In an age where faster computers and advanced software are providing access to more information at lightning speed, traders are busy creating new technical tools and testing ideas. Technology has produced many changes in today's market world, resulting in an explosion in the number of new traders who are seeking the ultimate short-term trading strategy. Day trading and swing trading have become buzzwords for a new generation of traders who flock to online trading and embrace every new software program that promises trading success. The marketplace is full of sophisticated trading systems, but has any of this advanced technology made people more successful?

In the late 1990s many new traders jumped online, bought software programs, and started to trade their way to riches. It was a great time to enter the market, but all too often these new traders confused a bull market with trading savvy. As soon as the market topped, so did their trading accounts, because they lacked an important ingredient for success: a working understanding of market behavior.

TRADING TECHNICALLY

More than 20 years ago, I attended my first seminar on technical analysis. I walked away with extensive knowledge about one magic indicator: the trendline. That was all I needed, or so I thought. But like other new traders, I quickly realized I needed more. This led to an extensive study of chart patterns, cycles, and technical indicators. I kept studying, adding more and more clutter to my trading toolbox. Soon, my computer screen was muddled with charts and technical indicators.

How I longed for the earlier days when things were so much simpler. Back then, I would sit back and dream about the type of chart I'd like to see. It would have fewer technical indicators. It would highlight the future turning points and provide the price levels where the market reversal would occur. I would be able to pull up any chart and see both the time and the price where the market would most likely turn, long before it happened. Then a line would appear to identify the price level where time and price would likely converge. The chart itself would predict and identify future market swings based on market behavior.

But that was all a dream - or was it?

THE BEAUTY OF CYCLES

Traders have been studying recurring cycles for many years. Usually, cycles are determined by counting the trading days between two lows. It's accepted that all markets have certain defined cycles, such as a 28-day cycle in cattle or a 21-day cycle in soybeans. Sometimes
these cycles bottom early or late, and sometimes not at all. This poses a problem for traders using this type of analysis. Years ago, I read about technician Robert Babson and his
action/reaction theory about the markets. He wrote: "For every market action there is an equal and opposite reaction." From this statement, I theorize that market cycles can be looked at in a different way. If it is true, then all I have to do is identify where the action ends
and the reaction begins. So instead of looking from low to low, I should be looking for the exact center of a cycle.

A simple idea, yet a daunting task. Even so, I found the answer! There is a pattern that appears at the center of a cycle and divides the action segment from the reaction. Once this is identified, all I have to do is look at the recent market action and project the future reaction. I call this the reversal date indicator. Using this technique, the market itself will predict and identify future market swings. All I have to do is trade them.

REVERSAL DATE INDICATOR

Swing traders take advantage of the price fluctuations that follow a breakout from an area of consolidation. The key to successful swing trading has always been to time your entry and exit appropriately. "You've got to know when to hold 'em and know when to fold 'em," as Kenny Rogers sings.

Knowing where and when these price fluctuations will begin and end has been an aspiration for swing traders, but not an easy task. Swing trading has been defined in different ways, but mainly as a trading method that takes advantage of a three- to five-day cycle. Traders using this approach buy into weakness and sell into strength. Other methods utilize several different technical indicators to identify support and resistance; however, these indicators are lagging and often trigger signals after the move has already begun.

The reversal date indicator differs from these methods because it uses the market's own predictive patterns to identify future market swings. Thus, it's a leading indicator that allows traders to trade from one swing pattern to another with a high degree of confidence.

Figure 1:

Predicting Future Swing Points. By constructing action/reaction lines and by reverse counting price bars, it is possible to predict where the next high and low of the swing will take place.

APPLYING IT

Let's put this theory into action and see if the chart I imagined becomes a reality. In Figure 1, you can see that in mid-June 2003, the September dollar index bottomed at 92.50 (B). the subsequent rally lasted 10 days before a three-day retracement interrupted the new trend. This is where it gets interesting! On the third day of the correction, the market closed on the low of the of the daily range before turning higher the following day (D). As soon as the market resumed the main trend, it confirmed a price pattern I call the reaction swing. This pattern has identified the end of the action and the beginning of the reaction in the current cycle. I can use this pattern to identify the time and price of the next market swing.

In Figure 1, this reaction swing is marked (C) and (D). Since this is the center of the cycle, I want to look back at the previous market action leading to this point. I do this by counting in reverse from the high at (C) to the low at (B). The count equals 10 days. I can use this information to calculate the future reversal date by counting forward from the low of the reaction swing. Starting at the low (D), I count forward 10 days and identify July 16 (E) as the future reversal date and the end of the cycle. In this way, I have just used market action to predict the time of the next reversal several days in advance.

Figure 2 -

September Dollar Index. Here you see how by using the reaction swing C to D, you can predict the end of the next short-term rally and correction.

The next step is to draw the action line. This is done by drawing a line from the high at (C) to the low at (D). Once the action line is in place, I move forward 10 days from (D) and mark the center line on the chart. (Remember the reverse count used to determine the reversal date of July 16.)

At the spot I just marked on the center line, I draw a line parallel to the reaction line. This line is the reaction line and acts as a magnet and target level for the market. By using the combination of the projected reversal date and the reaction line, I have identified the time and price of a future market swing advance.

Now that I have identified the beginning of the swing pattern, I will use the same technique to find when the correction will end. First, I will continue the reverse count past the low at (B) on the low at (A). This adds up to 16 days. When I count forward 16 days from the July 2nd low, I project another reversal date on July 24, one day before the end of the correction and the beginning of a new bullish leg in the dollar index. By using the (C) to (D) reaction swing, I was able to project the high at (E) and the low at (F).

In Figure 2, the dollar index has just completed the correction and resumed the upward trend. In the process, it also formed a new reaction swing marked as (E) to (F), which represents the center of a longer-term cycle. This type of reaction swing pattern is very versatile and offers a wealth of information. The first thing I do is a reverse count. Starting at the high marked (E), I count back to the low at (B) and continue the reverse count to the low at (A). The reverse count equals 22 days and 28 days, respectively. I use this information to project forward and identify future reversal dates on August 26 (I) and September 3 (J). As soon as I can identify future reversal dates, I draw the center line and add the action and reaction lines to project the future price objectives.

The dollar index continued the upward trend, reaching the reaction line on the predicted reversal date of August 26. You can't get much closer than that! The reversal date marked the highest point of the 11-week rally. Even the small swing pattern between the low at (F) and the high at (I) could have been predicted days before it occurred. I reverse counted from (E) to the high of the small swing pattern marked (A) to (B). This count equals five days. The forward count or five days from (F) falls on the high pivot and the reaction line at (G), marking the time and price for the market to begin a five-day correction.

To review, by using the reaction swing of (C) to (D), I was able to predict the end of the 10-day rally and the beginning of the correction at (E). I followed this by projecting the low of the market swing at (F). Then I moved to the newly formed reaction swing of (E) to (F) and used it to project the beginning of the swing pattern (G) to (H), followed by the major high on August 26. This reversal date marked the end of the long-term rally and the beginning of a new downward trend. In each case, the market reached the price level at the time determined several days earlier.

Figure 3:

Applying it to intraday charts. Here's an example of the reversal date indicator at work on intraday charts.

You may be wondering whether this technique can be used for daytrading. Yes, it can, and I'll illustrate this by using a five-minute chart of the Standard & Poor's 500. In Figure3, the five-minute chart of the December S&P 500 offers a good example of price overtaking time during a sudden and extended price move, and yet, the reaction line target still worked.

The S&P displayed some weakness and fell sharply, closing near the low (B). The next morning an attempted rally failed 20 minutes after the open (C). The next price bar confirmed the bearish reaction swing and triggered a sell signal. As soon as the sell signal was triggered, I calculated the next reversal bar and overlaid the action/reaction lines to get a price target. The reverse count from (B) to (A) was 17 bars.

The forward count indicated the pending price move should last about 85 minutes (17 bars x 5 minutes = 85 minutes). However, the market fell harder than expected and touched the reaction line at 1140.80 in 55 minutes. (The S&P dropped more than 11points in 55 minutes.) It was time to exit the short position and put the money in the bank!

The market reached the reaction line, even though the projected reversal was not due for another 30 minutes. During the next 30 minutes, the market rallied back up to 1145 to meet the junction of the center line and reaction line at the predicted reversal time. At the center line, the market formed a new reaction swing and marked the beginning of a new upswing in the S&P 500. This is a case of price exceeding time. Using the reaction line as a target provided an extra five-point potential over exiting on the reversal date.

The predictive behavior of the market itself can be a powerful tool when determining future market movements. Traders are always looking for that edge when it comes to opening and closing their positions. Little do they know the market itself has the answer. All you have to do is interpret the charts and understand market behavior.

John Crane is cofounder and director of research at Traders Network, Inc. His market comments can be read nightly on the Reversal Date Worksheet. He is the author of Advanced Swing Trading: Strategies to Predict, Identify, and Trade Future Market Swings. Crane can be reached at 1-800-831-7654 or via email at john@tradersnetwork.com

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SUGGESTED READING
Crane, John [2003]. Advanced Swing Trading: Strategies To Predict, Identify, And Trade Future Market Swings, Marketplace Books.