Creations of Highs and Lows

By: Lee Gettess

The following is an excerpt from Lee Gettess' Lee Gettess on Day Trading

There is an aspect of technical analysis that is often overlooked, which I believe might be one of the most important clues to probable market direction almost all technical analysis begins an a bar chart. Each bar represents some unit of time, although many software packages now allow the use of tick bars, which are units of activity rather than time. Since those basically function under the same rules as time bar charts, we will discuss on the basis of time only.

Each bar on a chart could represent one day's worth of price action. It could also be an hour, a 10 minute period, a week, a month, a year, etc. The exact time frame we are dealing with is irrelevant. All of them hold to the same basic truth.

That basic truth is that each bar has to make both a high and a low. It doesn't matter how active or inactive, or whether the market is going up, down, or sideways. Each and every bar will make a high and a low.

It should be equally obvious that one has to be made before the other. That is, a bar will either make a low and then go make a high, or it will make the high first and then go down to make the low. Attempting to understand exactly which is unfolding can be a tremendous help in anticipating price action.

The direction that any given price bar takes is directly related to when the high and low forms. If a market is going to up for the day, for instance, it will generally make a low first, then spend the majority of the day traveling up to make the high. Conversely, a market that is going down will normally make the high of the day first, and then go down to put in the low.

How can this information help you? By making you aware of probable direction. When I day trade, I am always trying to determine if the market has created the high or low for the day. I don't need to be the hero that picks the exact high or low in order to make money. I just need to be aware of what has happened, which clues me into what should happen. If I can recognize that the low for the day has probably already been created, then I can assume that we need to go up to make the high. I have a firm opinion on what the probable direction should be, so I know which side of the market I want to trade on.

The time frame that you trade in is a personal decision. It should be directly related to your personality and temperament. Everyone has a different comfort level, both in terms of risk and length of time holding positions. While I make use of the directional bias for day trading, there is no reason it can't be used by longer term traders.

A monthly bar, for instance, also has to make a high and a low. If you can recognize that the market has probably made a high, you can look to the short side of the market knowing that it has to go make the low for the month somewhere.

If you remember that a market going up will generally make a low first and a market going down normally makes a high first it can also clue you in to problems with a trade you are already in.

Let's say you are short some market and you are anticipating that it ought to go down for 3 months or so. If you can recognize that the current month seems to be making the low first, isn't that important information? You could perhaps exit the position and make more money than you would have. You could even go back short once the market goes up to make its high, if you still think your original position is correct.

Real World Example

In 1997 the Japanese Yen started the year absolutely falling like a rock. It had been as high as 12625 in April of 1995, and had been coming down hard ever since. In early 1997, it reached back down to the levels it had been trading at in 1992. It certainly looked like it was making the low for the year first. I am primarily a day trader, but I told numerous clients that I thought it was making the low for the year around 8000. It went as low as 7894 on May 1 (making the low for the first month first), and was over 9000 by June 11! These indications can be dramatically profitable! 

There is no magic way to always know whether the high or low for any given price bar is in. If you can make some reasonable assumptions based purely on recent price action, it will greatly enhance your understanding of the flow of the markets.