Nick Hodge is a leading expert in the resource sector, focusing on junior and small cap commodity pl...
“Perfect” Pattern Works in All Markets
07/04/2011 7:00 am EST
When learning to trade certain patterns or trade set-ups, it's best to start with "ideal" real-world examples to understand the logic of the set-up.
Doing so allows us to recognize similar patterns or set-ups in real time as they develop, which calls us into trading action (entry, management, exit).
Crude oil recently (on June 28) gave us an intraday "symmetrical triangle" pattern breakout that was a textbook example of the formation, trigger, target, and outcome of a classic symmetrical triangle pattern.
While I'm showing it on the one-minute chart, this basic pattern/set-up logic works on all time frames (and in all markets).
Symmetrical triangles are consolidation price patterns that give rise to a breakout trade set-up when price breaks through one of the two converging trend lines, usually just ahead of the apex (point where the two trend lines eventually meet to complete the triangle).
Price narrows down into equilibrium at the "midpoint" price as each swing compresses between visual trend lines into a point.
See my prior article on a Richard Wyckoff description of this type of situation, Staying Sharp in Dull Markets.
Once you observe this type of pattern in real time, you can prepare for a potential breakout trade.
NEXT: How to Trade This Proven Set-up|pagebreak|
The official trigger is a break and close above the upper descending trend line or under the lower rising trend line.
The aggressive entry is to position on the breakout, but many traders prefer using "prove it to me" conservative strategies, such as:
- Demanding two or three bars close in the breakout direction
- Demanding the breakout form on higher volume (or momentum)
- Demanding price move one two ATRs (average true ranges) from the break
While we're not seeing volume in this example, you can observe the 3/10 momentum oscillator breaking out of a similar triangle compression pattern in the indicator, confirming the upside break.
If you're expecting an upside breakout, there are two logical places to locate your stop loss should the breakout become a trap:
- Conservatively: Just under the midpoint of the pattern (horizontal line)
- Aggressively: Under the low of the rising trend line
The target is your classic Edwards and Magee (or Richard Schabacker) projection:
- A measured move of the height of the triangle added to the breakout price
In this case, we had an initial choppy breakout, but the buyers stepped in as price took out the prior swing high at $92.20, which created a "feedback loop" that powered this trade to the upside target near $93.00.
Feedback loops form when buyers happily enter new positions while bears/short sellers unhappily cover shorts for stop losses (buying). Feedback loops give power to breakout trades like this.
Finally, as price reached its upside pattern projection, we observed negative divergences in the momentum oscillator (a non-confirmation of the upside move) and then price triggered the official exit by breaking down under the rising short-term trend line into the target.
The real world won't be as clean as a textbook example, but you have to form a baseline for comparison for what to look for and what to expect in a trading opportunity.
When you see examples as clean as this, study them and make a reference for your education. The more you see these types of patterns/set-ups, the better you'll be at recognizing them in real time and can trade the pattern with confidence.
By Corey Rosenbloom, trader and blogger, AfraidToTrade.com
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