US Stocks Investing and Trading

This article is taken from :  

http://tradinggoddess.blogspot.com/

Wednesday, October 24, 2007

While there may be an unlimited number of potential price patterns in the market, most popular price patterns fall into two broad categories in relation to trends: Reversal Patterns or Continuation Patterns. Knowing more about specific patterns may help you determine which resolution in price is likely to occur.

Without delving too deep into the topic, popular reversal patterns include the “head and shoulders,” broadening formations, and rounding formations, while popular continuation patterns include rectangles, triangles, and flags/pennants.

Any of these patterns can actually resolve into the unexpected direction (a reliably consistent reversal pattern may resolve to be a continuation pattern) at any given time and without warning.

Are there hard and fast rules you can apply quickly to assess the probabilities of resolution, or the significance of a given price pattern?

While these suggestions will not work all the time when you feel you have identified a pattern, they just might help you preserve capital or temper your expectations.

1. The longer the pattern forms, the more likely it is to be a reversal pattern.

2. The shorter the pattern, the more likely it is to fail to conform to expectations.

3. The deeper (greater price fluctuation) the pattern, the more significant the likely price ejection from the pattern (due in part to the ‘measuring rule’ inherent in some patterns).

4. The more accurately the expected volume pattern unfolds, the more reliable the pattern (examples: Volume should contract during a triangle, flag, or pennant pattern. Volume should be heavier on the left shoulder than the right shoulder. Volume should confirm a pattern break-out. etc)

5. The longer (and more steep the angle) a trend has endured, the more likely a pattern is to be a reversal pattern.

6. The more “perfect” (textbook) the pattern, the more likely it is to fail to conform to everyone’s expectations.

Each pattern has its own set of expectations and rules, but these generally encompass most resolutions of price patterns. There are a plethora of books or websites that can give you more information on specific patterns and the rules associated with them, but always keep in mind suggestion #6. If everyone sees the same pattern and expects the same thing, the pattern will most likely fail due to the often sinister resolution of mass-expectations in the market.

Remember, patterns are expected to reflect psychological patterns of human participants, and many observed patterns have been categorized, classified, and tested through the years.

While no pattern is 100% accurate, they can help add a new level of trade selection to your growing toolbox of trading ideas and tactics.

Corey