for months. Get a quote before trading. If the quote is lower than the lasttime you checked, delay buying. Why buy now when it will becheaper later? Is the stock trending up? Wait for price to turn up before buying. Better yet, trade stocks moving up and don’t wait for a reversal of the downtrend. View the stock on the weekly scale (orhigher time scale) to help decide the trend. If the stock is up a lot, skip the trade. Don’t chase a stockhigher. After you buy, the stock will come tumbling down. Howhigh is high? I usually skip trades in which a stock is 75 centshigher, but it depends on the stock. The stock has to be up overthe prior day, but not by much, and trending higher to be a buy. Is the stock trading near the yearly high? I learned that buyingstocks near the yearly low increases my losses because they invariably tumble. Instead, I buy stocks showing chart patternsnear the yearly high, preferably breaking out to a new high. Ifthey are making a new high, I don’t have to worry about priorresistance zones (except for round numbers). When the breakoutoccurs, price coasts higher on momentum, allowing me to raisemy stop and cut my potential loss. Look for overhead resistance. How high is the price likely toclimb before hitting resistance? If the answer is not much, thenskip the trade. Look for underlying support. If the stock drops, you will wantto know how far down it’s likely to go. Nearby support helpswith selecting a stop-loss point. Place a stop below nearby underlying support. Avoid mental stops. Don’t use a mental stop (one kept in yourhead) unless you are a seasoned professional.
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 How likely is a throwback or pull back? Prices return to thebreakout price usually in just a few days. Consider initiating oradding to your position once price resumes the original breakoutdirection. However, the statistics show that chart patterns withthrowbacks or pullback have worse performance than thosewithout throws or pulls. Check for dead-cat bounces (DCBs). I won’t trade any stockshowing a DCB within the last six months to a year. Those companies with earnings problems often have one DCB followinganother. Prices don’t trend forever. If you are about to buy a stock thathas been trending upward for several days in a row, the chancesincrease that you will be buying near a price peak. The same goesfor consecutively declining prices. The trend may reverse soonafter you sell. This, however, is not a license to hold onto a declining stock forever. Price versus market divergence. Intraday, if the stock is downwhen the market is up a lot, avoid the stock.
How to Sell?I show this checklist item separately because it is so important: Use stops. In most of my trades, price stops me out. I raise thestop as price rises. That way, selling is easy. I let price take me outinstead of relying on more esoteric indicators. If you can’t makemoney in the markets, chances are you don’t use stops. If you domake money, then it’s a bull market where everything is goingup. When the stocks stop going up, then what are you going todo? Place a stop on every trade.
When to Sell?Each trading situation is different, but as your experience grows, you’lldevelop an inner voice that tells you when it is time to sell. Listen to thatvoice. Many of the trades that I’ve made within days of a high (and recounted in this book) are the result of listening to that voice coupled
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with supporting evidence. Since I can’t lend you my voice, here is achecklist of the supporting evidence that may suggest a sale: The stock is about to hit your stop. Sell it immediately. Whywait for price to hit your stop if you know that it will? You dohave a stop in place, don’t you? A bearish chart pattern has broken out downward. This is theclassic sell signal. Exit the stock immediately. Hoping price willrise won’t turn it around, but if it does, it is a pullback and stockwill soon head back down anyway. Sell it now! The stock has closed below an upsloping trendline. This isthe first indication of a trend change, but I usually sell instead ofwaiting for additional evidence. Remember, the longer thetrendline, the more reliable it is. Switch to the weekly (or highertime) scale and check the trendline again. Stock falls more than 62% retrace. Measure the retrace afteran up move. Most will fall in the 38%, 50%, or 62% retraceamounts of the prior move. Anything more than that and expectprice to continue down. The 1-2-3 trend change method signals a trend change. Review the discussion in the section 1-2-3 Trend Change Methodin Chapter 3. If the trend changes, get out. Price has hit the target. In many of my trades, I accurately pickhow far price is going to rise before it stalls or reverses. For swingtrades (a short-term trade that rides the move from trough tocrest or the reverse), place an order to sell at the target (orslightly below the nearest resistance zone). That will often getyou out near the peak. For other trades, use a trailing stop.(Raise it as price rises.) The averages are dropping. The market is taking other stocksdown along with yours, so it is time to get out. Flip to theweekly scale. If the trend is still down, then sell. Stocks in the industry are topping out. Any bearish chart patterns that appear in stocks in the same industry are warningbells. If other stocks are turning down then consider selling.Rare is the stock that can swim against the current for long. Look at the weekly scale. New chart patterns, trendlines, andsupport and resistance zones all appear on the weekly chart, souse them as sell signals.
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 The market is up but the stock is down. When I get a stockquote, I also check the Dow industrials, NASDAQ composite,and S&P 500. If the Dow is up 100 points, but my stock isdown, I will want to know why. This intraday price divergenceI use as a warning, not as an automatic sell signal. Sometimesthere’s a good reason for the divergence. Currently, when theprice of oil drops, my Exxon stock is going to go down and themarket is going to soar. That’s divergence, but it’s not a sell signalunless oil keeps going down too. Historical price review. What happened the last time the stockmade a new high, shot upward in a straight-line run, consolidated in a tight knot of price movement, dropped a few points injust days, or stalled at an old high? Past behavior can give you anindication of how well the stock will behave in the future. However, the more you rely on past behavior, the more likely the stockwill surprise you. I remember looking at Schwab and seeing thatprice dropped after each of the last two stock splits. So I sold nearthe third split and watched from the sidelines as price soared. Check the indicators. Are your favorite indicators saying sell?Recognize that the more indicators you check, the more contradictions you’ll have. Check a dozen indicators and some will saybuy, some sell, and some hold. What does the best indicator—price—say? Is price rising or falling? Is price trending up or down?Don’t know? Then switch to the weekly scale and ask if price isrising or falling. If it’s falling, then sell. Indicators are diverging from price. This is usually a reliablesell signal, but not an automatic one. Price can diverge fromindicators for months before the stock turns down, if it turnsdown at all. Indicator failure swings. These M- and W-shapes in the indicator can call short-term turning points accurately. Overhead resistance. Has the stock hit overhead resistance andis now heading down? Sell. Is a throwback or pullback happening? Review the section onthose. Throws and pulls happen often after a breakout. Initiateor add to your position after a throwback once price resumes themove up. For a pullback, it’s often your last chance to exit astock before the decline resumes. Take the sell signal and get out.
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General Trading TipsJake here. If you think no one cares if you’re alive, try missing a few car payments. Bye!Consider the following trading tips as well: Tighten stops. If other stocks in the same industry begin trending down, then tighten the stop in the stock you own in that industry. If your stock shoots up several points in a few days, thentighten the stop because price may reverse and retrace much ofthe gain. See the inverted dead-cat bounce in Chapter 8. Trade tall patterns. Tall patterns outperform short ones. This isthe single best predictor of chart pattern performance. What isshort and tall? It varies from pattern to pattern, so refer to mybook, Encyclopedia of Chart Patterns, 2nd ed., for complete details. Narrowing prices. If the daily high-low range narrows over time,then expect a trend change. For example, a symmetrical triangle,with its narrowing price trend, shows this behavior. The breakoutcomes after the price range contracts and volume diminishes. Don’t forget busted patterns. Chart patterns that break outdownward then quickly reverse often soar higher than you expect.Jump aboard and ride the wave. Trade with the trend. If the market and industry are moving up,select stocks with upward breakouts. Avoid countertrend trades—the market or the industry is going down and your stock is movingup. The rise will be less than you expect unless the market or industry reverses. If you buy a stock even though the market is trending lower, that’s fine providing you expect the market to reverseshortly. Just hope that you don’t get stopped out while waiting. Reversal chart patterns must have something to reverse. Forexample, if a diamond top appears several points above a priceplateau and the breakout is downward, expect prices to return tothe plateau. Don’t average down. If you buy and hold, then ignore this advice; you can likely ride out the downturn unless your stock isnamed Enron, WorldCom, Penn Central, United Airlines, or . . .
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If a stock is declining, consider selling it. Don’t add to yourposition hoping that it will eventually turn around. It may not,but, more likely, you’ll get fed up and sell just days before it bottoms. Never try to prop up the price by buying more. Even Jakedoesn’t have that much money, and he’s doing very well now. Trade on the intraday scale. Switch to the intraday scale or thenext shorter period to place the trade. The shorter time scale willzoom into the price action and highlight support and resistancezones. I use the one- and five-minute scales to time my entry. Raise that stop as price rises. Check the volatility and place thestop no closer than 1.5 times the current price volatility. (See thevolatility stop example in Chapter 5 for details.) Never lower a stop. If you feel a desire to lower a stop, sell thestock. Fall in love, just never with a stock. Follow the same stocks each day. Become familiar with them.Don’t invest in unfamiliar stocks. Over time, you’ll know whenthe stock is expensive and when it’s cheap. That voice will tellyou when to buy and sell. Choose chart patterns that work for you. Some chart patternsperform better than others. Be selective and become an expert inthe patterns you trade. If you find a quirk that works, then tellme about it at tbul@hotmail.com. Keep a trading diary and review it periodically. I log eachtrade and review them periodically. I look for untimely entryand exits, bad habits that I’ve picked up, that sort of thing. Ithelps. In my notebook, I keep the date, trade time, number ofshares traded, order type (stop, market, limit), price filled at,stop-loss price, price target, future S&P 500 index direction (aguess), buy or sell reason for the trade. Explore. Trading takes work. You have to believe the system youtrade or you’ll ignore the signals. Explore new techniques thatadd value to your system and prune the deadwood as it becomesless effective. Diversify. If you see a symmetrical triangle in an oil servicescompany, chances are other stocks in the same industry show the
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same pattern. Don’t buy them all. I choose the most promisingto trade and then look at other industries. Don’t over diversify. “At one time, I had over 40 stocks in myportfolio,” Jake said. “I couldn’t keep track of them all.” No kidding. I usually have fewer than 10 stocks in my portfolio. Check commodities. I follow oil, copper, and natural gas because so many of the industries I track rely on them. If the priceof oil is shooting up, the airlines, truckers, and chemicals may suffer but oil service companies, refiners, and drillers should prosper. Tune your system. The markets change over time and so shouldyour system and your trading style. When the markets arechoppy, directionless, I make short-term trades. When the market is trending, I relax and my hold time increases. Ignore chat room chatter. Some of the worst trades I’ve madecome from scenario trading. I’d read that the price of oil was predicted to rise because of a production shortage. Then I’d buy arefiner and get cleaned out when the price of oil dropped instead. Don’t restrict this advice to the Internet chat room. Applyit to newspaper articles and television news as well. Don’t tradescenarios. Buy-and-hold investors may do well with scenarios,but they can wait years. If you have to ask, you’re making a mistake. If you havedoubts about a trade, such that you feel compelled to ask someone’s opinion about it, then skip the trade. Don’t let othersspend your money. Set price targets. With experience, you’ll be able to tell whenprice is about to turn. Use the measure rule for the chart pattern(usually the pattern’s height added to the breakout price) to predict a price target. For more conservative targets, use half the formation height projected upward. If the target and overheadresistance are nearly the same, then you’ve struck gold. Place asell order to dump the stock just below the resistance zone. Youmay be early, but you never go broke taking a profit. Late entry. If you find that you are consistently late getting intoa trade, then place an order to buy the stock a penny above the
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breakout price. I use that strategy, and it works. Prematurebreakouts happen infrequently (between 3% and 22% of thetime for triangles, for example), so don’t worry about them. Watch for a throwback or pullback. Prices turn postbreakoutin an average of 3 days and return to the breakout usually in 10or 11 days, so watch for that. Have faith that prices will resumethe original breakout direction—they do—86% of the time. Don’t short a stock. If you can’t make money on the long side,you won’t make it on the short side either. Try it on paper first. Prices drop faster than they rise. I found this out when I reviewed the statistics measuring the time from the breakout tothe ultimate high or low. Price trends after downward breakoutswere quicker and steeper than their upward counterparts. Thisemphasizes the need to use stops to get out. If you can’t sell, yourlosses will grow quickly. Jake again. Always borrow money from a pessimist. He doesn’t expect to be paid back. Bye! Price reverses one month after the breakout in a bear market.This is also true in a bull market, but less often. The one-monthbenchmark also varies from pattern to pattern. It’s rarely shorter,but often longer—five to seven weeks after the breakout. I founda slight rise in the number of patterns reaching the ultimate low amonth after the breakout, so don’t expect price to turn on adime every time. Price moves most in the first week after a breakout. I discovered this when looking at failure rates. This emphasizes the needto get in early after a breakout. The best way is to have a buy order positioned a penny above the breakout price. That will getyou in early and you won’t have to worry as much about throwbacks taking you out.Table 11.1 shows where in the yearly price range the chart patternperforms best. High means the pattern performs best when the breakoutis within a third of the yearly high, low means within a third of the yearlylow, and middle is the final third.
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TABLE 11.1 Breakout Position in Yearly PriceRange for Chart PatternsChart Pattern
Performs Best Where?
Broadening Bottoms, downward breakout
Low
Broadening Bottoms, upward breakout
High
Broadening Formations, Right-Angled and Ascending,downward breakout
Low
Broadening Formations, Right-Angled and Ascending,upward breakout
High
Broadening Formations, Right-Angled and Descending,downward breakout
Middle, High
Broadening Formations, Right-Angled and Descending,upward breakout
Middle
Broadening Tops, downward breakout
Low
Broadening Tops, upward breakout
High
Broadening Wedges, Ascending, downward breakout
Low
Broadening Wedges, Ascending, upward breakout
Middle, High
Broadening Wedges, Descending, downward breakout
Low
Broadening Wedges, Descending, upward breakout
Low, Middle, High
Diamond Bottoms, downward breakout
Low
Diamond Bottoms, upward breakout
Low
Diamond Tops, downward breakout
Low, Middle
Diamond Tops, upward breakout
Middle
Double Bottoms, Adam & Adam, upward breakout
Low
Double Bottoms, Adam & Eve, upward breakout
High
Double Bottoms, Eve & Adam, upward breakout
Low
Double Bottoms, Eve & Eve, upward breakout
Low
Double Tops, Adam & Adam, downward breakout
High
Double Tops, Adam & Eve, downward breakout
Middle
Double Tops, Eve & Adam, downward breakout
Low, High
Double Tops, Eve & Eve, downward breakout
High
Flags, downward breakout
Low
Flags, upward breakout
High(continued)
General Trading Tips
275
TABLE 11.1 (Continued)Chart Pattern
Performs Best Where?
Flags, High and Tight, upward breakout
Middle
Head-and-Shoulders Bottoms, upward breakout
High
Head-and-Shoulders Bottoms, Complex, upward breakout
Middle
Head-and-Shoulders Tops, downward breakout
Middle
Head-and-Shoulders Tops, Complex, downward breakout
Middle
Pennants, downward breakout
Low
Pennants, upward breakout
Low
Pipe Bottom, upward breakout
High
Pipe Tops, downward breakout
Low
Rounding Bottoms, upward breakout
High
Scallops, Ascending and Inverted, upward breakout
Low
Three Rising Valleys, upward breakout
High
Triangles, Ascending, downward breakout
Low, Middle
Triangles, Ascending, upward breakout
High
Triangles, Descending, downward breakout
Low
Triangles, Descending, upward breakout
Low, High
Triangles, Symmetrical, downward breakout
Low
Triangles, Symmetrical, upward breakout
Low
Triple Bottoms, upward breakout
Middle
Triple Tops, downward breakout
High
Totals for upward breakouts: high, 13; middle, 7; low, 9.Totals for downward breakouts: high, 5; middle, 6; low, 14.The numbers show that upward breakouts perform best within athird of the yearly high. Downward breakouts perform best within athird of the yearly low. What does this mean? Buy a stock making newhighs and sell them short when they make new lows.Table 11.2 shows where in the yearly price range the event patternperforms best. High means the pattern performs best when the breakoutis within a third of the yearly high, low means within a third of the yearlylow, and middle is the final third.
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TABLE 11.2 Breakout Position in Yearly PriceRange for Event PatternsEvent Pattern
Performs Best Where?
Dead-Cat Bounce, downward breakout
High
Earnings Surprise, Bad, downward breakout
Low
Earnings Surprise, Good, upward breakout
Low
Flag, Earnings, upward breakout
Low
Stock Downgrade, downward breakout
Low
Stock Downgrade, upward breakout
Low
Stock Upgrade, downward breakout
Low
Stock Upgrade, upward breakout
High
Totals for upward breakouts: high, 1; middle, 0; low, 3.Totals for downward breakouts: high, 1; middle, 0; low, 3.Both breakout directions do best when the breakout is within a thirdof the yearly low.
Trading PsychologyIn this checklist, I help you analyze your own trading psychology. Youshould also refer to Chapter 2 for more information. Are you trading because you want to trade? Sometimes I findmyself hunting for chart patterns because the market is movinghigher and I’m not in the market. At other times, I’ll trade thenmake another trade a few days later with disastrous results. Jake here. Tom’s going to kill me if he finds these things, but if Iplant enough of them, then maybe some will get printed. Anyway,did you know that research causes cancer in rats? Bye! Are you not trading? This is the opposite of trading too often.You may be so scared of taking a loss than you avoid trading altogether. Do enough research that you are confident your trading system works. Then get back into the game. If you get stopped out of several stocks, walk away. At the startof 2005, I was stopped out of every one of my stocks. That told methe market was tumbling so I let it drop while I remained in cash.When I started seeing a plethora of bottoming patterns appear,
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277
then I started getting interested again. That’s the beauty of chartpatterns. Bullish ones appear when the market is poised to moveup or is rallying. They disappear in falling markets so you getstopped out and remain on the sidelines as the market corrects. Follow the system. Would you be making more money if youfollowed your trading system? Understand why you’re ignoringthe trading signals you receive. Don’t overtrade. When I first started trading, I discovered thatthe more often I traded, the worse I did. With experience, themore I trade, the more I make (but a bull market helps). Thishappens to inexperienced day traders. They think that if theycan just pull $100 or $500 out of the market each day, they’ll beset. I remember Jake telling me that “If I only make a buck oneach of a million trades, I’d be a millionaire.” If you cannotmake money position trading or buying and holding, then it’sunlikely you’ll do well day trading or swing trading. Start withlonger holding periods and move to the shorter ones as yourtrading experience grows. Learn from your mistakes. Are you making mistakes? If youdon’t review your trades periodically, you’ll form bad habits thatwill lead to larger losses. Focus on the positive. The disaster you had today pales to thekilling you made last week. Push the comfort zone. Make every trade seem rote. Don’t letyour losses bother you, and don’t get too excited about your winners, either. An e-mail acquaintance wrote me that he was cutting his profits short. “Can you help?” I suggested that he mightbe holding on too tight. He was getting quotes too often insteadof paying attention to his job, obsessing over every penny gainedor lost. I suggested he check the stock once, at the end of theday, or flip to the weekly scale for his trades. He’s trading muchbetter now, and his stress level has gone down. Ignore profits. If you find yourself getting nervous about a winning trade or making too much money (believe me, it happens),then don’t look at the bottom line. Concentrate not on themoney but on improving your trading skills. Get used to makingtoo much money.
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 Obey your trading signals. Otherwise, what are you tradingfor? Plan your trade and trade your plan. Don’t trade when you’re upset. This also goes for being too excited. I find this happens to me in a bull market. All of mystocks are exploding upward; everything I pick is a winner.That’s when I know a huge loss is coming. And it does when Iplace a stop too far away just as the market turns, sucking mystock down with it. Abandoning a winning system. In a bull market when everything you trade seems to hit gold, you become bored. You chucka winning system for something more exciting. An acquaintancetold me that he made money in 9 out of 10 chart pattern trades.He decided to abandon his system and invested the proceeds in acompany called Bre-X. He lost most of it when the authoritiesdiscovered the stock was a scam. Jake again. Keep this country beautiful. Swallow your beer cans. Bye,or is it buy?
12Chapter
Crunching the Numbers
he statistics shown in Tables 12.1 and 12.2 are from chart patternsin bull markets only. The numbers reflect hundreds and sometimesthousands of perfect trades without any trading costs deducted.Thus, don’t expect your trading results to match them.Not all chart and event patterns are shown, so the rankings may skipnumbers. For a complete list of chart and event patterns in both bull andbear markets, consult my book, Encyclopedia of Chart Patterns, 2nd ed.
T
Chart Pattern Performanceand Rank Table: NotesThe following notes apply to the tables:The average rise or decline is the percentage price move from thebreakout to the ultimate high or low.The breakeven failure rate is the number of patterns with prices thatfail to rise or fall at least 5% after the breakout.Once price reaches the ultimate high or low, the change after trendends measures the next price move until the trend changes again.Throwbacks are for upward breakouts and pullbacks are for downward breakouts.279
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280
Rank is the sum of the individual ranks of the average rise or decline, breakeven failure rate, and change after the trend ends sortedand reranked. Two patterns can share the same rank, and patternswith downward breakouts are ranked separately from those withupward breakouts.N/A means not applicable. The performance of some chart and eventpatterns are measured differently from most others (measuredmoves, flags, pennants, gaps, and so on) and are not ranked.
TABLE 12.1 Chart Pattern Performance and RankAverageRise orDecline(%)
BreakevenFailureRate (%)
ChangeAfterTrendEnds (%)
ThrowbackPullback(%)
Rank
Broadening Bottoms,downward breakout
–15
16
52
42
17
Broadening Bottoms,upward breakout
27
10
–34
41
17
Broadening Formations,Right-Angled andAscending, downwardbreakout
–15
20
53
65
19
Broadening Formations,Right-Angled andAscending, upwardbreakout
29
11
–31
47
19
Broadening Formations,Right-Angled andDescending, downwardbreakout
–15
14
55
51
13
Broadening Formations,Right-Angled andDescending, upwardbreakout
28
19
–26
52
23
Broadening Tops,downward breakout
–15
18
53
48
18
Broadening Tops,upward breakout
29
15
–33
54
19
Chart Pattern
Chart Pattern Performance and Rank Table
281
TABLE 12.1 (Continued)AverageRise orDecline(%)
BreakevenFailureRate (%)
ChangeAfterTrendEnds (%)
ThrowbackPullback(%)
Rank
Broadening Wedges,Ascending, downwardbreakout
–17
11
49
57
14
Broadening Wedges,Ascending, upwardbreakout
38
2
–31
50
6
Broadening Wedges,Descending, downwardbreakout
–20
9
47
53
11
Broadening Wedges,Descending, upwardbreakout
33
6
–33
53
12
Diamond Bottoms,downward breakout
–21
10
59
71
1
Diamond Bottoms,upward breakout
36
4
–33
53
8
Diamond Tops,downward breakout
–21
6
47
57
7
Diamond Tops,upward breakout
27
10
–29
59
21
Double Bottoms,Adam & Adam,upward breakout
35
5
–33
64
10
Double Bottoms,Adam & Eve,upward breakout
37
5
–33
59
8
Double Bottoms,Eve & Adam,upward breakout
35
4
–31
57
11
Double Bottoms,Eve & Eve,upward breakout
40
4
–31
55
6
Double Tops,Adam & Adam,downward breakout
–19
8
54
61
4
Chart Pattern
(continued)
282
CRUNCHING THE NUMBERSTABLE 12.1 (Continued)AverageRise orDecline(%)
BreakevenFailureRate (%)
ChangeAfterTrendEnds (%)
ThrowbackPullback(%)
Rank
Double Tops,Adam & Eve,downward breakout
–18
14
50
59
15
Double Tops,Eve & Adam,downward breakout
–15
13
54
64
13
Double Tops,Eve & Eve,downward breakout
–18
11
63
59
2
Flags, downwardbreakout
N/A
2
41
46
N/A
Flags, upward breakout
N/A
4
–22
43
N/A
Flags, High and Tight,upward breakout
69
0
–36
54
1
Gaps
N/A
N/A
N/A
N/A
N/A
Head-and-ShouldersBottoms, upwardbreakout
38
3
–31
45
7
Head-and-ShouldersBottoms, Complex,upward breakout
39
4
–29
63
9
Head-and-ShouldersTops, downwardbreakout
–22
4
51
50
1
Head-and-ShouldersTops, Complex,downward breakout
–23
4
48
67
3
Measured MoveDownward
N/A
N/A
46
N/A
N/A
Measured MoveUpward
N/A
N/A
–26
N/A
N/A
Pennants, downwardbreakout
N/A
4
40
31
N/A
Chart Pattern
Chart Pattern Performance and Rank Table
283
TABLE 12.1 (Continued)AverageRise orDecline(%)
Bre