A. It depends on your trading style. Shallow pullbacks tend to lead tolonger term, smoother continuation moves. Deeper pullbacks tend tolead to much shorter term and much sharper “knee-jerk” reactions.
Q. Why not wait until the old highs are exceeded (b) instead of enteringas soon as the trend begins to resume (a)?
(b)
A. You would miss the move from the pullback entry (a) to the old highs(b). Often, this can be substantial. And, in many cases, this might beall you get.
Q. Why?aPullbacks 57
A. Once you get all the way back to the prior new high (b), those whobought at those levels previously may be looking to get out atbreakeven.
Q. Hence, a potential double top?
>
Exactly.
Q. Provided you entered during the resumption of the trend (a), wouldyou look to take profits as the old highs are approached?
A. Yes, at this juncture, the market either breaks through or fails. There-fore, you should take partial profits and tighten your stops on the restof your position. This way if it doesn’t break through, at least youmade money on your overall position. And if it does, then you have achance at a home run on your remaining shares.
Q. You discussed that markets often “stair step” higher. How do youknow that this stair step won’t be the last?
A. You don’t. You have to keep playing the stock as if the trend will lastforever. Hopefully, you won’t get triggered on that last pullback (i.e. afalse pullback). Or, at worst, you'll get stopped out with a modest loss.The good news is that markets often offer many opportunities beforethey eventually fail.
Q. On your retracement examples, you drew lines at 38.2%, 50% and61.8%. Were these generated by the computer?
A. Yes, but I had to manually pick the low and the high I was measuring.Retracement lines are available in most charting packages.
Back to the levels, why 38.2%, 50% and 61.8%?
a)
The 50% level is a logical level, as it is half of the original trend. We’reall familiar with the phrase “two steps forward, one step back.”
And the 38.2% and 61.8% levels?The 38.2% and 61.8% levels are based on Fibonacci Ratios.
Fibonacci?
POP vo
A Fibonacci sequence is derived by adding a series of numbers to-gether. The sum of each two numbers is added to the prior number.The process is then repeated. For instance, 1+1=2,1+2=3,2+3=58 Chapter 5
>
or OP vO
5 and so forth. So you end up with the sequence:1,1,2,3,5,8,13,21,34,55,89.... What’s interesting is that after about seveniterations, any number in the sequence divided by the prior number =1.618. Therefore, any prior number is the subsequent number less38.2% (1 - .618). What's also interesting is that you can start with anytwo random numbers and these ratios will begin to show up afterabout seven iterations.
Is there something magical about these numbers?
The numerologists believe they hold the answer to the universe asthese ratios can be found throughout nature. They point out every-thing from planetary relationships to the level of a women’s navel.Others think it was originally just a math exercise developed to teachstudents how to add.
Where do you stand?
I always considered them hocus-pocus until I noticed Kevin Haggerty,former head of trading for Fidelity, occasionally showing retracementsin his commentary on TradingMarkets.com. I figured if someone ofhis stature watched these levels then so should I.
So they are magical?
No. I think they have become a self-fulfilling prophecy.Anything “watched” is worth watching?
Exactly.
You mentioned outside days in pullbacks. Hasn’t this setup alreadytriggered as a pullback?
Yes, it has. But, you can’t watch every single pullback to see if it willtrigger. By looking for outside days in pullbacks, you not only catchthose that triggered, but triggered from an intraday reversal.
Does an outside day in a pullback work better if the stock gaps lower(for longs) before reversing to form the outside day?
A gap down would likely scare out more players and when it cameback, it would draw them back in. So, yes, a gap lower would proba-bly work as well, if not better. 
 
SECTION TWO ee
 
 
MORE SWINGTRADING PATTERNS 
 
CHAPTER 6
FAKEOUTS ANDFALSE MOVES
We won't get fooled again.~—- The Who
Even markets in the strongest trends are prone to shakeout moves and falserallies. These markets may also form false tops that draw in eager shortsand knock out nervous longs.
The following patterns were born out of the frustration of being caughtin these shakeout moves, false rallies and false tops. From this I’velearned that no matter how strongly a market is trending, I should notenter until after some sort of correction has occurred. I’ve also learnedthat I shouldn’t try to pick a top and that a stock may still be worth trad-ing even if I’m stopped out on my first entry.
61 
62 Chapter 6
TREND KNOCKOUTS
 
While it’s a good idea to trade in the direction of the trend, I’ve learnedyou’re much better off waiting until the weak hands are knocked out ofthe market before entering yourself. The reason is, you never know whenthese traders are going to dump their positions and take you out withthem. Trend Knockouts (TKOs) identify strong trends from which theweak hands have already been knocked out. By placing your order abovethe market, you have the potential to capture profits as the trend re-sumes.
Here are the rules for Trend Knockouts:For Buys: (Short Sales are reversed).
1. The market should be in a strong trend as defined by a com-puter-based indicator such as ADX >= 30 and +DMI > -DMI or as de-fined under Trend Qualifiers (Chapter 3).
2. The market should make at least a two-bar low. Buy tomorrow or thenext day (allow yourself two days to get filled), 1/16 above today’shigh.
3. Place a protective stop below the low of the knockout bar (2). If this ismore than 5% away from your entry, risk no more than 5% of thestock’s value.
Let’s look at four examples.Fakeouts and False Moves 63
FIGURE 6.1
 
 
 
 
 
 
m
Viratra Corp. (VRTA) qualifies as a strongly trending stock by havingan ADX of 52 and +DMI > -DMI. Other Trend Qualifiers include itsdoubling in value in two weeks and having wide-range bars andstrong closes in the direction of the trend (a), (b), (c) and (d).
2. The stock sells off and takes out (trades below) the two prior lows.Buy tomorrow at 71 13/16, 1/16 above today’s high.
3. The stock trades at 71 13/16 and we go long.
4. Because the low of the setup (6] 1/4) is more than 5% away from ourentry, we place our protective stop at 63 3/16 for a risk of 5%.
5. The trend resumes as the stock gaps open and explodes over 30 pointshigher on the following day.64 Chapter 6Here we have an example of getting filled on the second day.
FIGURE 6.2
 
Gene Logic Inc-Daily 02/18/2000 C=129.000_ 6)
 
120
      
"Created wih supercharts by Umega Research © 19: 7
 
 
 
1. Gene Logic (GLGC) qualifies as a strongly trending stock by risingmore than 300% in less than a month and by having an ADX of 63and +DMI > -DMI (not shown).
2. The stock makes a two-bar low. Buy tomorrow at 79 7/8, 1/16 abovetoday’s high.
3. No fill.4. The stock trades at 79 7/8 and we go long.
5. The low of the setup (68) is more than 5% away from our entry so weplace a protective stop at 75 7/8 for a risk of 5% of the entry price.
6. The trend resumes and the stock explodes higher over the next fewdays.Fakeouts and False Moves
FIGURE 6.3
65
 
r
 
Abgenix-Daily 03/02/2000 C=90.625 +3.213 6)
  
"Created with Super-harts by Umega Research © 1997
 
Abgenix (ABGX) qualifies as a strongly trending stock by having anADX of 47 and +DMI > -DMI (not shown). Other Trend Qualifiers in-clude its more than doubling in less than three weeks and havingwide-range bars (a), (b), (c) and (d), and its having strong closes in thedirection of the uptrend (b) and (d).
The stock makes a two-bar low. Buy tomorrow or the next day at 689/16, 1/16 above today’s high.
The stock trades at 68 9/16 and we go long.
The low of the formation (57 7/8) is more than 5% away from our en-try, so we place a protective stop at 65 1/8 for a risk of 5%.
The trend resumes and the stock trades over 20 points higher over thenext six days.
 LL66 Chapter 6
Here’s another example of Gene Logic (GLGC) but this time, it’s on theshort side.
FIGURE 6.4
 
‘Gene Logic Inc-Daily 04/17/2000 C=21.750 -3.687
 
 
 
 
1. Gene Logic qualifies as a strongly trending stock by having an ADX of31 and -DMI > +DMI (not shown). Other Trend Qualifiers include itslosing more than 80% of its value in a month and its havingwide-range bars (a), (b), (c) and (d), and weak closes (a) and (d).
2. A two-bar high. Go short tomorrow at 43 7/16, 1/16 below today’slow.
3. The stock trades at 43 7/16 and we go short.
4. Because the high of the setup (51 3/4) is more than 5% away from ourentry, we place a protective stop at 45 5/8 for a risk of 5%.
5. The downtrend resumes and the stock drops over 24 points in sevendays. 
Fakeouts and False Moves 67
Q&A
Q. How did you discover this pattern?
A. Many times, I would get stopped out of positions, only to watch infrustration as the trend resumed.
Q. Why not just re-enter when the trend resumed?
A. I now know that second entries, after being stopped out, are often thebest entries but I didn’t always know that. Someone once said that aloss is not a loss as long as something is learned from it. I learnedTKOs from getting stopped out.
Q. So the loses were painful?
A. Yes. I found it aggravating that I sold stock or futures at a bargain tosomeone who was now making money. I would eventually “throw inthe towel” and jump back into the market, only to get knocked outone more time. I knew I had to come up with a better way to enterstrongly trending markets.
Q. The setup calls for “at least” a two-bar low. Does a three-bar low orpgreater work better?
A. Yes, in general, the more players that are knocked out the better. Youare just less likely to get filled. 
68 Chapter 6
DOUBLE TOP KNOCKOUT (DT-KO)
 
Reversal patterns of markets in strong uptrends attract eager top pickers.These patterns also shake out the nervous longs. When the reversal failsto follow through, these players are trapped on the wrong side of themarket or knocked out.
The Double Top Knockout (DT-KO) seeks to take advantage of thesetraders’ predicament as the shorts scramble to cover their positions andthe longs that were shaken out are forced back in.
Here are the rules for the Double Top Knockout:For Buys (Short Sales are reversed):
1. The market should be in a strong trend as defined by a com-puter-based indicator such as ADX >= 30 and +DMI > -DMI or as de-fined under Trend Qualifiers (Chapter 3).
2. The market must make a new two-month calendar high.
3. The market must make another new high no-sooner-than three tradingdays later. This is important as it allows the false double top to form.
nA oOil| L_J
At least 3 days
  aFakeouts and False Moves 69
4. The market must then make (at least) a two-bar low. This actiondraws in eager shorts (or shakes out longs) on what appears to be aconfirmed double top. Buy tomorrow 1/16 above today’s high.
5. If filled, place a protective stop 1/16 below yesterday's low. If this ismore than 5% of the stock’s value, risk no more than 5% of the stock’svalue.
Let’s look at four examples. 
70 Chapter 6
FIGURE 6.5—
 
 
 
 
 
1. Anadigics (ANAD) qualifies as a strongly trending stock by having anADX of 33 and +DMI > -DMI. Other Trend Qualifiers include itsmore than doubling in 10 days and having wide-range bars andstrong closes in the direction of the trend (a), (b), (c) and (d).
2. The stock makes a new two-month high.3. The stock makes another high six days later.
4. The stock sells off and trades below the two prior day’s lows. Buy to-morrow at 52 1/16, 1/16 above today’s high.
5. The stock trades at 52 1/16 and we go long.
6. The low of the setup is more than 5% away from our entry, so weplace our protective stop at 49 7/16, 5% below our entry.
7. The trend resumes as the stock explodes more than 30 points over thenext seven days. 
Fakeouts and False Moves 71
FIGURE 6.6
 
 
an PF WD N
Plantronics Inc-Daily 07/20/2000 C=48.937 +1.969 =?)
     
Mperchare by lime Hesearch © 1a07
 
 
. Plantronics (PLT) qualifies as being in a strong uptrend by having an
ADX of 34 and +DMI > -DMI (not shown). Other Trend Qualifiers in-clude its rallying nearly 70% in Jess than a month and a gap (a), itshaving wide-range bars (b), (c) and (d), and strong closes in the direc-tion of the trend (b) and (d).
. PLT makes a new two-month high.
. The stock makes another new high five days later.
. A two-bar low. Go long tomorrow 1/16 above today’s high (44 1/16).. The stock trades at 44 1/16 and we go long.
. Because the low of the setup is more than 5% away from our entry,
we place a protective stop at 41 13/16 for a risk of 5%.
- The stock trades over six points higher in two days.I72 Chapter 6
Here’s a low ADX example.
FIGURE 6.7
 
 
 
1. Clarent Corp. (CLRN) has a low ADX reading of 18 but qualifies asbeing in a strong trend by having rallied over 230% in Jess than amonth.
2. The stock makes a new two-month high.3. The stock makes another new high four days later.
4. The stock trades below the prior two lows. Go long tomorrow at 7413/16, 1/16 above today’s high.
5. The stock trades at 74 13/16 and we go long.
6. Because the low of the setup (68 7/16) is more than 5% away fromour entry, we place our protective stop at 71 1/16 for a risk of 5%.
7. The trend resumes as the stocks rallies more than 22 points over thenext four days.aFakeouts and False Moves 73
FIGURE 6.8
 
 
 
 
 
1. Broadcom (BRCM) has an ADX reading of 28 (not shown) but quali-fies as being in a strong uptrend by its rising more than 80% in lessthan two months.
2. A two-month high.3. Another two-month high four days later.
4. The stock trades below the two prior day’s lows. Go long tomorrow at193 3/8, 1/16 above today’s high.
5. The stock trades at 193 3/8 and we go long.
6. Because the low of the setup (180) is more than 5% away from our en-try, we place our protective stop at 183 11/16 for a risk of 5%.
7. The trend resumes as the stock explodes more than 50 points higherover the next five days. 
74
Chapter 6
O&AHow did you discover the DT-KO?
I know several very talented traders who are great at “putting theirface in the fire’ (going against the trend). When they are right, thepayoff is substantial as they latch on toa major market turn. However,I noticed that more-often-than-not, they are quickly stopped out as thelonger-term underlying trend resumes. I saw this fakeout as an oppor-tunity.
So you are basically taking the other side of their trades?
Yes and no. If the reversal is for real, my trade probably won't be trig-gered. However, if the reversal is false, then yes, I’m buying as the re-versal players are getting stopped out.
Why not play the double top and short the stock, then, look to reverseyour position if stopped out (i.e. cover and go long)?
You could, but, again, I’d prefer going with the trend. Also, youwould have to be very disciplined and willing to switch from bearishto bullish very quickly. Psychologically, this may be tough for many.Further, there are execution costs and risks in doing all those trades.You could probably make such a “stop and reverse” strategy work infutures where there isn’t an uptick rule for shorting and the increasedleverage would help to cover the execution costs. 
Fakeouts and False Moves
TREND PIVOT (FALSE RALLY) PULLBACKS
Like the Trend Knockout, here’s another pattern born out of frustration.Often { would enter pullbacks and find myself quickly stopped out a fewdays before the market mounted a major move. This was difficult as Iwas “right” but too early. It’s now obvious to me that the correction was-n’t over and I should have been looking to re-enter the market as thetrend resumed.
Trend Pivot Pullbacks seek to identify pullbacks that have had this falserally. This rally draws in, and subsequently shakes out the “fastmoney”—~traders without staying power (money) and/or patience. Oncethese players are cleared out of the market, the stock often resumes itsuptrend.
Here are the rules for the Trend Pivot Pullback:For Buys (Short Sales are reversed):
1. The market should be in a strong trend as defined by a com-puter-based indicator such as ADX >= 30 and +DMI > -DMI or as de-fined under Trend Qualifiers (Chapter 3).
2. The market must make a two-month calendar high.
3. The market must subsequently make at least one, but no more thanfive, lower highs.
7 
76 Chapter 6
4. The market must stage a one-day rally (a high greater than the priorday's high) followed by a lower high. This is known as a pivot highand is illustrated below. Go long tomorrow or the next day 1/16above this pivot high.
Pivot Point
I
 
5. If filled, place a protective stop 1/16 below the lowest bar in the setup.If this is more than 5% of the stock’s value, risk no more than 5% ofthe stock’s value.eee eee eee ee ee eeFakeouts and False Moves 77
FIGURE 6.9
 
 
 
 
 
1. Cirrus Logic (CRUS) qualifies as being in a strong uptrend by havingan ADX of 49 and +DMI > -DMI (not shown). Other Trend Qualifiersinclude its nearly doubling in less than a month and havingwide-range bars and strong closes (a) and (b) in the direction of thetrend and a high-level base breakout (c).
2. The stock makes a new two-month high.
3. The stock begins rallying out of a pullback but fails, leaving a pivotpoint at 33 3/8. Go long tomorrow at 33 7/16, 1/16 above pivot high.
4. The stock trades at 33 7/16 and we go long.
5. Because the low of the setup (30 3/8) is more than 5% away from ourentry, we place a protective stop at 31 3/4 for a risk of 5%.
6. The trend resumes and the stock rallies nearly 20% in two days.I78 Chapter 6
Here’s a low-ADX example.
FIGURE 6.10[— 7
 
 
 
 
 
 
1. Tektronix (TEK) has a fairly low ADX of 25 (not shown) but qualifiesas being in a strong trend by rising nearly 60% in less than a month.Other Trend Qualifiers include its having wide-range bars (a) and (b),a gap (c), and strong closes in the direction of the uptrend (a) and (b).
2. Tektronix makes a new two-month calendar high.
3. After three lower highs, the stock begins rallying out of a pullback butfails on 6/29/2000 leaving a pivot point at 35 15/16 (the high of theprevious day). Go long 1/16 above the pivot high (36) tomorrow orthe next day.
4. The stock trades at 36 and we go long.5. Place a protective stop at 34 5/8, 1/16 below the low of the formation.
6. The trend resumes as the stock trades more than 20% higher over thenext eight days.aFakeouts and False Moves 79
Here’s another low-ADX example.
FIGURE 6.11
 
Cell Therapeutics Inc-Daily 06/22/2000 C=28.062 (6)
 
 
 
 
1. Cell Therapeutics has a low ADX (17) but is in a strong uptrend basedon the fact that it has risen over 70% in just over two weeks. OtherTrend Qualifiers include its having Daylight (a), positive slopes on the10-period simple, 20-period exponential and 30-period exponentialmoving averages (b), proper order (IOSMA>20EMA>30EMA) of itsmoving average (c) and its having a wide-range bar higher with astrong close (d).
2. The stock makes a new two-month high.
3. The stock has a one-day false rally, forming a pivot point at 23 1/4 (alower high the day before and lower high the day after). Go long to-morrow or the next day at 23 5/16, 1/16 above the pivot high.
4. The stock trades at 23 5/16 and we go long.
5. Because the low of the setup (21 1/2) is more than 5% away from ourentry, we place a protective stop at 22 1/8 for a risk of 5%.
6. The trend resumes as the stock trades more than 20% higher over thenext five days.I80 Chapter 6
Here’s a low-ADX example on the short side.
FIGURE 6.12
 
 
 
 
1. Open Market (OMKT) has a low ADX of 22 but is in an obviousdowntrend by losing over half of its value in seven days. Other TrendQualifiers include its having wide-range bars lower and poor closes(a), (b) and (c).
2. The stock makes a new two-month low.
3. The stock forms a pivot point (a low surrounded by two higher lows).Go short tomorrow or the next day at 35 1/16, 1/16 below the pivotlow.
4, The stock opens at 34 % and we go short.
5. Because the high of the setup is more than 5% away from our entry,we place a protective stop at 36 1/4 for a risk of 5%
6. The downtrend resumes as the stock implodes, losing over 50% of itsvalue over the next six days. 
P
Fakeouts and False Moves
Q&AShould the pivot high be less than the two-month high (rule 1)?Yes, otherwise it wouldn’t be a pullback
Don’t you give up some of the move by requiring the stock to tradeback above the pivot high?
Yes, but you also often avoid getting caught in a potential second falsemove.
So when it trades above the pivot high, it helps confirm the rally?Yes.
What’s the difference between this pattern and the Simple Pullback(SP)?
The SP doesn’t require the one-day false rally. With the Simple pull-backs, you actually enter the market on that false rally. Of course, atthat time, you don’t know that it’s going to turn out to be a false rally.
So why not wait until a Trend Pivot Pullback is formed?
You could. It all depends on your trading style. However, you willmiss all of the stocks that don’t come back in. For me, its tough towatch all these stocks go by.
81 
CHAPTER 7
BOW TIES
Picking tops and bottoms can be costly, as markets are prone to long-termcontinuation moves and false reversals. On the other hand, blindly jumpingon an established trend can also be costly, as these markets are prone to cor-rect. Bow Ties avoid these pitfalls associated with trend trading andtop/bottom picking by waiting for the trend to turn based on multiple mov-ing averages followed by a countertrend correction.
In Chapter 3, Trend Qualifiers, we defined “proper order” for an uptrendas when the faster moving averages (shorter periods) were above theSlower moving averages (longer periods). Conversely, for a downtrend,we defined proper order as when the faster moving averages were belowthe slower moving averages.
 
83 
84 Chapter 7
With Bow Ties, we are looking for these moving averages to switch fromdowntrend proper order to uptrend proper order over a period of threeto four days. This gives the moving averages the appearance of a bow tieas they all cross and spread out from one point. When the Bow Tieforms, it suggests that the market has made a major trend shift. How-ever, it’s still prone to correct. Therefore, Bow Ties seek to enter after aminor correction.
Here are the rules for Bow Ties.For Buys (Short Sales are reversed):
Using a 10-period simple, 20-period exponential and a 30-period expo-nential moving average:
1. The moving averages should converge and spread out again, shiftingfrom proper downtrend order (10-SMA < 20-EMA < 30-EMA) toproper uptrend order (10-SMA > 20-EMA >30-EMA). Ideally, thisshould happen over a period of three to four days. This creates the ap-pearance of a bow tie in the averages. This is illustrated below.
30ema10sma
20ema 20ema
10sma 30ema
  
Bow Ties 85
2. The market must make a lower low. That is, today’s low must be lessthan yesterday’s low.
3. Once qualifications for (2) have been met. Place a buy order 1/16 abovetoday’s high good for tomorrow. Continue to work an order above to-day’s high good for the next trading day until filled or the markettrades below its 20-period exponential moving average.
4. If filled, place a protective stop below the lowest bar in the setup. Ifthis is extreme, then place your stop no more than 5% away from
your entry.
Let’s look at five examples.a86 Chapter 7
FIGURE 7.1
 
 
EMC-Daily 06/19/2000 c=82.875 +3625 O-78.250 6
 
 
 
 
1. The moving averages on EMC converge and begin to spread out.2. A lower low. Go long at 69 15/16, 1/16 above today’s high.
3. The stock trades at 69 15/16 and we go long.
4. Place a protective stop at 67 1/16, 1/16 below the low of the setup.
5. The trend resumes as the stock rallies nearly 13 points over the nextfour days.aBow Ties 87
FIGURE 7.2
 
Lynx Therapeutics-Daily 06/21/2000 C=43.500 — 8)
 
 
 
 
1. The moving averages converge on Lynx Therapeutics (LYNX) and be-gin to spread out—giving the appearance of a “bow tie.”
2. A lower low. Go long tomorrow at 32 3/16, 1/16 above today’s high.3. The stock trades at 32 3/16 and we go long.
4. Because the low of the setup (29 1/4) is more than 5% away from ourentry, we place our protective stop at 30 9/16 for a risk of 5%.
5. The uptrend continues as the stock trades 40% higher over the nextfour days.I88 Chapter 7
Here’s an example on the short side in the Nasdaq Composite. Signals inindices can help you time your stock market entries and exits or they canbe traded in and of themselves by using index futures or holder shares.
FIGURE 