Easter Financial: Three techniques for judging the formation of tops in futures trading - Eastern Airlines Futures

by donghang0728 on 2011-08-13 20:31:28

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Investors continuously trade in the futures market, trying to find the essence of the changes between long and short positions and earn a profit from it. Futures trading involves making judgments on buying and selling directions, and these directions are either long or short. The confrontation between longs and shorts in the futures market is akin to the game theory between two armies on a battlefield—either one advances while the other retreats, or both engage fiercely together, or they face each other without moving. How to judge the situation of longs and shorts, especially the formation of tops or bottoms in futures prices, is a question many investors are very concerned about.

The judgment of longs and shorts involves the use of analytical methods, which mainly fall into fundamental analysis and technical analysis. Here, we mainly discuss the technical analysis method. The foundation of technical analysis is K-line analysis. Since technical analysis involves changes in price, and the four elements of price (opening price, closing price, highest price, and lowest price) are contained within a single K-line, changes in K-lines largely reflect changes in the strength of longs and shorts. The construction of tops is composed of a series of positive and negative K-lines. How can we better analyze changes in K-lines to better judge the situation of longs and shorts?

1. Indicator Judgment - Double Divergence of MACD Indicators

The divergence form of the MACD indicator can well judge a top-level trend above the medium level. The divergence of the MACD indicator is divided into two types: one is divergence within the same cycle trend; the other is divergence between cross-cycle trends.

Divergence within the same cycle trend refers to the state where the peaks of two adjacent red columns of the MACD indicator are divergent, meaning that the peak of the most recent red column is lower than that of the previous red column. This situation indicates that in the current upward trend, the energy of the bulls is gradually being consumed and is in a state of exhaustion, and there are signs of bearish energy emerging during the consumption of bullish energy. Generally speaking, when this internal divergence appears, a bearish trend may occur at any time, meaning that the top could arrive at any moment.

Cross-cycle trend divergence refers to the divergence of the values of the red columns of the MACD indicator when the price peaks of two adjacent trend markets appear, meaning that the peak of the most recent red column is lower than that of the previous red column. When this situation occurs, it indicates that the market reacts more sensitively to the pressure of the previous price peak. The current market's bullish energy cannot effectively break through the previous price peak, making it easy for a false breakout to occur, i.e., a double-top situation is likely to appear.

The above two types of divergence are explained with examples as follows. In the case of PVC index, the April and October 2010 market trends formed a cross-cycle trend divergence in the MACD indicator. At the same time, the mid-October and early August 2010 market trends of the PVC index formed an intra-period trend divergence in the MACD indicator. The coexistence of these two types of divergence significantly enhances the reliability of the divergence producing a top. Therefore, investors can make a judgment that the PVC futures reached a medium-to-high level top on October 15, 2010, and appropriately go short.

2. Application of Classic Patterns

Classic patterns include double tops, triple tops, round tops, head-and-shoulders tops, and inverted V shapes, etc. During the application of patterns, many investors often use them unsatisfactorily, even making numerous mistakes or incorrect judgments. The main reason is the inaccurate grasp of some detail issues in pattern judgment, mainly in terms of the time span of the pattern and the strength of its construction.

The time span of the pattern is very important. Patterns formed by too small or too short time spans do not generate much force, or should not be taken seriously, and they might even be traps. Generally speaking, patterns with a time span of around 34 months produce market trends at a slightly higher medium level, with high credibility and strong effectiveness.

The construction strength of the pattern refers to the traces left by the forces of longs and shorts during the process of constructing the pattern, i.e., the form of a series of K-lines. Ideally, important positions in the construction of a top pattern should have a large number of large black candles, or even large black candles with gaps down, indicating that the top pattern contains significant bearish energy, and the subsequent strength generated by the pattern will be greater.

3. Secrets of K-line Combination Density and Length

K-lines represent the traces left by the contention between longs and shorts, and the forms of such contention vary. The main forms can be divided into: stalemate between longs and shorts (preparing momentum), fierce battle between longs and shorts, and acceleration of longs and shorts. The K-lines under different forms of expression are different, and the density of positive and negative lines within the K-lines and the length of the K-lines themselves are crucial indicators for measuring the energy of longs and shorts. Based on these different characteristic K-lines, investors can better judge the current situation of longs and shorts, better understand the circumstances faced by the futures price, and make better investment decisions.

Generally speaking, if the position of the futures price is relatively low, the K-lines generally show very small fluctuations, mainly manifested as small black K-lines, small white K-lines, and a lot of doji K-lines. The amplitude of price fluctuations over a certain period is also not large. Of course, there is a special case, which is the bottoming out after an extreme plunge, during which the K-lines are likely to be continuous accelerating large black K-lines.

When the position of the futures price belongs to a relatively high stage, the K-lines generally show large fluctuations, mainly manifested as large black K-lines or large white K-lines, and the highs and lows of a certain day's K-line may reach the limit up or down price.

When the position of the futures price is in the middle stage of rising or falling, or in a lateral consolidation stage where it could go either way, the K-lines generally alternate between positive and negative lines, with moderate fluctuations.

Generally speaking, if the K-lines over a period of time are predominantly black lines, then the bearish forces are accumulating during this stage, and the futures price generally faces a downward or plunging trend later on. For example, the PTA1009 contract in the first half of April 2010 and the rice ER1101 contract at the end of April both experienced downward trends later on.

In addition, if after a period of upward trend, the futures price begins to show more black K-lines, especially large black K-lines, it indicates that the bearish forces at this position are very strong, and the possibility of forming a stage top is also very high. For example, in the Zhengzhou sugar SR1009 contract in early January and late February 2010, the trend showed large black K-lines, and once reached the limit down position, indicating that the price above 5900 yuan/ton was a stage bearish area, thus forming an important stage top.

In summary, there are many methods to judge the top of a commodity price, but they should be tailored to individual differences and specific situations. Under different circumstances, different analytical methods should be used to achieve better results. If many methods have been used but still fail to determine the appearance of a stage top signal for a particular variety, it means that the futures price of that variety has not yet reached the top.