Peaks And Troughs

The oldest ways of chart analysis had to work in the days

before computers (B.C.). There’s no reason they shouldn’t

work now. Here’s a look at peaks and troughs, a classic form

of chart analysis that worked B.C. and work now.have always thought that, in

general, the simplest techniques

work the best. High up

in this category, and perhaps

the most underrated, is the concept

of peak and trough analysis,

a technique first brought to

our attention as a tenet of Dow

theory. While the theory itself

has lost much of its luster in

recent years, the peak and

trough part of it has not. It is arguably the most important

building block of technical analysis.

When you look at almost any chart, it’s fairly evident that

prices do not go up and down in straight lines, but move in

zigzag patterns instead. During a bull trend, a rally is interrupted

by a correction in which part of the advance is retraced.

This is then followed by another rally, after which a subsequent

correction follows, and so on.

These are the peaks and troughs. As long as a trend

experiences a series of rising peaks and rising troughs, it is

considered to be intact. However, when the series of rising

peaks and troughs is replaced by a series of declining peaks

and troughs, the prevailing trend has reversed.

Figure 1 shows a series of rising peaks and troughs. When

a subsequent rally fails to make a new high for the move (A),

this alerts us the trend may have changed. It is not until the

price slips below the previous bottom (B), however, that the

price action reveals a declining peak and trough. The trend,

according to this technique, is now deemed to be bearish.

In a bear trend, prices continue their downward zigzag

(Figure 2) until the latest trough fails to make a new low for

the move (C). The subsequent rally takes the price above the

previous high (D), and the series of declining peaks and

troughs gives way to a series of rising ones. The actual signal

takes place at E, when it is evident that the price has made a

new high. At that point, we do not know where the next peak

will occur, but we do know it is likely it will be higher than the previous one.As you can see from the price

action at point F, there is nothing

to stop the price from falling

below the trend reversal signal

(E), but pricing will still be consistent

with a rising trend.