Trading Setups (Part 3)

07/02/2008 12:00 am EST

Focus: STOCKS

Toni Hansen

President and CEO, Trading From Main Street

Yesterday I introduced you to a setup called the 2B. The sister pattern is the 2T, which is a reversal off highs.

2T Short

Description: A 2T is the 2B setup reversed at highs for a short. Simply change "support" to "resistance" and "buy" to "sell" and vice versa in the above description of the 2B to give the short criteria for the 2T. This pattern is a form of a double top, whereby the second high is just slightly higher than the first, serving to trap new longs and flush out those holding onto positions as a short. A 2T is also a form of a bull trap, since it traps any new buyers, as well as flushes out any remaining bears whom suddenly become scared that the bulls are going to continue to push the security higher (see "double top" for an example of another variation on this setup.)

Criteria: One high followed by a slightly higher high. The second high should not be barely noticeable as a higher high in order to be the most favorable as a reversal pattern. Intraday this may be just a few ticks but it could be a few points in a stock on a weekly chart.

Entry: Under the prior bar's lows after the second high is made. For instance, if the low of the bar making the second low is $50, entry is under $50. The only time it is not under the bar that made the second high is if that low is followed by an inside range bar, in which case the entry is a break in the lows of the inside range bar. Alternately, a downtrend line can be drawn on the move into the second high with an entry when that trend line breaks, as well as the previous bar's lows in that smaller downtrend into the second high.

Stop: Over the second high or drop down and watch for a smaller time frame Avalanche or Head & Shoulders pattern to place the stop over a smaller time frame base which is lower than the absolute high of the second high.

Target: Price or moving average support. The more levels of support converging at one particular level, the more likely the move will stall or end there. Correction periods will also often stall or end a move. 

Ideal 5 Tech Tools Traits on a 2T Setup:
Pace: Strong initial move into highs, followed by a much more gradual move into the second high. Sometimes it will begin by moving slowly into the second high and then make a rapid move at the last minute as it comes into the prior high with a spike in volume. When this happens then an Avalanche or a 2T on a smaller time frame is common before a larger correction off the highs occurs.

Volume: Strong volume prior to first high with declining volume into the second high.

Correction Periods: First and/or second highs hitting with a correction period.

Support/Resistance:

  • Strong resistance on multiple time frames or multiple types of resistance hitting at once. 
  • When the security hugs a support levels as it moves into the second high.
  • When there is no immediate support to stall a move lower off the second high.

Trend Placement/Trend Development:

  • Watch for this setup to follow three waves of buying. Sometimes the second high in the 2T is the third one in a larger trend. Sometimes it is a fake attempt at a fourth continuation in a trend.
  • This pattern can also form within a trading range and is particularly of interest when that base is at lows in a larger downtrend, leading to a breakdown from the trading range.

Another setup, called the Avalanche will be featured tomorrow.
By Toni Hansen
http://www.TradingFromMainStreet.com

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