Hansen, Toni - Quick Reference Guide To Successful Market Timing
Hansen, Toni - Quick Reference Guide To Successful Market Timing
About Toni Hansen Toni is one of the most respected technical analysts in the industry with a high reputation for accuracy in both bull and bear markets. She began her trading career as an equity swing trader and has since expanded to position trading, long term investing and Day Trading eMini futures. Throughout the boom and bust of the last decade, Toni has been consistently trading and educating new traders. Her students include money managers, professional market analysts and traders, as well as those simply wishing to hone their market skills. Toni has pioneered unique strategies that adjust with the changing markets. Toni is a frequent presenter at the trade shows and trading expos. Toni recently co-authored of Online Trading by Stocks, Futures & Option (SFO) Magazine. Toni is also the author of three widely distributed trading recommendation newsletters.
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Introduction
Dear Trader,
Market participants are often divided into two distinct categories: Fundamental Analysts and Technical Analysts. Fundamental analysts focus on the cause of market moves, whereas technical analysts study the moves themselves and care very little as to what causes them. There are many die-hard proponents for each of these two styles and even within the categories themselves there are many different approaches. While I certainly respect the fundamentalists, this style of trading tends to favor those who are looking to maintain long-term positions and for whom market timing is not as relevant. Many fundamentalists have a basic concept of technical analysis and will utilize it to assist in market timing, but the opposite is not as important. Success as a technical analyst requires no knowledge or skill as it relates to understanding the fundamentals of a security. In fact, as strange as it may seem, one does not even need to know what the underlying security is or what it does in order to profit from the technical analysis of the security. Many participants in the financial sector find it difficult to place much trust in technical analysis. In some circles it is viewed as akin to studying astrology as a means of predicting ones future. In recent years, perhaps as a result of the plethora of information available on technical analysis on the web and the appeal of the simplicity it appears to represent, technical analysis is becoming more main stream, although still not viewed with as much credibility as its counterpart. On a recent visit to New York, I was at CNBC and one of the senior producers for their top programming inquired as to what recent positions I had found myself in. Given that the topic was on longer term positions, I told him the symbol of my most recent acquisition. What do they do? he asked. I have no idea, was my reply. Well, what is the company? I dont know, I only know the symbol, but I can draw for you exactly what the chart looks like. The folks in the room were incredulous. Another producer commented, That seems a little unusual, dont you think? Given the company I was in, I was actually surprised myself at just how speculative many are when it comes to this line of study and the question caught me completely off-guard. Nevertheless, I have found it to be one of the most accurate methods of producing consistent results that has proven the test of time. I do not take an extreme view of market analysis, however, since I know many traders who are primarily fundamentalist traders and do quite well. The main difference is that technical analysts, or chartists, as they
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are often called, have the advantage of being able to apply their skills across numerous market vehicles and times. For instance, once a trader has a solid knowledge of technical analysis, he or she can apply it to scalping, holding only a few minutes at a time, or to long term investing. They can trade stocks, or apply their knowledge to options or futures markets. They can also move from one time frame and market to another with relative ease, whereas a fundamental analyst tends to have a more limited choice of trading or investment options. The underlying principle of technical analysis is that it is based upon human psychology and that human behavior can be displayed in the form of a chart. Coming from a background in anthropology, and particularly archaeology, this seemed like a logical conclusion since I had studied everything from language development to migratory settlement patterns in just such a manner. Chartists are quite aware that there are reasons why markets move higher or lower, but we dont believe that understanding them is necessary to predict where the market is heading next. For example, it may be a drought that is pushing a food source further north in a particular region, and hence the population is also moving in that direction. The cause, however, may not be recognized until after a great deal of study. What first becomes apparent to the archaeologist is that a population is on the move and at some point that movement slows or comes to a halt. If an archaeologist sees that a population has moved from one location to the next, and is pushing further in a certain direction, it is possible to guess which direction to continue to explore. If he or she waits to discover the reason that a move has taken place, however, before making an educated guess as to where they have gone, then another team of archaeologists may beat them to the punch and already establish the rights to excavate in the new locale. Similarly, the fundamental reasons for a market move may not be apparent at the beginning of a market move. Often an upside price movement will begin prior to the realization that the fundamentals in a security have begun to reverse and favor such a move. If the trader waits for the fundamentals to be favorable, then he or she will often miss the most ideal entry price on a security. When it comes to technical analysis itself, there are a number of schools of thought as to what the best strategies and techniques are. My own understanding of the market and the style of technical analysis I have employed over the years has changed a great deal, evolving as my own understanding of the markets has evolved and matured. I have identified a number of highly successful patterns that repeat on virtually all time frames and in every security that I have studied. For those traders familiar with basic technical analysis, many of these will look very familiar. In this manual I have compiled the setups illustrating my own specific take on how to enter and manage each of these market patterns. Many of these methods vary in some degree from the mainstream teachings of these patterns and my style relies having upon the combination of time frames and identifying patterns
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within other patterns to aid in the most precise entry and exit timing possible. When studying the patterns in this manual, I recommend first reading through each of the setups and the accompanying examples of the patterns. Next, begin compiling your own notebook with charts that illustrate the patterns I have outlined and create both pro and cons lists on each of the setups. This will help you grow and develop a better understanding of the dynamics at play within each of the patterns. Good trading! All my best, Toni Hansen http://www.tonihansen.com
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Table of Contents
Legal Notices and Disclaimer ............................................................................... 2 Introduction .......................................................................................................... 3 Table of Contents................................................................................................. 6 Terms to Know ..................................................................................................... 7 1-2-3 Continuation Buy Pattern ............................................................................ 9 1-2-3 Continuation Short Pattern........................................................................ 13 2B Setup ............................................................................................................ 15 2T Short ............................................................................................................. 19 Ascending Triangle............................................................................................. 20 Avalanche .......................................................................................................... 25 Bear Flag............................................................................................................ 31 Bear Trap ........................................................................................................... 34 Breakout (from a Trading Range or Consolidation) ............................................ 35 Bull Flag ............................................................................................................. 42 Bull Trap............................................................................................................. 44 Core Buy Setup.................................................................................................. 45 Core Short Setup................................................................................................ 46 Cup-with-Handle................................................................................................. 47 Descending Triangle .......................................................................................... 50 Double Bottom ................................................................................................... 52 Double Top......................................................................................................... 53 Gap Trap ............................................................................................................ 57 Head and Shoulders........................................................................................... 62 Oops Pattern ...................................................................................................... 66 Pennant.............................................................................................................. 67 Phoenix .............................................................................................................. 68 Symmetrical Triangle.......................................................................................... 69 Wedge Pattern ................................................................................................... 71
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Terms to Know
Apex: The point at which the upper and lower trend lines in a triangle converge. Confirmation: When a number of factors are working together to support a price move. For example, if volume is increasing when prices move higher on a range breakout, then the volume is confirming the buying. Divergence: When market indicators and prices are showing different biases, such as when prices are moving higher out of a trading range, but volume is light. Pattern setups in the direction of the trend become higher risk when there is a lot of divergence in a security since it often warns of an upcoming price reversal. Downtrend: When the primary price direction of a security is to the downside, created by a series of lower highs and lower lows within the declining trend channel. Gap: Spaces on a candlestick or bar chart where no trading has taken place. When a security closes trading on one day at a certain price for instance, and opens at a different price, then the space in between the two price levels is called the gap. Inside range bar: This occurs on candlestick and bar charts where the range of one bar is inside the range of the previous bar. For example, if a stock has a bar with a range from $49 to $50, and the next bar has a range of $49.50 to $49.90, then the second bar is inside the range of the first and is hence called an inside range bar. Momentum: Also known as pace, it is a measure of the rate of change in price over a selected span of time. Moving average: An indicator used to show support and/or resistance levels that averages the price action in a given time span. They work best in a trending environment. A 20 period simple moving average takes the closing prices of the last 20 bars (20 days on a daily chart) and adds them together. It then divides that number by 20 to give the price of the moving average. Other types of moving averages are the exponential moving averages and weighted moving averages. Narrow range bar: In candlestick or bar charts, it is a bar that has a much more narrow range than average. For instance, if a daily bar has a typical range of $1, then a bar with a range of $0.25 would be considered to be a
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narrow range bar. It is typically a period of consolidation or indecision in the security. Resistance: A price zone above the current trading level where sellers are likely to appear and end or stall a rally. The most common type of resistance is a form of price resistance. Stop: A price level at which point, when broken, it proves that a position is incorrect and unlikely to produce gains, at least not without a greater adverse move. It is also the maximum price that a trader is willing to put at risk on a position. Support: A price zone underneath the current trading level where buyers are likely to appear and end or stall a price decline. The most common type of support is a form of price support. Tick: The smallest move possible in a security. In stocks this is one cent. In the S&P and NASDAQ EMini futures it is a quarter of a point. In currencies this is called a pip. Trend channel: It is the channel between the trend line in a trend and a line that connects the pivots on the opposite side of a trend. In an uptrend the trend line connects the lows in the trend, while the upper trend channel line would connect the highs of that uptrend. Trend line: A line drawn on a chart that connects either the highs in a downtrend or the lows in an uptrend. When prices break a trend line, then a reversal or larger correction to the trend is common. This is particularly true when prices hug the trend line prior to breaking. Uptrend: When the primary price direction of a security is to the upside, created by a series of higher highs and higher lows within an ascending trend channel. Volatility: A measurement of price fluctuation in a security. When a security
moves sharply with a lot of back and forth activity, then it is considered to be volatile.
Wide range bar: In candlestick or bar charts, it is a bar that has a much larger/wider range than average. For instance, if a daily bar has a typical range of $1, then a bar with a $3.00 range would be considered to be a wide range bar.
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first bar. Volume: Lighter than average volume on Bar #2, followed by increasing volume as the highs of Bar #2 are broken. Correction Periods: Higher probability of success if the setup triggers on Bar #3 as it is coming out of a correction period. Support/Resistance: This pattern tends to be the strongest when it is coming off a larger time frame support level. A base on Bar #2 that pulls into a moving average support level as it sets up, particularly the 20 period sma, will increase the odds of success. Often the highs of Bar #1 and Bar #2 will be at a resistance level such as whole number price resistance. If a significant resistance level is just above the highs of those bars, then it will add risk, since the security will more often stall at that point. Watch for prior highs such as the highs of the third wave of selling on ATVI shown below in Figure 2, for resistance to assist with targets. Trend Placement/Trend Development: Look for a setup near the beginning of a new trend, such as after three waves of selling, as was the case in the daily setup on ATVI shown in the example which follows. This pattern is also strong when it takes place on a larger time frame breakout.
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5. The base on the 15th lasted right into the 30 minute 20 sma support, which was followed immediately by the breakout. 6. ATVI had three waves of selling on the daily charts ahead of the continuation pattern. This trend development is typically followed by a larger correction. 7. ATVI had hit strong daily support at previous lows, making a bounce highly probable. 8. There was a lot of room from the time of the breakout until the next major resistance from the highs of the third wave of selling on the daily time frame would hit. This left quite a bit of potential for the setup.
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3. Within the second bar on the weekly time frame, SGR formed a strong consolidation and broke lower on the third test of lows within that consolidation and heading into bar 3 on the weekly time frame. 4. Volume declined as SGR consolidated in the second bar of the continuation pattern. 5. No immediate support to stall the continuation move. 6. The momentum at the beginning of bar 3 was as strong as heading into bar 2, allowing for SGR to hit an equal move target on the weekly time frame.
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2B Setup
Description: This pattern is a form of a double bottom, whereby the second low is just slightly lower than the first, serving to trap new shorts and flush out those holding onto positions as a long. A 2B is also a form of a bear trap, since it traps any new short traders, as well as flushes out any remaining bulls who suddenly become scared that the bears are going to continue to push the security lower. Criteria: One low followed by a slightly lower low. The second low should not be barely noticeable as a lower low in order to be the most favorable as a reversal pattern. Intraday this may be just a few ticks, but it could be a few points in a stock on a weekly chart. Entry: Over the prior bar's highs after the second low is made. For instance, if the high of the bar making the second low is $50, entry is over $50. The only time it is not over the bar that made the second low is if that low is followed by an inside range bar, in which case the entry is a break in the highs of the inside range bar. Alternately, a downtrend line can be drawn on the move into the second low with an entry when that trend line breaks, as well as the previous bars highs in that smaller downtrend into the second low. Stop: Under the second low or drop down and watch for a smaller time frame Phoenix or Reverse Head & Shoulders pattern to place the stop under a smaller time frame base which is higher than the absolute low of the second low. Target: Price or moving average resistance. The more levels of resistance converging at one particular level, the more likely the move will stall or end there. In the example of DECK shown in Figure 5 for instance, $71.50 price resistance hit at the same time as the closure of the gap from the 27th into the 28th, which was also some congestion from the afternoon on the 27th. At the second target level, DECK hit $72.00 exactly. This was also the 15 minute 200 simple moving average, which is typical resistance on a 2B. This corresponded to the congestion zone from most of the trading day on the
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27th prior to the breakdown that afternoon. Correction periods will also often stall or end a move, such as 9:45 am ET on March 30th and the open on April 2nd. Ideal 5 Tech Tools Traits: Pace: Strong initial move into lows, followed by a much more gradual move into the second low. Sometimes it will begin by moving slowly into the second low and then make a rapid move at the last minute as it comes into the prior low with a spike in volume. When this happens then a Phoenix or a 2B on a smaller time frame is common before a larger correction off the lows occurs. Volume: Strong volume on first low with declining volume into the second low. Correction Periods: First and/or second lows hitting with a correction period. Support/Resistance: Strong support on multiple time frames or multiple types of support hitting at once. When the security hugs a resistance levels as it moves into the second low. When there is no immediate overhead resistance to stall a move higher off the second low. Trend Placement/Trend Development: Watch for this setup to follow three waves of selling. Sometimes the second low in the 2B is the third one in a larger trend. Sometimes it is a fake attempt at a fourth continuation in a trend. This pattern can also form within a trading range and is particularly of interest when that base is at highs in a larger uptrend, leading to a breakout from the trading range.
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2T Short
Description: A 2T is the 2B setup reversed at highs for a short. Simply change support to resistance and buy to sell and vice versa in the above description of the 2B to give the short criteria for the 2T. A 2T is a form of double top as well as a type of bull trap since it traps new buyers who entered when the security made new highs. (See double top for an example of another variation on this setup.)
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Ascending Triangle
Description: This triangle pattern has a narrowing trading range, just like any triangle, but the upper trend line is flat, or nearly so, and has a rising lower trend line. In other words, as the security comes into the upper end of the narrowing trading channel, it is more consistent at hitting similar prices along the highs, while it has greater price differences from one low to the next. This is typically regarded as a bullish pattern, but when the height of the triangle is much wider than the average ranges in the security, then it tends to have a higher failure rate. Criteria: A series of comparable highs and higher lows, creating a narrowing trading range that hugs the upper trend line of the trend channel. There must be at least two highs and two lows within the range to be identified as a triangle. Entry: There are several entry techniques that work well on this pattern. 1. The first, and probably the most common, is to wait for the upper trend line of the triangle to break higher. 2. Another is to watch each of the highs within the triangle and to place a buy above the prior high once it breaks. 3. A third setup, which is the one that will generate the higher reward compared to risk, is to watch the moves within the triangle and monitor the pace of each of the moves. When the security pulls back more gradually off the highs then before, or hugs the upper trend line, then use a break higher from that smaller downtrend or sideways trend within the larger triangle pattern.
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Stop: Under the last pivot low within the range, or if it bases on a smaller time frame within the larger triangle, then a stop can be placed under the lows of that smaller range. Be careful using these tighter stops, however, if the security is very volatile, meaning there is a lot of back and forth action and overlap even as it trends, if the pace has yet to change within the range when it breaks, or if the security is thin, such as under 500,000 average shares traded per day in the case of a daytrade in a stock. Target: There are several main price resistance levels based purely on the triangle itself that can be used as targets. The one which is most appropriate at any given time will depend upon where the pattern is located in the larger trend. 1. As a more aggressive setup and the level most likely to hit independent of the trend placement, measure the last upside move within the triangle itself and then add that to the last low within the triangle that leads into the breakout of the range. This is the first price resistance. 2. The second method is to measure the pattern at its widest point, which is typically from the first high of the triangle to the first low within the triangle and then project this out from the breakout point of the triangle. 3. When trend placement is within a newer uptrend, whereby the pattern is serving as a continuation pattern for that trend, and there is little overhead resistance, then another type of target can be used, measuring the upward move leading to the first high of the triangle. Then take that move and add it to the second low of the triangle, or if one of the subsequent lows is lower than the second, then add it to that and project that move higher. Sometimes this yields a similar target as the second method, but this method can only be used in an uptrend, whereas the second can be used even when the ascending triangle takes place as lows and is serving as a reversal pattern.
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Watch for higher volume on the upside moves within the triangle and lighter volume on the downside as the pattern progresses in order to serve as a buy setup.
Correction Periods: When the last pivot low within the triangle, or the breakout from the triangle occur at the same time as a correction period. Support/Resistance: As a continuation pattern this setup is most ideal when it forms into the uptrend line on a larger trend, or moving average support such as a 20 period sma. Look to check to see if that level was also support on a previous correction, or if this is the first correction in a new uptrend, then check to see what the previous moving average resistance level was that broke to create the first higher high. If there is strong resistance on a larger time frame, such as the triangle forming intraday on a 15 minute time frame and there is a 50 day sma overhead that will be hitting for the first time in the trend move, then that level will have a more difficult time breaking. The same is true of it forms on a 5 minute chart and has a 5 minute 200 sma shortly overhead.
Trend Placement/Trend Development: The ascending triangle is typically considered to be a continuation pattern, but can also be a reversal pattern. As a continuation pattern, it is best if the uptrend has only has one or two waves of upside. As a reversal pattern it helps if the pace of each of the downside moves in the previous downtrend is slower then the one that preceded it and that there were three waves of selling within that downtrend. Even though such a reversal can take place after only two waves of downside, this is higher risk unless those two waves of downside, followed by the ascending triangle, takes place within a much larger uptrend, so that the downtrend itself is simply a correction in that uptrend. In terms of trend development, a typical triangle will break out somewhere between 2/3 and 3/4 of the horizontal width of the triangle if the upper and lower trend channels are extended until they converged. The break tends to take place on the third or fourth test of the upper trend line. Example of an Ascending Triangle Buy Setup Example #1: 2 Minute Ascending Triangle in Liberty Media Holding Corp. (LCAPA) Figure 8: 2 Minute Ascending Triangle in Liberty Media Holding Corp. (LCAPA)
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Avalanche
Description: The Avalanche is a reversal pattern that triggers a short. Essentially, it is the first continuation pattern that creates a new downtrend. It can occur as a breakdown from an uptrend, or as a smaller breakdown pattern within a larger trading range breakdown. Two specific types of Avalanches are more commonly known as a Head & Shoulders pattern and a Reverse Cup-withHandle. The entry trigger on an Avalanche, however, is not the same as on a Head & Shoulders pattern.
Criteria: 1. Uptrend or sideways trend. 2. Stronger than average rally. 3. Pullback that is comparable to or stronger than previous rally, usually on increasing volume into moving average support (typically the 10, 20, 40 or 50 simple moving average). 4. Hugs the moving average support on decreasing volume.
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5. Moving averages start to converge (10 and 20 sma if it's been hugging the 20 sma.) Entry: Switch to smaller time frame and enter on a breakdown in support or going into resistance. A break in the trend line from the lows of the congestion along the support level can also be used, particularly if the waves of buying and selling within that congestion are more difficult to discern. Stop: Over the last pivot high within the trading range, or drop down to smaller time frame and look for a smaller base at lows in the larger base and place a stop over the highs of that smaller base. Target: Next major simple moving average support. An Avalanche along the 20 sma would have a target of the 40 or 50 sma. Also watch for an equal move compared to the drop into the Avalanche range from the highs. This works best if the pace of the breakdown is the same as the pace of the drop into the Avalanche base. Notice how this level stalled both the move in the ES intraday, as well as on the daily of GROW, which also was subject to simple moving average support at the 100 day sma when the 40 day sma that the Avalanche formed along gave way. Ideal 5 Tech Tools Traits: Pace: Above average pace on the reversal from highs, followed by slower than average upside as support holds. Within that congestion along support, it is preferable to see the momentum slow on the upside moves and increase on the downside. Volume: An increase of volume into the simple moving average support, declining volume as the support holds and congestion forms (particularly at the end of that congestion), followed by an increase in volume as the support level gives way and the pattern triggers. This provides confirmation for the setup. The volume will often spike again as it comes into the next support level and first target zone. Within the congestion itself, prior to a breakdown, it is best that upside volume is lighter than downside volume. Correction Periods: Higher probability if the setup triggers coming out of a correction period. Support/Resistance: When the base of the Avalanche pattern is directly on top of or is cut in half by the moving average that it is hugging, the odds are higher for a strong momentum breakdown than if the base or consolidation is directly under the moving average. When forming along moving average support, the approach of the next fastest moving average and an impending crossover of those two is a strong pro. For instance, if the security is basing along the 20 day sma,
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then the imminent crossover of the 10 and 20 day simple moving averages will increase the success of the breakdown. Check the next larger time frame for support. For instance, if an Avalanche is forming on a daily chart at the 20 day sma, then the 20 sma on the weekly chart is strong support. So if it is near at hand, then it can place a strong constraint on the reward potential for the setup. If the Avalanche is forming within a trading range, then it is nice to see the range pulling into a larger moving average resistance level just prior to breaking lower.
Trend Placement/Trend Development: When a security has had three waves of buying already and then attempt to form an Avalanche, the odds are higher for success on a subsequent Avalanche. When dealing with an Avalanche that forms within a trading range then it is best if there have been at least two waves of selling already within the range, if not three.
Avalanche Examples
Example #1: ES 5 Minute Avalanche
Figure 10: Intraday ES Avalanche
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8. GROW had a narrow trading range along support, allowing for a small stop compared to the potential based upon the expectation of an equal move on the breakdown as compared to the drop at the start of the year. 9. The pace at the start of the breakdown was strong and volume picked up as the support broke. These confirmed the move and allowed the stock to put in an equal move on the breakdown as compared to the initial drop into January.
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Bear Flag
Description: A bear flag is a continuation pattern in a downtrend. The term is most commonly associated with a more gradual counter-trend move in the form of a parallelogram that slopes higher, creating a smaller time frame uptrend. Criteria: Established downtrend with at least one lower low and one lower high. Bounce off support that is more gradual than the previous drop into it. Entry: Several methods can be used for entering a bear flag. The first is to draw a lower trend line that connects the lows of the gradual uptrend that forms the flag and use a break of that trend line to enter. The second method is to wait for at least two pivot lows to form within the flag and then when the flag breaks the previous pivot low, use that to enter. The third and most ideal entry trigger is to drop down to a smaller time frame and look for a smaller base or more gradual move higher after at least two lows have formed and draw a trend line under those lows, using a break of that trend line as an entry trigger.
Stop: The most conservative stop is over the highs of the flag. A more aggressive one, which is ideal when the 5 Tech Tools line up, is a stop just over the last segment of the flag, such as the last tiny base or uptrend within the flag just before it breaks down. (For more information on the 5 Tech Tools, check out Tonis latest CD course at http://www.swingtrader.net.) Target: When the pace of the breakdown is similar to the pace heading into the flag, meaning the prior selloff, then a move identical to the previous selloff is an ideal target. For example, if an index falls 10 points from highs to the lows at the start of the bear flag, then a target on the breakdown from the flag is another 10 points, starting from the highs of the flag and then subtracting 10 points from that level. If the momentum is faster than the drop into the flag when the flag breaks, then it can form a larger than equal move, where if the momentum is a lot more gradual coming out of the flag than it was heading into it then the security will have a more difficult time achieving that equal move.
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fourth wave of selling, then the flag should take a bit longer to form than the previous two correction periods. In the case of two 30 day corrections and three waves of selling, the next correction would last 45-60 days before breaking down with a larger bear flag. In order to easily break the lows at the beginning of the flag, the flag should retrace no more than 1/3 of the previous selloff. If it corrects more than that, then the low at the start of the flag will tend to serve as initial support and this can lead to a bounce back into the upper zone of the flag before it then can continue on to break that low. The risk in a larger percentage of price correction is that the support holds, a longer triangle forms, and the momentum reverses. Risk also increases that if the previous lows do break, usually after at least a 50% retracement of the prior selloff, then they do so with only a slight break and a 2B reversal will form, trapping any bears that shorted under the previous low. This will usually take place when volume is lighter on the continuation out of the flag than compared to the drop heading into it.
Bear Flag Example: See Bull Flag for an example of the opposite pattern for a continuation in an uptrend. The criteria are the same, just flipped upside down.
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Bear Trap
Description: This is a rather generic term given to any pattern which traps bears by triggering a false break in support which is immediately followed by an upside reversal, hence trapping any new bears who took a short position on the attempted break in the support level. A 2B is one form of a bear trap. See gap trap for examples of other bull and bear traps on the daily time frame.
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3. A third setup, which is the one that will generate the highest reward compared to risk, is to watch the moves within the triangle and monitor the pace of each of the moves. When the security pulls back more gradually off the highs then before, or hugs the upper trend line, then use a break higher from that smaller downtrend or sideways trend within the larger trading range for an entry trigger. Stop: Under the last pivot low within the range, or if it bases on a smaller time frame within the larger trend channel, then a stop can be placed under the lows of that smaller range. Use greater caution when keeping a tighter stop such as this if the security is very volatile, meaning there is a lot of back and forth action and overlap even as it trends, if the pace has yet to change within the range when it breaks, or if the security is thinly traded. Target: The targets on a breakout will depend upon whether they are continuations or reversals of the previous trend. In the case of a continuation buy pattern, when the pace or momentum on the breakout move is comparable to that of the move heading into the trading range itself, then a target is an equal or measured move. This involves taking the move into the range, from the lows of that move to the highs at the start of the range, and then comparing that to the lows at the start of the breakout and projecting them higher. If the momentum is slower than the previous rally, then it will be more difficult to hit that equal move and it will be necessary to identify closer resistance levels. If the momentum is stronger than that previous move, then a larger than equal move can form. When the breakout from the range is a reversal pattern off lows, however, then monitor the price and moving average resistance levels overhead. If a downtrend preceded the base at lows and then it turned around and headed higher, then the level at which a previous bear flag broke lower would be resistance and a strong initial target, as would a resistance level such as a 200 period simple moving average, although any number of major moving averages can come into play on multiple time frames to serve as resistance. The resistance will be much stronger if several resistance levels are hitting at about the same time.
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Volume: Watch for declining volume throughout the patterns development with higher volume on the upside moves within the range and lighter volume on the downside as the pattern progresses. The best ones are when the volume is at its lightest level of the day just prior to the breakout as it bases at highs or pulls back gradually (in the case of a daytrade). Correction Periods: It is ideal when the last pivot low within the range, or the breakout from the triangle occur at the same time as a correction period. Support/Resistance: As a continuation pattern this setup is most ideal when it forms into the uptrend line on a larger trend, or moving average support such as a 20 period sma. Check to see if that level was also support on a previous correction, or if this is the first correction in a new uptrend, then look to see what the previous moving average resistance level was that broke to create the first higher high. If there is strong resistance on a larger time frame, such as the triangle forming intraday on a 15 minute time frame and there is a 50 day sma overhead that will be hitting for the first time in the trend move, then that level will have a more difficult time breaking. The same is true if it forms on a 5 minute chart and has a 5 minute 200 sma shortly overhead.
Trend Placement/Trend Development: A breakout is typically considered to be a continuation pattern, but can also be a reversal pattern. As a continuation pattern, it is best if the uptrend has only has one or two waves of upside. As a reversal pattern it helps if the pace of each of the downside moves in the previous downtrend is slower then the one that preceded it and that there were three waves of selling within that downtrend. A typical breakout tends to take place on the third or fourth test of the upper trend line for the trading range.
Breakout Examples
Example #1: Weekly Breakout Buy Pattern in Chicago Mercantile Hldgs Inc. (CME)
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with another narrow stop level as compared to a setup with the absolute breakout from the $500 zone (entry #3). 8. No strong resistance overhead.
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Pros on Breakout:
1. Stronger upside momentum out of the 10:45 ET reversal period as compared to the drop into it. 2. Slower sideways base with consistent back and forth action within a trading range. 3. Volume declined as the range progressed. 4. Narrow trading range as compared to the upside move into it, allowing for strong reward potential versus the risk. 5. Momentum was strong out of the range, with an increase in volume, allowing for FUL to hit an equal move target. 6. FUL based into the 50 period simple moving average, which served as a support level for FUL to bounce off of and trigger the breakout. 7. FUL held the upper trend line from the range more steadily than the lower end, which hit twice ahead of the upside breakout. This meant that essentially, FUL broke out on the third test of the highs of the range, even it looking at the highs made this difficult to discern, and instead it was important to count the lows.
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Cons on Breakout:
1. No solid back and forth moves within the trading range to show a strong momentum change within the range itself. 2. Volume spiked ahead of the breakout itself on a brief flush into 11:30 ET. 3. No correction period to correspond to the breakout trigger.
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Bull Flag
Description: Also known as a core buy setup, the traits for a bear flag can be reversed to apply to a bull flag. A bull flag is a continuation pattern on the upside, consisting of a gradual pullback in the form of a parallelogram which slants slightly lower on the right.
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3. Volume declined throughout much of the trading range, except at the beginning of January when volume typically increases as a result of annual portfolio turnover. The volume decline on the last wave of selling within the range was particularly important. 4. The best breakouts from a trading range occur on the third or fourth test of the highs of the trend channel. In the case of AUY the third pullback from highs was less than the prior two and was followed by the breakout from the flag on the fourth test of highs. 5. January is a correction period for the market, so continuation patterns are more common at this time.
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Bull Trap
Description: This is a rather generic term given to any pattern which traps bulls by triggering a false break in resistance which is immediately followed by a downside reversal, hence trapping any new bulls who took a long position on the attempted break in the resistance level. A 2T is one form of a bull trap.
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Cup-with-Handle
Description: This is a specific type of Phoenix pattern is named after its appearance. It consists of rounded lows which resembles a cup, followed by a gradual pullback or base at the upper right lip of the cup formation, aptly name the handle. Often the handle will begin at a slightly lower high than the left side of the cup. For instance, if the downward slop on the left has a high of $50.25, then the high heading into the cup might be right at the $50 price resistance. Cups-with-Handles which have a slightly lower high at the right are often stronger when they break out than those that have comparable highs or a slightly higher high at the right side of the cup. Criteria: A stock coming out of a downtrend with rounded lows, creating a cup-like appearance. This is then followed by a base or gradual pullback, called the handle, that only retraces a fraction of the right side of the cup. Entry: Draw a trend line along the highs of the handle and enter when that trend line breaks. Ideally, drop down to a smaller time frame and use the entry criteria from a flag, triangle, or breakout pattern in order to minimize the risk and increase the reward potential. Stop: Under the lows of the handle or using the stop criteria from a flag, triangle, or breakout. Target: An equal move when comparing the move from the low of the cup to the high at the left side of the handle to the move from the low of the handle upward. Also watch the next time frame higher. If the cup-with-handle formed the handle along a 5 minute 20 simple moving average for instance, then the 20 period sma on the 15 minute time frame will be resistance.
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Correction Periods: Higher probability of success if the cup finds support at a correction period and the security breaks out of the handle at a correction period. Support/Resistance: Support hitting on multiple levels at the low of the cup is ideal. The handle should then form just under a resistance level such as a 20 period sma, hugging that level. If it breaks the 20 sma and then bases along the top of it the risk is higher that the follow through will not be as strong. Check the resistance levels on multiple time frames. Those with the least overhead resistance will have the most room to move when the pattern triggers and hence be the most likely to have strong follow-through. Trend Placement/Trend Development: This pattern can form at several levels as either a reversal pattern off lows to end a downtrend, or it can take place along a larger resistance level, creating a continuation pattern in an uptrend. In the cup with handle pattern itself, the risk is lower when the handle takes 1.5-2 times as long to form as the move up off the lows into the start of the handle.
Cup-with-Handle Example
Example #1: Intraday Cup-with-Handle Setup in Archer Daniels Midland Co. (ADM)
Figure 16: Archer Daniels Midland Co. (ADM) Intraday Cup-with-Handle Setup
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Descending Triangle
Description: This pattern is the opposite of the ascending triangle. All of the characteristics of an ascending triangle and criteria for that pattern can be reversed to apply to the descending triangle. A descending triangle has a narrowing trading range, but the lower trend line is flat, or nearly so, and it has a declining upper trend line. In other words, the lows gravitate around one particular support level, while each consecutive high is lower than the last. A descending triangle is typically a bearish pattern, but there are plenty of exceptions, particularly when the height of the triangle is extreme.
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2. The initial pullback from highs took the form of two waves of selling before falling into a descending triangle along the $30 price support level. 3. The triangle took between 1.5-2 times as long to form as the decline off Julys highs. 4. The 20 week sma served as resistance during the formation of the descending triangle. 5. The triangle had three waves of buying within it before breaking lower. 23 waves of buying in a descending triangle is ideal. 6. The lows of the triangle were very comparable, while the highs moved steadily lower. 7. The pace within the triangle turned over on the last wave of buying, creating a significantly slower upside move than the previous downside one and allowing for entry potential when that last uptrend within the descending triangle broke lower as opposed to taking a trigger when the lows of the triangle itself broke. This allowed a trader to take twice as many shares and still have the same risk, hence doubling the potential gain. 8. Volume declined during the last wave of buying within the triangle. 9. There was no immediate support once the triangle gave way that would hinder a decent continuation to the new downtrend.
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Double Bottom
Description: This reversal pattern is the opposite of the double top. It is formed when a new low is made and then is tested for a second time. A 2B is a form of double bottom whereby there is a slight difference between the two lows with the second low slightly lower than the first. In other variations of a double bottom the second low can be exactly the same as the first or be very slightly above the first. The difference between the two, however, should be barely noticeable.
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Double Top
Description: This is a reversal pattern formed when a new high is made and then is tested for a second time. A 2T is a form of double top whereby there is a slight difference between the two highs with the second high slightly higher than the first, but in other variations of a double top the second high can be exactly the same as the first or be very slightly under the first. The difference between the two, however, should be barely noticeable. Criteria: The first criteria consist of an uptrend that has an initial high established at resistance. After a correction off this initial high, that price level is retested but holds and the security retraces off the highs. If the trend is not extended or at strong resistance on a higher time frame, then this setup may have limited potential, pulling back only slightly or basing at the second high before continuing higher. Entry: Connect the lows in the last portion of the second move, when this lower trend line breaks, the short pattern is triggered. A trader can also drop down to a smaller time frame and watch for a 2T, Avalanche, Head and Shoulders, Reverse Cup-with-Handle, or triangle reversal pattern and take the trigger based upon that smaller pattern. This will increase the accuracy and timing on the position in many cases, although a smaller time frame pattern may not give a clear short setup and waiting for one may entail missing the double top pattern completely. Stop: Over the highs of the second high. The stop based upon a smaller time frame short pattern could be used instead when it applies. Target: The low made between the two highs is the first support level. A double top which serves as a reversal pattern will then break that support level with a continuation pattern, confirming the reversal. Previous congestion zones, previous lows, and moving average support are some of the main reasons that a move out of a double top will stall or complete its move. The more of these support levels that hit at the same time, the higher the odds are that the support holds, at least providing a base or gradual rally on a smaller time frame before it breaks to the next support level.
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Volume: Overall volume declines on the move into the second high, although it may pop briefly if the security experiences a small surge in buying at the last minute before holding the resistance at the previous high. Correction Periods: Higher probability of success when the second high corresponds to a correction/reversal period or when the trigger on the double top takes place heading into a correction period. The first is preferred. Support/Resistance: Strong resistance level overhead with the security constantly testing a support level such as a trend line or 20 sma on the move into the second high, particularly as it approaches that second high. Trend Placement/Trend Development: An extended uptrend is ideal for creating a larger trend reversal on a double top. For instance, this is common when the security already has three waves of buying. It helps a lot if the move off the low made between the two highs takes 1.5-2 times as long to regain the ground it lost coming off the initial high than it did to make that drop in the first place. If the security pulls back $10 in 30 days as it comes off the first high, for example, then it is nice to see it take 45-60 days to regain that lost ground and retest the initial high. The pattern can still work well if it takes longer than twice as much, but is significantly less accurate if it only takes as long to retrace back to the highs as it did to fall from them. This means that a $10 pullback in 30 days would lower odds for successful a double top if it takes 30 days or less to return to the previous highs. Many times this type of double top will then create a triangle after making the second high in order to extend the correction time and lead to a stronger breakdown, or it might make another double top again to help assist in turning over the upside momentum and create greater favor for a selloff.
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Gap Trap
Description: In the case of an upside gap, this pattern is form of a bear trap reversal which tends to catch the bears unawares on a daily time frame. After at least several days of selling, the market gaps up in the morning, usually above the previous days highs. This traps traders who were short, or bearish. Criteria: 1. A bearish daily pattern. Preferably where the market opens at highs and closes at lows. This could mean a bear flag in play. 2. A gap up in the morning, generally on news, whereby the security opens at or above the previous day's highs. Entry: Drop down to a smaller time frame intraday. The 1 minute chart can be used initially. Then look for buy setups on this smaller time frame, such as a breakout or triangle pattern. A 2B intraday could also take place. Stop: Under the lows of the day at the time of the intraday continuation pattern triggering. A stop based on that smaller time frame continuation pattern can also be used. Target: Look at the larger time frames for resistance levels. This can include a daily equal move when measuring the lows of the pullback ahead of the gap to the move that took place ahead of the pullback (i.e. the previous upside move) if the trap is triggering a bull flag or breakout pattern on the daily chart. It could be a previous high or congestion level as well that will stall the buying, such as if the trap takes place on a move out of a downtrend.
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Support/Resistance:
Higher than average odds if the security was moving into daily or weekly support levels, such as a moving average or previous low on the day before the gap. On the gap itself, risk is higher if there is any major resistance level directly overhead, including an intraday level such as a 15 minute 200 sma, and lower if the security opens just above a strong support level, such as a 10 day sma.
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congested. Volume then increased when that intraday triangle broke lower, confirming the breakdown.
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Trend Placement/Trend Development: Stronger odds of success for a head and shoulders reversal pattern when the head is made after three waves of upside, or if the security had three waves of buy into the highs of the left shoulder and then fails to put in a strong fourth move and instead makes only a very slightly higher high to create the head of the head and shoulders pattern. When the head and shoulders pattern is a continuation pattern, then a much larger downside move should be in place, followed by the bounce into the left shoulder, a slightly higher high for the head, and then a lower high for the right shoulder, leading to another strong breakdown.
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Example #1: Weekly Reverse Head & Shoulders Buy Setup in Yahoo Inc. (YHOO)
Figure 22: Yahoo Inc. (YHOO) Weekly Reverse Head & Shoulders Pattern
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previous highs, but only stalled it briefly. The next major resistance was not until the congestion in the $32.00 zone. 7. The reverse head and shoulders pattern also gave a Phoenix within the right shoulder to allow for a tighter entry than the trend line break.
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Oops Pattern
Description: See also Gap Trap. This is another term used to describe a bull or bear gap trap formation. In the case of an Oops short pattern, the security closed near highs after several days of buying and then gaps lower the next and opens under the previous days lows. Risk increases for an intraday continuation short if the gap is more than twice an average days range or if the security opens at price or moving average support (or both) on the daily charts.
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Pennant
Description: This is another term used to define a symmetrical triangle, but is typically associated with triangle that lasts for a briefer amount of time as compared to the move into the triangle. It is a continuation pattern.
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Phoenix
Description: The Phoenix is a pattern named by Toni Hansen which is the opposite of the Avalanche. It is typically considered to be a reversal pattern off lows, although it can also occur within a trading range just prior to a breakout. It is the first continuation pattern on the upside following the lows of a downtrend, or the first continuation pattern within a trading range leading to its breakout. Use the Avalanche criteria in reverse to locate a Phoenix pattern. See head and shoulders to view an example of a Phoenix entry within a reverse head and shoulders pattern.
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Symmetrical Triangle
Description: These are forms of a triangle trading range where the security forms lower highs and higher lows, indicating indecision within the security. They are typically viewed as continuation patterns, but can also occur at both highs and lows within a larger trend move. In order to accurately judge the most likely direction of the triangles breakout, it is imperative to monitor the momentum within the range itself. If the security begins to hug the upper end of the triangle, then it is more likely to break higher, whereas if it hugs the lower end of the triangle, such as in OMRI shown below, then it is more likely to break lower.
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Wedge Pattern
Description: This is a specific type of triangle that has a noticeable slant to it with higher highs and higher lows for an ascending or rising wedge or lower highs and lower lows for a descending or falling wedge. The characteristics detailed below apply to a rising wedge for a short setup, but can be easily reversed for a falling wedge buy setup. The wedge formation is typically a reversal pattern, meaning that the trend within the wedge itself will reverse when the trend breaks, although it can serve as a continuation pattern if the trend is new. For the purposes here, however, it will be discussed in terms of a reversal, with a rising wedge viewed in terms of a break lower and a falling wedge breaking higher. Criteria: Uptrend with higher highs that break by a lesser degree than before, while the higher lows are still separated by greater differences in price, creating a triangle that slants higher when the upper and lower trend lines are drawn. Entry: When the lower trend line breaks. Alternate entries are when the last uptrend within the wedge breaks lower or drop down to a smaller time frame and watch for a 2T or Avalanche and utilize those entry criteria. Stop: Over the highs of the rising wedge, or over the highs of the base on an Avalanche formation if the wedge begins to hug the lower trend line after pulling off the highs before breaking lower. Target: The target on the wedge depends on where it occurs in the larger trend. The main support levels in a rising wedge will be at each of the pivot lows within the wedge itself. When a downtrend is new and the rising wedge is a continuation pattern, then an equal move out of the wedge as compared to the drop into the wedge is the larger target.
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3. The volume decline throughout the rising wedge and did not increase at all coming out of the last pullback into 10:45 ET, indicating that despite the strong upside, there were not a lot of determined buyers present. 4. The second high in the wedge was only slightly higher than the first and the third high was comparable to the second, whereas each low was significantly higher than the last. 5. The final pivot high within the wedge took place heading into the 11:00 ET correction period. 6. As the wedge hugged the lower trend line leading into the second setup, the volume declined even further, despite the correction to the selling into 11:00. 7. The pace of the moves out of 11:00 and then along the lower trend line indicated a bearish bias since the upside was much weaker than the downside.
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www.swingtrader.net
1999-2007 Toni Hansen and The Bastiat Group, Inc. Copying or electronic transmission of this document of any of the contents herein is protected by copyright and is strictly prohibited.
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