the stock or sell a long holding whenprice closes below the upsloping trendline. Watch for price to stall asit dips to the lowest valley in the pattern. For conservative traders, entera new trade when price declines below the lowest valley in the bustedpattern.For downward breakouts that bust the triangle, take a positionwhen price closes above the top trendline.In Chapter 7, Figure 7.18 shows an ascending triangle that qualifiesas a busted pattern because price drops 8%, just short of the 10% benchmark. Figure 5.1 in Chapter 5 shows another example of a busted ascending triangle. This one is treacherous because price breaks out upward andthen moves down for just four days before gapping back into the triangle.Descending Triangle
The adjacent figure shows a descending triangle witha downward breakout. When price closes abovethe downsloping trendline on the top, it busts thepattern.Throwbacks and pullbacks occur at the ratesshown in Table 9.15. Look at the performance of busted patterns. Thosewith downward breakouts that curl upward and shoot out the top rise anaverage of 60% and that is with 180 samples. Clearly, a busted descending triangle is one you will want to focus on. The other busted directiondoes well, with prices dropping 26% after a failed upward breakout.
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TABLE 9.15Description
Upward Breakouts
Downward Breakouts
Throwback or pullback rate
37%
54%
Busted-pattern performance
–26% (77 samples)
60% (180 samples)
For aggressive traders in a busted downward breakout, take a position once price pierces or closes above the downsloping trendline. Forconservative traders, wait for price to rise above the highest high in thepattern. That way, price is likely to continue moving up.Be sure to check the market averages and other stocks in the sameindustry. If they are trending in the same direction, that improves yourchances of a profitable trade.Figure 8.3 in Chapter 8 shows an example of a busted descendingtriangle. Price barely closes below the lower trendline before moving upsubstantially. Another example appears in Chapter 6, Figure 6.12.Symmetrical Triangle
Symmetrical triangles are almost as common as aphidson my cucumber plants in summer, and the lower leftof Figure 9.5 shows an example of a busted symmetrical. If price breaks out in one direction and shoots outthe other side, then it’s a busted pattern. That behavioroften, but not always, leads to a large price move.Table 9.16 shows the results. Throwbacks complete 37% of the time andpullbacks are more frequent, 59% of the time. Prices that break out downward then reverse and punch through upward soar an average of 43%. Upward breakouts that bust show declines of 26%. Both directions have plentyof samples, so the results are solid.TABLE 9.16Description
Upward Breakouts
Downward Breakouts
Throwback or pullback rate
37%
59%
Busted-pattern performance
–26% (97 samples)
43% (97 samples)
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BUSTED PATTERNS
Once a symmetrical triangle breaks out and reverses, crossing bothtrendlines, trade in the direction of the new trend. Take a position onceprice closes outside the second trendline. Figure 8.5 in Chapter 8 showsan example of this scenario when price broke out downward, returned tobreakout upward, and made a large gain. Figure 7.19 in Chapter 7 showstwo busted symmetrical triangles; and Figure 7.18 shows a busted symmetrical in May.If you are concerned about a reversal, especially if the industry ormarket is trending opposite your stock, then wait for price to move abovethe highest peak or below the lowest valley before trading. Price oftenstalls or reverses at prior peaks and valleys.Falling Wedge
I’m not keen on wedges, regardless of whether they arerising or falling. Other traders seek them out. I thinkthe profit potential is meager compared to otherpatterns because price will often rise to the top of thepattern and then reverse. That doesn’t leave muchroom for profit unless you are a talented swing traderaiming for those types of moves.Figure 9.5 shows a busted falling wedge, one with an upward breakout but prices soon plunge.Table 9.17 shows the numbers. A throwback happens over half thetime and pullbacks occur over two thirds of the time. Based on few samples, downward breakouts bust then prices rise a sumptuous 51%. Upward breakouts drop and tumble 19%.TABLE 9.17Description
Upward Breakouts
Downward Breakouts
Throwback or pullback rate
56%
69%
Busted-pattern performance
–19% (53 samples)
51% (21 samples)
Trade falling wedges like you would most other chart patterns.When prices break out in one direction, reverse and pierce the oppositetrendline moving in the new direction, then take a position in the stock.If prices are moving upward, watch for them to stall near the top of thepattern—a common resistance zone.
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For example, Figure 9.5 shows a falling wedge with an upwardbreakout. Sell a long holding or short the stock when price closes belowthe lower trendline.Rising Wedge
The rising wedge shown in the lower right of Figure9.5 has a downward breakout in which price curlsaround and then moves above the highest peak inthe chart pattern, confirming a busted pattern.Table 9.18 shows that 73% of the risingwedges throw back and 63% pull back. Busted patterns show prices rising an average of 43% or dropping 26%. The upward move with 84 samples is particularly solid. Maybe that’s why sometraders like wedges. They have learned to search for busted ones.TABLE 9.18Description
Upward Breakouts
Downward Breakouts
Throwback or pullback rate
73%
63%
Busted-pattern performance
–26% (25 samples)
43% (84 samples)
Figure 9.5 shows a rising wedge with a downward breakout. In sucha situation, buy the stock once price closes above the top trendline. Forupward breakouts, a close below the lower trendline is the trading signal.Expect support when price nears the lowest valley in the pattern.Case Study
Figure 9.6 shows a trade Jake made on the weekly scale. He bought 200shares, filled at the market for 65.33. “The company projected 20% annual growth through 2005,” he said, “and I was foolish enough to believethem. The problem was their projections had nothing to do with thestock’s price.”He bought the upward breakout from a symmetrical triangle. “I expected the price to stall at overhead resistance of 67 and again at 74 withsupport at 55 and 59–60.” The 67 call was a good one even though pricecoasted to 69 during the week he bought. Below the symmetrical triangle, the stock dropped to a low of 53.28, with solid support showing in
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the 55 to 57 range, just as he predicted. The 59–60 support area onlyslowed the stock a bit.“I wanted to hold the stock for the long term because it was tradingnear the yearly high,” he explained. “A rise to 74 would only be a gain of13%, and I wanted more which would take longer.”Ten days after he bought, the company announced that it was buying Immunex. That sent shares tumbling, causing a throwback and priceto close below the lower trendline a few weeks later. A few days into theNew Year, the stock pierced the 55 support zone.“Although I wanted to hold it for the long term,” he said, “I didn’twant a massive loss on my hands.” He received a fill at 54.20 for a hugeloss of 17% or $2,250. “There was red ink all over my keyboard thatmorning. I expected the stock to pull back to the triangle bottom thencontinue its decline.” The stock pulled back and continued rising, piercing the top trendline before heading back down again. The stockplunged to 30.57 in July, less than half what he paid for it.
Amgen Inc. (Biotechnology, NASDAQ, AMGN)76
Bought
7268646158555249
Sold
46434139
SymmetricalTriangle
37353331292725A M
J
J A S O N D 01 F M A M J
J A
S O N D 02 F M A M
23J J A S O
FIGURE 9.6 An upward breakout from a symmetrical triangle bustswhen prices drop to the other side of the triangle and close outsidethe lower trendline. Shown on the weekly scale.
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Did Jake make a mistake selling? No, but he could have timedhis entry better (by placing a buy order at the triangle trendline). Thatwould have lowered his loss.Look at Figure 9.6 again. Regardless of when you bought the stock,the upward breakout or the downward one, you would have likely takena loss. A double turn like this happens occasionally, so do not be surprised when it happens to you. Keep trading those busted patterns forthe big bucks.
Other Busted PatternsIn this chapter, I’ve covered 18 busted chart patterns that you are likelyto see in your trading travels. I didn’t cover all busted patterns. The safestway to trade a busted pattern is to buy when price closes above the peakin the pattern or short when price closes below the lowest valley. If trendlines shape the chart pattern, then a close outside those trendlines opposite the breakout direction also provides another trading signal. Watchfor price to stall or reverse at support and resistance zones, especially thepattern’s highest peak or lowest valley.I think you’ll find that trading a busted pattern is more profitablethan trading non-busted ones. But remember that even busted patternsbust. The one shown in Figure 9.6 had an upward breakout, droppeddown to breakout downward, and then returned to close above the toptrendline before making the final plunge.
10Chapter
More TradesPutting It All Together
his chapter gives you more trades that I made with my own moneyin the market. Use them as a quiz to test what you’ve learned.For the most benefit, pull up each trade on your computerand view it on your trading setup. Decide whether there is a reason totrade each stock. Look at the general market and any trading indicatorsthat you like to use. Search for chart patterns because that’s the point ofthis book. I show each company twice, the first figure has little detail.Decide whether the trade is worth making. The second figure shows howI traded it. All figures use the logarithmic price scale.
T
IMC GlobalFigure 10.1 shows a chart of IMC Global. In August 2004, the JusticeDepartment cleared the merger of the company with a unit of Cargill, soit may be difficult to find the historical prices.Gina’s birthday is coming up and you want to buy her a new car.The problem is your petty cash is low so you go hunting for a trade andfind the stock shown in Figure 10.1. At point A, do you buy the stock,hold it, sell it (assuming you already owned it), or sell it short (whichsuggests the stock will tumble so you can buy it back at a lower price)?239
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IMC Global (Chemical (Diversified), NYSE, IGL)A
S&P 500
-12
1143-111113
Jan 04
Feb
1083
-10
1053Mar
-9
-8
-7
-6
-5
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 04
Feb
-4Mar
FIGURE 10.1 Do you buy, sell, hold, or sell short the stock at point A?
Doing nothing is always an option, but Gina would be upset at notreceiving a gift, and she might tell your wife that you have been foolingaround.Trading out of desperation (you need the money for her gift) is often a way to the poor house. Those trades have a habit of going bad rightwhen you need the income. Let’s assume that money is no problem, it’sjust a question of whether to skip a week’s stay at the bungalow inHawaii this month. That will save fuel and other costs for running theLear jet, especially if you hire a pilot to man the controls while you playgames with Gina in back.Because the stock’s price is near the yearly high, you don’t want toshort the stock. Stocks making new highs have a tendency to continuemaking new highs. You also don’t want to sell because the stock is rising.Why sell today if you can get a higher price for it tomorrow? That leavesbuying the stock. Why would you want to buy it at such a high price?Answer: Momentum.The inset in Figure 10.1 shows the S&P 500 index poised to makea new high when it breaks out upward from an ascending triangle.
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Figure 10.2 shows how I traded the stock. The stock began risingfrom point A to B. Then the stock went horizontal in a high, tight flag(HTF). Of course, the outline of the move after B does not look like aflag or even a pennant. That’s typical for HTFs; some have an irregularshape. The key is that the stock nearly doubled in two months frompoint A.The low at point A is 5.82 and the high at B is 12.40. That meansthere is a 90% probability that price will rise to 13.14 in a bull market.How did I get that? Using the measure rule, compute the price differencebetween the trend low at the start (A) and the high in the flag (B), whichis 6.58. Take half of this (3.29) and add it to the low in the flag (C at9.85) to get the target. Since C is clearly an outlier, you might want touse a higher valley (like point D).Where should you place a stop? Below the low at point E is a goodchoice because the tight pennant should help support the stock. The lowat E is 10.76, so I would place a stop at 10.67, an oddball number (avoidround numbers) far enough away from the low.IMC Global (Chemical (Diversified), NYSE, IGL)-15
Sold
-14
Bought
-13
B
-12
F
-11
ED
-10
Pennant
C
-9
S&P 5001159
-8
1135-7111104
Feb
1087Apr
Mar
-6
A
03
Nov
Dec
Jan 04
Feb
Mar
Apr
May
Jun
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Aug
FIGURE 10.2 The stock moved up and was sold just days beforeit peaked.
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With a target of 13.14 and a stop of 10.67, everything is in placefor the trade. The stock is trading at 12.20. Do you take it? If you arewrong and the stock tumbles, that would represent a loss of 13%. Is thattoo high?If the answer is yes, then compute a volatility stop using the averagedaily high-low difference over the prior month. That turns out to be 41cents. Multiply this by 1.5 (62 cents) and subtract it from the currentlow of 11.80 for a stop of 11.18. That cuts the potential loss to 8%. Remember, low priced stocks (below $20) are more volatile than highpriced ones. Placing the stop so close would have worked in this case, butI feel it’s a bit close.On March 2, 2004, I bought 1,000 shares at the market, filled at12.20. My notebook entry for the trade used the 13.14 target and oneat 14.36, found using the low on 2/27/04 at 11.07 (two days before Ibought). The nearer target would be a gain of just 8%, but the fartherone would be an 18% rise.I placed a stop at 10.67, good till canceled. I raised the stop to11.57 at point F because the general market was weak, and I wanted toclose the distance. The price is just below the March 10 valley to the leftof F. On 3/30, I raised the stop to 11.93 and a day later to 12.93. Thenext day, I decided to sell.Here is my notebook entry:4/1/04. I decided to sell my holdings because the market hasbeen strong for the last several days, and I think it’s still executing a pullback to formations (symmetrical triangles in some ofthe indexes). This stock is showing slowing momentum andhas been moving up for the past six days. It’s due to drop, soI’m taking my money and running. RSI says it’s overbought.CCI will likely say sell tomorrow because CCI is dipping andabout to hit the DCCI line. I looked at prior data and foundfour or five up moves in a row and looked at the aftermath.Since this stock has moved up sharply, I expect a 50% retraceof the up move and I don’t want to give back $1,500 of a potential $2,100 profit, so I’m selling.The CCI did signal a sale on the day I sold, but the stock closedhigher.
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Let me dissect the entry. A pullback to a chart pattern often meansthat price will turn down when the pullback completes. Holding a longposition when the market turns downward is swimming against thecurrent, something no trader wants to do. With momentum slowing inthe stock, it also suggested a turn. The indicator, relative strength index(RSI with a 16-day lookback), was overbought, meaning traders hadpushed up price to unsustainable levels. The stock could go higher andoften does, but RSI was warning that things were pricy. The commoditychannel index (CCI with a 20-day lookback) and the dual CCI (DCCI,a 5-day exponentially smoothed moving average of the CCI) said sell. It’sa short-term indicator that confirmed my sell decision. I looked at thehistorical behavior of the stock when it moved up several days in a rowand found that prices often reversed. All of this convinced me that it wastime to sell. I sold the 1,000 shares at one time because selling half andholding half I think is like trying to rip a Band-Aid off slowly: It hurtslonger. I’ve found that I earn more money selling all at once instead ofscaling out.The inset shows what the S&P did, ending on the day of the sale.The ascending triangle broke out downward in early March but the stockignored the tug of the market current pulling at prices. Both the indexand the stock moved higher in late March.I made just over $2,000, or 17% on the trade. That’s not enoughfor Gina’s car, but it’s a good start. Perhaps a plastic snap-together modelwould suffice. Make it a Corvette. You can brag that you bought yourgirl a ’vette and watch their jaws drop.
Giant IndustriesFigure 10.3 shows the next potential trade. The stock moved up from theAugust low at a steady clip, trending upward at about 45 degrees, whichusually makes for a powerful and long lasting rally—which it did. Thestock peaked in March and backtracked, pausing to gather strength forthe next move, whatever direction that may be. Volume followed priceand made its own mountain peak. Would you buy, sell, hold, sell short,or avoid trading the stock?The inset of the S&P 500 index gives a clue. Price broke out downward from the ascending triangle, piercing the upsloping bottom trendline.
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Price pulled back to the trendline at A and eased lower then made a smallbroadening bottom pattern.I think the pullback in the index was the key to this stock trade.When a stock or index pulls back, prices often continue moving in thedirection of the breakout—downward in this case. Based on that, I wouldexpect the index to move lower, just as it started to do. The question thenbecomes, would the stock follow the index down?Figure 10.4 shows the trade. This is another high, tight flag (HTF),or really a high, loose flag. Loose flags have a tendency to fail more oftenand perform worse than tight ones. The difference is in their appearance.Tight flags seem compact, with highs and lows following straight trendlines. Loose flags have wild swings up and down. Figure 10.2, for example, shows a tight pennant, but the associated HTF is also a loose one.Returning to Figure 10.4, the stock bottomed at A in December2003, began the uptrend at C and peaked at B, almost tripling in pricefrom A, an easy double in about a month from the January launch pointat C.Giant Industries, Inc. (Petroleum (Integrated), NYSE, GI)
1103
-24-22-20-18-16-15
1087
-14
S&P 500A
115111351119
04
Feb
Mar
Apr
-13-12-11-10-9-8-7-6
03
Jul
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Jan 04
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Mar
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FIGURE 10.3 Is this stock a buy, sell, hold, sell short, or avoid altogether?
Giant Industries
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Giant Industries, Inc. (Petroleum (Integreated), NYSE, GI)-28-26-24-23-22-21
BBought
-20-19-18-17
S&P 500
D
-16
Sold
11481130
C
1112
-15-14-13
1094-1204 Feb
Mar
Apr
May
1076-11-10
AJan 04
Feb
Mar
Apr
May
Jun
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FIGURE 10.4 This high, tight flag failed to follow through on theupward breakout.
When price closed above the downsloping trendline, I thought theHTF was breaking out upward, so I bought 800 shares, filled at 20.38.The buy reason was a high, tight flag breakout in a hot industry.The inset shows the direction of the general market. From the beginning of March (point B on the stock), the index trended downward andwas moving lower on the day I bought. A declining market won’t help along trade.I expected the market to rise for a few days until forming a largedouble top. The first top would combine as one the three peaks fromJanuary to March accompanied by the second peak now forming. Theindex was midway through creating a broadening bottom chart patternat the time I bought.The stop-loss point was at 17.30, or 15% away, “too far to place thestop with my broker,” my trading notes say. That in itself is a warning. Ifthe stop is too far away, then skip the trade. I chose the stop point because it was a nickel below the prior valley at D. Most of the stocks in the
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industry were near their yearly highs, ready to jump up, so maybe that’swhy I wasn’t worried about the long drop to the stop. I was confident—overconfident—that this trade would work.The upside target was 25.70, using half the height of the HTF(6.35) from where price started moving up at C to the high at B, projected upward from the closing price the day before the breakout.The stock tumbled immediately then started to recover. Some saythat a winning trade usually performs well right from the start. Bad onesgo south quickly. I agree, and this trade is one example.I did place the stop with my broker at 17.30, two days after Ibought. Volatility was $1.01 over the past month, giving a volatility stop$1.50 below the current low. That would place the stop at 17.80, makingit a bit closer than the one I used.On May 19, the stock hit my stop and sold a nickel below it, filledat 17.25, for a loss of $2,500 or 16%. That’s double the loss I like to see.Prices collapsed in the S&P from the April high, sucking my tradedown the drain along with the index. Look at the stock. I sold a day before prices bottomed. Had I held on, the stock would have fulfilled themeasure rule and exceeded the 25.70 target.Did I make the right decision to sell? Yes. Once you start secondguessing and removing or lowering a stop, that’s when your losses become uncontrollable. You’ll find that the size of your wins diminish, too,because you’ll be so paranoid about taking a loss that you’ll sell as soon asthe trade shows a profit.An e-mail acquaintance has that problem now. He wrote asking if Icould help him stop selling too soon. I told him he was probably checking his stock too often during the day, and he should place a stop withhis broker and not worry about it. “Check it once a day, after the marketcloses,” I told him. He wrote back and said he was checking his tradeup to 20 times a day while working at his job. Employers don’t like thatbehavior.
Lam ResearchFigure 10.5 shows the next case study on the weekly scale. The insetshows the general market trending downward over the intermediateterm. The NASDAQ composite looked similar to the S&P, a series offalling peaks with an uphill run leading to the end of the chart. The stock
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was also trending downward from the start of the New Year, but withslowing momentum. Do you trade the stock, and if so, what direction?Let’s discuss the index first. The chart pattern might be a measuredmove up. The low at 788 to the top of the chart would be the first leg.The corrective phase is the decline shown to the right of the peak near1,157. The thinking is that when price leaves the corrective phase, pricewill rise, completing a nice run during creation of the second leg up.Another interpretation is that the index shows a confirmed threefalling peaks (3FP) chart pattern. What is different with this 3FP is thatprice has moved up since confirmation instead of down. Confirmationoccurs when price closes below the lowest valley in the three-peak pattern.That happens as price drops to 1,075 before the last valley on the right.One interpretation suggests price will rise and another says it willfall. Which is right? Since we’re trading the stock and not the index, itdoesn’t matter, but that explanation doesn’t wash with me. I think themarket direction is important, and I vote for higher prices. Even thoughthe 3FP confirmed, price has risen. Perhaps a closer look at the index onthe daily scale would clarify the situation.Lam Research Corp. (Semiconductor Cap Equip., NASDAQ, LRCX)S&P 500
-34-31-29-27-25-23-21-19-17-15-14-13
11571075993
F MA M J J A S O N D04F M A M J J A S
911870829788
-12-11-10-9-8-7
02 F M A M
J J A
S O N D 03 F M A M J
J A
S O N D 04 F M A M J
J A
S
-6
FIGURE 10.5 This stock appears on the weekly scale. Do you buy, sell,hold, sell short, or avoid it altogether?
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Figure 10.6 shows how I handled it. The index did move higher(the inset chart ends on the day the stock sold).As to the trade, five minutes before the close, I bought 700 shares at23.10. Why? I wanted to trade the rounding bottom. Buying just afterthe halfway point I viewed as a wonderful profit opportunity. This iswhat I wrote in my notebook: “Fundamentals are good when comparedto others in the semiconductor capital equipment business. A triple bottom (123 in Figure 10.6) and pipe bottom round out the base of theturn. This may take nine months to return to the old high, but it looksvery promising. Expect price to blip up then return to the rounding bottom base as happens in some rounding turns. When it gets over 30, beprepared to sell. I feel confident about this trade.”The pipe bottom is the parallel price valley two weeks to the left ofwhen I bought (point three on the chart). The triple bottom, 123, is thethree prior valleys near the same price. The triple bottom did not confirm—price close above the highest peak in the pattern—until after Ibought. The “blip up” in the rounding bottom is a jump in price just after price rounds from down to up. Price soon settles down at a slightlyhigher price before resuming the upward arc. That jump didn’t happenduring this trade.I placed the stop at 19.64, for a potential 15% loss. The stop was 7cents below the lowest valley in the rounding turn. “I am willing to sacrifice this drawdown to get to the old high of 33.” I viewed this trade as along-term one and was willing to take a larger loss to achieve my goal.I put a 200-day moving average on the daily chart and found theNASDAQ was above its moving average. I expected the general marketto rise and for the trade to reach the 33 target.As the trade progressed, I raised the stop to 24.83 (11/17/04),25.47 on 12/6, and 27.13 on 12/16.On January 4, 2005, the stock hit my stop and filled at 27.131, suffering from the downturn that gripped the market at the turn of the NewYear. I made $2,800, or 17%.“I want to play,” Jake said.I hunched over the computer screen, but it was too late. He alreadyread what I was writing.“I want to tell them about the four million I made in KB Home.”I swung around and faced him. “This is a Getting Started book, notHow I Make Millions Trading.”
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Lam Research Corp. (Semiconductor Cap Equip., NASDAQ, LRCX)
Sold12 3BoughtS&P 5001159
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1053
-11
947894841788F MA M J J A S O N D04F M A M J J A S O N D05
-10-9-8-7
02 F M A M J J A S O N D 03 F M A M J J A S O N D 04 F M A M J J A S O N D 05 F
-6
FIGURE 10.6 A rounding turn leads to a profitable trade. The S&P 500index cooper