- 1997: Volume 6, No. 3 Chartist Corner: Fan Lines

There are many times when market technicians are frustrated in their attempts to place trend lines. The market seems to define a trend then quickly breaks it to establish a shallower trend. This can happen several times before the market finally makes a clear reversal and leaves a slowly rolling-over chart pattern behind.

What's in a Name?

The name for this pattern, "Fan Lines," is derived from the appearance of the chart when the multiple trendlines 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.

The September 1995 U.S. Bond futures 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 trendlines 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 trendline.

Figure 1

The fact that the market reversed after the third trendline illustrates the significance of the number three in technical analysis. Fibonacci retracements are nearly 1/3 increments, head and shoulder patterns have three peaks or valleys and the most common point and figure combination is a one box by three reversal. With Fan Lines, traders who missed the first buy/sell opportunity (the trend break) get a second and finally a third chance as the market moves back up to the previous trendlines. Fan Line patterns are, by definition, congestion zones as buyers and sellers position themselves.

When it Fails

The real test of Fan Lines as a reversal pattern comes when the third trendline is touched. If that line successfully supports or resists prices, then the original trend is still intact. The S&P 500 futures continuous contract (Figure 2) showed such a pattern near the start of the bull market in 1984. A classic fan shape was developing but the third trendline held. That line went on to support the rally for the next 12 months.

Figure 2

The bottom line is that, like any technical pattern, trades must not be made until the pattern has been resolved. Fan Lines give ample warning of a possible reversal plus a clear signal when it is time to trade.

Michael N. Kahn is a columnist for Barron's Online based out of Florida. He also writes a free technical newsletter. To subscribe to this service, please visit www.midnighttrader.com. The complete collection of Michael Kahn's "Tips on Technicals" is available in Real World Technical Analysis.