line. The 50-day moving average gives direction to the medium-term period. The 200-day moving average is
Self-Test Answers 359 important for a look at the long-term trend. Around the 50- and the 200-day averages, you will almost always notice some form of support or resistance. 11. What does zero-lagging mean? The zero-lagging principle shows less lag compared to the standard moving averages. The reversals are faster, but the zero-lagging average also follows more closely the price action, so there is a bit less smoothing. 12. When is a head and shoulders bottom reversal pattern confirmed? The head and shoulders bottom reversal pattern is confirmed when the price moves above a descending neck line or after the right shoulder with an ascending neck line. 13. In LOCKIT, what are the three types of V-formation patterns we look for? In a V-formation, we look for a V-shaped reversal pattern. A bottom reversal creates a V-character; a top reversal creates an inverted V-character. The price at the start of the V-formation will form a one-day reversal, an island reversal, or a spark. A one day top reversal arises if the price makes a new high on the same day and reverses and closes below the closing price of the previous day. An island reversal occurs when there is a window between the prices of today, the previous day, and the following day(s). A spark is a big, one-day high volatility price move. 14. Triangles are (most of the time) what kind of pattern? Triangle formations appear as symmetrical triangles, ascending triangles, and descending triangles. The triangle is mostly a correction pattern for the previous price move. A triangle formation takes a minimum of 30 bars. A breakout in the direction of the previous trend confirms the continuation pattern. 15. Flags and pennants are what kind of price pattern? Flags and pennants are short-term continuation patterns, reliable 90% of the time. Most of the flags and pennants take up from 10 to 15 bars. Generally, the volume goes down during that phase. 16. What do you know about falling and rising wedge patterns? The falling wedge exists as a reversing pattern in a falling trend and as a continuation pattern in a rising trend. The rising wedge exists as a reversal pattern in a rising trend and as a continuation pattern in a falling trend.
360 Capturing Profit with Technical Analysis 17. What type of windows do you know? We distinguish four window types: a common window, a breakaway window, a continuation window, and an exhaustion window. A common window is aptly named because it is common in the normal price evolution. Most of the common windows can be found during periods of price consolidation. A breakaway window will appear at the start of a new medium- to longerterm price trend. A continuation window will be found halfway through a running trend, often after a consolidation pattern. The exhaustion window can be found near the end of the running trend. Test Your Chapter 2 Knowledge 1. How do you recognize an RSI bottom divergence? When the RSI creates a higher bottom while the price makes a lower bottom, they diverge. This is mostly found at the end of a downtrend, indicating an uptrend reversal. 2. How do you recognize an RSI top divergence? When the oscillator makes a lower top while price makes a higher top, they diverge. This is mostly found at the end of an uptrend, indicating a downtrend reversal. 3. How would you describe RSI inverse or hidden divergences? When the oscillator has a lower bottom while the price sets a higher bottom, they diverge creating an inverse or hidden divergence. This is mostly found in a price uptrend after a price correction, indicating a continuation of the uptrend. When the oscillator makes a higher top while price makes a lower top, they diverge creating an inverse or hidden divergence. This is usually found in a price downtrend after a price up correction, indicating a continuation of the downtrend. 4. What do you know about RSI M- and W-shaped patterns? M- and W-shaped patterns are patterns visible in the overbought or oversold areas of the RSI indicator giving reliable short-term price reversal signals. The second leg of the M-shaped pattern does not move above the first leg. The second leg of the W-shaped pattern does not move below the first leg. They are more useful with an RSI convergent move because at that moment in time, it is the only visible indication of a short-term reversal.
Self-Test Answers 361 5. The Bollinger bands %b indicator is a measure of? With trending prices, Bollinger bands will be wider as a result of the higher volatility in price, whereas consolidation-period bands will be narrower as a result of smaller price moves. The %b is a measure of where the last price is in relation to the Bollinger outer bands. Test Your Chapter 3 Knowledge 1. Is this candle pattern a bottom or top reversal pattern? What is it called? Bottom reversal pattern. Bullish harami. 2. Is this candle pattern a bottom or top reversal pattern? What is it called? Top reversal pattern. Dark cloud cover.
362 Capturing Profit with Technical Analysis 3. Is this candle pattern a bottom or top reversal pattern? What is it called? Top reversal pattern. Hanging man. 4. Is this candle pattern a bottom or top reversal pattern? What is it called? Bottom reversal pattern. Piercing line. 5. Is this candle pattern a bottom or top reversal pattern? What is it called? Top reversal pattern. Engulfing bearish.
Self-Test Answers 363 6. Is this candle pattern a bottom or top reversal pattern? What is it called? Bottom reversal pattern. Morning star. 7. Is this candle pattern a bottom or top reversal pattern? What is it called? Bottom reversal pattern. Engulfing bullish. 8. Is this candle pattern a bottom or top reversal pattern? What is it called? Top reversal pattern. Bearish harami.
364 Capturing Profit with Technical Analysis 9. Is this candle pattern a bottom or top reversal pattern? What is it called? Bottom reversal pattern. Hammer. 10. Is this candle pattern a bottom or top reversal pattern? What is it called? Top reversal pattern. Evening doji star. 11. You have a long position. What would you do? Sell or hold on, or add to the position? Best is to close the position and take profit. A doji in an uptrend with a closing price below the previous closing is a strong indication for a reversal.
Self-Test Answers 365 12. Would you open a long position here or not? Why? NO. There is no candle pattern and no previous confirmed support. Also, a doji in a downtrend has little significance. 13. Would you open a long position here or not? Why? YES. A previous bottom in April with a bullish engulfing pattern support is now confirmed with a morning doji star. The risk-to-reward ratio is good with an initial stop at the low of the morning doji star 14. Would you open a long position here or not? Why? NO. A previous bottom at the end of January with a bullish engulfing pattern support is now confirmed with a piercing line; however, with a first price target very close by, the risk-to-reward ratio is NOT good. There is resistance from the window and around the same level previous support now may become resistance. Better wait for at least the window resistance to be broken.
366 Capturing Profit with Technical Analysis Test Your Chapter 4 Knowledge 1. Label this chart with an Elliott wave count. 2. Label this chart with an Elliott wave count.
Self-Test Answers 367 3. Label this chart with an Elliott wave count.
368 Capturing Profit with Technical Analysis Test Your Chapter 5 Knowledge 1. After a previous downtrend, this stock is now in an uptrend. Below the price chart is the SVAPO oscillator. Would you now buy or sell this stock. What are your arguments? SVAPO is making a low and turning up now. There is a hidden divergence with lower bottoms in SVAPO and higher bottoms in price. These indications point in the direction of a continuation of the uptrend. Price accelerates and finds support on the last uptrend line. Defining an Elliott wave count, it looks like we have reached the end of correction wave (4) ready to start wave (5) up. A stop at the last turning point gives a very good risk-to-reward ratio. An eventual loss will be very small. This is a buying point!
Self-Test Answers 369 2. SVAPO is diverging with a lower top compared to a higher top in price. Would you sell here? SVAPO diverging with price indicates that a price reaction is expected. However, there is support nearby from a new sharper uptrend line and from a window. Most important, Elliott wave (5) seems to have an extension and if there is a reaction now, it is probably an intermediate wave 4, so we expect wave 5 higher than the last top. I would hold the position as long as the last uptrend line is not broken.
370 Capturing Profit with Technical Analysis 3. Price went up and again now SVAPO is diverging with a lower top compared to a higher top in price. Would you sell here? Look how price held above the previous uptrend line and above the window support. That moment in time, there was also a hidden divergence that pointed in the direction of a further up move. With the divergence now in SVAPO, a steeper uptrend line and a possible completed Elliott wave count (and not to forget a 70% profit since the buying point end of June) give you many good reasons to take profit!
Self-Test Answers 371 Test Your Chapter 6 Knowledge 1. We are probably starting wave 3 of a new uptrend. Can you make some projections for what price levels could be reached? First, we can setup a Fibonacci projection from the lowest point to the first turning point of the price up move. This gives us projections at 161.8%, 261.8%, and 423.6%. We can also draw a pitchfork at the turning points of waves (1) and (2) and the previous low point. If we take the lowest point, the inclination of the pitchfork will be much too steep. It can maybe hold that level for a short time, but certainly not for a longer time period. So, we can take a previous smaller turning point, or we could take the low side of the window just after the turning point. There won t be much difference taking either of these two possibilities. Finally, we can draw a multi-reversal line from the top of wave (1) to the bottom of wave (2). Parallel with this line, we can draw an action line through a previous low point. The inclination of the prive move down is quite comparable with the inclination of the down move between waves (1) and (2). We project this action line at equal distances a number of times in the future. Figure 1 : Chapter 6 test
372 Capturing Profit with Technical Analysis Have a look at what really happened in figure 2. Figure 2 : Chapter 6 test 2. We have most likely made correction wave (A) and correction wave (B). Can you make a projection for wave (C) down? From the highest high and the first reaction after that, we can start a Fibonacci projection downwards. Between the start of the down wave and the turning points of correction waves (A) and (B), we create a downward pitchfork. The last medium-term trend line up through (A) we can use as a reference for action-reaction lines. We take the previous top as an action reference and project a reaction line at the same distance below the reference line. We can now see three important targets. Have a look at what really happened in figure 4.
Self-Test Answers 373 Figure 3 : Chapter 6 test Figure 4 : Chapter 6 test
374 Capturing Profit with Technical Analysis Test Your Chapter 7 Knowledge 1. LOCKIT is a short name that stands for? Long term look first what the long-term trend is doing and only trade in that direction. Open Open a trade based on the technical analysis LOCKIT rules. Close Close a trade based on LOCKIT technical analysis rules and based on an initial or a trailing stop. K-ratio Keep risk under control managing capital and using stops. Initial stop Aways use of an initial stop based on technical analysis and make sure the risk-to-reward ratio is preferably 1 to 3 or better. Trailing stop Always use a trailing stop to get you out of the trade if other closing signals failed (inclusive human failure). 2. Why are we looking at the long-term market trend? We first look at the long-term trend with the idea that we should only trade in this direction. 3. To open a trade we use? All technical analysis tools and trading rules proposed with the LOCKIT system and a good risk-to-reward ratio. 4 To close a trade we use? All technical analysis tools proposed by the LOCKIT rules, and an initial and trailing stop. Within the technical tools, we will specifically make use of price projection techniques. 5. How do we apply good money management with LOCKIT? With LOCKIT, we are using a fixed selection of a minimum of 20 stocks. The starting capital is evenly distributed between these stocks from the start. There is no profit or loss sharing between the stocks. 6. How do we limit risk with LOCKIT? We limit the risk in a single trade by setting an initial stop. 7. The initial stop setting is based on?
Self-Test Answers 375 The initial stop is based on LOCKIT technical analysis tools and must limit the possible loss to an average of about 10% trading with daily charts. 8. Why do we use a trailing stop with LOCKIT? We use a trailing stop as a last warning signal that a position must be closed. Normally, a position will be closed based on technical analysis signals before the breaking of the trailing stop. Test Your Chapter 9 Knowledge 1. What is a good sign of a medium-term bottom reversal? Generally, a good sign for a bottom reversal is a first higher bottom in price. A medium-term reversal will also show divergences in the indicators. 2. What is a good sign of a medium-term top reversal? Generally, a good sign for a top reversal is a first lower top in price. A medium-term reversal will also show divergences in the indicators. 3. What are reliable indications for a trend continuation after a correction? There are a number of indications that point to a trend continuation after a correction phase. Perhaps the most reliable is that the indicators show a hidden divergence, confirming a continuation of the previous trend. Of course, there is also price reacting inside of a trend channel or a pitchfork channel, price turning at support or resistance, and Elliott wave counts reaching the end point of waves 2, 4, or B. 4. The heikin ashi TEMA average crossover system is a profitable system. How would you make this system even more profitable? The most important improvement would be not to trade automatically on every signal but to make an evaluation of technical parameters with every signal to avoid losing trades.
376 Capturing Profit with Technical Analysis Test your chapter 10 knowledge 1. I would not open a new long trade here. Can you tell me why? We have a hammer support at the end of March, now confirmed with a bullish engulfing candle pattern. Buying now with a stop at this support gives a good initial stop. Still, I would not open a long trade here because there is an immediate resistance from a window in the previous downtrend. In other words, the risk-to-reward ratio is bad.
Self-Test Answers 377 2. You missed the entry at the start of the new uptrend. But your friend tells you that this stock is going to move much higher, should you buy? NO! Don t ever buy a stock because somebody suggests you should. Only trust your own judgment. Here you should of course not buy. First, moderate support is almost 20% lower and first resistance is very close. So, both the initial stop and risk-to-reward ratio are bad.
378 Capturing Profit with Technical Analysis 3. Would you close an open long trade and would you risk a short trade here? Yes, I would close an open long trade and open a new short trade here. Price is falling through the medium-term uptrend line. There is a very reliable head and shoulders reversal pattern visible. This pattern is confirmed by the breaking of the up moving neck line. Buying here and with an initial stop at the previous high limits the risk. And with the head and shoulders pattern reliability, the risk-to-reward ratio should be OK.