The Third Universal Truth is this: There is only ONE price pattern. Everything trades in a continuous series of broadening formations because there are only three scenarios that can possibly play out from one bar to the next. Therefore only THREE types of bars exist: the Outside Bar, the Inside Bar, and the Directional Bar. It is impossible for price to do anything else. Range expansion on both sides occurs ONLY because Outside Bars exist.
Broadening Formation on quarterly, monthly, weekly, and daily Apple Inc (AAPL) charts.
Inside Bar = 1 | Directional Bar = 2 | Outside Bar = 3
Almost every book on technical analysis claims that the broadening formation is extremely rare, when the truth is it is one of the only things that can possibly happen. A broadening formation is a pattern where ranges continue to expand on both sides, thus an outside bar is a broadening formation when you shorten the time frame of the chart. It must be because by definition the range is expanding on both sides. While many traders will talk about stocks making higher lows and lower highs, one thing is that securities will always trade in a series of higher highs and lower lows. Even if a stock is in a steady uptrend from, say, $80 to $100, somewhere along the way that stock will make a series of higher highs and lower lows on some time frame.
Basic Diagram of the Broadening Formation.
While this may seem irrational, it helps to analyze this statement from the perspective of supply and demand. When a stock reaches a new high, it means that a new group of buyers have been identified above the previous high. Eventually, that buying pressure exhausts, and the stock retreats. This new group of buyers becomes trapped, and this will create pressure to the downside, either on a short-term time frame or a long-term time frame. Inevitably, the stock will eventually get pushed towards a previous low, whether it's a recent low on a 15 minute chart or a major inflection point on a monthly chart. As the stock pushes towards this low, those buyers at highs will succumb to the selling pressure, drive the stock to a new low that is bought up by the sideline traders or natural buyers, and the stock will resume higher until it reaches the next new high. This series repeats itself, which creates a formation that can be fit into a triangle.
Nasdaq (Daily Bars)
Inside Bar = 1 | Directional Bar = 2 | Outside Bar = 3
Every chart shows but Broadening Formations, nested series of Range Contractions and Range Expansions
on yearly, quarterly, monthly, weekly, daily and lower time frame charts.
Full Time Frame Continuity occurs when all time frames point in the same direction, providing a more reliable assessment of the market's direction.
Inside Bar = 1 | Directional Bar = 2 | Outside Bar = 3
How to find a Broadening Formation?
- Identify an Outside Bar on a Higher Time Frame.
- Remember an Outside Bar takes out BOTH sides of the previous bar's range. This is how we gauge the potential magnitude of an expected move.
- An Outside Bar = A Broadening Formation on a Lower Time Frame chart. This is a FACT. Ignore previous Technical Analysis textbooks.
- Locate the High of the Outside Bar and DRAW BACK to a previous Higher High (HH Point #1 to #2). Generally try and use an extended line type drawing tool on your charting software as this will extend the line forward.
- Locate the Low of the Outside Bar and DRAW BACK to a previous Lower Low (LL Point #1 to #2).
- View the same chart on a Lower Time frame and watch the magic happen. Now you have a Broadening Formation.
- Note depending on your charting software you may have to adjust your lines at key high and low points when switching between different time frame charts this is normal and due to the difference in candlesticks between timeframes.
Reference:
#TheStrat Setups with Entry, Stop and Target Levels. #TheStrat Risk/Reward Ratios are mostly sub-optimal.
28 #TheStrat Setups = 14 bullish + 14 bearish.
Inside Bar = 1 | Directional Bar = 2 | Outside Bar = 3
