Tips on Technicals - Fan Lines
Indicator type: |
Trend line tool |
Used to: |
Identify support and resistance |
Markets: |
All cash and futures, not options |
Works Best: |
All markets and time frames but most often used for daily and longer analysis. |
Formula: |
N/A |
Parameters: |
N/A |
Theory: |
The name, Fan Lines, is derived from the appearance of the chart when multiple trend lines are drawn. It could easily have been called "Rollover Lines" or "Trend Reduction Lines" with the latter indicating that the initial steep trend is flattening into a more sustainable level. |
Interpretation: |
Fan Lines illustrate the significance of the number three in technical analysis. Traders who miss the first buy/sell opportunity (the first trend break) get a second and finally a third chance as the market moves back up to the previous trend lines. Fan Line patterns are, by definition, congestion zones as buyers and sellers position themselves.
The real test of Fan Lines as a reversal pattern comes when the third trend line is touched. If that line successfully supports or resists prices, then the original trend's direction is still intact. The market moves at a slower and more sustainable pace.
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The September 1995 US Bond future contract (Figure 1) was trending higher for most of 1995. A steep trend line was broken in June but the market traded back higher on a shallower trend line to meet the first line later that same month. Since supporting trend lines often act as resistance after they've been broken, the market fell again. This pattern was repeated in July until finally, prices fell below the third trend line.
The S&P 500 future continuous contract (Figure 2) showed the pattern near the start of the 1980's bull market in 1984. A classic fan shape was developing but the third trend line held. That line went on to support the rally for the next twelve months.
