The Importance of Identifying Favorable Stock Chart Patterns
To be a successful investor it’s important to look for those stocks which are forming a favorable chart pattern such as a "Cup and Handle", "Double Bottom" or "Flat Base". In 2002 some of the best performing stocks exhibited the above mentioned chart patterns before breaking out and undergoing significant price appreciation.
Here are a few stocks that exhibited a "Cup and Handle" pattern before breaking above their Pivot Points on strong volume. CBZ formed a 7 month Cup from July of 2001 until February of 2002 and then developed 3 week Handle (H) before breaking above its Pivot Point in early April on strong volume. After breaking out of its Handle CBZ appreciated nearly 155%.
FSTW formed a 1 year Cup from January of 2001 until January of 2002 and then developed a 9 week Handle. FSTW then broke out of its Handle and above its Pivot Point in April accompanied by strong volume. After breaking out of its Handle FSTW appreciated nearly 225% over the next few months.
HL formed a shallow 9 month Cup from May of 2001 until February of 2002 and then developed a 4 week Handle (H). It then broke out of its Handle and above its Pivot Point in late March on good volume. After breaking out of its Handle HL gained nearly 275% over the next few months.
MWRK formed a 5 month Cup from September of 2001 into the early part of 2002 and then formed a 4 week Handle (H). MWRK then broke out of its Handle and above its Pivot Point in early March. After breaking out of its Handle MWRK gained nearly 200% over the next several months.
Another chart pattern to look for is the "Double Bottom" which looks like the letter "W". Here is a stock (CFI) that formed a Double Bottom pattern from May of 2000 into the early part of 2002 and then developed a small 3 week Handle (H) before breaking out in March accompanied by strong volume. After breaking out in March CFI gained nearly 170% over the next four months.
The third type of chart pattern to look for is called a "Flat Base". Flat Bases form as a stock basically trades sideways for several weeks or months. CVU formed a Flat Base for nearly 6 months before breaking out in April on good volume and appreciated over 300% over the next few months.
TENT is another example of a stock which formed a Flat Base for 10 months before breaking out in the early part of 2002. After breaking out TENT appreciated nearly 450% over the next 6 months.
These are some of the chart patterns you should be looking for when deciding which stocks to invest in. Investing in a stock which doesn’t have a favorable looking chart pattern can lead to poor performance while other stocks which are breaking out of a favorable chart pattern ("Cup and Handle", "Double Bottom" and "Flat Base") undergo significant price appreciation. Also if you examine the stocks mentioned above they all broke out of a favorable chart pattern on strong volume as well.
Technical analysis describes different ways of predicting the future of the stock/futures market based on its history. Unfortunately, technical analysis is not an exact science. Many prominent scientists label it as "voodoo science". They claim that due to market efficiency, if you use TA to find your entry positions, you’re no better off than someone who chooses those positions randomly. Market efficiency means that all the available information is already calculated in the stock prices, and that you can only guess how the price will behave in the future.
The "voodoo science" theory would make sense if it wasn’t for the fact that there is a significant number of traders who are able to consistently make profits in the stock/futures market. These traders use technical analysis as their main tool. Since any trader has or can have access to the same TA tools we have to ask how can a small group of traders consistently win and the other larger group, more or less consistently lose in the stock market game. What is it that winning traders know about technical analysis that gives them the upper hand?
The answer is simple: Technical Analysis works but not necessarily for the reason most people believe. Many successful traders don’t want to share this secret. TA works because many people use it, and successful traders are able to predict how other people will react on the different TA indicators and signals. In other words, while the losing traders are using TA to determine their trades, the winning traders are winning because they know how the losers are going to react based on this data. For example, when a price goes below one of the key moving averages, (MA’s) many investors sell that instrument to protect themselves against additional losses. By doing so, they will drive the price of that instrument lower and that will prompt some traders to start short selling that instrument in anticipation of further decline. Prices continue the downward trend, forcing traders who were long on that stock to sell their positions because it is going below their stop limits. This creates a domino effect as the price continues to decline. However, at this point, successful traders realize that most of the current price action was created artificially. They start to enter positions on the buy side and more often than not price starts to reverse. The losing traders have already sold their contracts based on the TA tools. The winning traders buy the contract because they understand that the fluctuation was temporary, and they seize the opportunity based on the losing trader’s reactions.
No TA tool by itself will give you reliable buy or sell signals. There is no Holy Grail or magic black box that will give you the perfect, accurate signal. However, the combining of the right group of TA indicators with discipline and adequate trading capital has been the road to fortune for many traders. There is no reason why you cannot emulate their success. Let’s take a look at an example.
Understanding Pivot Points
Pivot Points are those price levels that are most likely to act as levels of support and resistance on any given trading day. As we already know, Technical Analysis works because many people use it. For the same reason, the most influential pivot points are those that are used by majority of traders. The most widely used formula for calculating pivot points is as follows:
H = previous day’s high
L = previous day’s low
C = previous day’s close
Pivot Point = (H + L + C)/3
Resistance = 2*PP - L
Support = 2*PP - H
Previous day’s last two hour high = L2HrHigh
Previous day’s last two hour low = L2HrLow
When the price moves through the known pivot point on increased volume it is most likely to continue current trend, and if the price hits the known pivot point but is unable to move through it is most likely to reverse the current trend.
Figure above is a 5-minute candlestick chart for S&P 500 E-mini contract and you can observe how the Pivot Point was acting as a major support line throughout the trading day.
When the advancing/declining price is not able to move through the known pivot point after two or more tries there is a good probability that it will start to decline/advance. Trading method in which a trader is waiting for a price to reverse after hitting S/R level is called swing trading. On the other hand if the advancing/declining price has easily moved through known S/R level there is a good probability that it will continue to advance/decline. Trading method in which a trader is looking for a price to continue to move in the same direction after moving through S/R level is called breakout trading.
There are three favorable Chart Patterns to look for as an investor. They include the "Cup and Handle", "Double Bottom" and "Flat Base". This article will concentrate on the "Double Bottom" pattern which looks like the letter "W" as it develops. An example of a stock which had formed a Double Bottom pattern before breaking out to new 52 week highs was NVR in 2002.
NVR peaked in the Spring of 2001 and then sold off before making its 1st bottom in June (point A). From there it rallied into July (point B) but then sold off again and made a 2nd bottom in September (point C). After making the 2nd bottom NVR then rallied strongly again before stalling out near its previous Spring 2001 high and completed its Double Bottom "W" pattern. NVR then traded nearly sideways for 6 weeks and formed a Handle (H) before breaking out in late January of 2002 accompanied by strong volume (point D).
Each week we look for stocks which are exhibiting favorable chart patterns that have good Sales and Earnings Growth which may break out in the future and undergo significant price appreciation.
A Pivot Point resides near the top of a trading range as a stock is developing a Handle. The proper time to buy a stock is when it begins to break above its Pivot Point and is accompanied by increasing volume.
Here are some Examples
EBAY formed a 1 year Cup and then developed a 6 week Handle with a trading range between $65 and $71. The top of the trading range was near $71 which acted as the Pivot Point for EBAY. EBAY eventually broke above its Pivot Point in early January accompanied by an in increase in volume (point A).
Another example is shown by ERES which formed a 1 1/2 year Cup followed by the development of an 8 week Handle with a trading range between $10 and $11. In this case the top of the trading range was near $11 which served as the Pivot Point. ERES broke above its Pivot Point in April of 2002 accompanied by very strong volume (point B).
Another example is of HITK which formed a 1 1/2 year Cup followed by a 5 week Handle (point C) with a trading range between $9 and $11. In this example the top of the trading range was near $11 which served as the Pivot Point. HITK eventually broke above its Pivot Point in November of 2002 accompanied by an increasing in volume as well (point D).
As you can see the best time to purchase a stock is when it begins to break out of a favorable chart pattern such as the "Cup and Handle" and above its Pivot Point accompanied by increasing volume.
The two primary approaches of analyzing Forex markets are technical analysis and fundamental analysis. Fundamental analysis comprises the examination of economic indicators, asset markets and political considerations when evaluating a nation’s currency in terms of another. The focus of fundamental analysis lies on the economic, social and political forces that drive supply and demand. There is no single set of beliefs that guide forex fundamental analysis, yet most fundamental analysts look at various macroeconomic indicators such as economic growth rates, interest rates, inflation, and unemployment.
Economic Indicators
Economic indicators are reports released by the government or a private organization that detail a country’s economic performance. These economic indicators can be released on a weekly basis, but the more common report is monthly. Indicators are based around a number of economical situations, of which the two primary factors are that of International trade and Interest. Subsidiary factors also include Consumer Price Index (CPI), Purchasing Managers Index (PMI), Durable goods orders, retail sales and Producer Price Index (PPI).
Currency’s Interest Rates
One of the major indicator factors, Interest rates, are a key economic function of any nation. Generally, when a country raises its interest rates, the country’s currency will strengthen in relation to other currencies as assets are shifted to gain a higher return. Interest rates hikes, however, are usually not good news for stock markets. This is due to the fact that many investors will withdraw money from a country’s stock market when there is a hike of interest rates.
International Trade
The trade balance portrays the net difference (over a period of time) between the imports and exports of a nation. A trade deficit can be an economic disaster for a government and a currency. A deficit may appear when a country is importing more than it is exporting, meaning that more money is leaving and less is coming in. In some ways, however, a trade deficit in and of itself is not necessarily a bad thing. A deficit is only negative if the deficit is great
How professional traders optimize profits
Futures spread trading is probably the most profitable, yet safest way to trade futures. Almost every professional trader uses spreads to optimize his profits. Trading spreads offers many advantages which make it the perfect trading instrument, especially for beginners and traders with small accounts (less than $10,000).
The following example of a Soybean-Spread shows the advantages of futures spread trading:
Example: Long May Soybeans (SK3) and Short November Soybeans (SX3)
Four Advantages of Futures Spread Trading
Advantage 1: Easy to trade
Do you see how nicely this spread starts trending in mid February? Whether you are a beginner or an experienced trader, whether you use chart formations or indicators, the existence of a trend is obvious. (If you are looking for a concept of how to identify a trend, we strongly recommend visiting http://www.tradingeducators.com/?source=Tradejuicetrading_philosophy.htm). Spreads tend to trend much more dramatically than outright futures contracts. They trend without the interference and noise caused by computerized trading, scalpers, and market movers.
Advantage 2: Low Margin requirements
Many spreads have reduced margin requirements, which means that you can afford to put on more positions. While the margin on an outright futures position in corn is $540, a spread trade in corn requires only $135 — 25% as much. That’s a great advantage for traders with a small account. With a $10,000 trading account risking 8% of your account, you can enter 6 corn spreads, instead of only 1-2 outright corn futures trade. How’s that for leverage?
Advantage 3: Higher return on margin
Each point in the spread carries the same value ($50) as each point in the outright futures ($50). That means that on a 3 point favorable move in corn futures or a 3 point favorable move in the spread, you would earn $150. However, the difference in return on margin is extraordinary:
Corn futures - $150/$540 = 27.8% return
Corn spread - $150/$135 = 111% return
And keep in mind that you can trade 6 times as many spread contracts as you can outright futures contracts. In our example you would achieve a 24 times higher return on you margin.
Advantage 4: Low time requirements
You don’t have to watch a spread all day long. You do not need real-time data. The most effective way to trade spreads is using end-of-day data. Therefore, spread trading is the best way to trade if you do not want to watch or cannot watch your computer all day long (i.e. because you have a daytime job). And you can save all the money you would have had to spend for real-time data systems (up to $600 per month).
So where is the catch?
If futures spread trading is so fantastic, why does it seems that hardly anybody trades spreads? Well, it is not true that hardly anybody trades spreads: the professional traders do, every day. But either by accident or design, the whole truth of spread trading has been hidden from the public over the years.
The purpose of this website is to inform you about futures spread trading. In the following we will answer the four frequently asked questions:
What Is a Spread?
A spread is defined as the sale of one or more futures contracts and the purchase of one or more offsetting futures contracts. You can turn that around to state that a spread is the purchase of one or more futures contracts and the sale of one or more offsetting futures contracts. A spread is also created when a trader owns (is long) the physical vehicle and offsets by selling (going short) futures. Furthermore, a spread is defined as the purchase and sale of one or more offsetting futures contracts normally recognized as a spread by the fact that the two sides of the spread are actually related in some way. This explicitly excludes those exotic spreads put forth by some vendors, which are nothing more than computer generated coincidences which are not in any way related. Such exotic spreads as Long Bond futures and Short Bean Oil futures may show up as reliable computer generated spreads, but bean oil and bonds are not really related. Such spreads fall into the same category as believing the annual performance of the U.S. stock market is somehow related to the outcome of the Super Bowl sporting event. In any case, for tactical reasons in carrying out a particular strategy, you want to end up with:
The primary ways in which this can be accomplished are:
Intramarket Spreads
Officially, Intramarket spreads are created only as calendar spreads. You are long and short futures in the same market, but in different months. An example of an Intramarket spread is that you are Long July Corn and simultaneously Short December Corn.
Intermarket Spreads
An Intermarket spread can be accomplished by going long futures in one market, and short futures of the same month in another market. For example: Short May Wheat and Long May Soybeans.
Intermarket spreads can become calendar spreads by using long and short futures in different markets and in different months.
Inter-Exchange Spreads
A less commonly known method of creating spreads is via the use of contracts in similar markets, but on different exchanges. These spreads can be calendar spreads using different months, or they can be spreads in which the same month is used. Although the markets are similar, because the contracts occur on different exchanges they are able to be spread. An example of an Inter-exchange calendar spread would be simultaneously Long July Chicago Board of Trade (CBOT) Wheat, and Short an equal amount of May Kansas City Board of Trade (KCBOT) Wheat. An example of using the same month might be Long December CBOT Wheat and Short December KCBOT Wheat.
Why Spreads?
The rationale behind spread trading is one of the best-kept secrets of the insiders of the futures markets. While spreading is commonly done by the market "insiders," much effort is made to conceal this technique and all of its benefits from "outsiders," you and me. After all, why would the insiders want to give away their edge? By keeping us from knowing about spreading, they retain a distinct advantage.
Spreading is one of the most conservative forms of trading. It is much safer than the trading of outright (naked) futures contracts. Let’s take a quick look at some of the benefits of using spreads:
What Can You Expect?
Here is an example of what you can expect from Intramarket spread trading. We think you may be pleasantly surprised!!
This spread was entered not only on the basis of seasonality, but also by virtue of the formation known as a Ross hook (Rh). The spread moved from -69.0 to -7.5 = $3,075 per contract. The margin required to put on this spread was only $608, thus the return on margin is more than 500%.
Here is an example of an Intermarket spread. Look at the the following chart: Would you want to have been long live cattle from December until February?
But, what about a spread between Live Cattle and Feeder Cattle?
The spread moved from -10,200 to -7,200 = $3,000 per contract. The margin required to put on this spread was only $540. The return on margin is more than 550%.
Lastly, we show you another intermarket spread. This one was made between Euro and British Pound. Although you might have made money on a Euro trade, you would have suffered from serious whipsaw during the entire length of the trade.
What about a spread between the Euro and the British Pound?
You didn’t have to be in this spread for very long in order to take some fat profits: During February the spread moved from $32,500 to $36,187.50 = $3,687.50 per contract.
How do I start trading spreads?
We can barely scratch the surface of what is available in the almost lost art of spread trading. There are times when seasonal spreads, coupled with chart formations, make a lot of sense. Backwardation in any market often provides an excellent signal for entry into a spread.
Stocks that have large price gains typically will stair-step upward and form Flat Bases before resuming their up trend. This action may occur several times as a stock remains in an up trend and could last from a few days to several weeks depending on the situation. Flat Bases are characterized by small daily trading ranges with volume being lower than normal. Although it doesn’t happen every time, the longer a stock remains in a Flat Base, the greater the price appreciation may be when the stock breaks out. Lets look at some examples below.
Here is a chart of EMLX. Notice how it formed a Flat Base (small trading range) from July through mid-August and then broke out of the base in on increasing volume (point A). It then formed another Flat Base in September and broke out of this base in early October and skyrocketed from $80 to $200.
Another example of a stock that had a few Flat Bases was KIDE. Notice in May and June the small daily trading ranges with low volume. Then in early July the stock broke out with increasing volume (point A) and went from $10 to $30 by mid-August. KIDE then formed another Flat Base from mid-August though early October and then exploded out of the base on higher volume (point B). The stock then went from $30 to $90 in four weeks. The total gain from July to November was 800% ($10 to $90).
Another example of a stock that was in a Flat Base pattern for a significant amount of time was MCOM. Notice that it traded sideways for at least 3 months before breaking out of the base on strong volume (point A). In this case MCOM went from $10 to $55 in 4 weeks for a gain of 450%.
As you can see, finding stocks that exhibit certain chart patterns (Cup and Handle, Double Bottom and Flat Base) can lead to strong price appreciation when they breakout on strong volume.
Regards,
Bob Kleyla
May 2004
Ask most NEW traders, and they will tell you about some moving average or combination of indicators or a chart pattern that they use. This is, as the more experienced trader knows, an entry point and not a strategy.
Any trader who is more experienced will say a strategy should also include money management, risk control, perhaps stop losses and of course, an exit point. They might also say that you must let your profits run and cut your losses short. A well-read trader will also tell you that your strategy should fit with your trading personality.
BUT there is one other vital ingredient that many traders forget - and that is to fully understand the "personality" of what you trade. Some traders specialise in say, gold or Brent crude or currencies or they might specialise in a particular index such as the FTSE 100 or the Dow but many traders choose to trade shares. Indeed some traders dabble in a bit of everything. I think this is the area that causes many traders to fail or at least not reach their full potential.
In my view: You absolutely MUST specialise.
I am sure that on the surface most people would say that sounds sensible but here is why it is a MUST!
Superficially, many charts look the same. I bet if you had not seen the charts for some time and someone where to show you a chart of Brent Crude over 6 months and then a chart of Barclays PLC over the same 6 months you would be hard pushed to say which was which purely on the look of the chart.
However, I bet that if you found a trader who trades ONLY Barclays day in and day out and also found someone who trades ONLY Brent Crude day in and day out, both of them would easily identify which was which. WHY?
Because every share, index or commodity has it’s own "personality".
Some will be volatile intra-day, some will follow their sector or the main index (market followers), some will do their own thing, some will spike up and down regularly, some will stop at key moving averages and some will just plough through. Some will move by 5% on average before they retrace and some by 2%. Some will gap up or down regularly, some will not. You get the idea!
Therefore, no matter how good you are at analysing indicators, moving averages, trends and patterns, the same strategy WILL NOT work for everything. I would go so far as to say that a strategy that works well for Bovis Homes, for example, is likely NOT to work for BT Group - they have very different "personalities".
So let’s return to our question: What makes a good trading strategy? Let me answer with a series of ten questions that you need to find answers to, in order to build a REALLY GOOD strategy.
Once you have an answer to each question you need to do one final thing. Make sure all those things fit together and complement each other. For example, if the ideal stop loss position represents a big average risk and conflicts with your own attitude to risk, you need to start again. If you will override your exit point because greed makes you hang in for more, you need to think again. Perhaps you shouldn’t trade that stock in the first place - look for one with a different "personality" which will lead to a strategy you can trade comfortably.
It is a long and sometimes painful iterative journey. You might need to go round and round in ever decreasing circles over a long time. Testing and refining, testing and refining before you can truly have a reliable and repeatable strategy that REALLY WORKS for you.
THEN, you can look for other things to trade that have the same "personality" as your specialist stock, index, commodity or currency.
Currencies are traded in dollar amounts called “lots”. One lot is equal to $1,000, which controls $100,000 in currency. This is what is known as the "margin". You can control $100,000 worth of currency for only 1,000 dollars. This is what is called “High Leverage”.
Currencies are always traded in pairs in the FOREX. The pairs have a unique notation that expresses what currencies are being traded. The symbol for a currency pair will always be in the form ABC/DEF. ABC/DEF is not a real currency pair, it is an example of a symbol for a currency pair. In this example ABC is the symbol for one countries currency and DEF is the symbol for another countries currency.
Here are some of the common symbols used in the Forex:
USD - The US Dollar EUR - The currency of the European Union "EURO" GBP - The British Pound JPN - The Japanese Yen CHF - The Swiss Franc AUD - The Australian Dollar CAD - The Canadian Dollar
There are symbols for other currencies as well, but these are the most commonly traded ones.
A currency can never be traded by itself. So you can not ever trade a EUR by itself. You always need to compare one currency with another currency to make a trade possible.
Some of the common PAIRS are:
EUR/USD Euro / US Dollar "Euro"
USD/JPY US Dollar / Japanese Yen "Dollar Yen"
GBP/USD British Pound / US Dollar "Cable"
USD/CAD US Dollar / Canadian Dollar "Dollar Canada"
AUD/USD Australian Dollar/US Dollar "Aussie Dollar"
USD/CHF US Dollar / Swiss Franc "Swissy"
EUR/JPY Euro / Japanese Yen "Euro Yen"
The listed currency pairs above look like a fraction. The numerator (top of the fraction or "left" of the / however you want to SEE it) is called the base currency. The denominator (bottom of the fraction or "right" of the /however you want to SEE it) is called the counter currency. When you place an order to buy the EUR/USD, for instance, you are actually buying the EUR and selling the USD. If you were to sell the pair, you would be selling the EUR and buying the USD. So if you buy or sell a currency PAIR, you are buying/selling the base currency. You are always doing the opposite of what you did with to base currency with the counter currency.
If this seems confusing then you’re in luck. You can always get by with just thinking of the entire pair as one item. Then you are just buying or selling that one item. Thinking like this will still enable you to place trades. You only need to be aware of the base/counter concept for Fundamental Analysis issues.
So why is it important to know about the base/counter currency? The base/counter currency concept illustrates what is actually taking place in a Forex transaction. Some of you reading this, know that short-selling was restricted in the stock market *(Short-selling is where you sell a stock/currency/option/commodity first and then try to buy it back at a lower price later). But in the FOREX you are always buying one currency (base) and selling another (counter). If you sell the pair you are simply flipping which one you buy and which one you sell. The transaction is essentially the same. This allows you to short-sell with no restrictions.
You want to be able to short-sell with no restrictions so you can make money when the market drops as well as when it rises. The problem with traditional stock market trading is that the market has to go up for you to make money. With FOREX trading you can make money in all directions.
