What the Hell is "Pattern Failure?"
Friday, September 15, 2006 at 02:31PM In order to correctly identify entry and exits while trading patterns, you must be able to draw a line in the sand that states when a pattern has failed. Think of pattern failure as a way for a trader to determine the likelihood that the stock will still make a reasonable attempt to achieve it's target price. If it moves beyond a certain point in the pattern, this substantially reduces the LIKELIHOOD that the target price will ever be achieved. Let's take another look at CTSH.
I have drawn the triangle pattern on the chart, and you can clearly tell when the signal was generated. 9/13 provided a close above resistance on heavy volume. This is your signal to enter the trade...but how can you tell when the pattern has failed?
Actually there are two ways to determine pattern failure. One will happen before you get a trading signal, one will occur after you enter the trade. Let's assume we are in a trade on CTSH. We got in on the 13th according to our signal, but we are losing money right now after a recent retracement.
Have you ever heard that after resistance is broken, it will become new support? That fundamental understanding of support and resistance applies to this particular trade. Now that resistance has been broken, that should become new support. NOTE: This is really important...Make sure you draw support and resistance lines with a crayon rather than a razor sharp line. That means your line should be an area more than a specific dollar value.
$71.50 was an old resistance for CTSH. After the breakout has come and gone, the price has come down to re-test old resistance as new support. If this has you worried, STOP BEING SO EMOTIONAL! You need to anticipate this and be willing to give the trade this flexibility to stop here and bounce. If it does not bounce and move higher off this new support line, and trades back into the pattern, this is when you consider it to have failed. A close above or below an old support/resistance level confirms your pattern has failed.
With a better understanding of this, you should be able to be a little less unemotional and more systematic in trading these patterns. So far what you see happening in CTSH is textbook. In fact, many traders wait for this signal instead of the breakout to enter this trade. I for one do not do this since it doesn't always re-test after the breakout. Maybe only 60-70% of the time.
If you are thinking about sending me an e-mail challenging the level of resistance drawn, or things like that, save your breath. The wonderful element of price pattern is that the analysis is subjective. You may not agree with me (and you are wrong... just kidding :) and that's great! It's an art, not a science. Once you get familiar with what a pattern should consist of, the consistency of where the prices move within the pattern, you will be able to see these patterns more clearly, and you will be able to draw these lines based on your own personal perspective. If you want to learn more about them, come to my Price Pattern presentations on Tuesday mornings in the Advanced Technical Analysis Trading Rooms, or buy a book.
If you do have questions, please post comments to this page rather than send me an e-mail. I will keep an eye on what is being discussed and pipe in accordingly. I'd rather involve everyone on your questions so more enlightenment can take place. Everyone will be better off because of it.
Reader Comments (10)
I am certainly not at your level (yet - ha ha) but I agree this pattern has not failed yet. I too had support drawn at exactly 71.5. I missed the initial break out because of a meeting. I still have to work but it certainly does get in the way of my trading education and golf.
I was in the right position (in front of my computer)the next morning and was able to enter the trade as it bounced off 71.5. I set my stop .75 below support and went home thinking I entered the trade as close as possible to "new support". I was proud of myself. Heck I was even up 30% at the end of the day.
Can you say "WHIPSAW" at $70.74?
A couple pennies kicked me out of this trade (once again while I was in a fricking meeting) which at first really pissed me off, however there are a couple of good things from this trade.
I did not break my stop rules, which I used to do and I am confident to enter the trade again if I get confirmation.
I fought my emotions today but I will win in the end thanks to what I am learning from you.
Thanks.
Work is really starting to get in the way.
I'm going to hit a bucket of balls.
Monday is another day.
Good explanation and nicely put. Thanks, for the reassuring words. You do an excellent job of explaining concepts and analyzing stock charts. Keep up the good work and good night.
Couldn't agree more. Another way to look at the price action today is that the bears thrust hard with a lot of men at the bull's new front line (support). The Bulls obviously got a lot of reinforcements to "hold the line" (at least for today).
I entered a trade on TWGP that I mentioned to you last week. It broke out of a symetrical triangle Thursday on heavy volume. Today it bounced up 90 cents more to close around 30 cents lower than the all time high (again on high volume). It will be interesting to see if it can garner enough volume to break the all time high on its first test of that level. The intraday trading hovered right below it for most of the day. Thoughts?
I am one of the ones that usually wait for the backtest of the breakout after having been on the wrong side way too many times when I first started trading. I now know that this was in large part to not having a proper trading account that would allow me to set stops and limits on my Options trades (Bracket Order). My work schedule does not allow me to watch a screen during the day and use Mental stops as some suggest. This caused me great stress and emotional anguish not to mention some pretty significant monetary losses.
I had been watching CTSH and COF as well for several days and entered COF as an Options trade this morning after the upward move was confirmed off of the old resistance and now new support with all my appropriate stops and limits in place (thanks to my IB account!) and did not have any issues with it allday while I was in meetings and while flying back to Atlanta from Baltimore. I plan on being prepared to enter CTSH as another Options trade on Monday morning if all my entry criteria is met (solid retest of the new support/old resistance).
I thank you so much for your teaching and willingness to challenge our thinking to new heights! My confidence is definitely on a more solid footing here of late due in large part to your mentoring. I am actually realizing regular profits with controlled minimal losses from adhering to what you are teaching!
I for one would not want you to stop this invaluable teaching platform for lack of "hits". It is not in the numbers but in the quality. I think you provide enough "suggestions" intermingled in your AWESOME teaching!!!
Thank you,
Randy B
I agree with your assessment on price action and support with CTSH. However, are you a little concerned with the huge volume on today's down day, or do you attribute it to expiration?
I don't think it's a good sign that the market was flying all day long (until the end) and CTSH was unable to advance further.
I was travelling yesterday and sold my October $75 calls on the fly when the price broke below $71.50. No big deal, it was a small loss. Plus, I wrote in my journal that this was an aggressive entry looking for a quicker move, and i was slightly uncomfortable buying such little time. Nonetheless, October was the only one available and i didn't want to buy many months of time.
here's the silver lining for me and everyone else who seems to be upset about CTSH:
The pattern should take over a month to complete itself. Monday the NOVEMBER options are available. Yay! So watch for a bounce off this support level and buy a little more time.
It might wind up being a blessing in disguise if you sold yesterday.
1.Anticipatin the bounce
2.Anticipating the bounce II
3. Downtrending stocks w/ high MACD
4. ????
Thanks for any input.
Sarah
I beleive the fourth was called "price pattern" search. Do a search in either the momentum or growth archives
JohnO
#4 is Searching for a Bullish Breakout.
Thanks!
Jeff
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