Mechanics and Dynamics of Charting
series is raised by another $10 due to the September contract trading at a $10
premium, the historical prices associated with the troughs in the March contract
will now be raised again from $90 and $100 to $100 and $110 instead. As can
be seen, historical prices continue to undergo change and are adjusted to the net
accumulated spread.
Another disadvantage is that due to back adjusting, there is a possibility that
past prices may become negative, especially if newer contracts are continually
trading at a discount.
This continual shifting of historical prices in back‐adjusted continuous charts
diminishes their use in relative strength analysis. Relative or comparative strength
charts will not display accurate ratio relationships if past prices on continuous
charts keep varying every time data is back adjusted. In such cases, it would be
better to use perpetual contracts, as prices are not back shifted with each new
front‐month contract. Unfortunately, perpetual contracts do not display the cur-
rent market price, but rather an estimated price, which is useless for trading
purposes. It estimates the new or further‐out rollover contract price by means
of a weighting factor, interpolating the contract price between expiration dates.
Nevertheless, perpetual contracts are useful when used as a basis for construct-
ing relative strength charts. It does not introduce as much distortion in the ratio
relationship, unlike continuous charts.3.5 Chapter Summary
In this chapter we learned how prices are filtered and used to construct various
types of charts. We also observed how the bid‐ask spread affects trading and R/r
ratios as well as how linear and ratio chart scaling affects geometrically based
overlay barriers such as trendlines and channels. The discussion on futures con-
tracts highlighted the challenges that chartists face when trying to make sense of
a sequence of individual futures contracts and how backwardation and contango
affected profitability. The various chart constructs mentioned in this chapter will
be analyzed in greater detail in subsequent chapters.figure 3.40 Back Adjusting in Continuous Charts.