Pattern Tools The Basics

The market can be analyzed in a number of ways, but one form of analysis that works and that makes a lot of sense is by looking at the relationships between:

1) Pivots in the market
2) The height of the runs between pivots
3) The width between the price zones that are created by the above.
A pivot is a point inflection where price changes from down to up (point A) or up to down (point B).  This is the most basic market structure.

The Basic Pivot

There are a number of ways to define such a pivot. But to understand this, we must first define an even more basic structure: The bar.

Bar Chart - 3 minute intervals

Most charts used in trading are what are called bar charts. Most commonly,  a bar shows the range of price that occurred in a given time interval.  Just about any interval can be used all the way down to one tick (the smallest interval).  A 1 tick chart shows price with no height at all. If the many ticks that display price data for a given symbol are compiled into time intervals, they will make what are called bars (there are many other types of charts, but for our purposes this description will suffice).
Building from this basic bar structure, we go to having many bars. Eventually one bar will be higher or lower than the previous one (points A or B in the first image above). At this point, we will have an inflection or pivot point. There are a several ways to define a pivot point.  For our purposes here, it is simply a point where the market or data changes direction from going higher or lower to its opposite.
From the concept of pivot, we then move on to having multiple pivots that form various shapes. There are three basic relationships. If the pivots are even (horizontal), then the data (market)  is moving sideways in time. Otherwise, it is trending.
The definition of trend as follows:
1) An uptrend is defined by a sequence of pivots that are higher highs and higher lows:

Up Trend

2) A downtrend is defined by a sequence of lower lows and lower highs:

Down Trend

Now that we have defined all that, let’s cover all the ways a market can zig and zag in two runs (Down only shown):

Two Run Zigzag #1

1)  The market can make a move of equal segments (above)
2)  Where AB > CD (below). Market weakens:

Weakening Market

3) Or AB <CD (below). Market strengthens:

Strengthening Market

But we also have the translation of the zigs and zags. Or, an analysis of how long it spends going up or down in each segment compared to the next segment.  So, we get this:

Market Translation #1

Above, we go down 3 units (in AB), while going sideways 3 segments (3X3). So, we have units of height vs. segments of width.  This may seem so fundamental that it is not worth paying attention to, but it is the very structure of all market movements, and all market patterns.
This is followed by,  up two units in two segments of width (2X2) for BC.  Four by four in CD.
So all these make right angles as it zigs and zags going down. But the slopes and angles can change, such as:

Market Translation #2

Here, instead of having all square angles, we now have BC as moving up 2 units in one segment. So, the slope of this segment has doubled.
This introduces the concept of translation.  In cycle analysis, the most fundamental wave is a sine wave, or, as we are doing here, a triangle wave.  a natural wave has symmetrical distribution. where the peaks and troughs of the wave are evenly distributed.
That gives us this:

Evenly Distributed

B, is at the midpoint of AC and C is at the midpoint of BD etc.
When a market trends, the most common pattern, say in the case where it is trending upwards, it to translate to the right.

Translation #3

Put in more plain terms, it is simply saying that the market is spending more time going up than down as it cycles upwards.  This pattern is stronger, and has more energy than the structure with right angles.  Because C is to the right of the center of BC, we say it is translated to the right.  Note in this pattern, we have retained the right angles at each of the pivots.  We could further add strength to this wave, by modifying this angle.

Complex Waveform

Here (above) we have the strongest wave, as we are doing both right translation (points A & C are to the right of the mid of the wave) and stepping upwards at a higher slope in the up portions of the wave i.e. the slope of BC is > CD, making the BCD angle <90 degrees.
There is yet another way we can modify and look at this wave. That is by analyzing the widths not between the peaks, but between where a peak exists, and where it’s level is exceeded by the next run.
The reason this becomes important in analysis of patterns in the market is because the most basic definition of trend is when you have higher highs and higher lows (as we have in the above images), then you have an uptrend.  For a downtrend, you have lower highs followed by lower lows.   So, at the moment point A in the above image is exceeded, an uptrend has been established.  Therefore, if we analyze the width of the cycle at this point, it will tell us if we are stronger or weaker than a centrally translated wave.  This becomes important for our attempts as traders to identify if a move has the energy to continue, or is more likely to fail and go the other way.  The old saying is, “The trend is your friend.”  But, here, we are trying to identify just exactly how much energy is in the wave we are looking at.
Popular indicators such as an MACD, or looking at the difference between price and a moving average accomplishes a similar function, however, due to the fact that moving averages are by definition a delayed evaluation and the patterns we are discussing at what is happening now, it clears a lot of misreading out of the process by dealing with the ultimate indicator; price.  Often these kinds of analysis are so ahead of what a typical indicator will give you, that it will make the difference between a profit or a loss, as markets are anti persistent in many ways.
All of this gets much more complicated in real life where we have trends in both directions interspersed with non-trends as in the case of the triangle wave above.  Therefore, any tools we can come up with to identify the bias of a market in congestion or in trend (or both) can give us a large advantage over other traders who cannot see these patterns because their indicators remove the very data they need to analyze the market’s complexity.  This is not to say you cannot trade successfully by just following trends, you can, but if you know these things we are discussing here, it can keep you from being whipsawed by the low win % associated with such trading approaches (for more on this topic, go here.
The following statement sums up much of what we have been talking about from a cycle analysis viewpoint: When a market trends, the cycles become longer.  When a market consolidates, cycles become shorter.  This, and other statements in this article should be committed to memory.
Let’s look at the chart below and analyze this in action:

Real World Waveform Analysis

Note the two red bars just before 8:45.  These bars have a cycle width of 3 bars from the bar that exceeded them.  Then following that when we came back down, at the moment we had exceeded two bars down (2+ intervals past the peak at 8:45), we knew at that moment that if we broke higher, the cycle would be expanding.  So, by analyzing and gearing ourselves to see this, we can determine, in advance if we are likely to continue higher (if this seems confusing, don’t worry, it is covered in detail in the Nindicator Pattern Tools and Total Package Manuals).
So, we have turned what a typical moving average/trend following player might have taken as a trade into a much higher probability scenario.

Cycling Waves and Trading

As traders what we want to do ultimately is sell A, buy B, sell C and buy D etc.  This would be 100% efficiency (less slippage and commission).  The wave above is 3 units up and 3 segments wide, so the cycle is 6 from A to C or from B to D.  If we put a moving average (or other algorithm) on this wave,  it would actually track it quite inefficiently, unless we were to use offset moving averages and some form of cycle prediction to manage the length of the cycle (i.e. trigonometric regression,  Fast Fourier transformations, or Maximum Entropy methods).
This is a very complicated topic that is beyond the scope of this article.  Suffice it to say however, I have spent huge amounts of time and effort researching such things. The problem with this kind of analysis is it is subject to the introduction of delay, lag noise etc.  Further, it presumes cycle persistency, which is most often not present.  To make matters worse, financial data is intermittent. For example, the market is open 6.5 hours a day and is closed on weekends and holidays. Or, there are intraday seasonal tendencies that confuse cycling as amplitudes expand and contract.  This can make the finding of cycles extremely complicated, if not impossible. For this reason, I have found using real time simple price data and analyzing it with the basic tools and concepts written about above are the most superior form of analysis.
Nindicator Pattern tools utilize concepts in the above discussion to predict waves and wave failures as they are occurring in real time. Because they do this in the simplest form possible, it makes it possible to learn from the use of the tools easily, where other methods may likely obscure such learning.   When you have a tool you use to trade that also makes it possible to contextualize, or identify what is going on in other levels of analysis, it provides a powerful backdrop to becoming a market master with practice.
Do you really need to know all this to trade using Nindicator Pattern Tools?  Of course not, but if you understand this kind of wave theory, then you may be just that much further ahead as a trader. This is why I put these articles here on the blog; as an extension of the Nindicator Manual.
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Astiina, by: Amie Suzako