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Triangles give birth in a state of high volatilityTRIANGLES Triangles present a major class of patterns that don’t fit easily into continuation or reversal categories. Their eventual outcomes depend on their unique characteristics and positions within larger trends. Each triangle begins with a natural tendency that the swing trader must evaluate in context with the charting landscape. Ascending triangles print the most bullish patterns, while descending triangles form the most bearish ones. Symmetrical triangles display a zero bias for either outcome: the formation suggests a state of perfect balance. Well-formed triangles gather tremendous predictive power because they point directly at negativepositive feedback interfaces. A powerful vertical thrust often develops when congested price finally exits a triangle and surges into trend. While false moves occur near these apex points, breakouts tend to print with a higher degree of reliability than many other patterns. However, the dependability of all patterns mutates with the crowd’s participation. The most perfect and widely recognized triangles will cause the most grief for those trading in the direction of the common knowledge. Angle and location define the pattern’s identity. Ascending triangles rise again and again toward a ceiling resistance level. Symmetrical triangles surge rhythmically across both sides of a horizontal axis that divides the formation right through the middle. The bearish descending triangle bounces weakly off bottom support. All three variations can occur at bottoms, tops, or in the middle of ongoing trends. Unfortunately, this relative location does not reveal itself until the pattern completes and price ejects out of one side or the other. Triangles give birth in a state of high volatility. This agitation decreases sharply as they approach their termination points. This poses one of the risks inherent in trading these patterns. Volatility may flatline if no ignition sparks a breakout. This forces price to meander endlessly in sideways motion and lose its potential. Close out positions without hesitation when caught in this phenomenon. Buying pressure builds in ascending triangles as price tests upper boundaries. The setup normally triggers on the third rise to the top. A sharp expansion through this horizontal zone signals the breakout. Watch for a failure at the third high that may print a triple-top reversal. The best patterns show precise horizontal resistance. This builds strong demand just above that level. Slowly ascending highs do not characterize these bullish triangles. They represent bearish rising wedges. The difference lies in the loss of buying power as each nominal high fails to produce a significant profit. Ascending triangles commonly appear as continuation patterns in the middle of trend development. When they emerge near potential bottoms, upside breakouts often print parabolic rallies. Many miss this outstanding opportunity because the event tends to occur within a countertrend (bear market) environment. Regardless of location, the pattern fails if the trendline of the rising lows breaks to the downside. Symmetrical triangles form the most common congestion patterns seen on price charts. Formations that persist for years can be found on monthly bars, while day traders note their repeated appearance on 5-minute Nasdaq stock charts. These triangles form a central pivot axis that can yield powerful moves on price ejection. The challenge is to predict which way that price will break. While popular tutorials describe a bullish tendency, the pattern really has no inherent bias and can go either way with ease. Watch for a directional signal when the pattern nears two-thirds of the distance from its inception to the apex point where the triangle lines converge. Examine the symmetrical triangle within the context of an ongoing trend. Those that appear early in a move support that trend more consistently. General trading tactics use the lines that form the upper and lower boundaries to target breakout points. Regardless of direction, expanding price faces an additional test at the initial pattern high or low before it can thrust into a new trend leg. This last barrier often forces a final pullback to the breakout line that swing traders can use for late entry. Pay special attention to rare double symmetrical triangles in which one pattern prints right after the other. The center point between the two formations marks the halfway point of a major trend in the same manner as a continuation gap. Study the symmetrical triangle up close to uncover its secrets. Examine price action and volume at the second and third bottoms. Look for long bullish candle reversals that suggest bargain hunting. Examine the pattern’s ability to hold well above the first low on good accumulation. This stokes the breakout fires when the new trend finally begins. Beware of flatline bars beyond the two-thirds point that continue for more than a few prints. Many swing traders will be watching this same dead action and go elsewhere if nothing happens. The triangle’s apex point marks important S/R for price pullbacks and future trend mirror passages. These common patterns fail when they break one way but fall back through the apex in the opposite direction. Once this type of failure prints, price should continue to fade for some time as the false breakout relieves substantial pressure in the opposite direction. Many participants associate descending triangles with topping formations, but they can appear anywhere. These bearish patterns sap buying power through three declining highs that lead to an eventual breakdown. A horizontal bottom builds selling pressure that triggers many stops on a first violation. This triangle fails when price rises above the trendline formed by the descending highs. Price expansion through that violation will often be more dynamic than the expected breakdown move. When price pierces the horizontal bottom for a few ticks and pops back above, look for an immediate test of the declining high trendline. Any break through that point represents a buy signal. All types of triangles turn into something else with great frequency. No guarantees exist that any pattern will act according to textbook rules. Growing knowledge of triangle formations increases the frequency of this mutation into other forms of congestion. For this reason, trade these patterns according to strict planning that encompasses both breakout and failure strategies. Demand price bar and volume cross-verification or exit the position quickly. Intraday traders must also consider time-of-day bias when patterns hit execution targets. Look for clear signals or let other participants risk their capital first. FLAGS Flag patterns appear as countertrend parallelograms between waves of strong trend movement. These continuation patterns exhibit characteristic behavior and provide dependable trade setups. In less dynamic markets, this common formation will often mirror the same angle as the prior trend but in the opposite direction. Flags appear equally in bull and bear markets. Bull flags decline against the rally in uptrends, and bear flags rise against the selloff in downtrends. Vertical price movement precedes the most reliable flag patterns. Strong volume from the prior trend should drop off sharply as the range evolves. Expect price bars to narrow as volatility and interest flatline, as with other negative feedback events. Near pattern completion, volume should increase in the direction of the eventual breakout and spike just as a new trend leg begins. Flags should yield to new trends in no more than 15-20 bars. Bear flags tend to take less time to conclude than bull ones. When this pattern persists longer than expected, it may evolve into a long sideways market with little profit potential. Flags print a minimum of four relative extensions: two highs and two lows that form parallel trendlines. S/R may also generate a price axis through the center of the formation. Expect a breakout from the pattern after a pullback from the third strike at each extreme. But watch for an early move after price touches only one line for the third time, reverses, and then drifts back toward it. The eventual breakout mimics the action of better-known parallel channels. Price bars expand sharply away from the broken line on increased volume. Flag retracement follows classic Fibonacci proportion. The second low or high against the primary trend often strikes right at the 50% pullback, while the third hits the 62% level. If this second strike occurs closer to 38%, the third may go no further than 50% before the underlying trend reasserts itself. Fib grids provide an excellent cross-verification source for impending flag breakouts. For example, the third small rally in a descending bull flag may push upward into the bottom of a 38% retracement that also marks the location of an important moving average. This convergence of S/R increases odds that the upside price break will be dynamic. Common trading wisdom dictates that flags fly at half-mast. This suggests that these patterns print about halfway through trends. Use this anecdotal information for general price targeting. Measure the length of the sharp price move that precedes the pattern. Add that to the flag low that initiates the new trend and look for another reversal when price approaches the target. CANDLESTICK PATTERNS Swing traders spend months trying to memorize the dozens of candlestick patterns found in popular books but still learn little about the subject. While technicians attempt to define many different candle sets, only a few major formations deserve attention. First, realize that each candle pattern displays an internal bias toward continuation or reversal. But so do many simple sets of price bars. Candlesticks draw their real power through an ability to highlight how the crowd will drive prices higher or lower. Popular candlestick patterns focus on intense bull-bear conflict but rarely allow easy profit. Precise trade entry comes when swing traders drop down to the time frame below the developing bars and interpret these pockets of emotional crowd behavior. Look for more recognizable patterns, S/R, and common landscape features that place the larger action into perspective. This candle microanalysis works well with the intuitive mind to generate accurate and consistent prediction. Examine the charting landscape in which each candlestick pattern appears. Most important formations take place within the context of ongoing trends rather than constricted ranges. Always consider timing within a trend. Some patterns will display a bullish bias near the beginning of a price move but a bearish one as it matures. Look for predictive bars that form right through other forms of S/R, such as prior highs-lows and major moving averages. Then visually compare candle length with the recent price action. The most important events will exhibit above-average volume and bar range. Don’t depend on candle reversals to last very long: most formations only offer short-term prediction. Price frequently moves back and takes out the pattern within five to seven bars. This tendency makes candles an outstanding tool for swing traders, but it also opens the door to major trend relativity errors. Long-term reversals depend strongly on precise volume, trend, and location. For example, broad dark cloud cover events may print the high price for years. But these require new highs on panic participation following a parabolic rally. A tall real-body candlestick represents strong single-bar S/R. If price retraces back into its range, the subsequent action should not pierce the entire length without several small reversals. The chances of a 100% reversal on the next bar carry low odds when a long daily candle prints. For this reason, buying an immediate pullback after a tall bullish candle presents a low-risk opportunity under most circumstances. The safest trades arise when the new bar opens near the previous closing price and starts to fade immediately. This signals profit-taking by those still long from the prior candle. Price should spring back quickly through the interest of new participants when this pressure lightens up. Candlestick patterns have great power at the edges of central tendency. Watch closely for candle shadows that shoot through the sides of Bollinger Bands, especially when they point against constricting bands. This combined pattern provides significant warning of an impending reversal. Prediction here works well through both rangebound and trending markets. Focus on dojis and hammers more than any other candle events. These short-body, long-shadow single bars generate diverse trading strategies and offer important clues about subsequent price change. Their broad power reveals trend change in the next-lower time frame through very brief price discovery. These major candles comprise a larger collection of finger formations that includes the haramis and shooting stars. They are examined in greater detail in Chapter 10. The harami pattern closely aligns with the classic inside day. One difference allows the candle shadow to extend outside the range of the previous bar as long as the body remains within it. This pattern represents a potential reversal when it appears within a tall expansion bar after a strong price move. Drop down one time frame and notice that the opening tick often prints a gap from the previous close. In an uptrend, this hole-in-the-wall may present a significant boundary to further price gains. In a downtrend, the gap may initiate a breakaway move to the upside. Apply three different tactics to haramis that carry graduated risk. Each strategy executes in the same direction as the short-term break. The first enters a position when price exceeds the expansion bar high or low, the second when it exceeds the range of the inside bar, and the last when price ejects past the real body of the inside bar. Set stop loss according to the chosen entry level in each case. In other words, if the trade uses the real body to trigger execution, exit the losing position when price then violates the real body’s range in the opposite direction. The harami cross presents a specialized form of this pattern through a doji that appears inside the range of the prior expansion bar. It signals a possible 2B reversal in the time frame beneath the candlesticks. In that chart length, price dips to a new low or high but jumps back across S/R by close. Trade this formation in the direction of the reversal rather than looking for price to break through the shadow. The odds of a strong reversal increase if a long-legged doji shadow prints across S/R. Bearish dark cloud cover and its bullish piercing pattern cousin signal sharp price reversal. They both hide significant exhaustion gaps that mark the end of extended trends. Each two-bar pattern begins with a long expansion candle in the direction of the prevailing trend. The next candle opens well beyond the last bar’s close but then reverses deep into the prior range. Price typically completes this rout on the next few candles and thrusts well out of the pattern in the opposite direction. Consider a fade entry if price returns to test the filled exhaustion gap on the chart just below the event. But when price doesn’t reverse quickly off the gap, congestion may form right through it. This suggests that a continuation move will ultimately allow that market to head off into new highs or lows. If no pullback occurs, execute when the next bar or two pierces the range of the second pattern candle. Latecomers will find that the best trade often appears after the completed reversal retraces into a test that reenters the edge of the formation. Long dark cloud cover can stop a rally for months or years when it occurs on a daily chart well into new highs. The two candles represent significant overhead supply that fresh demand must absorb before that market can go higher. A second lower high often forms the rounded Eve of the classic Adam and Eve top after the sharp pattern event. Measure the ratio between this bounce and the pattern high. If it cannot rise more than 38-50% before pulling back, that market will likely move quickly to much lower levels. |
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