Understanding Trading Patterns for Big Profits
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Jason Cimpl (from Trademaster Daily Stock Alerts) has recently returned from the Roth Conference in California with a boatload of great ideas. So together we’re going over our favorite small cap profit opportunities right at this very moment. And part of what we’re looking at are technical patterns. Jason’s a wiz at analyzing technical patterns, and has been leading subscribers of Trademaster Daily Stock Alerts to big short-term trading profits based on his analytical prowess. You can learn more about Jason and this service by clicking here.
I’ve discussed technical analysis before in Small Cap Investor Daily. And I’ve been very clear that it should not be used as a substitute for fundamental analysis. But used together, the two methods give investors the whole picture. So where do we begin with our technical analysis? I look at six important technical patterns. These all require a basic understanding of trading ranges, resistance and support lines. If you need a refresher, click here to read my article from a couple of weeks ago.
Now, I’d like to discuss the first three technical patterns. Later this week I’ll follow up with the second three.
1. Double tops or bottoms: In this very common pattern, price trends move toward a top or bottom. In a double top, it is likely that the price will spike close to resistance, retreat, and then spike once again. When a stock’s price double tops like this without successfully breaking through resistance, technicians believe it foreshadows a decline in price. So the pattern following the double top is for prices to move downward.
In a double bottom, the opposite occurs. Price trends down to support and spikes twice, only to retreat. This anticipates a rise in price after the double bottom. Here’s an example of a double top: Questcor Pharmaceuticals (Nasdaq: QCOR) experienced a double top between December 2008 and January 2009 as the chart below clearly shows. As the pattern often foreshadows, the double top was followed by a sharp decline in price.
Double tops and bottoms are very common patterns. They are easy to spot and interpret. However, as with all patterns, a double top or bottom can also be misread. False indicators do occur, so it helps to have some experience in chart interpretation and a working knowledge about a company’s fundamentals.
2. Head and shoulders: Similar to double tops and double bottoms is an equally important pattern: the head and shoulders. In this chart pattern, price spikes upward in three parts. The first and third are the shoulders, and the second is the head. The head spike is higher than the two shoulders and often reaches right to the level of resistance. Following the head and shoulders pattern without continuing upward, prices tend to fall. This is a reliable formation that leads to further decline. Also, the total decline is usually twice the difference between the neckline and the top of the head. The illustration below clearly shows this pattern. Below that is an actual stock trend in this pattern.
A reverse head and shoulders displays the same pattern, but on the downside and at support. It consists of three downward price spikes, with the middle one (the head) moving lower than the first and third shoulders. It precedes a price increase. The chart below shows the reverse head and shoulders.
3. Triangles: The triangle is most often a continuation pattern, which means it confirms the current trend and gives a signal that price is going to move in the same direction. Some very specific triangle patterns can also be reversal signals, which mean the current trend is slowing down and price levels may turn in the opposite direction in the near future. The three triangle patterns are ascending, descending, and symmetrical. Triangles generally start out with their widest trading range and then narrow. An ascending triangle is characterized by a narrowing trading range with price levels finishing on the higher side of the range, or even culminating in a breakout above previously established resistance.
This is a bullish pattern for the stock as depicted in the illustration below. After moving higher following an uptrend, the price of the stock reaches a wall of resistance. Each time the price moves up to the resistance point it quickly moves lower. Buyers are still interested in the stock, so each downward move is met with buying. As a result, each pullback brings less downward movement. Finally, the buyers overwhelm the stock and the price quickly moves beyond the former resistance level.
A descending triangle ends up with the narrowest portion ending on the lower side—near support—or even breaking out beneath it. This is a bearish signal and, just as the ascending implies a continuing upward trend, the descending implies that the downward trend is going to continue.
The symmetrical triangle implies that price is in a period of consolidation, and no one is sure where it is going to move next. Volume may also be low in these situations, leading to a narrowing of the trading range and overall uncertainty. Most traders will want to wait out this pattern until something more specific emerges.
Just like most things, understanding technical stock price movement takes practice. But to a trained eye, a stock chart can give the astute investor an idea where the stock price may go. Practice before you act, and gain confidence. You’ll be glad you did when you start to make profitable trades.
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