Stock Up Your Trading Arsenal

04/06/2011 2:00 pm EST

Focus: STRATEGIES

Linda Raschke

President, LBRGroup, Inc.

Some of the more classic trade set-ups don't occur that often, says Linda Raschke, and traders would be wise to adapt by looking at higher time frames and trading a more diverse set of patterns as a result.

Seeing chart patterns clearly and pattern recognition in your trading is very important to your success, and our guest today is Linda Raschke to talk about that and what she's seeing. So Linda, talk about the general pattern recognition and chart set-ups that you're watching right now. What are you looking for?

Well, I see two things. I see an over focus or emphasis on looking at short-term charts and classic patterns like you would think, like a bull flag or a bear flag or so forth. 

Honestly, they just don't set up that often like a trader would think. So you need to have a lot more in your arsenal than just that type of approach.

With that said, I do believe in lovely chart formations and a thing to keep in mind is that the lower the time frame that you go down to, the more noise. It's not going to be a really clean, lovely chart formation.

If you step up to hourly charts or even daily charts, you'll have a lot more consistent, smooth swings, double bottoms, triangles, that type of thing. You'll probably have better success concentrating on the higher time frame than getting too concerned with the little short-term patterns.

Big picture, I think that right now we've been in pretty strong trends across the board just because of the QE2 and an incredible amount of stimulus going into the economy.

People have to recognize that a tremendous amount of money has been driving trends and I think as that starts to end and you enter broader trading range or whatever, that it's going to be more important for people to pay attention to the little traps, the little false breakouts to the upside or false breakouts to the downside. 

If you want to go and read in classic literature, Wyckoff's concepts on springs and upthrusts, you know, I think that's something that's not talked about very much, but it's like very little bull traps and bear traps. I think that the trader can get more mileage out of moves coming out of those than thinking for bull and bear flags. 

The thing to keep in mind when you're having a breakout that fails is the entry spot is not trying to pick that failure point, it's recognizing it after it's had the price rejection. So you don't have to try and be a hero and pick the point of the failure. Let the price spike through and come back up, and then when it comes back up you'll have a nice tight risk point and sometimes you get some moves all the way back up to the other end of the range.

Linda, there's so many patterns for people to watch for, so many candle patterns and so many things. Do you recommend that they actually concentrate on two or three patterns that they really become familiar with so that they can see them start to form and use them day in and day out?

I'm not a big advocate of candlestick patterns because they're going to tell you something after the fact. I think there's better ways to approach a candlestick concept. They really don't have any long-term forecasting value if you do look at statistical modeling of them, they don't mean anything. 

Candles will have value if putting them in a context of a larger, broader structure or point in the swing. But again, you're looking at something that's after the fact, the information that's after the fact. 

So I think there's better ways to approach that, but however, with that said, the important thing is traditional classic bar chart formations.

Study them and know them like the back of your hand; triangles, wedges, rounding bottoms, rounding tops.  The most important thing with all of these is that they represent areas of accumulation or distribution and you have a lot of price bar overlap.
 
If you start thinking about something that's come back in vogue a lot more in market profile or the concept of a value area, the breakout from a chart formation is the move outside of a value area or previously well-accepted range. So that's what can cause a stronger trend. 

So it's not just the chart formation itself, it's understanding conceptually why breakouts can have some good follow through and the things that cause a good chart formation having the lots of price bar overlap and trading around central price value.

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