Many traders and analysts, and most casual traders have no idea how to really read

a chart. For most people, chart reading involves some variation of looking for a
handful of favorite patterns on charts. Others are simply overwhelmed by the mass
of information and have no idea how to sort out what is really significant from the
hundreds of small details and random noise. Large buyers and sellers, whose
actions really determine the price of a stock, leave tell-tale patterns in the prices of
stocks. Chart patterns can be powerful tools to understand the relative conviction of
these two groups, and to get some advance warning of when their convictions wax
and wane. Nothing works all the time, but this provides the trader with a tremendous
potential edge in the market that, properly applied, can lead to consistent profits.

The first important concept is a swing high or swing low, which can also be called a
pivot (or a pivot high or low). This tiny, seemingly insignificant little pattern is the
most fundamental element —the very building block of market structure. One of the
most interesting things to notice about a market is what happens when it moves past
prior support or resistance. If, for instance, buyers push the market through
resistance but the move immediately stalls out, then we are able to define an
important “high water mark” that shows where the bears temporarily won the battle.
On a chart, the previous bar’s high and low always represent support and resistance
(though sometimes only minor), so we can define a swing high as a bar whose high
is higher than the bar before and the bar after. Old-school, the analyst would have
gone through the charts with a pencil and put a “ring” above and below these points,
so these are sometimes called “ring highs and lows”, but are marked on the chart
below with dots above and below the bars.

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Exercise 1: Take 10 charts of markets of your choosing and mark every swing high /
low on the charts. Use the following timeframes: 1 minute, 3 minute, 5 minute, 30
minute, 78 minute, daily, weekly, monthly at your discretion, but make sure to only
use the lower timeframes on active markets.

We can see several interesting facts about these swing highs and lows. First, it is not
possible to define them until the next bar has closed, meaning that there is no way to
tell if the current bar may represent a swing point until the next bar closes. Second,
these vary in importance. Some are insignificant, and would be missed by a casual
glance at the chart while some are very obvious and important. If we consider the
basic swing point to be a short-term high, we can define intermediate term highs as a
swing high immediately preceded and followed by lower swing highs. The
intermediate term highs and lows are marked on the chart below with “old school”
ring-style pencil markings:

Click picture to view in full size

Exercise 2: Take the charts from ex. 1 and mark the intermediate term swing highs
and lows on the chart.

This idea obviously can be extended to long-term highs, which are intermediate term
highs surrounded by lower intermediate term highs:
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Exercise 3: Take the charts from ex. 2 and mark the long-term highs and lows on
those charts.

So far, everything has been very rule-based and detail-oriented, but now we move
into something that is slightly more discretionary. The reason for devoting such much
attention to these intermediate and longer term swing points is that they show the
points where buyers finally overcame sellers on the downside and vice versa to the
upside. These points are important because they will act as support and resistance
on the next swing, and, by noticing how the market acts around these critical levels,
the trader can begin to understand who is really in control of the market.

We can connect the intermediate term highs and lows with lines to show the
underlying structural swings in the market. This requires some flexibility because
sometimes there will be no intermediate term low in between two intermediate term
highs, in which case you can pick another significant swing low to anchor the
downswing. There also may be the occasional swing high or low that technically fits
the rules, but is not incredibly significant on the charts. In this case, you may ignore
that point in drawing swings. Ideally, you will have swings that tend to change
direction every 3-10 bars on average, though it will depend on the market conditions
at the time. One possible way to delineate the swings in the charts above is shown
here:
Click picture to view in full size

Exercise 4: Create swing charts by connecting intermediate term highs and lows on
all the charts from ex. 2. When you have to make an adjustment or adaptation for
the placement of a pivot, write a short note explaining your decision and why it was
better than an alternative. (There is usually not one right answer, but there certainly
are wrong answers, and the thought process is most important.)

The patterns introduced here are not as exciting as some you may have seen in
other books or other websites. The truth is that those patterns do not work as many
authors would have you believe, and focusing your trading career on those patterns
will not train your eye to see balance and imbalance on the chart. This is slow going
at first, but, over a lot of time, will lead to intuition about the underlying market
structure and future direction of prices. There certainly is information to be gleaned
from the details of each bar and its relationship to the surrounding bars, but in most
cases the big-picture market structure dominates. Even if the details are important,
they are most meaningful in context of the big picture, so it is worth your time to
invest a lot of energy into learning to see swing points and market structure in any
chart