J-Charts: The Next Evolution of Technical Analysis
It shouldn’t surprise anyone that the analysis itself is becoming more mathematical and/or scientific. But that doesn’t make it more attractive to average investors. People are still going to prefer the easier methods of “going with the gut” or simply hiring an advisor.
But an investor armed with some serious mathematical and scientific ammo has an edge over the competition. Which is why I’m sharing J-charts with you…
Although technical analysis has been around since the nineteenth century, economists and most fundamentalists are lukewarm to the “science.” The fact is, with the human emotional element involved, much of the science available is inexact.
So just like the scientist working on his or her hypothesis, technicians have been attempting to tweak aspects of charting in order to successfully predict price.
It was this chartists’ reliance in placing price action into specific time slots that John Chen took exception to. He was looking for a model that would express the dynamic nature of markets, which he likens to the thermodynamic process.
What the Heck is a Thermodynamic System?
While researching another subject, I came across two articles by Matt Blackman, the host of TradeSystemGuru.com. In these pieces, separated by eight years, he goes into detail of Mr. Chen’s epiphany by means of the software he created. I’m going to try to give you the highlights.
John Chen believed that alternating between periods of equilibrium and chaos, price seeks to find a new balance point after each trend, similar to going up (or down) sets of stairs separated by landings. When more buyers enter, prices move out of equilibrium and trend higher until a new equilibrium point is reached (the next landing of the stairs). This isn’t governed by time, but is totally price dependent.
What’s driving all this action?
Chen's program, called J-Chart, plots price as a five-part Chinese “Jeng” or JE character
(). One part of the character plots each time a transaction occurs at a specific price, allowing the user of the program to determine the level of equilibrium at any given time.
Depending on your preference, any time period may be set and periods may be combined. Opening prices are plotted in yellow and closing prices for the period are plotted in cyan (I just call it turquoise because I don’t know better).
As price plots in a given frame, a triangle begins to form. If it’s top-heavy, like Figure 1 below, the part of the plot with indentations (or caves) will generally be filled in following sessions, unless the market is trending strongly in the opposite direction.
[caption id="attachment_29072" align="alignnone" width="500" caption="Figure 1 - Price plots in a J-Chart showing triangular formation from high (point of origin) to low (image point) with open (yellow) and close (cyan) and balance point (solid red line). Chart provided by J-Chart.com."][/caption]
The point of origin is either the high or low where price plots occur. The image point in Figure 1 contains no price plots, making this formation top heavy and out of balance. If we were looking at the equilibrium, the high and low would be the same distance from the balance point (center), where the greatest number of price plots occur and the little characters would symmetrically fill the triangle outlined by the gray lines.
This system is trying to let us see when the market is or is not in equilibrium. A market in perfect equilibrium would appear as an isosceles triangle turned vertical. But the assumption has to be made that efficient markets make sense. If you’ve looked over the market for just the past six months, you know that’s far from the truth. Prices respond by moving up too far in a bull run and then back down again when emotion ebbs.
Yet, even when they’re driven by strong investor sentiment, markets must obey certain energetic laws. Prices moving too quickly upward must at some point come back and fill the areas that have been missed. These show up on the J-Chart display as gaps (caves), narrow price activity, or unbalanced triangles (see Figure 2).
[caption id="attachment_29073" align="alignnone" width="450" caption="Figure 2 - Real price action showing double balance points and price vacuum or “cave” in the middle. The natural tendency is to fill this void in subsequent price action unless there is an overwhelming move either higher or lower. However, sooner or later, this price cave will have to be filled. Chart provided by J-Charts."][/caption]
Price forecasting is achieved by using the J-Chart forecasting tool. Using two balance points, or an image or point of origin and subsequent balance point, a triangle is plotted by the program from which the trader can then draw a horizontal line forward (see Figure 1). And this forecasting ability is pretty cool. The program allows you to set your options as to what you can see depending on your investing objectives.
Stop losses are set using major balance points from prior days, past highs, or lows and at the horizontal blue lines plotted by the program showing significant support/resistance (Figure 1).
The trader also can use the previous day together with overnight price activity before the market opens on the trading day – trying to see if the market is still trending. Once the trading day begins – and with the intraday interval set – the trader watches everything unfold and sets new targets and stop losses as the market moves.
What to Take From This
There’s a lot of indicators and systems being churned out there in the marketplace that claim they are the best way to predict price. What sticks will be an equal combination of what has great marketing pizazz and then what works.
We’re looking at stock picking by means of science that most Americans don’t know about or want to understand. And this seems to be a trend. I think everyone needs to think about what they want from the market (and maybe you have several end games from investing). Either way, this is an available tool that gives you another way to discover trends – and that’s the whole point of technical analysis.