ChanLun
Price movements generate various highs and lows. Their connections form three chart types: uptrend, downtrend, and range. This is true to any market, any timeframe.
It is imperative to appreciate that on any chart, the current price is always in one of these three chart types. Since all the previous chart types have completed, the ongoing chart type will complete too. Once completed, the market will switch to one of the two remaining chart types. This cycle continues endlessly.
Chan termed this phenomenon as 走势终完美, meaning chart types will eventually complete perfectly. This simple yet critical conclusion has three meanings:
Any charts can be decomposed into completed chart types and an ongoing yet-to-complete chart type;
The uncompleted chart type will ultimately end, and
Once completed, market will transform into one of the other two remaining types.
By decomposing the chart into completed and uncompleted chart types, ChanLun traders can
isolate the ongoing uncompleted chart type from the completed ones,
determine if the current type structure is "perfect" (meet necessary and sufficient conditions) as per 走势终完美,
use its unique multilevel nested-divergence technique to identify market turning points and transitions with high confidence and accuracy.
Because the remaining two chart types are either range or reversal, traders can draw trading plans for either cases in advance, observe market's selection, and execute the plan accordingly.
This philosophy complies with the principles of markets operation, focuses on the transition areas where reward / risk ratio is the highest, provide traders with a deterministic framework with high reliability and accuracy.
As traditional methods rely on indicators or chart patterns to analyze the market, they work on certain market conditions and fail on other situations.
ChanLun, on the other hand, works in all market conditions. Therefore, it is inherently superior to the traditional trading methods.
Traders can either
apply ChanLun on its own, or
combine ChanLun's advanced multi-level structural analysis with tradition approach to achieve better timing, location and success rate.
As 走势终完美 is referred to over and over again, ChanLun traders just use "structure perfect" to describe situations where the on-going structure has met the necessary and sufficient conditions for the current chart type to end.
Now we have understood the principles of ChanLun. To apply ChanLun, we need to know how to
decompose chart;
determine turning points, i.e. buy/sell points;
plan ahead and execute the trades for the upcoming new chart types.
Two of the three components for decomposing charts, pens and pivot zones, are presented in the following sections. The other component, segments, is too complex to explain briefly, will be taught in the course.
The philosophy of ChanLun
Fractals
Definition of Fractals
In ChanLun, top and bottom structure patterns are called fractals (分型). It is different from fractals which are based on mathematical concept. As shown in Figure on the left, the high point of the second bar is the highest of the three adjacent bars’ highs, and the low point is also the highest of the three adjacent bars’ lows. This is termed as “top fractal”.
Likewise, the one in Figure on the right is called “bottom fractal”, where the low of the second bar is the lowest of the three adjacent bars’ lows, and high is also the lowest of the three adjacent bars’ highs.
Since the bottom of the top fractal and high of the bottom fractal are not meaningful, we will simply refer the highest point of the top fractal “top”; and the lowest point of the bottom fractal “bottom”.
Standardization of Fractals
In real situations there can be more complex combinations between the bars. In particular, two adjacent bars may have an inclusive relationship. Inclusion means the high and low of a bar fall within the range of another bar, either before or after it.
Inclusive bars don’t have a direction. However, on a standard ChanLun chart, every bar should be part of directional moves, either up or down. This uncertainty can be removed by merging the inclusive bars to form a new bar. Following is the approach:
a. Bearish engulfing bar
B. when moving downward, i.e. the nth bar is lower than the n-1th bar, and bar n has an inclusive relationship with n+1th bar, the lower of the two highs, and lower of the two lows will be taken as the high and low of the merged bar.
After such treatment, the chart will have no more inclusive bars.
To repeat the procedure, first, according to the definition, the fractals in the analyzed chart should be marked based on the basic processing of inclusion relationships and the law of association. The top fractals can be marked with downward arrows, while the bottom fractals can be marked with upward arrows. This way, everything becomes clear at a glance.
Psychological implications of fractals
Clearly, the reason why a top pattern is established is that the selling force ultimately overcomes the buying force. Among them, the buying force makes three attempts, while the selling force counters with three resistances.
Using the most standard three-candlestick model: after the high point of the first candlestick is blocked by the selling force, there is a retracement that occurs in the upper shadow part of the first candlestick or the lower shadow part of the second candlestick. In the second candlestick, a higher high point appears, but this high point clearly exhibits a divergence in buying force that appeared in the high point of the first candlestick, thereby at least creating the upper shadow part of the second candlestick. Lastly, the third candlestick will once again face an attack from the buying force, but this attack is completely defeated by the selling force, preventing it from becoming a new high point.
From the above, it can be seen that the topping structure undergoes a three-fold psychological struggle, the so-called "once, again, thrice" process. That's how a top pattern emerges, and the situation is reversed for a bottom pattern.
However, if the second candlestick has a long upper shadow or even a directly long bearish body, and the third candlestick fails to close above the midpoint of the second candlestick's range, then the strength of the top pattern is significant, and there is a high possibility that it will continue as a trend. For example, on the Shanghai daily chart on June 18th, 19th, 20th, and 21st, there is an inclusion relationship, but this inclusion relationship directly engulfs a bullish candlestick with a long bearish one, which is the worst type of inclusion relationship.
A. when moving upward, i.e. the nth bar is higher than the n-1th bar, and bar n has an inclusive relationship with n+1th bar, the higher of the two highs, and higher of the two lows will be taken as the high and low of the merged bar.
a. Bullish engulfing bar
b. Bullish contained bar
b. Bearish contained bar
Components for decomposition
Now, we can delve deeper into these three candlesticks.
Firstly, a pattern structure without any containment relationship indicates that both sides of the market are straightforward without much hesitation. An inclusion relationship (as long as it doesn't directly engulf a bullish candlestick with a bearish one) implies hesitation, uncertainty, and observation. Generally, on a smaller scale, there will be extensions or expansions of a congestion zone.
Secondly, let's take an example of a top pattern without an inclusion relationship. If the first candlestick is a long bullish one, while the second and third are small bearish and bullish ones, then this pattern structure has little significance. On a smaller scale, it will definitely show the formation of a new sub-level congestion zone after the sub-level congestion zone has shifted upwards. Generally speaking, the possibility of this top pattern becoming a true top is very small, and the vast majority of them are continuations. For example, the top pattern structure formed by the three candlesticks on the Shanghai Stock Index daily chart on September 17th, 18th, and 19th of 2007.
Pen
A pen is a wave-like line that connects two adjacent top and bottom fractals. Pens are one direction moves, ignoring the fluctuations in between their tops and bottoms.
A line must satisfy the following requirements to qualify as a pen:
1. The top and bottom must be adjacent, no other tops and bottoms in between them.
(Comments: it means there are no other pens inside a pen.)
2. There are at least one independent bar which does not belong to either the top or bottom fractal. This is because the associative property must be observed when connecting bars. If a bar is shared by both fractals, it would violate this law.
3. The low of the highest bar of the top fractal must not overlap with the high of lowest bar of the bottom fractal. Otherwise the high and low cannot be adequately distinguished.
Figure 5 (reproduced below) shows the standard pens. An ascending pen, as per associative property, constitutes a bottom fractal + up bar(s) + top fractal. Conversely, a descending pen must have a top fractal + down bar(s) + bottom fractal.
Components for decomposition
Pivot Zones
Sufficient Conditions For Ongoing Chart Types To Complete
In the market, inevitably there will be counter-trends. Otherwise, the current direction would continue indefinitely, which is unsustainable.
In practice, the opposing force will not give up after just one attack. It will keep attacking until it successfully terminates the current level's trend type. Therefore, each chart type must have at least two sub-level counter-trends, test(s) and confirm. This is also the implicit meaning of the perfect ending of chart types.
Therefore, any chart type of any level must consist of at least three sub-level chart types. This is the case with all the completed chart types. It is sufficient condition for any ongoing chart types to complete.
Necessary Conditions For Ongoing Chart Types To Complete
The necessary condition for the ongoing chart type to complete is there is divergence. This divergence may not necessarily be of the current level. It could be of lower level, or multiple levels form divergence simultaneously.
Note
This requirement means that Category One Buy Point is not necessarily the lowest point of the current level if there is no divergence at the lowest point. Conversely it is true for Category One Sell Points.
Category Two Buy/Sell Point
Taking the case of an upward reversal as an example, after a trend turns upward at a category one buy point and experiences its first pullback, there will be at least one more sub-level upward move.
The starting point of this second upward movement is another safe buy point, referred to as a Category Two Buy Point. Conversely, the opposite is Category Two Sell Point.
Definition of Sub-Level Chart Types
The strength of the counter-trend may not always be evident at the current level. However at a level that is low enough, usually about 1/5 of the current level, the opposition can form clear chart types. This low level is referred to as the sub-level of the current level. For example, if the current level is the weekly, the sub-level would be the daily.
Components for decomposition
Pivot Zones
When two or more sub-level counter-trends overlap, the overlapping portion of the first three sub-levels is defined as a "pivot zone".
New Definition of Trends and Ranges
Based on the concept of pivot zones, Chan redefined trends and ranges as follows:
Trends consist of two or more pivot zones at the same level. When the direction is upward, it's called an uptrend, and vice versa for a downtrend.
Range consist of only one pivot zone.
Any chart type of any level contains at least one pivot zone at that level. A pivot zone at the current level consists of three or more overlapping sub-level chart types, and a sub-level pivot zone consists of sub-sub-level chart types, and so on. Obviously, pivot zones cannot be infinitely subdivided. The lowest-level pivot zone is defined as the overlapping range of three bars.
This way, chart levels and chart types form a multi-level hierarchical structure that is recursively interrelated.
According to this definition, any chart type of any level must have pivot zones, and an ongoing chart type is only considered perfect once it has formed pivot zones. However, perfection does not necessarily mean completion. The chart type may still continue until the ending point.
Only when divergence of one or more levels occurs can the chart type be terminated. We will discuss this in later sections.
Pivot Zones
Category 2 Buy/Sell Points
Sufficient Conditions for the End of Trend Types and Category 3 Buy/Sell Points
What features indicate that the current level's chart type is no longer continuing?
According to the definitions of trends and ranges, if a trend continues, it must produce a new pivot zone at the current level. If a range continues, no new pivot will be formed. Therefore, determining whether the current level's chart type has ended becomes a question of whether a new pivot zone has been formed. To generate a new pivot zone, the trend must leave at a sub-level chart type, and the pullback at a sub-level chart type must not return to the pivot zone; otherwise, a new pivot zone cannot be created. The endpoint of such a pullback is called a category 3 buy/sell point.
Until a larger-level pivot zone is formed, the current chart type will continue. In other words, to end the current chart type, a higher-level pivot zone must be formed.
How does the perfect ending of chart type help determine buy/sell points? Several questions are involved here. First, what is a level? Second, what is a chart type? Third, how are different levels related?
These high and low points have different sizes and importance. Smaller-level trends are nested within larger-level trends, or we can say that the growth and extension of smaller-level trends construct larger-level trend types. When a larger-level trend type completes, all its smaller-level trend types are also completed.
Based on the three fundamental elements of chart analysis, "price action" (缠论) decomposes trends, isolates ongoing trend types, and confirms their ending positions as entry points. This method makes the most secure and effective use of the trend's space. This deterministic trading approach is evidently superior to probabilistic methods based on indicators or pattern trading.
