Learn How To Read Stock Charts Reading charts is an art form that can take years to fully master. Why do we read charts? Because, by reading charts, we can determine what the "big money" is doing! You have to be able to analyze a chart and come to a conclusion about whether or not to risk your hard earned money on a trade. That is really the bottom line. And this is what separates the novice trader from the professional. There are several factors on a chart that make it worthy of trading. By analyzing these factors, we can determine with high probability which direction a stock will move. There several questions that you want to ask yourself when you look at a stock chart. Here they are... What stage is this stock in? Is this stock in and uptrend or a downtrend? Is the stock at the beginning, middle, or end of the trend? How strong is the trend? Where are the trend lines? What wave is this stock in? What do the moving averages tell me? Was there a breakout recently? Is the chart "smooth" or "sloppy"? Are there any chart patterns? Are there wide range candles in the direction of the trend? Are there any gaps in the direction of the trend? Are professionals selling strength or buying weakness? Where are the support and resistance areas? Is this stock at a Fibonacci level? What does volume tell me? I know it seems like a lot of information to try and keep track of but all of the above questions are essential to chart reading mastery! Now, copy and print out that list of questions and keep it handy next to your computer. Make several copies so that you can check off and make notes as you analyze your next chart. Go ahead, I'll wait... Got it printed out? Great! Now you won't forget anything important when it's time to analyze a chart for your next trade. In the heat of battle, when emotions are running high, it is very easy to forget to look for some of the most basic things on a chart. I've done it. That is, until I made this list!
Ok, now let's go through the list one by one to make sure that you know how to answer the questions correctly. Don't worry, with practice, you will not even need to think about these things. It will become automatic. You will be able to read charts with lightning fast speed. In just a couple of seconds you will be able to glance at a chart and know all the answers to the questions above. Stages, trends and waves Let's look at an example chart... Nice chart! This stock broke out through a consolidation in July and now it is in a nice strong trend. The arrow is the day on which we see this stock. So, what questions can we answer just from glancing at this chart? This stock is in stage two. You remember the stages right? Stage one is a consolidation, stage two is an uptrend, stage three is another consolidation, and stage four is a downtrend. This stock was in a stage one in July but at the end of July, it broke out into a stage two. It is currently still in a stage two.
This stock is in an uptrend. This is the easy part. If a stock is heading toward the upper right corner of a chart then it is in an uptrend! For some reason, this tends to elude some traders! This stock is near the middle or end of the trend. How do we know that? The breakout signals the start of the trend. There has already been one significant pullback. Had we bought stock on the first pullback, then we would have concluded that we are at the beginning of the trend. But since this is the second pullback, then we know that this trend may not last much longer. This stock is in a strong trend. The ADX indicator (not shown) is near 30 which we consider to be a fairly strong trend. The higher the ADX, the stronger the trend. This stock is at the lower trend line. You can see by the thick green line that this stock has hit the lower trend line. You can draw the trend lines in manually, but after you have been trading for awhile, you will not need to draw them. You will be able to see them automatically. This stock is in the fourth wave. In Elliott Wave theory, a stock goes through 5 waves in an uptrend. In the chart above, the first wave after the breakout is wave 1. The first pullback is wave two, the next wave up to $17.33 is wave three, and the pullback that we are in now is wave four. There is one more wave to go! Conclusion Now we have identified that the possible future direction of this stock is up. Nothing is ever certain in the stock market! However, by looking at this chart we can be certain that the probabilities are on our side for a continued move to the upside. After you finish reading this tutorial, run your scans and go through some charts. Try to identify the various factors mentioned above. Just understanding the nature of stocks and the different stages, trends and waves that all stocks go through will greatly improve you trading. Soon, all of this direction analysis will become second nature. You won't even have to think about it.
How To Read Stock Charts (continued) Chart analysis Price, as interpreted by candles, is the most important factor to consider on a chart. Put away the technical indicators. You do not need them. Technical indicators serve one purpose: to confuse novice traders! There isn't anything on a chart that can be learned from them. Everything you need to know is right in front of you in the candles! Ok, let's go back to our chart example: There are some very significant things happening on this chart. Do you see them? You will in a minute. We continue answering questions... The moving averages are lined up. We want the 10 SMA above the 30 EMA and we also want there to be plenty of space in between the two moving averages. This creates the Traders Action Zone (TAZ) that we can trade
in. If the moving averages move too close together, then a trading range or basing pattern will likely develop. We don't want that! There was a breakout recently. This is good! We want to buy a pullback as close as possible to a breakout as we can. Why? We want to know that there is interest in a stock. Remember that institutional traders have to accumulate shares over time. They can't buy tons of shares all at once. They have to buy a little at a time. By looking for break outs, we can expect them to have to buy more in the future. This will propel the stock higher. This is a smooth chart. We don't want to trade stocks that are whipping around everywhere! That is a good way to get stopped out on trades. This stock is in a smooth uptrend that can be traded with confidence, and without fear of getting shaken out of the trade. No significant chart patterns. In this example, there aren't any significant chart patterns. This is fine. You don't need any kind of a chart pattern like a cup and handle pattern, or a triangle to trade a stock. You do, however, want to be able to identify them when they are there. This could add some weight to the setup and may make us favor one trade over another. There are wide range candles in the direction of the trend. See how at the end of August there are three wide range candles that close near the top of their range? There was also a wide range candle on the breakout in July. This is very significant! In fact it may be one of the most significant things on the chart. Stocks tend to move in the direction of wide range candles. There is one significant gap. There is only one significant gap to the upside on the breakout in July. Ideally, we would like to see more. A better case scenario would be if there was a more recent gap. Why? Because stocks tend to move in the direction of gaps! Be careful though. After three or more gaps, a stock can become overbought and may not continue to move forward. Professionals are buying weakness. How do we know this? We know by looking for "tails" or "shadows" at the bottom of the candles. On the sixth of September there is a tail, and on this day (green arrow) there is a tail. This is very significant! You want to see that the big players are coming in to support the stock. You want them to protect you from any downside risk.
This stock is at support. This stock has pulled back to a prior high made in the middle of August. This is identified by the red/green support line drawn on the chart. When a stock pulls back to a prior high it is known as minor support. It is still a significant support area, just not as significant as if it pulled back to a prior low. For example, if the stock pulled back to the prior low at $15.68 (see chart), then it would be major support. Also, notice how the lower trend line and the support line converge into one right at today's candle (green arrow). This is very significant! This increases the strength of the support. This stock is at a Fibonacci retracement level. There are three Fibonacci retracement levels that you look at: 38.2%, 50%, and 61.8%. This stock has pulled back to the 38.2% level (not shown on the chart above). You want to trade pullbacks to this level or the 50% level. If it goes down to the 61.8% level, it may be signaling weakness. Avoid those stocks. Note that this level also corresponds with the support line. Volume is showing that there is interest in the stock. See the big volume on up days and the lower volume on down days? This is the ideal scenario but it isn't absolutely necessary. I tend to favor low volume pullbacks over high volume pullbacks but I will trade both. If a stock is pulling back on low volume, it means that traders have lost interest in the stock and things get really quiet. This is usually when institutional traders come in: when everyone forgets about the stock! Conclusion This concludes our analysis of the stock. We have determined that we are going to trade this stock! Want to see what happens next?
Nice! All of our analysis has paid off. This stock has successfully moved in our favor and now we can just trail our stops under the lows of the candles until stopped out. I know it seems like a lot of work went into analyzing this chart but what can I say? Trading stocks does take some work! It will, however, get faster with time. After you look at thousands and thousands of charts in this manner, everything will become second nature. Instead of it taking minutes to look at a chart - it will take seconds!
How to Trade Pullbacks Buying weakness and selling strength is the art of buying pullbacks. Stocks that are in up trends will pull back offering a low risk buying opportunity and stocks that are in down trends will rally offering a low risk shorting opportunity. As a swing trader, you have to WAIT for these opportunities to happen because... Doesn't it make more sense to buy a stock after a wave of selling has occurred rather than getting caught in a sell-off? Doesn't it make more sense to short a stock after a wave of buying has occurred rather than getting caught in a rally? Absolutely! If you are buying a stock then you want as many sellers out of the stock before you get in. On the other hand, if you are shorting a stock, then you want as many buyers in the stock before you get in. This gives you a low risk entry that you can manage effectively. Buying pullbacks and shorting rallies Where do you buy a pullback and where do you short a rally? You buy them and short them in the Traders Action Zone (TAZ). Here is and example on the long side:
See how you are buying stocks in strong up trends after a wave of selling has occurred? Ok, now here is an example on the short side:
Now you can see how you are shorting stocks after a wave of buying has occurred. When going long, wait for the decline into the TAZ and when going short wait for the rally up into the TAZ. Are all of them created equal? Nope. You have just a standard pullback like in the example above and then you have... The first pullback These are exactly what the name implies. It is the first one after a change in trend. How do you identify a change in trend - when the 10 SMA crosses the 30 EMA. After that happens, you look for an entry when the stock gets into the TAZ. Here is an example:
This is the most reliable type of entry into a stock and this is the likely area where institutional money is going to come into the stock. If you only trade one pattern, this should be it! You can get into a stock at the beginning of a trend, at a point of low risk, and you can take partial profits and ride the trend to completion! What more could you ask for? Oh yeah, speaking of getting in on the beginning of a trend. This next setup fits neatly into an Elliott wave pattern... First pullback after a breakout There is one other type of pullback worth mentioning and that is the first pullback after a breakout. If you are looking at a stock that is trading sideways or forming a basing pattern, and it suddenly breaks out of the pattern, you can look to buy the first pullback after the breakout. This also gives you a low risk entry into a stock that will likely continue the current trend. Here is an example:
Most traders are going to buy breakouts. The word breakouts sounds so exciting doesn't it? The problem with buying breakouts is that it is hardly every low risk. Think about it. If you are buying stocks when everybody else is, then who is left to buy the stock after you get in? Also consider this: The majority of breakouts fail and return (pullback) to the breakout point! Forget buying breakouts. Step away from the crowd. Wait for the breakout buyers to get scared and sell. This sets up the pullback that you can get into with much lower risk and higher odds of having a successful trade.
10 Price Action Tips That Will Make You a Better Swing Trader What is price action? Price action for swing traders is the art of looking at individual candles to determine the probable direction of a stock - without using any technical indicators. Ultimately, analyzing price action tells you who is in control of a stock. It also tells you who is losing control: the buyers or the sellers. Once you are able to determine this, you can pinpoint reversals in a stock and make money. Learn the price action tips on this page and I guarantee you that you will be a better swing trader. Let's begin. Tip #1. Identify support and resistance levels This is a no brainer. Identifying support and resistance levels is one of the first things you learn in technical analysis. It is the most important aspect of chart reading. But, how many traders really pay attention to it? Not many. Most are too busy looking at Stochastics, MACD, and other nonsense. Some traders think that a support or resistance level is a specific price. Wrong. It's an area on a stock chart. Let me give you an example.
The areas that I have highlighted are the correct support and resistance levels. Often times you will hear traders say something like this: "The support level for XYZ stock is $28.76." This is wrong. It's an area - not a specific price. Tip #2. Analyze swing points Swing points (some call them "pivot points") are those areas on a stock chart where important short term reversals take place. But not all swing points are created equal. If fact, your decision to buy a pullback will depend upon the prior swing point. Here is an example:
Look at the area that I have highlighted in green. You may have considered buying this pullback. Now look at the prior swing point high (yellow highlighted). There are two problems with buying this pullback. First, there isn't much room to work with! The distance between the pullback and the prior high is too small. You need more room to run so that you can at least get your stop to break even. The second problem is this: The prior high (yellow area) is composed of a cluster of candles. This is a strong resistance area! So, it will be very difficult for a stock to break through this area. Instead, look to trade pullbacks where the prior high is only composed of one or two candles. Tip #3. Look for wide range candles Wide range candles mark important changes in sentiment on every chart - in every time frame. They mark important turning points and can often be used to identify reversals. Take a look at the following stock chart:
This stock was moving lower in October (highlighted) and then suddenly it dropped more significantly than on previous days. This created the wide range candle and it marked an important turning point (actually the bottom!). You can also use wide range candles to identify when a stock might reverse. Looking at the same chart...
This stock reversed inside of prior wide range candles. Why would a stock do this? Because all of the traders that missed out on "the big move" now have a second chance to get in. This buying pressure causes the reversal. Simple, huh? Tip #4. Narrow range candles lead to explosive moves Narrow range candles can also tell you that a reversal is imminent. This low volatility environment can lead to explosive moves.
Narrow range candles tell you that the previous momentum has slowed down. Buyers and sellers are in equilibrium but eventually one of them will take control of the stock! Tip #5. Find rejected price levels On candlestick charts, lower or upper shadows on candles usually means that there is a hammer candlestick pattern or a shooting star candlestick pattern (if the shadow is long enough). Regardless of the name, these shadows mean one thing: A price level has been rejected.
Imagine what this hammer candle looked like during the day (before it became a hammer). It was really bearish! But, at some point during the day, the bulls rejected the lower price level. I can imagine the bulls saying, "Hey wait a just a second. You bears have taken this too far. This stock is worth much more than the price that you moved it to." And the buying begins. Tip #6. Learn the 50% rule How can you tell if a candle is significant? Easy. Look to see how far it has moved into the prior days range. If it moves at least 50% into the prior days range, then it is significant. And, it is especially significant if it closes at least 50% into the prior days range. This usually shows up on the stock chart as a piercing candlestick pattern or an engulfing candlestick pattern. Here is an example:
All of the important reversals in this stock happened only after a candle moved at least 50% into the prior days range (some moved much more than 50%). This concept is so powerful that I am suspicious of buying any pullback unless it moves at least 50% into the prior days range. Tip #7. The gap and trap price pattern All gaps are important "tells" on any stock chart. But, there is one type of gap that is especially important when analyzing price action (and pinpointing reversals). This is called a gap and trap. This is a stock that gaps down at the open but then closes the day above the opening price. It is easier to see this on a chart...
You can probably see what is happening here. The stock gaps down at the open. Everyone thinks this stock is going to tank. But it doesn't! Buyers come in and move this stock right back up. You can look at one of these candles and almost see all of the confused faces on other stock traders! Tip #8. Measure the depth of a swing How far does a stock move into the prior swing? More than halfway or less? The answer to these questions are important because it can determine the future direction of the stock. Let me give you an example:
The price action moved about halfway down (arrow) into the prior swing (dotted line). This is good. If it retraced more than that, you may want to question the validity of the move. This is because a stock in a strong trend should not retrace more than halfway into a prior swing. It should encounter buying pressure sooner than the half way mark. And many times stocks will reverse right at the halfway mark. Tip #9. Consecutive up days and consecutive down days Stocks will reverse direction after consecutive up days or down days. So, it pays to keep this in mind when you are looking to buy or short a stock. Here is an example:
You should always look to short a stock after consecutive up days. And, you should look to buy a stock after consecutive down days. This is counter intuitive for new traders because they tend to associate a stock going down as "bad" (meaning sell) and a stock going up as "good" (meaning buy). In fact, it is just the opposite! Tip #10. Location of price in a trend You have heard the saying, "The trend is your friend." I say, "The beginning of a trend is your friend!" That is because some of the best moves occur at the very beginning of a trend...
This stock broke out (horizontal line) from a double bottom (circled). A new trend has begun. So, you want to buy this stock on the first pullback (arrow) after the breakout. So, there you have it. These price action tips and tricks will make you money in the stock market. You can use this information to make your own trading strategies and systems. Best of all, once you master this art, you will never have to rely on technical indicators again to make trading decisions. They won't be necessary.
4 Profitable Chart Patterns For Swing Traders Here are four profitable chart patterns that you can use the next time you are looking for entries into individual stocks. Wait! There is no holy grail. These patterns can and will fail. You must manage your money correctly! The four chart patterns are: 1. T-30 2. Ghost Town 3. Swing Trap (my personal favorite) 4. Side Trap Read more about these patterns below... T-30 chart pattern
This is the one chart pattern that I trade the most often. If you are new to trading stocks, then start with this pattern! It is easy to identify, easy to learn, and easy to trade. What more could you ask for? This pattern is my "everyday" pattern. This is the one pattern that I trade the most often because of its reliability. It is easy to spot on a stock chart and simple to trade. The setup The name T-30 refers to a "tail" that slices down through the "30" period exponential moving average. This looks like a hammer candlestick pattern on the chart but it doesn't have to be a perfect hammer to be considered a T-30. Also, the color of the real body is not important. This tail on the chart flushes other traders out of the stock. Note: There is nothing special about the 30 period moving average. It is just a reference. Look to the left on the chart to determine support and resistance. When you are trading any kind of tail or hammer pattern, always look for volume to be higher than the previous day. This suggests that many traders were shaken out and demand is picking up. This is important! Here is an example:
How to trade this pattern There a multiple ways to trade this setup depending on your desired risk/reward. I'll tell you how I trade it and give you an alternative that you may want to consider. The entry If you are able to trade during the day then buy the stock on the day of the hammer (tail) near the end of the day. You not need any kind of "confirmation" or anything else. You only need to see that this stock is at a support level and that demand is coming into the stock (volume). That is all the confirmation that you need. If you cannot trade during the day, then place your buy stop above the high of this hammer day. The next day you will have to check to see if you get filled and then place your stop loss order. You could also use a bracket order. The stop loss order There are two options for the placement of your stop loss order. Each has advantages and disadvantages. You decide what is right for you. Option 1: Put your stop under the low of the hammer. The advantage to this is that your stop is far away from your entry price and you will not likely get stopped out prematurely. The disadvantage to this is that because your stop is so far away, you will have to buy fewer shares in order to comply with your money management rules. Option 2: Move down to the 60 minute chart and put your stop under a support area closer near the real body of the candle. The advantage to this is that you get to buy more shares because your stop is closer to your buy price. The disadvantage to this is that because your stop is so close, you may get stopped out more often, before a big move happens. Personally, I prefer option 1. I have no problem buying fewer shares in order to have a successful trade. I like that fact that my stop is far away from the "market noise". Then I can sit back and wait patiently for the stock to move in my favor. Taking profits When you are trading wide range days like hammers, you will find out that many times, the stock will trade sideways for a day or two. That is fine. You are already in the stock just waiting for other traders to enter. Also, the days that follow a hammer are typically low volatility, narrow range days like stars or doji's.
Be patient! Do not get anxious to move your stop up. Wait for the stock to actually move in your favor before you begin trailing your stop. Once the stock moves in your favor, then you safely begin to trail your stop using your favorite exit strategy to lock in profits. Trading tips Focus on those stocks where the real body of the candle is close to the 30 EMA. You want as many traders as possible shaken out of this stock before you get in. This setup is reversed for short positions except now you are looking for stocks with a shooting star pattern through a declining 30 EMA. Give more weight to setups with multiple tails over several days. Give more weight to setups where the stock gaps away from the previous candle to end the day in hammer. Always look to the left on the chart to make sure the stock is at a significant support or resistance area. When good chart patterns go bad Yes, you will have losing trades with this pattern. There is no pattern that will guarantee all winning trades! But with proper money, trade, and self management, you can do very well with this setup.
Ghost Town chart pattern Some potentially explosive moves can result from trading this pattern. The best thing about this pattern is that you can usually get a low risk entry. What happens when traders ignore a stock? You get narrow range candles and low volume. When you see this developing on a stock chart, it will remind you of a ghost town - deserted. Get ready, the stock is about to explode. The setup The name "ghost town" refers to a low volatility setup. And what follows low volatility? High volatility! This repeats over and over again on every chart - in every time frame. With this chart pattern, you will see pullbacks into the Traders Action Zone that end in narrow range candles. These candles are also known as stars or doji's. Combine these price patterns with low volume and you have a winning trade in the making! Note: In candlestick terminology, stars, technically have to gap away from the previous candle to be called stars. I don't find this to be necessary to trade them.
Here is an example: See how AMB pulls back into the TAZ, there are narrow range candles (stars), and low volume? Now look at what happens at the next swing point high ($44.50). See the narrow range candles again? Volume drops off for a couple of days, momentum has slowed, and the stock pulls back again. This is where professional traders come into the stock. Here is another example:
How to trade this pattern This can be tricky. When you have a potentially explosive situation, the stock can be prone to whipsaws. Here is how to avoid them. The entry With this pattern, you want to avoid just putting your buy stop above the previous high. You will get likely get filled prematurely! Method 1: Put your buy stop above the high of the highest narrow range candle. In the first example (long), there are three candles that I highlighted. The middle one has the highest high. Put your buy stop in above that. This is reversed for short positions. Method 2: Wait for another pattern to develop before you enter the stock. Did you notice the T-30(s)?
Method 3: Move down a time frame to the 60 minute chart and wait for it to breakout. Many times the 60 minute chart will give you an early warning sign that the stock is about to break (in one direction or another). The most difficult part of this pattern is the entry. Many times the stock will move up and then sell off. Or, it will move down, and then rally. This can cause whipsaws. The advantage to this pattern is that your stop can be very close to your buy price, so your risk is small. If you get stopped out, consider another entry. The move that follows is usually worth it! Taking profits There isn't anything special here. Just trail your stops using your favorite exit strategy. However, when the stock market offers you a gift, take it! If the stock explodes, and goes up 15% in a couple of days, at least take partial profits and trail your stops on the rest. Trading tips Low volatility leads to high volatility. High volatility leads to low volatility. Narrow range candles mean that momentum is slowing. The buyers or sellers are losing strength. Always look to the left on the chart to make sure the stock is at a significant support or resistance area. It's amazing what happens on a stock chart. Right when everyone loses interest in a stock, it takes off. Go figure! Think of the ghost town pattern this way: When you see a pullback into the TAZ and narrow range candles develop, the price action that preceded it, is coming to an end. A reversal is coming.
Swing Trap chart pattern What happens when swing traders and momentum traders get trapped in a stock and have to take a loss? The stock rallies! You will see this chart pattern ALL the time. It took all of about 5 minutes to run a scan and find an example for this page! Learn it. It is one of the most reliable patterns I know of. You'll see why in a second. The setup Like the name implies, this chart pattern "traps" swing traders (and momentum traders) right in the middle of a move. In Elliott Wave theory this pattern is known as an A-B-C pattern - just on a smaller scale. I call them "swing traps" because it's a lot more descriptive! Let's look at a chart...
The circled area is what we are interested in. That is what you want to look for when you are running your scans. It is very easy to identify this pattern. You'll recognize it in a second! This is what is happening in the pattern: This stock rallies hard to $42.00 (see chart). It then pulls back real nicely into the TAZ. This would have been a nice pullback to trade. But look at what happens next. It rallies up a little bit, but then it fails and goes right back down. This traps the swing traders who are long this stock. They put their stop loss orders under the first rally attempt. But, when the stock fell, it took out their stop loss orders. Now that the majority of sellers are out of the trade, the stock can rally. And that's exactly what it did. How to trade this pattern The key with this chart pattern is to look for the "shakeout". The final swing MUST go below the low of the first swing. Many times, this final swing will end in a hammer. This hammer will take out all of the stop loss orders and you are ready to go!
The entry Wait for a candlestick pattern to develop on the final swing (in this case, it was a hammer). Then you can buy the stock on the day of the pattern, or wait, put in a buy stop above the high of the candlestick pattern. It's up to you how you want to enter the stock. Your stop loss order Nothing special here. Just put your stop where it makes the most sense. Usually this will be under the low of the day of entry, but look to the left on the chart to identify support and resistance levels. Taking profits On the exit strategy page, you will find several options for trailing your stops. If the stock is entering into a stage two cycle, then I will usually want to give the stock a little room. In this case I would just trail my stops off of the weekly chart (a trend trade versus a swing trade). Trading tips The secret to this pattern is for the final swing to go below the low of the first swing. This is crucial. You will find this exact pattern on the short side also. The pattern is just reversed. This pattern is not limited to the daily chart. You will see it in all time frames. Your going to love trading this chart pattern. It represents a short term extreme in the market that gets a lot of potential sellers out of the stock before you get in!
Side Trap chart pattern This chart pattern occurs when a stock trades side ways, breaks down, and then reverses. This chart pattern is a good example of why the majority of stock traders lose money. They get caught (trapped) on the wrong side of a move. This results in some potentially explosive moves in a stock. The setup We have talked about the swing trap chart pattern. This pattern is similar in that it catches traders on the wrong side of a move. Let's begin... First, I want you to look at the highlighted area in the following chart:
What are your thoughts about this stock? You, like most traders, are probably thinking that this stock is trading sideways (consolidating) but since it is in an uptrend, it may breakout soon. And you would be right in thinking this. There are some traders that are buying this stock inside of the consolidation in anticipation of a breakout. But really, there is nothing to do with this stock except wait for a breakout. Remember that there are thousands of traders looking at this stock. And they are thinking the same thing that you are. Now look at what happens on the next day:
Now, what are your thoughts about this stock? Well, the stock broke down through the consolidation. And, it closed with a very bearish candle that closed near the bottom of the intra day range. There are some traders that got stopped out (they put their stop under the lows of the consolidation) and there are some traders that have aggressively shorted this stock. So no matter how you look at it - at this point this stock looks bearish. Plain and simple. Now, look at what happens on the following day:
Whoa! What just happened? There was no follow through to the down side. This means that there are no sellers left to move this stock lower. So, with all sellers flushed out, this stock can now move higher. And, that is exactly what it did...
Also keep in mind that those traders that shorted this stock on the day of the breakdown probably put their stop loss orders above the consolidation. When the stock moved above that area, their stop loss orders were taken out - causing the gap up. How to trade it There are three components to trading this chart pattern: consolidation breakdown reversal (see stock chart above) You need a sideways consolidation, then a breakdown causing the chart to look bearish, and finally a reversal pattern. This is why this pattern is called a "side trap". The stock trades sideways and then traps traders who shorted the breakdown. Here is another example:
Here is an example where the consolidation doesn't last very long:
another example...
The entry You want to establish a position with this stock on the day of the reversal candle. But, you do not want to trade just any reversal candle. You want the candle to be strong one. Make sure it closes at least halfway into the range of the breakdown candle. This will show up as a piercing candlestick pattern or a bullish engulfing candlestick pattern (see the examples above). Taking profits Nothing special here. Just trail your stops using your favorite exit strategy. However, when the stock market offers you a gift - take it! If the stock explodes, and goes up 15% in a couple of days, at least take partial profits and trail your stops on the rest. Keep in mind that you are wanting to see this stock move above that sideways trading pattern (consolidation). That is where the explosiveness will kick in. Create a scan for this pattern? I don't scan specifically for this pattern. I just run a general pull back scan and look for this pattern. If I see a consolidation forming, I will add it to my watch list to see if the breakdown candle forms - then wait to see if a reversal occurs.
You could create a scan that searches for a piercing candlestick pattern or a bullish engulfing candlestick pattern. Then you can sift though the stocks to see if this pattern shows up. It's up to you. Trading tips The longer the consolidation the more potential for an explosive move. The reversal candle must be a powerful one. Volume is not important but you may see high volume on the breakdown candle. If the overall market (S&P 500) has a big down day, the odds of this pattern showing up increases. There are two things that I love about this chart pattern. First, you are establishing a position after a wave of selling has occurred. And second, you are trading opposite the crowd. These are the two components of successful swing trading.