Natural laws are immutable: an overripe apple cannot deny Newton. “Gravity” describes the apple’s fate. Newton went on to create Calculus to best understand and communicate his discovery of a natural law. Similarly, financial markets operate with rules that traders identify with such terms as “Buy Low and Sell High” and “The Trend is Your Friend.” Translation – trade in market direction. Fortunately, traders don’t need to generate a whole new brand of technical analysis to understand market direction. The trader’s “calculus” is a concept known as Median Line Analysis (MLA).
The first and most important trading signal is identifying market direction; traders short down markets and buy up markets. Accurate MLA lays the foundation for determining market direction by defining the slope of the price in a particular timeframe. A line drawn through the slope of price identifies market direction.
The following GC (gold futures) chart displays the price downtrend defined by median and parallel lines. This bounding of market price direction in terms of sloping lines creates a fork or “Andrews pitchfork”, named after its creator Dr Alan Andrews. Created from the high designated as Point A, the slope of price action is created by a median line. This particular fork is a derivation called a Modified Schiff, a form of pitchfork where the A pivot is moved 50% of the way down (in price) and forward (in time) towards the B pivot.
The Median Line (ML) defines the core path of price. There are two origination points (B and C) that are used to draw parallel lines forming the Upper and Lower parallel lines. Note that the Upper and Lower parallel lines are equidistant from the ML. Once two parallel lines are created, the Median Line can be shifted from origination at Point A to better fit the B & C points. The trader is not limited to a specific number of lines that can be added to the chart; add parallel lines that have meaning to describe market direction to setup the short trades.
Examining the gold chart, notice how well the price tends to hug the ML. This price action helps validate the pivots that we used to draw the fork. The more occurrences that prices hug the ML or tests resistance of the Upper parallel or support of the Lower parallel, the higher the validity of the lines. Such confidence allows for lower risk entries since we expect the price to follow the current path: down.
Market prices tend to gravitate around these lines generating trading signals. From March to May, the Median Line offered support. Once price dropped to 1512 in mid-May, the ML became resistance. Then support again (defined by the green lines in Figure 2).
Now that we have identified the direction or slope of the market, how does a trader convert this to a trade decision? There are two possibilities, both short since the market direction is down.
The first short opportunity is located at the Upper parallel. This entry is lower risk since prices are pushing against the Upper parallel resistance. However, it may take some time to climb back up to the 1600 range. This means patience. An even lower risk trade would be for price to touch the Upper parallel, pullback and then short on a subsequent Upper parallel touch. This provides both a confirmation that the fork is still valid and gives an exit to cover at the previous first touch price of the Upper parallel (lower risk).
The other short entry opportunity would be at the Quartile Line between the Upper parallel and the ML. Note the green parallel line in Figure 2 that captures the lower highs of price. What is occurring is that the green line is more representative of the resistance that the Quartile Line would be normally providing. There is a small phase difference between the Quartile Line and actual price highs. So, we treat the green parallel line as we would treat the actual Quartile Line. Therefore, when price touches the green parallel line as denoted by the green box in Figure 3, we prepare to short using similar technique as described above.
The theory behind the selection of these median lines lies in the belief that price will continue in the current direction, supporting current structure, and that price will respond to support and resistance. Only until some event occurs causing a change in direction would the trader switch from short to long positioning.
Every month a free public webinar with the main focus on Median Line Analysis is held at Coghlan Capital. If you are interested in learning more be sure to register a seat right away.