Make Money with the “M” Formation

04/11/2012 8:00 am EST

Focus: STRATEGIES

Ron Wagner

Principal Partner, RevolutionaryTrading.com

Ron Wagner from RevolutionaryTrading.com profiles a proven chart pattern that is now setting up on more than half of the sectors he has reviewed recently.

Self-fulfilling prophecies are very powerful and are watched carefully by technical analysts in the trading and investing communities. We can clearly see the money flow by looking at candle formations and where areas of support and resistance are formed.

Over the years, I have found that rather than look only at a technical pattern we all want to memorize, it’s much easier to think in terms of the people and their money represented in each candle as it forms and completes.

What were those people thinking? Are they trapped in a position by entering it too late? Did they sell out as a pattern was bottoming? These are questions to ask ourselves each time before we enter a trade.

Below is a monthly chart of the Russell 2000 as of April 6, 2012. You can clearly see one of the most recognizable patterns in existence, which is a double top. The candles do not have to go all the way back to the exact top, as in this case, where we have stopped just short of that.

In fact, a deep pullback at this point would signify a potential change in trend, which would be more obvious on the daily chart. A shallow pullback and we just might be able to overcome the previous high from 2011.

A double top does not have to become an “M” formation we see setting up below.

See also: A Chart Formation the Pros Love

The characteristics of a good double top, or “M” formation, is that it should have a nice “V” to it (as in this case), with a relatively deep pullback that puts fear into those that bought on the first leg up.

As the second leg of the “M” begins to form, any approach to, or near, the previous high would be recognizable by most. This usually sets in motion several dynamic potentialities with the longs selling in anticipation of reaching that area and others wanting to short the reversal.

In the meantime, knowing this information, we can easily move down into the smaller time frames to take our trades on a move up to a double top. We must have significant room to match our personal reward to risk parameters as set in our own trading plans, or know when we might short as a reversal forms near or at a double-top area.

Chart1

The monthly chart below is for the CFSB Technology Index, also captured on April 6, 2012. As you can see, it came right up to nearly the exact location of the previous high set in 2011.

Already in 2012, some sectors and stocks have shot up way past any resistance, with Apple (AAPL) leading the way. Sometimes we will see a single stock or group of stocks that can be so heavily weighted in an index that they will affect how that index moves.

Chart2

I scan each evening and look at the major markets, about 40 sectors/indexes, and hundreds of charts. It’s a treasure hunt each day, but I can always find some potential gems.

Right now, over half of all the sectors I look at are developing one form or another of an “M” formation. Some have already started a reversal pattern, while others may move up a little more before reversing. Will this tie in nicely to the potentially slower trading/investing time of year when many cite the old adage “Sell in May and Go Away?”

Many project that this coming earnings season will have lower results than the past nine quarterly increases in a row. Many are keeping an eye on the unemployment numbers, and others are concerned about the potential for pain in Spain or other European concerns that could affect what is now a global economy.  

Don’t worry! With very few other good alternatives to produce a good return on our capital, we will always find good opportunities in sector rotation and individual stocks or commodities that perform nicely.

It’s just a matter of what kind of treasure you’re looking for and then sticking to your plan to find it!

By Ron Wagner, active trader, investor, and principal partner, RevolutionaryTrading.com

Related Articles on STRATEGIES