trade entry, a target is set at the lowest point in the wedge formation. Another targetmeasure would be the length of "wedge" pattern from the breakdown level.Stop:Place a "stop" order above the last "swing high" of the "wedge" pattern.
4/8/07 6 02 PM
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Trade Chart Patterns Like The Pros
12 46
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Trading Rising Wedge Pattern
Trading Rising Wedge PatternThe example above illustrates a "Rising wedge" pattern from the Russell Emini futures ( E M )6 10 tick chart. ER2 made a "Rising wedge" pattern in a downtrend. The pattern suggests apullback rally in downtrend. ER2 made higher highs and higher lows with trend linesconnecting in an angle suggesting a potential opportunity for a "short" trade when prices closebelow the trend line.1. Enter a "short" trade below the low of the breakdown bar (at C).2. Place a "stop" order few ticks above previous swing high at B.3. The first target is placed at 100% of the AB range from C.
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Falling Wedge Pattern
.
"Falling Wedge" patterns are similar to "Symmetric Triangles" as they form in an angle;where as the "Symmetrical Triangles" form horizontally. "Falling wedge" patterns have lowerhighs and lower lows and are connected with two angled, slanted trend lines. These trend linesdiverge at the bottom. Another type of "wedge" (inverse) pattern has trend lines converging atthe bottom. The trend direction on the breakout from the "Falling Wedge" pattern would beupside."Falling wedges" are usually bullish in uptrend and downtrend markets. Similarly, "Fallingwedge" patterns have a high failure rate. They are relatively difficult to spot them, and tend towork well in bearish markets.Trade:The "wedge" patterns are defined by trend. lines connecting the "higher-highs" and "lowerlows." A trend line breakout suggests a "long" trade. Trades are entered after a clear breakoutfrom the trend line. Enter a "long" trade, one tick above the high of the breakout bar from thetrend line.Target:Place a target at the higher "swing high" level of the "wedge" pattern. A secondary target is setat the depth of the wedge pattern from the breakout level.Stop:Place a "stop" order below the lowest level of the "wedge" pattern.
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Trading Falling Wedge PatternQER2.D - 5 rnin L=790.60 +8 60
F d b g Wedge-792.00
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Trading Falling Wedge Pattern
The example above illustrates a "Falling wedge" pattern from the Russell Emini futures (ER2)5m chart. "Falling wedges" are bullish patterns. On January 22,2007, during the afternoon'strading, ER2 made lower highs and lower lows to form a "wedge" pattern. On January 23,ER2 traded higher and closed above the trend line.1. A "long" trade was entered above the breakout bars high.2. A "stop" order was placed below the low of the "wedge" at the 780 level.3. A target is set at the depth of the "wedge" pattern from the trade entry.
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Trading Falling Wedge Pattern
Trading Falling Wedge PatternThe example above shows a "Falling wedge" pattern from the Russell 2000 15 minute chart.A "wedge" pattern developed from March 13,2007 to March 14,2007 (until 12pm) as ER2made lower lows and lower highs. Two trend lines are drawn in the chart above connectingthese "lower highs" and "lower lows." A "close" above the upper trend line signals a "long"trade above the 775 level.1. Enter a "long" trade above the high of the trend line breakout bar.2. Place a "stop" order below the low of the "wedge" pattern.3. Target the depth of the "wedge" pattern from the trade entry level.
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6.5. Diamond Pattern
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Diamond PatternThe "Diamond" pattern is very reliable and consists of four-sided price action. It is alsosimilar to adding two "triangle" patterns, Inverted and Symmetrical, together. "Diamond"patterns are both continuation and reversal patterns. If the pattern occurs in the midst of atrend, it will present a continuation of the trend in the same direction prior to the formation. Ifthe pattern occurs at the tops or bottoms, it will be a reversal pattern. Diamond "tops" formmore often than Diamond "bottoms."
Trade: In "Diamond" patterns, continuous patterns form more often than reversal formations.In a continuation pattern, wait for a breakout of the "Diamond" pattern and trade in thedirection of the trend prior to the pattern formation. In reversal formations, trade in theopposite direction of the prior trend. Confirm breakouts and breakdowns by price-action.Target: Continuation "Diamond" patterns provide excellent target criteria. The prior rangebefore "Diamond" formation is the target from the breakout or breakdown level. In reversalformations, prior major swing highsllows are set as the targets.Stop: Place a "stop" order above the high of the "Diamond pattern for a short-trade andbelow the low of the "Diamond for a long-trade.
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Trading Diamond Pattern.
13:32
13:58 11:23
Trading Diamond PatternThe example above shows a "Diamond pattern continuation from the S&P Futures (ES) 610tick chart. On January 25,2007, after making a "swing high" of 1446 (at A), the ES correctedand traded lower to 1438 (at B). The ES formed a "Diamond pattern from 1436 and 1438.1. Wait for a clear breakdown from the "Diamond pattern.2. Enter a "short" trade in the direction of the prior trend (before the "Diamondpattern) at 1435.3. Place a "stop" order above the high of the "Diamond at 1438.4. Target the range of AB (8 pts) from C to 1428.
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119
Chapter 7: Channels7.1. Rectangle Channels
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Rectangle Channels
,
"Rectangle Channels" are continuation patterns. Rectangle channel breakouts in the trenddirection are more reliable than breakdowns against the trend. Rectangle channels form morein the beginning stages of longer-term trends. A base building before a clear trend run is a veryreliable pattern."Rectangle" channel tops are rarely formed compared to the channel "bottoms." Intermediatetrend "rectangle" formations are reliable continuation patterns and they continue in the priortrend directions.
Trade:A trade in "Rectangle channels" is triggered when a top (resistance) or bottom trend line(support) is broken and confirmed by price-action. A "long" trade is entered when price closesabove the high of the breakout bar. A "short" trade is entered when price closes below the lowof the breakdown bar.Target: The width of the "Rectangle" channel usually defines the resulting target move. Thewider the rectangle (like base), the bigger the move. The height of the rectangle, at the top tobottom trend line, is the first target in "Rectangle" channel trades.Stop: "Rectangle" channel failures can happen if prices trade against the prior trend before thepattern formation. A "stop" order is placed at the middle of the rectangle channel to protect thetrade.
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4/8/o77 48 PM
Trading Rectangle Channels
T r a d i n ~Rectan~leChannelsThe example above shows A "Rectangle" channel formation from the Dow Emini futures(YM) 30 minute chart. The first "Rectangle channel" pattern was confirmed in early Octoberas it closed below the lower trendline. But there was no trade triggered as prices never tradedbelow the breakdown bar's low. On October 3, YM traded higher and closed above the uppertrend line to confirm a "Rectangle" channel breakout in prior trend. A "long" trade is enteredin the direction of the prior trend before the "Rectangle" formation (up side). A "stop" orderwas placed at the center of the channel. A target is set at the height of the "Rectangle" channelfrom the breakout level. The following week, a second "Rectangle" channel emerged with asimilar long trade setup.
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rRectangle Channel
I
Trading Rectangle ChannelThe example above shows a "Rectangle" channel formation fiom the Level ThreeCommunications (LVLT) daily chart. From February 2006 to April 2006, LVLT traded in anarrow range "Rectangle" channel from $3.25 to $3.75. In late March 2006, LVLT tradedoutside the "Rectangle" channel suggesting a potential upside in the stock. Most "Rectangle"channels are continuation patterns and trades are entered in the prior direction of the trendbefore the channel formation.1. Enter a "long" trade above the high of the breakout bar.2. Place a "stop" order below the low of the "rectangle" channel.3. Targets are set at rectangle's height from the breakout level.
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Donchian ChannelRichard Donchian created one of the best trading systems based on 4-week price channelbreakouts and breakdowns. This system is widely used by traders on a daily, weekly andmonthly basis. A breakout is described as the price exceeding the high or low of n-Number ofdays/weeks/months. Donchian method uses 20-period channels. This method works well inboth up and down trends, but it evaluates poorly in side-ways markets as most breakoutsystems do. There are many other variation theories which are created using the DonchianChannel breakout method.Donchain trading methods suggest entering new trades at retracement in the direction of thechannel. Donchain also used a mid-channel between the "highest h i g h and "lowest low," andclosed positions at mid-channels.Trade:1. Enter "long" or "cover short" when price exceeds the highest high of a 4-weekrange.2. Enter a "short" when price falls below the "lowest-low" of a 4-week range.Target: Most breakouts do not result in trends. However, protection of Donchian channels atthe price range or fixed profit range is necessary. Exit trades when prices reach 1.5 to 2Average True Ranges from the entry.Stop: Protect trades at mid-channel level or when price trades at a 10-day "low" in a "long"trade or at 10-day "high" on "short" trades.
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Trading Donchian ChannelI@ERZ.D
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1
Trading Donchian Channel
The example above illustrates a Donchian Channel trading system from the daily RussellEmini (ER2) chart. In mid May 2006, ER2 triggered a "short" trade as it closed below the 4week Donchian price channels at 755 levels. The Average True Range (ATR) in mid Maywas 12 points.1. Enter a "short" trade below the low of the breakdown bar at 754.2. Place a "stop" order at mid channel above the trade entry bar.3. Set targets about one to two ATR levels from the breakdown levels.
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Trading Donchian Channel.
...........
Trading Donchian ChannelThe example above illustrates a Donchian channel from the Johnson and Johnson (JNJ) dailychart. A 4-week Donchain channel is plotted on JNJ's daily chart. In late July 2006, a longsignal was triggered when JNJ closed above the 4-week upper channel at $62. The AverageTrue Range (10 period) for JNJ was 0.85 cents.1. A "long" trade was entered above the breakout bar's high.2. A "stop" order was placed at the mid Donchain channel line and used as a trail stop.3. Targets were either set at fixed ATR lengths or used the center Donchian line as thetrailing stop. The target was achieved around $64 using a center line as the trailingstop.
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7.3. Broadening Pattern(Megaphone)
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Broadening Top/Bottoms-
-
"Broadening Tops and Bottoms" are rare and difficult to detect, but they are very reliablepatterns. They are also known as "Symmetric Inverted Triangles" or "MegaPhones." Thispattern consists of broadening each swing reversal with larger than the previous swing. The"Broadening top" consists of five swings points and usually the last swing reverses the trend1 direction that existed prior to the formed pattern. In a "Broadening top" formation, the firstpivot, or turn, must be down, and in a "Broadening bottom" formation, the first pivot, or turn,1 must be up.-
I
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-
One of the critical points in "Broadening" tops and bottoms pattern is the mid line. In manycases, the ralliesldeclines stop at the mid line to retest the prior trend line. Usually this is thelast swing before a clear breakoutJbreakdown occurs.
Trade: A trade is taken in the direction of the breakouthreakdown from of the pattern. Whena price bar closes outside the pattern in the direction of the breakouthreakdown, and that pricebar is followed by a close above the high, or a close below low of the breakouthreakdownprice bar, a trade is signaled.Target: The price objective of the trade is the height of the entire pattern addedlsubtractedfrom the breakouthreakdown levels.Stop: The midpoint in the "Broadening" pattern is the critical point and trades should beprotected with a "stop7' at this level.
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Height
Broadening Top
Target
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Trading Broadening SwingAn important opportunity the "Broadening" patterns offer is trading the last swing. Thenumber of swings in "Broadening" patterns is five. If the trend formation in the pattern is tothe upside, then trading the fifth swing would be downside and can be traded from the toptrendline. Similarly, if the trend direction before the pattern is to the downside, then the fifthswing will be to the upside. Keep in mind that "broadening" patterns are not infallible.However, they have a high success rate depending on where and when they form in a trend.Trade: In "Broadening tops," the potential trade is to go short at the beginning of the fifthswing. When the prices reach the top of the trend line, enter a short position when prices startdeclining and closed below the previous low. Similarly, in "broadening bottoms," a long tradeis possible at the lower trend line. Enter a long trade when prices start making higher highsabove the lower trend line and when the price closes above the previous high.Target: A typical target for the last swing in a "Broadening" pattern would be the trend lineon the opposite side of the pattern. Historically, this is the widest part of the pattern and is avery profitable setup.Stop:"Broadening" patterns are not infallible. They do fail and have significance as to how they fail.The pattern may be indicating a breakoutibreakdown rather than a reversal of the trend. A"stop" order is placed if prices reverse and trade outside the trend lines.
Stop-
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Target
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The example above illustrates a "Broadening swing" trade from the Russell Emini (ER2) 15minute chart. The ER2 chart shows two significant swings in a broadening channel as it madehigher high swings and lower low swings. After two complete swings, ER2 presented anopportunity to trade the last swing from 4 to 5. When prices reach the bottom trend line atmarker 4, wait for a reversal bar (close above previous high) before entering the trade.1. Enter a "long" trade on the bar above the previous bars7 high.2. Place a "stop" order below the trend line low.3. Take partial profits at the mid channel line.4. Target is set at the upper trend line.
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Trading Broadening Breakouts
Trading Broadening BreakdownThe example above shows a "Broadening" pattern from the AMZN daily chart. In September2005, AMZN developed a series of higher highs and. lower lows to form a "Broadening"pattern. The last swing of AMZN started in December, 2005 at $50 and reached the other endof the pattern at $33 (by May 2006). AMZN closed outside the "Broadening" channel in Maysignaling a potential reversal. Most Broadening patterns result in 5thswing continuation afterbreakoutbreakdown. AMZN temporarily reversed its 5thswing from May to June 2005. Inlate June, AMZN traded below the lower trendline for a continuation of Broadening pattern.
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1
Trading Broadening Bottom@YM - 61 0 Tick Bars L= 131 11 -5
5/1/07 1:4o PM
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Trading Broadening BottomThe example above shows a Broadening bottom pattern in intra-day trading from the DowEmini futures (YM) 610 tick chart. On May 06, 2007 Dow futures sold off and closed at13100 levels. On May 07,2007, YM attempted for a brief rally but continued its prior trendand closed at 13090 (2). YM attempted another rally to close above prior swing high (1) andsold off again to close below prior swing low (2) at 13080 level (4). The intra-day swingsgave a "Broadening bottom" trading opportunity for the 5" swing.1. Enter a "long" trade above the previous bars' high at 13092.2. Place a "stop" order below the low of the prior swing at 13078 (4).3. Target the 5thswing above the prior swing's high (3) at 13150. A partial position maybe exited at the mid channel level (Target 1).
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Linear Regression ChannelA "Linear Regression Channel" (LRC) is created by drawing an equal Standard Deviation(SD) distance from the "Linear Regression" based trend line. A "Linear regression" trend lineshows equilibrium prices, where as "Linear regression" channels show the deviation of pricesfrom the equilibrium or center line. A "Linear regression" channel is plotted on the price chartusing the least squares method. In a LRC, the bottom channel indicates support and the toptrend line indicates resistance. Prices trade within the LRC, and when prices exceed the upperor lower trend line, it signals a potential reversal. If the prices continue to close outside theLRC for about half of LRC length bars, then it may be signaling a trend change and a potentialformation of a new LRC. Many traders use LRCs with the price-action to find key entrylexittrading opportunities.Trade: Wait for a LRC to form for at least 12-15 bars. Price closing outside the LRC suggestspotential breakouthreakdowns. Traders enter above the high of the breakout bar for a "long"trade and below the low of the breakdown bar for a "short" trade.Target: The range prior to the LRC formation would be the target fiom the breakout orbreakdown level.Stop: Place a "stop" order 1 tick above the high of the LRC for "short" trades and 1 tick belowthe low of LRC for "long" trades.
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1
Trading LRC--
Trading Linear Regression Channel BreakdownsThe chart above shows a LRC pattern from the Russell Emini (ER2) 610 tick chart. On Jan.16,2007, ER2 sold off during the morning trade and closed near 798. At lunch hour, ER2formed a LRC from 798 to 801 as prices tried to recover and traded higher. Around 12 pm,ER2 continued its prior down trend and closed below the LRC.1. Enter a "short" trade below the low of the breakdown bar at 798.5.2. Place a "stop" order to protect the short at 801.2.3. The previous range prior to the LRC formation is set as the target range. The priorrange is from 805 to 798. Subtract this range from level C at 801. The target is set at794.
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Trading LRC
Trading Linear Regression Channel Breakout
The example above shows a LRC breakout from the ER2 610 tick chart. On January 17,2007, ER2 formed a LRC at about 1lam, where prices closed outside the LRC signaling along trade at 795.1. Enter a "long" trade at one tick above the "high" of breakout bar at 795.2. Place a "stop" order below the low of LRC at 793.3. Set the target (previous range, AB=CD) at 797.
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7.5. Andrew's Pitchfork
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Andrew's Pitchfork PatternThe concept of the "Pitchfork pattern and its powerful trading method were first developedby Dr. Alan Andrews. "Pitchfork" and median line concepts work in all time-frame charts andin all instruments. Other "Pitchfork" theories were developed by Roger Babson and TimothyMorge.Andrews' "Pitchfork" consists of three "swing" pivot points, A, B, C and three parallel lines.Construction of the "Pitchfork" is relatively simple. Draw a line connecting B and C points.From A pivot point, draw a line connecting A to the mid point of B-C. The middle line-fromA is called the "median Line." Draw parallel lines from B and C along the median line toform a "Pitchfork."
Trade: Dr. Andrews suggested that about 80% of the time, when trend is intact, pricesgravitate towards the median line. Hence, when prices reach to the top trend line, take profitsor short the market. Also, when prices reach the bottom trend line, enter a long position orclose a short position.Target: The targets for "Pitchfork" are usually at the median line. If the price does not stop atthe median line, it will tend to move to the lower trend line (for shorts) or move to the uppertrend line in case of a "long" trade.Stop: Pitchfork upper and lower trend lines act as the "stop" levels for trades. For "short"trades, place a "stop" order above the upper 'pitchfork" line, Similarly, for "long" trades,place a "stop" order below the lower pitchfork line.
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Pitchfork TypesHere are a few variations of how to calculatea "Pitchfork."I
Standard:The median line is extended from A pivotpoint parallel to B and C pivot lines.Schiff Method:The mid point of A and B is used to draw themedian line.Modified Schiff:A parallel line is drawn from the midpoint ofA and B to B and C Pivot lines.
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Trading Pitchfork
T r a d i n ~Pitchfork PatternThe example above displays a "Pitchfork" formation from the Russell Emini (ER2) 30 minutechart. The basic premise of "Pitchfork" trading is that prices trade from support to resistancein a channel format. In the example above, the "swing" pivots, A, B and C are identified and a"Pitchfork" is plotted to show the support and resistance areas. On January 10, ER2 reachedthe lower trend line support at 779. A "long" trade is triggered at 780 at point 1. A "stop"order was placed below the trend line. The first target is the median line at 788. ER2 ralliedthrough the target level and closed at 796 (upper trend line). Next a "short" trade wastriggered at point 4 at 805. A stop loss is placed at 807. The target was set at median line (at799). This "short" trade continued to trade below the lower trend line (at point 5).
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Chapter 8: Bands8.1. Bollinger Bands
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Bollinger Bands"Bollinger Bands" were invented by John Bollinger, and are designed to identify pricevolatility using "standard deviation" around a simple moving average. As the volatilitychanges, these bands constrict and expand to give potential trade opportunities. "Bollingerbands" do not produce any BuyISell signals; however they help traders with other analysistechniques and indicators. The direction and width of "Bollinger bands" (%B) provide goodtrading ideas.One of the techniques in trading "Bollinger bands" is when a new highllow price trade outsidea band and subsequent highsllows are falling inside the band. This occurrence may signal aprice or trend reversal.Another important technique of "Bollinger bands" is to compare the Bollinger bandwidth(%B) at key price levels. These bands constrict and provide an early warning signal before abig price change.Traders use multiple "Bollinger bands" on multiple time-frames along with other momentumindicators. "Bollinger bands" dynamically change and provide a constant feedback to themomentum regarding the price and the direction of the trends. "Bollinger bands" are also usedwith other indicators to find trade opportunities.
Bollinger Bands Construction
- - - -- - - --- --- --- - - - --
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Bollinger Bands have three band likestructures around a key simple movingaverage.Central: SMA (20 Periods)Upper : SMA + 2 StandardDeviationsLower : SMA - 2 StandardDeviations
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Trading Bollinger Bands,
Trading Bollinger BandsThe example above illustrates a "Bollinger bands" trade setup from the Russell 2000 chart.On January 23,2007, around 12.45 pm, the "Bollinger bands" expanded and made a new 20bar high and pierced the bands outside of its price range. On subsequent highs, the priceclosed inside the bands to signal a potential trend reversal. At about 1.30 pm, the pricereversed to test the lower bands. About 2.30 pm, the price made a 20-bar low and tradedoutside the bands. On subsequent trading, the price traded inside the bands to suggest apotential reversal to the upside. "Bollinger bands" trade setups can be traded along with otherkey technical indicator entrylexit signals.
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Bohger B&
Expansion
"Bollinger Bands" provide excellent feedback as their shape changes along with the pricechanges. They provide an early warning about "volatility" contraction and expansion. Whenprices trade in a consolidation range, the bands constrict (squeeze) and provide an early signalabout an impending sharp price change. Price expansion makes the bands expand outward andprovide a volatile shape and suggest that prices may trade outside the bands until the"volatility" returns to the norm within the bands.The example above shows GOOG price chart with "Bollinger Bands." In mid October 2005,the Bollinger bands contracted to suggest an impending move. After bands expansion, pricesreached new highs. Trades are taken in the direction of the breakout form bands contraction.
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8.2. Keltner Bands
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Keltner Bands"Keltner Bands" were first revealed from the book,"How To Make Money in Commodities" byChester Keltner. "Keltner Bands" look similar to "Bollinger bands" and are computed using asingle moving average with a fixed width envelope using Average True Range (ATR). Thecenter line is the 10-period average of "high,"and "close" prices. The outer bands areconstructed using a 10-day ATR. For a "lower" band, a 10-period ATR is subtracted from the10-period Pivot MA and for "upper" band, A 10-day ATR is added to the 10 period Pivot MA.Trading signals are generated when prices reach outside the bands as prices may be out of thenormal trading ranges and potentially may retrace back to the normal prices.Linda Bradford Raschke, later developed various theories and added modifications for KeltnerBands using different exponential moving averages and Average True Ranges."Keltner Channel" trading is a trend based system method and only suitable for trendingmarkets and fail in congestion or side-ways markets. "Keltner Bands" can be effectively usedalong with other indicators and patterns.Another way to use "Keltner Bands" is to trade in the direction of the trend. When prices closeabove the upper band, it may signal strength and prices may continue to rise. Similarly, whenprices close below the lower band, it may signal weakness and prices may continue to fall.When prices retrace back into the bands, the prior trend may signal a reversal.Overall, "Keltner Bands" are like "moving average envelopes" or "Bollinger bands." Thetrading principles are similar except they are computed differently.
Keltner Bands CalculationsP~2.-o610 Tick B a a L=836.80 dd073:lBPM
Pivot: (H+L+C)/3ATR = Average(TrueRange, 10);Middle Band: Pivot MA = MA(Pivot, 10);Upper Band : Pivot MA + ATR (10);Lower Band : Pivot MA - ATR(10);
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Trading Keltner Bands
,
Trading Keltner BandsThe example above shows "Keltner Bands" trading system from the Russell 2000 Eminichart. The middle band is represented by A 10 period Moving Average of Keltner averageprice (H+L+C)M. The upper band is computed by adding 10-period average of ATR to themiddle band. The lower band is computed by subtracting a 10-period average of ATR fromthe middle band. "Keltner Bands" Trading System includes buying when the marketspenetrate the upper band and selling when the markets penetrate the lower band. A "stop"order is placed at the middle band to protect the trade. "Keltner Bands" are very effective intrending markets and should be avoided in side-ways or congestion zones.
Trade Chart