Congestion

Stocks & Commodities V. 3:1 (13-18): Chart Congestion Analysis by Holliston Hill

Chart Congestion Analysis by Holliston Hill

Congestion areas appear in all markets whether it be gold, soybeans, IBM, or the Dow Jones Industrial Average. Being able to recognize the different types of congestion areas and knowing what they will lead to, can help the investor reap great profits.

A congestion area is a price level in which neither the bulls or bears are in complete control. Accumulation and distribution are other names for congestion areas. The market cannot make up its mind in which direction it wants to go. Congestion areas are pauses in the market action; many traders step aside to see what will happen next. During a congestion area the market fluctuates within a certain price range. These areas usually signal continuation or reversal in the previous market direction. Congestion area analysis can be applied to stocks or commodities or to any time frame whether it be a five minute chart, hourly chart, daily chart weekly or monthly chart. Because of the significance that congestion areas have in the movement of the market, it is important that the astute technician be aware of when they occur and what they lead to. I will define the different types of congestion areas and what each area signals.

Line Congestion AreaLooking at the overall picture, the most important congestion area is the Line Congestion Area. Tops and bottoms are usually defined by a Line Congestion Area. Markets have definite stagesa run up, accumulation, a run down, and distribution. Richard D. Wyckoff pointed this out 60 years ago. Accumulation and distribution, or Line Congestion Areas, occur approximately 85% of the time, and the runs only occur 15% of the time. The potential for the most profit is seen when a market has a run up or a

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run down. If one could predict when a market is beginning its run, a position at that time could prove profitable.

It is necessary to know what makes a Line Congestion Area form. The market is indecisive. The forces of supply and demand, and support and resistance are keeping the market in a particular trading area. The diagram shows how these forces pushing in both directions help form the Line Congestion Area. Once either supply or demand becomes stronger and the support or resistance lines are broken, a reversal is imminent. The more time spent in a Line Congestion Area and the larger the Congestion Area is, the more dramatic the run will be.

A reversal out of this area would signify that a top or bottom has been established. But the technician must beware of false breakouts. Very often a shakeout will occur prior to a big move in the opposite direction. These shakeouts are defined in a book by John R. Hill, Stock & Commodity Market Trend Trading by Advanced Technical Analysis, as springs and upthrusts. The chart patterns below display these false moves. A close outside of the Line Congestion Area would help confirm that a true breakout has occurred. Confirming breakouts will be discussed- in greater detail later. Springs and upthrusts signal reversals.

Still looking at the big picture (Figure 1), runs are filled with Small Congestion areas. Often a run up will form a series of L Formations, and a run down will form a series of Reverse L Formations. Figure 4 shows both of these formations. In studying these formations it was discovered that the lengths of the real runs, signified with "x"s, are close to being equal. Also, the width of the small Congestion Areas, signified with "y"s, are also approximately equal. In a long run two or more of these segments could be averaged to predict the next segment in the move. The technician may use either the Real Run or the Small Congestion Area to predict the next respective segment.

Small Congestion AreasIt is important to know the different types of Small Congestion Areas that occur so that the technician can anticipate the end of a move and predict a reversal. There are five types of Small Congestion Areas. The first type is the Descending Congestion Area (Figure 5), which can occur after either a run down or during a run up. It is signified by small periods of movement that form a descending channel of congestion. This type of Congestion Area signals a move to the upside. Just the opposite of the Descending Congestion Area is the Ascending Congestion Area (Figure 6), signified by small range periods which form an ascending channel. The Ascending Congestion Area signals an imminent move to the downside. Very often these two types of Congestion Areas form with three drives to the top or bottom of the Congestion Area before the breakout occurs. Both of these Congestion Areas are illustrated

Three other Small Congestion Areas appear in the form of triangles. Triangles usually are pauses in a run up or run down. The market will continue in the same direction it was going before the triangle formed. The Diminishing Triangle is constructed when the market makes a correction. It is distinguished by smaller and smaller range days moving out to the apex of the triangle. However, a breakout usually occurs before the apex is formed.

The support Triangle is most often found in a down move. The market reaches a support point it cannot break through. The market bounces off of this level two or three times, but rallies less and less, forming the Support Triangle. If the market can break through the support level, a breakout could be possible. The opposite of this triangle is the Resistance Triangle.



Figure 1

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Figure 2

Figure 3


The Resistance Triangle usually occurs in an upmove and has a line of resistance forming the top of the triangle. This occurs because the market tests this resistance level several times and falls back down less and less each time. A rise above the resistance level might mean a breakout is occurring, but breakouts must meet certain criteria to be true breakouts.

Predicting breakouts is the goal of Congestion Area Analysis. Certain qualifications must be observed to clarify a breakout.

1. Increased volume will be seen. Either the bulls or bears won out and a decision has been made. People on the sidelines get back in the market and the volume increases.

2. Because false breakouts often occur, there must be a close above or below the Congestion Area to confirm a breakout.

3. There must be two or three days follow-through.

4. A significant move above or below the pivot point of the particular congestion area is needed. Pivot Points of each congestion area are shown in the following diagram.

5. No immediate move back into the congestion area range within four to six days. Congestion areas ranges shown below.

Now that Congestion Areas and Breakouts have been defined, how can the technician use this analysis to profit? The hardest part is recognizing a Congestion Area and knowing which type it is. Looking at the overall picture can help here. If the market has just had a major move down, a bottom is likely to form. In this situation one would look for a corrective indecisive action. During a run, the technician would look for pausestriangles, or for reversalsCongestion Channels.

Specifically, when a Line Congestion Area has been defined, springs, upthrusts, and reversal periods signal breakouts. Take a position when a support or resistance level is broken. Put a stop loss at the midrange of the congestion area or at the support or resistance level. A reversal along with the stop loss would be smart in the event of a false breakout. A spring or an upthrust has occurred and a move in the opposite direction is expected.

When you have a Descending or Ascending Congestion Area, take a position when the market crosses the channel line or the pivot point line. A move above or below the left pivot point line signifies a stronger breakout. The stop on this trade should be put at the right pivot point line.



Figure 4

Figure 5


Figure 6

Figure 7


Figure 8

Figure 9


Diminishing triangles are often indecisive. Buy or sell on a move above or below the corners of the triangle. Put a stop loss and a possible reversal at the opposite corner.

When a Support or Resistance triangle forms, buy or sell when the market crosses the respective line. Put a stop loss and reversal at the pivot point line drawn off of the top or bottom of the triangle depending on which type of triangle. See the diagrams below.

All of this information can be applied when one is looking back at chart formation. The key is to use this



knowledge to predict the next move of a particular market. Also it is important to approach each position as a business person would. This means one should take small losses as well as small profits. Do not expect perfection. Each trade should carry a stop loss and possibly a liquidation. Trailing stops are recommended to protect your profit if you do not wish to liquidate your position.

The ideas presented here are the author's. In order to make them yours and to be able to profit from them, you must study many charts and be able to recognize the Congestion Areas and what each signals.



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Congestion

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