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Converging patterns on different
time frames can help pinpoint trade opportunities. This approach shows
you how to
set up these trades and take profits when opportunity arise. |
The chart (above) shows an example using
one-minute and five minute charts of the Standard & Poor’s tracking stock
(SPY). The
five-minute chart on the right has formed a rising channel pattern, and the
one-minute bars on the left traced out a head and-shoulders top pattern (a
reversal formation). Together, they offer a strong combination for entering
a trade. If you were just following the five-minute chart, you would have
most likely gone short as prices fell through the lower trend line of the
upward channel at 11:20 a.m., which was not a bad entry. However, the H&S
pattern provides confirmation the market is most likely done rising and the
downtrend will reassert itself, which reinforces the trade’s reliability.
You can enter the trade after the development of the right shoulder at11:36
a.m. In this case, you look to go short as price breaks the up trend line
drawn along the lows of the right shoulder. A break of the neckline
(the trend line connecting
the
lows of the patterns shoulders) is confirmation the pattern is complete and
a harbinger of lower prices If you pay
attention to support and resistance levels, you can see how you would look
for the right shoulder to develop. First,
b e f o re the right shoulder
forms, it’s possible to identify the resistance level for the left shoulder
(110.30) and the head (just below110.60). Once the market breaks the up
trend line of the channel on the five-minute chart.
Look for
continuation or countertrend patterns on the longer time frame and then drop
to the shorter time frame to find a reversal pattern to manage the trade.
watch for a support level for the right shoulder to
form (which occurs
just above 110.00 here). We would expect the
right shoulder to peak
in the vicinity of the resistance level of
the left shoulder (110.30), which is exactly what happens in this
case. By drawing an up
trend line along the lows of the right shoulder,
you go short when price breaks below this line; set
your stop-loss just above the top of the right shoulder. (We will
cover where to take profits shortly. )the chart below consists of daily and
weekly charts of
Veritas Software Corp. (VRTS). We follow the same criteria.
The daily time frame (left) has an H&S pattern (reversal pattern
and
the weekly time frame (right) has a rising channel pattern. Here, the daily
chart shows the right shoulder is higher
than the left
shoulder and the neckline is rising as well. We
can go short on a
penetration of the neckline with a stop-loss
just above the top of
the right shoulder. three
basic profit-taking targets can be used with this
approach, giving you different levels to work with as a trade
progresses. These
profit targets are for short sales. The same
approach, in reverse,
can be used for long trades.
The first target for the pattern is a 50-percent retracement of the
distance between the major low and the top of the H&S
pattern. Because a 50-percent retracement would be a typical
decline of the
previous price move, we take partial profits at
this level.
The
H&S pattern also has a profit objective we can use as a target: the
difference between the head and the neckline, subtracted
from the neckline. The
final profit target is the major
low. Use a
trailing stop placed at the declining resistance levels
once the trade moves in your favor.
As popular as technical indicators have become, a solid
understanding of classic chart patterns analyzed on multiple
time frames can provide the entry, exit and risk control structure of a
solid trading strategy. Here, we have shown that the
combined confirmation
of two chart patterns over two time frames can signal trading opportunities
near the completion
of a
countertrend price move. This approach offers a low risk to reward
ratio and keeps you trading with the longer- term trend.
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