Now that we agree on what the trend is in the market, we can go to the next step. Remember that a bull market is defined as a market that is making higher highs and higher lows. A bear market is a market that is making  lower highs and lower lows. A neutral market is defined as any other condition.

The highs and lows can come in any order. So, we could make two highs followed by two lows. Generally, however, we oscillate between highs and lows such that we make a high, a low, a high, and then a final low. But remember, it doesn’t matter in what order the highs and lows occur.

At the top of the chart in Figure 2.3, look at the high in August. I’ve labeled the first four highs and lows. Note that in this case, the second high is lower than the first high; we can say that we are making lower highs. Also note that the second swing low is lower than the first low. Thus, we can say that we are making lower lows. This is the definition of a bear market.

My concept is very simple but powerful. We must always be long in bull markets, be short in bear markets, and stand aside in all other markets. This is the basis for the most profitable technical analysis. We only need to look at the two most recent highs and two most recent lows to determine if it is a bull, bear, or neutral market. The analysis is updated every time a market makes a new significant swing high or low.

That new swing high or low is added to our analysis. Usually, that new high or low simply confirms the current analysis but sometimes it changes the trend.

The fifth circle on the chart is a lower low than the previous low, so it merely confirms what is already a bear market. But look at the sixth circle. It is a higher low. So, at that point in time, the market is making lower highs but higher lows. So, it’s a neutral market, right? The market then breaks lower and the next circle is a new lower low and the bear market is back in place.
Buy this book: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading)

Related Posts