Chart Patterns Master Series

Copyright 2008 Mark Deaton

U.S. Government Required Disclaimer - Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the stock/options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in this manual. The past performance of any trading system or methodology is not necessarily indicative of future results. CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

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Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www.renegadetrader.com 

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Table of Contents Introduction Megaphone or Broadening Bottom Megaphone or Broadening Top Cup and Handle Dead Cat Bounce Diamond Tops and Bottoms Double Tops and Bottoms Triple Tops and Bottoms Flags and Pennants Head and Shoulders Island Reversals Ascending Triangles Descending Triangles Ascending Wedges Descending Wedges Conclusion 2 3 6 9 12 15 18 22 25 28 31 34 37 40 43 46

Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www.renegadetrader.com 

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Introduction The theory of garnering profits through investments is easy to comprehend. Buy when prices are rising. Sell when they are falling. As everyone knows, however, prices just do not move steadily in one direction. They are volatile. The key to successful investing is, thus, being able to accurately determine whether the investment vehicle chosen for the time period in question will increase or decrease in price. Proper chart analysis is the methodology that will allow anyone to become a successful investor. For the astute investor, price charts are not just random movements depicted graphically. Proper recognition of the patterns that they form over time is the signals of where market participants are investing their money. If an investor can recognize these signals as they appear, it becomes a simple and self-evident exercise as to whether to buy (go long) or sell (go short) the investment under consideration. The price of a holding, whether it be the shares of IBM, crude oil, Japanese yen, or treasury bonds, will move based on the laws of supply and demand. When there are more buyers than sellers, the price will rise. When there are more sellers and buyers, the price falls. One classic investment methodology is called fundamental analysis. Basically, this technique attempts to look at all the factors that affect a particular investment under consideration, and based on an analysis of those factors, determine whether the likely demand for that investment will increase, stay steady, or fall. Once this analysis has been accomplished, the investor takes the appropriate position. In contrast to fundamental analysis are techniques referred to generally as technical analysis. The principles behind this methodology maintain that markets are in essence efficient, and they trend over time. This being the case, all the successful investor needs is to be able to recognize the repetitive patterns that develop in a chart in order to make proper investment decisions. Fundamental analysis becomes irrelevant because the price of an investment already reflects all the available information in the market. Whether an investor chooses to use technical analysis or fundamental analysis in his or her trading decision is a personal matter. It never hurts to be aware of all the tools available in making investment placements. Anyone familiar with markets knows chart patterns are actively used by the investment community. All brokerages supply investors with a plethora of information concerning charts to help their clients in making their decisions. Tens of thousands of analysts across the globe issue recommendations based on their interpretations of chart patterns. It would be foolish for any serious investor, no matter what type of market he or she is interested in, not to have knowledge of chart patterns and their importance to price movement. This book gives the reader the tools to identify the signals that chart patterns produce, with the goal of predicting with accuracy the direction of future price movement, the probable intensity of the direction, and the reliability of the movement. The information presented herein, when properly utilized, can greatly increase the wealth of any investor.

Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www.renegadetrader.com 

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Megaphone or Broadening Bottom A megaphone and broadening bottom formation on a price chart is generally regarded as a bullish signal. It signifies that the current downtrend is probably going to reverse itself, and then establish a new uptrend movement. This type of formation is characterized by successfully lower lows and higher highs which accumulate during an overall downward trend. For the proper formation to be recognized, there must be at least two higher highs situated between three lower lows. The chart pattern is considered complete when prices rise above the second higher high and do not return below it. This usually occurs during the third upswing during the formation of the pattern.

Source: http://www.marketscreen.com/help/chartpatterns/default.asp?hideHF=&Num=103 Performance Though considered a bullish formation, broadening bottoms that have downside breakouts can actually outperform those on the upside. Consequently, for the investor, this type of formation produces an opportunity both for a long and short position depending which way a breakout occurs. Statistical analyses of these types of formations tend to indicate that bullish breakouts will result in a significant move upwards from the point of breakout, as will downward breakouts on the downside. These formations appear to be remarkably accurate indicators, with some studies reporting as high as a 98% success rate of continued price appreciation when an upward breakout occurs. On the downside, the accuracy has been reported as high as 94%. Recognition

Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www.renegadetrader.com 

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prices are moving along in the direction of the least resistance. those that produce downside breakouts should be considered consolidations. and the actual range can be significantly shorter or longer. It should be kept in consideration that this is the average. Megaphone bottoms that produce upside breakouts can be generally considered as reversals of the underlying downward trend. if a breakout occurs in prices and then fails to move more than 5% in the desired direction before returning to the breakout point. This means than an intermediate strong trend has already established itself on one side of the formation to the other.com  Page 4    . The varying movements necessitated for the proper formation to occur require a significant amount of time to pass.  http://www. it should be subtracted from the lowest low for the short side target price upon a downside breakout. the best tactic to use is to subtract the lowest low from the highest high recorded during the formation of this chart sequence. This is the distinguishing aspect of a megaphone or broadening bottom chart pattern. it is important to try to determine the likely price move that will occur once the formation is broken. such that when a breakout occurs. positions should be liquidated. The point of entry when using such a formation as a signal should be a clear point above or below the trend lines that have been made. This logically makes sense as these formations can only be recognized as such after a distinct previous downward trend has been identified.In recognizing a broadening bottom formation. then that penetration point is the breakout point of the formation and represents the consideration price that needs to be exceeded for a position to be undertaken. In other words. this actually makes sense. Trading Considerations As these types of formations are so highly successful based on statistical regression analysis and their failure rate is so low. This depth measure should be added to the highest high in order to obtain a target price after an upside breakout. The opposite should also hold true. Generally speaking. from the intermediate lows to high. as can be seen from any chart. These trend lines should slope in opposite directions. If prices clearly extend beyond or below the trend line. and the one based on the lows should be headed downwards. On the other hand. the trend lines based on the intermittent highs should be rising upwards. there should be a visibly declining volume of activity. The failure rate of these formations is exceptionally low. however. it is difficult to formulate a defensive strategy for those rare instances when they represent false signals. These target prices will always be approached when breakout occurs though they may Copyright 2008 Mark Deaton DO NOT COPY or reproduce. between peaks and troughs. Breakouts occur. Another one of the distinguishing aspects of this formation is that volume follows price. the two trend lines drawn across the intermediate highs and lows are very important. at the widest point of the broadening formation. That is. A large amount of momentum has actually been established. This will give a measure of depth of range. When trading a megaphone or broadening bottom formation.renegadetrader. Similarly. The average time needed for the formation of this sort of chart pattern is about two months. If one is to give consideration as to how they are formed. Generally speaking.

not always be achieved. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. Broadening bottom megaphone chart formations have been widely statistically analyzed by trading professionals. Regardless of what profit goals are established. they can continuously adjust their stops to the successive intermittent minor highs or lows that occur during the major move that they have discovered. As it is generally considered a rare occurrence. The data tends to suggest that the breakage of this formation is an exceptional signal for continued movement in the direction of the breakout. regardless of the type of market: stocks. The results of these studies all indicate that these types of chart patterns can be exceptionally successful in predicting future movements. represents a remarkable tool for successful and profitable results in the investment markets. foreign exchange. As a result. Using this strategy. it is recommended to have a stop loss order placed at a level 20% below the minor low or high as has been exhibited in the formation. when it does happen. if they can be properly recognized.renegadetrader. the knowledgeable investor will use it to his or her advantage. For those aggressive traders. For the individual investor. these patterns. consequently. the investor will only have a minor loss should a formation failure occur. commodities. conservative investors may find it wise to have profitable exit points determined somewhat before the achievement of target prices. who want to hope that they have stumbled upon a major reversal or continuation pattern. every investor must be prepared for an unsuccessful trade.  http://www. etc.com  Page 5    . either on the upside or the downside.

and these formations signals act very much the same. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. What differentiates the top and bottom formations is the trend that has been established before the pattern arises. Formation Characteristics There are many different recognized variations of these broadening formations. these types of formations represent an exceptional tool for the investor in order to make investment decisions. The characteristics of this general chart pattern are always the same. When trend lines connect the intermittent highs and lows. These price highs and lows must be clearly distinctive within the charted range as per the example below. For megaphone tops. The slopes of the resultant trend lines distinguish this pattern from other similar. the price trend has been clearly upwards. It is the previous lower lows and higher highs that make this pattern obvious for the investor. If one of these trend lines is somewhat horizontal. The directional differences are not the only distinction. For a true megaphone top formation to exist. Some research has demonstrated up side price movement averages as high as 34%. The trend line created by connecting the intermittent highs must always be sloping upwards. there must be at least two minor lows and two minor highs before the pattern can be considered to be a proper formation. but different formations. statistically. or they both slope in the same direction. these types of breakout signals can result in subsequent significant price movement in the direction of the breakout as high as 96% of the time.  http://www. while the one connecting intermittent lows must clearly have a downward direction. while those for bottoms the opposite holds true. there must be a distinct precedent uptrend that can be seen in the chart.com  Page 6    . At a minimum. Given these statistical results. These formations may act similarly. Statistical Evidence There are basically two types of broadening top chart patterns for the investor: one that produces an upside breakout. according to certain studies. then the formation cannot be considered a broadening top. with down side breakouts averaging around 23%.renegadetrader. but their performance results differ.Megaphone or Broadening Tops Broadening or megaphone tops can be considered the opposite of broadening bottoms. what results should be a visualization that resembles a megaphone. As with broadening bottoms. and the other which produces a downside breakout.

however. Many analysts consider the formation of a megaphone top chart pattern to be a bearish indication. and the established uptrend will continue. is inconclusive in its findings. the formation was in essence a consolidation. when it finally pierces one of the trend lines. it becomes a very strong historical signal that the directional move established will continue significantly into the future. the volume of activity also tends to be rising. volume tends to follow the price movement being exhibited within the formation. Breakouts on the downside.thestreet. Trading Considerations The proper interpretive significance of this formation is dependent upon the direction of the breakout. the general rule of thumb is to take the largest range exhibited within a broadening top formation. when prices are rising.com/p/_rms/rmoney/technicalanalysis/10269434. Breakouts are the prices above and below the two trend lines that have been formed by connecting the relative highs and lows within the formation that produced the image of the megaphone. every time the price has approached the identified trend lines.html Linear regressions statistical studies have shown that during the formation of these types of patterns.  http://www. When breakouts have occurred on the upside. The point of interest for investors is that the breakout points that occur signal the formation has ended and a significant price move should be anticipated in the direction of the breakout.com  Page 7    . Copyright 2008 Mark Deaton DO NOT COPY or reproduce.renegadetrader. Consequently. The reverse is true in the opposite direction.Source: http://www. it retreats to within the previous range. What is distinctive about this formation is that it can be clearly seen that during its consolidating phase. however. As a result. represent the signaling that a reversal has occurred. Statistical research. From a tactical perspective in making decisions towards anticipated price movements.

every investor must be prepared for a failure. it is the beginning of a significant downward movement that can prove to be long-term. more often than not. unlike most consolidation formations. are characterized by ever-increasing tops and bottoms resulting from increased volatility in price ranges with the passage of time. as a result.and then add it to the previous highest high exhibited. Volume can be seen to be increasing significantly during intermittent price rises and falling during intermittent reversals. Traders who can properly identify a broadening top megaphone chart pattern can be expected to obtain extraordinary trading results upon implementation of the proper position. and an investor has taken the proper position. representing a truly extraordinary investment opportunity. and. thus. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www. As these types of formations can be the first indication of a significant reversal of trend. When the breakout occurred on the downside. Broadening or megaphone tops represent an exceptional tool for the trader to make proper investment decisions that will culminate in successful results. if this were to occur.renegadetrader. when a reversal breakout occurs. These patterns. in order to obtain an anticipated target price. and above the previous relative low in a downward break. Broadening top formations that have occurred after an exceptionally long previous uptrend signify that speculators have produced unrealistic expectations. Though these types of formations have been shown to be exceptionally accurate in predicting future movements in the direction of the breakouts. Since the bullish signals produced by the rallies are evidently short lived. even though its occurrence appears to be exceptionally rare. the reversal will usually result in an extremely significant correction. this range figure is subtracted from the lowest previous low exhibited for a similar target assessment price. it is highly advisable to adjust the stop loss order to subsequent exhibited relative highs and lows so as to maximize the benefit from having entered the trend reversal at the very beginning.com  Page 8    . The generally accepted methodology is to have a stop loss a certain percentage below the previous relative high in an upwards breakout.

it is usually followed by a significant appreciation of price. When the handle pattern has been penetrated upward. The general form." As the name implies. It shows a distinct curve continuation pattern. followed by a breakout upwards.com/school/doku.com  Page 9    . Once it has occurred. the cup and handle formation resembles a tea cup on the chart.  http://www. which then stops and sells off. It is attributed to William O'Neil and was first introduced in his book called "How to Make Money in Stocks. The length of time necessary for the pattern to form can vary from several months to a year. This selloff is the critical part of this pattern formation. at the end of which the established upward trend stalls and prices move downward to form the handle. the market in question basically trades in a relatively narrow range downward for an extended period of time and demonstrates no clear trending movement.renegadetrader. The trading range during this period can be seen forming a distinct Copyright 2008 Mark Deaton DO NOT COPY or reproduce. however. Source: http://stockcharts. the price moves back up towards the previous high. is always the same.php?id=chart_school:chart_analysis:chart_patterns:cup_with _handle Formation This type of chart pattern is characterized by a distinct upward move.Cup and Handle The cup and handle chart pattern is generally regarded as a bullish continuation pattern that represents a significantly long consolidation. Once this has occurred.

Adding this differential to that high produces the target price.handle formation relative to the large cup base of the preceding trading time period. It is also characterized as being difficult to truly objectively recognize. It is critical in this type of pattern to note what type of price movement occurred prior to the formation of the cup and handle. Waiting for this confirmation. This chart formation lacks the statistical certainties of other formations. one should always be prepared for formation failure. as the handle becomes a support level for corrective retracements. As a general rule. Consequently. nonetheless. The smaller the percentage taken of this previous range exhibited in the cup. a breakout occurs from the handle above the right cup lip’s previous high. the market moves distinctly higher and continues the previous upward trend. As there has already been a significant price appreciation prior to the formation of the current pattern. This means that less than half the breakouts reach this level. so as to maximize potential Copyright 2008 Mark Deaton DO NOT COPY or reproduce. Once this handle formation is broken. so as to distinguish it from a simple rounding bottom formation. statistical studies show this methodology has never produced a success rate of over 50%. However. In order to take advantage of the upward movement. and the price will increase but then come back to the lip high price. prior to recognition of a loss. the larger the likelihood of achieving that priceperformance. when trading this formation.com  Page 10    . Consequently. the lower the probability for a significant breakout once the pattern has been completed. Generally.  http://www. As with any chart pattern. Often. and then take a relatively modest percentage price goal in order to maximize trading results and performance. it tends to act as a confirmation that the upward trend will resume. when this pattern materializes. There are several aspects of this sort of chart pattern that should be noted in order to best to evaluate its potential as a trading signal. Trading Strategies Strategies for determining the upward price potential usually entail determining the height of formation from the lowest low that exists in the cup to the high produced at the cup lip on the right-hand side. When this occurs. it would be beneficial to have a moving stop 12 1/2 percent below clearly defined support levels. an investor would want to see a distinct penetration of that support level. greatly improves the probability of a successful trade. In addition. analysts confirm the formation of a cup and handle chart pattern by demanding a minimum 30 percent increase from the low point in the cup before it the formation of the handle. this weakens the momentum of the price movement for a continued upward appreciation. With this particular type of pattern stop loss. and there are certain techniques that can be used to improve the likelihood of undertaking a successful investment. the handle should have a minimum one to two weeks duration period. In addition. and only entering after the prices return to the upper lip before taking on a long position. there must be a period of very high volume somewhere during the rise and creation of the cup. the larger the prior rise was before the appearance of a cup and handle chart pattern. Investors do look for this type of pattern.renegadetrader. one should look for extended depths within the cup. orders are placed somewhere below the handle low in order to minimize losses. All the cups must have a distinctive U-shaped base with a handle. The rule of thumb is generally the place stops at 12 1/2 percent below this price.

future profits. As with almost all chart patterns. The cup and handle formation is no exception.renegadetrader. The difficulty in using this chart pattern is its recognition. the higher the probability that the upward trend will resume and continue. The cup and handle is just one of many successful chart formations used by investors to obtain gains from trading. This tactic will eventually force you into a profit.com  Page 11    . Generally speaking. the larger the volume on the upward breakout. which can only occur through time-tested practice.  http://www. volume of trading activity is a useful confirmation for implementing a position when a signal is recognized. but protect you from a potential reversal that would eliminate entirely any possibility of a successful result. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.

After such movements. The price starts to recuperate some of its losses. The dead cat bounce chart pattern concerns a short term recovery in an overwhelming downward trending market. if only but for a brief period of time. volume is exceptionally strong relative to what turnover was traditionally. All of these influences bring on a certain amount of buying sentiment. In addition.Dead Cat Bounce Within investment circles. It is in situations like this that the dead cat bounce chart pattern appears. and looks at his or her particular trading signals to try to identify an oversold market. After this.com  Page 12    . which sends the market up. there is an adage that says even a dead can bounce if it falls from a tall enough height. those who were lucky enough to have recognized the trend from an early point are closing out their positions in order to recognize some profits. The price declines and opens at a much lower level.renegadetrader. especially in a bear market. Formation A dead cat bounce chart formation is often characterized by a gapped down trading session. and that it may be appropriate to take a long position. The final type of trader to enter in this scenario is one who will use a strategy based on momentum. is usually short-lived. Whenever a price has moved significantly over a long period of time in one direction. Some sort of news event happens that is so surprising to market participants that sell orders completely overwhelm what little buying demand there is. This recuperation.  http://www. It is not uncommon to see 20 times or more normal trading levels. investors will start to rethink about whether they are holding the proper positions. a bounce consolidation phase begins. however. certain value oriented investors are beginning to believe the bottom has been reached. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. At the same time. and the downward trend shortly thereafter continues.

statistical studies tend to show. as they have occurred because there has already been an extremely severe decline. as measured from the high the day before the price gapped downward. however. the odds are in his favor in producing a successful result. the further decline will be modest. Based on historical studies. However. 90% of the time this formation appears.shtml Not all significant downward trends result in a dead cat bounce. Any reversal in price to the high of the day previous to the gap down is an almost guaranteed signal that the pattern has failed. As it is a high percentage trade. The problem with this type of formation is the fact there has been an already tremendous deterioration and fall in price when it appears. An appropriate position price should be determined at which the sell order should be placed. The average decline.Source: http://www. they can at times be precursors to a significant trend reversal. Consequently.  http://www.mrswing. a price needs to be determined on a subsequent bounce as an entry point. If it hasn't materialized within two weeks. The average recovery tends to be in the 20 to 30% range from the low register on the bounce day. but almost guaranteed. losses should be terminated at this point. you can throw a dead cat off from a high enough point and it will bounce. It is highly recommended that when contemplating this sort of chart formation that the gap that has occurred be at least 20% of the previous day’s range. The primary attractiveness with this sort of chart pattern is that it represents an opportunity for an astute investor to make a quick small profit. dead cat bounces can statistically be shown to be low risk trading opportunities.com/artman/publish/SwingTracker_stock_scan_/Trading_Dead_Cat_Bounc e. and that volume on the gap day is at least three to four times the recent daily average. This bounce should occur in a relatively short period of time. Where the dead cat bounce occurs relative to the historical price performance will determine the magnitude of the further decline. there is an additional significant downward movement. the profit potentials for a trader are extremely limited. short-term profit. a large enough fall in order to risk a trade. the percentage fall from that recovery high to the ultimate low ranges between 15 and 25%. to the ultimate low achieved subsequently. there is the possibility for low risk.renegadetrader. whenever considering entering a position at the occurrence of a dead cat bounce. Though they represent opportunities. however.com  Page 13    . will not be very high and the cat will still be dead. the best way to profit from a dead cat bounce is to wait for a recovery high enough in order to take a short position. ranges as a decline in the 30 to 40% range. As a result. the recovery high should occur within two weeks of the appearance of the bounce. However. If an investor wants to trade a dead cat bounce. Should this occur and the investor is in a short position. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. then there is no dead cat bounce. However. care should be taken when considering entering trades because of the inherent background of this chart pattern. Trading dead cat bounces can be risky. proper stop loss orders should also be in place. In order to maximize profitability. The continuation of the downtrend after the appearance of the bounce should last between three to six months. if he or she is not too greedy. Trading Strategies From a trading perspective. They do not represent a situation for an investor to obtain a large successful gain. The bounce. Therefore. Generally. As the saying goes.

however. then the continuation of the fall after the bounce will be greater and the failure rate much less likely. every investment will begin to look cheap.renegadetrader. that this particular chart formation only occurs after a dramatic fall in the price of a market has happened. It cannot be emphasized enough. one should take particular care in utilizing the dead cat bounce chart pattern as an investment indicator. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.If the drop precedent to the appearance of a dead cat bounce chart formation happens after the appearance of a previous long term high. And as the fundamentals of any successful investment strategy is to buy low and sell high. At some point in time.com  Page 14    .  http://www.

there must be an upward short-term price movement that leads to a minor high on the left side of the formation. whereas the average rise from diamond bottom chart patterns upon breakout is in the 35% range. in order to form a minor low. Source: http://www.Diamond Tops and Bottoms The only difference between a diamond top and a diamond bottom during the formation of these types of chart patterns result from the price trend that precedes the formation. unless they occur in conjunction with another indicator.com  Page 15    . prices begin to rise. Once again. before turning around and moving higher again.com/education/technical_analysis/chart_patterns/reversal/diamonds. Performance results of these types of chart formations are similar. which is roughly twice the rate for diamond bottoms. As this failure rate is relatively high for diamond tops.renegadetrader. These fluctuations that produce the relatively minor highs and lows will result in a diamond shaped formation when the Copyright 2008 Mark Deaton DO NOT COPY or reproduce. reaching another minor high before breaking down and penetrating the upward trend line on the right. using them as a signal for position taking purposes may not be well advised. while diamond bottoms have declining prices prior to appearance. The historical studies done on this chart pattern seem to demonstrate a failure rate of approximately 25% for diamond tops.  http://www. When breakout occurs. the average declines appear to be around 20% for top formations. Diamond top chart patterns are preceded by an upward trend.baresearch. Price is then expected to proceed to decline.phpF For the formation of a diamond top chart pattern to occur. They then reach a new high before tumbling down again to finish below the previous minor low. Both serve as signals that the precedent prevailing price movements are about to reverse themselves when a breakout occurs on high volume.

target prices need to be developed. Volume activity is extremely important in identifying a diamond formation and in helping not to confuse it with a typical head and shoulders pattern. there can be wide variations in volumes traded. there is an excellent potential for a short sale with a profitable result. With diamond tops and bottoms. The price trend then begins to narrow with resulting higher lows following lower highs. What usually follows next is a return to that breakout level. There is a clear precedent downward trend in prices prior to the appearance of the chart pattern. Historical studies seem to indicate that these distances will be traversed 95% of the time when the breakout occurs from a diamond bottom and 79% of the time when the breakout occurs from a diamond top. it appears that they do so more frequently at market tops rather than market bottoms. This is normally considered the minimum price move to be expected upon breakout.renegadetrader. The diamond formation then becomes evident when trend lines are drawn connecting the various limits of the price movements. and therefore. the range starts to expand. however.  http://www. Diamond top and bottom chart patterns form relatively infrequently on price charts. When breakout occurs.various relative high and low prices are connected. as irregular diamond chart patterns are very common. When breakouts occur from a diamond formation. the rule of thumb is to locate the highest high and lowest low in the formation and subtract the low from the high. and there is a retracement above or below depending on the type of breakout. The formation of a diamond top chart pattern is considered a bearish signal. they are almost immediately followed by a two to three percent movement in the direction of the breakout. the use of this sort of methodology for achieving your profit goals when instituting a trade is highly recommended. but in reverse. Volume tends to be declining. Trading Strategies As with any chart pattern formation. Diamond bottom formations are similar to those of tops. If the price is for any reason is not supported at this point. however. After this downward trend price has rebounded slightly. Overall. where one would expect more often after a strong bull run. Generally speaking. Support and resistance levels for diamond tops normally appear at the top of the formation.com  Page 16    . especially during the latter part of the formation of this type of chart pattern. It should be noted that the formation does not necessarily need to be symmetrical. When they do occur. but this is not mandatory for diamond bottoms. nonetheless. which appears to suggest an indecisive market. where volume is usually significantly higher. producing higher highs and lower lows. Volume during the formation tends to recede. when the price range begins to narrow. Genuine diamond chart formations are always identified by decreasing volume during the second part of the price pattern. This confusion can arise because of the upward sloping neckline in these patterns. these types of chart patterns are characterize by the right side volume being much lower when compared to the volume of trade on the left side. volume tends to reduce overtime until the point of breakout. When breakout occurs on the downside. As is characteristic in tops. which also can be used as an early entry point for the position. This appears to be quite logical and consistent with the shape of this type of formation. trading volume is usually higher than normal. Given this historical precedent. result in a greater profit. the pattern must be Copyright 2008 Mark Deaton DO NOT COPY or reproduce. but this is not a prerequisite for this pattern.

True diamond patterns are exceptionally rare. since when breakouts occur. for the investor who has mastered their recognition. subsequent movements tend to be very substantial. stop loss orders should be placed at these levels so as to minimize losses due to a formation failure. The distinguishing aspects of the diamond formation that the investor needs to master to properly identify are the upper and lower trading range and the volume behavior within the pattern.considered invalid. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. however. profit potentials are excellent. Consequently. they represent an outstanding trading tool.renegadetrader.com  Page 17    . Therefore. Diamond top and bottom chart patterns are extremely difficult to identify as they have characteristics that are very similar to other technical analysis chart formations.  http://www.

com  Page 18    . the exact opposite of a double top.asp Copyright 2008 Mark Deaton DO NOT COPY or reproduce. only to rebound and return a second time to that same level and to reverse once again upwards.  http://www.Double Tops and Bottoms A double top chart pattern is defined as the formation that occurs when the price has risen to a certain level and then drops back from that point. in essence. A double bottom chart pattern is. only to return to that same level and drop back off once again.com/articles/forex/05/032805. Source: http://www.renegadetrader.investopedia. This bottom formation occurs when prices decline to a particular level.

These patterns can clearly show the price points where other market participants have demonstrated that they will resist and support any further movement beyond these levels. This can be particularly true as regards to double top and doubled bottom formations.  http://www. these patterns are relished by individual traders who recognize their utility for proper position taking in successful trading activity. the successful identification and utilization of these patterns for trading purposes is very much an acquired skill that needs to be learned through practice over time. Strategies Copyright 2008 Mark Deaton DO NOT COPY or reproduce. they signify the market in question is testing previously recognized limits.investopedia.asp Interpretation The appearance of double top and doubled bottom chart patterns within investment markets is a fairly common place occurrence.com  Page 19    . The tactics used by the individual trader depends on that person's character and personality. One can react to their formation by one of two methods that could be characterized as either reactive or proactive. One of the biggest problems concerning technical price chart patterns is that what historically appears to have been quite obvious is extremely difficult to identify during actual trading conditions. As a result.renegadetrader.Source: http://www. these formations are viewed as indicators that a reversal in trend is likely to occur. That being said. The appearance of these types of patterns is usually regarded as strong signals that penetration beyond the established limits cannot occur. The proper identification of these types of chart patterns represents excellent opportunities for the initiation of profitable trades. When these formations appear.com/articles/forex/05/032805. As these formations arise with a high frequency in historical price charts.

will often liquidate their positions early in order to try to take advantage of smaller individual investors. but add to overall profitability. The risk. Risk Management In order to limit risks for these types of formations. Consequently. and as such. Profits. at the same time. is not always the case. this should be viewed as pattern failure. what arises are many stop loss orders on trades that would have been profitable. of course. Traders who are more conservative in nature will stand by until the chart pattern has clearly been established. This type of tactic reduces the risk of a double bottom or double top formation not actually completing the process of formation. nonetheless. as the range trader would immediately reverse his or her position to take advantage of the trend reversal that has been identified by the breakout. one would like to see declining volume when the second peak or second trough is approached and rising volume at the break up of or below the second top or bottom. however. It should be noted that though this is a conservative technique. which is always inevitable. These players. and then re-purchasing and eliminating the position as the price declines to the bottom. This. Due to the frequency of the Copyright 2008 Mark Deaton DO NOT COPY or reproduce. the investor is anticipating the reversal that is expected to occur. Gains made during these range trading tactics are modest. the investment position should be liquidated.renegadetrader. any loss that occurs during this price break would be modest. stop loss orders are placed at the identified tops and bottoms. Initiative Double top and double bottom chart patterns are common and therefore. represent opportunities for the investor to take advantage of what more often than not becomes a reversal in price movement. However. is that the price moves out of the range. The rationale behind this risk management technique is that as soon as the formation has been broken. The most conservative fashion for trading double tops and bottoms is to wait for the actual formation and then to implement a position when a breakout occurs in order to benefit from the anticipated reversal. the techniques used entails selling as the price approaches the identified top. Most investment markets are now dominated by large institutional participants and hedge funds. depending upon whether a double top or double bottom is involved. before entering into the appropriate position. Double top and doubled bottom chart patterns are clear signals that the price movement has failed to break certain clearly established levels that are resistance barriers for double top formations and support barriers for double bottom formations. The successful utilization of these types of formations is always dependent upon the skills of the individual who has properly recognized them. can be maximized when a trader becomes more sophisticated by actually trading the range established. These types of chart patterns are generally considered reversal signals. during these types of chart patterns.com  Page 20    . A conservative investor will await their clear formation and a distinct breakout before entering a position. Under this methodology.  http://www. it significantly reduces the profit potential. if left in place. Generally.For those individuals who wish to be proactive in exploiting double tops and bottoms.

renegadetrader. Once the techniques have been mastered. Practice makes perfect. is not difficult for the investor who wishes to use them as signals for the implementation of trades to acquire the expertise necessary for the proper utilization. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.occurrence of these types of chart pattern formations. to take the time to historically test the techniques anticipated to be used. Individuals will find what true double tops and double bottoms are by this type of exercise.com  Page 21    . successful trading results are almost inevitable. no matter what type of chart formation an individual trader wishes to utilize as strategies concerning his investments.  http://www. It is highly recommended.

In those circumstances when the opposite is true. occurs when a trader goes long after the formation of a triple bottom.com/university/charts/charts9. the average gains tend to be even greater. Some studies have shown successful trading possibilities over 95 percent of the time.investopedia. though successful results can be expected. These are truly outstanding results. Gains are more likely in the 20 percent range based on a frequency distribution analysis. they are of a more modest nature.com  Page 22    . The greatest success.renegadetrader.asp Copyright 2008 Mark Deaton DO NOT COPY or reproduce. and short when the triple top chart pattern has been broken. especially in those circumstances when volume on the center bottom or top is below that of the last formation of a top or bottom. however. Volume can be important. In these situations. Source: http://www.Triple Tops and Bottoms One of the outstanding attributes of the chart patterns formations known as triple tops and triple bottoms is their exceptionally low failure rate. Some research has suggested averaged gains approaching 40 percent. One can successfully trade these opportunities both on and long and short break outs of established support and resistance levels.  http://www. when these types of formations materialize.

there are unique characteristics that will distinguish it from other formations. rather than one that occurs after prices have fallen substantially. the investor should be more suspicious of a triple bottom that occurs after a significant or intermediate uptrend.com  Page 23    . they do possess a confirmatory nature when it comes to position taking. The opposite is true for triple tops. one should consider entering a short position.renegadetrader. One should be always weary of this type of visual formation that has not occurred after a significant substantial movement in one direction or another. For triple bottoms and triple tops to occur. Generally.com/university/charts/charts9. The tops and bottoms must be clearly distinct. These formations tend to be more successful when they occur after a significant move upwards or downwards. The overall volume trend for triple tops and bottoms chart patterns is usually downward. break out of this identified channel on the up side represents a long trading opportunity. However. there has to be a clear support or resistance level that has been approached and repelled three times. which could entail differing consequences. from the first to the second top or bottom. with the first initial top or bottom showing the highest volume within the trio. The center top or bottom is not significantly above or below the other two. for each of the subsequent tops and bottoms that are recorded in a price chart. the trader would prefer to see a decreasing volume of activity for each subsequent high or low that is exhibited within the chart pattern. The upper-level support and lower-level resistance levels that appear represent the area where consideration should be taken for the implementation of a position. The rallies or falls in prices for each of the individual high points or low points in the formation of a triple top or triple bottom chart pattern should be pronounced. there appears to be a broadening right angled ascending or descending directional movement with a horizontal bottom or top and a consequential up sloping or down sloping trend line.Source: http://www. and they are the weakest at the last relative high or low formation. This type of chart pattern usually takes a significant amount of time to form on a historical price chart. When this happens. while with the penetration on the down side.asp Formation For every chart formation pattern. as this would be an indication of a head and shoulders or reverse head and shoulders formation. In other words.investopedia. Regardless of which type of formation is under observation. Historically. Trading Strategies Copyright 2008 Mark Deaton DO NOT COPY or reproduce. Volume behavior is not critical during these types of formations. one should be suspicious. Triple tops and bottoms that form when no significant price move has occurred do not tend to be very well separated. Prices always need to stop their movement at or about the same level.  http://www. volume tends to peak preceding the formation of each individual top or bottom. During the beginning of the pattern. This should be viewed by the trader as a price pattern that does not represent a true formation of a triple top or bottom. The price variations at these levels must be minimal.

Copyright 2008 Mark Deaton DO NOT COPY or reproduce. when a true formation failure occurs. Re-penetration of prices back into the trading range after a breakout has occurred is not uncommon. He or she would then enter once again when penetration reappears.com  Page 24    . the trader should institute a series of trailing stops at identified support levels in order to maximize the profit potential of the trend reversal. however.  http://www. Consequently. When an anticipated reversal in trend appears. This would minimize the number of losses. The entry point for a long position would be the point of penetration represented by the upper resistance line that has been identified. before the reversal of prices continues in the direction of the original breakout. an investor has two possible tactics concerning stop losses. One would be to place to a stop loss back at the penetration point. while the entry point for short position would be that point as shown on the lower support line.renegadetrader.When trading triple tops and bottoms. An alternative strategy would be to place the stop at the opposite trend line in the formation. the loss that occurs using this tactic would be substantial. This tactic entails recognizing a modest loss when these instances of retracements occur. This may create a series of modest losses that are later recuperated. a target price is derived by adding the differential between the highest high and the lowest low that is evident within the chart pattern to the breakout point. which would be the upper trend line for a triple top and the bottom trend line for a triple bottom.

converge to a point to resemble a triangle. If these two trend lines. For an investor.com  Page 25    . if the subsequent trend lines run parallel. The chart patterns that form during these periods of consolidation often resemble what are referred to as flags and pennants in technical analysis terminology. This. Source: http://www.asp Copyright 2008 Mark Deaton DO NOT COPY or reproduce.renegadetrader.investopedia. Pennants are formed during periods of contracting prices and represent a consolidation of price activity.com/university/charts/charts6. Pennants are distinguished from similar formations referred to as triangles.  http://www.Flags and Pennants It frequently happens that when an investment market is trending. and does not possess a horizontal trend line. this type of formation is called a pennant. on the other hand. the chart pattern that has been formed is referred to as a flag. being able to identify flags and pennants will allow him or her to be able to establish entry points for positions. can produce profitable results by following the existing underlying trend price movements that have been clearly established. The occurrence of these events represents excellent opportunities to undertake an investment position. Formation When connecting the relative highs and lows during a precedent time period in a historical price chart. in turn. in that the pennant is not symmetrical. resembling a small angled rectangle. the market will stagnate over a certain period of time before deciding to continue or reverse the previous trend established.

investopedia. prices can be observed to be trading within a relatively narrow range. therefore.renegadetrader. price goals need to be established prior to undertaking the position. depending upon whether a long or short investment was undertaken. The most obvious tactic is to wait for a price movement that is a certain amount above or below the breakout point to ensure that a false signal has not been established. the probability of success of the position is greatly enhanced. activity will more often than not stall. the exit price for liquidation of the position would be the range that has been identified. Once the investor is confident that the breakout is in fact real.  http://www.com  Page 26    . the position entry will be less than optimal towards the maximization of profits. As a result.asp Following a distinctive price movement that has occurred in an investment market. When this type of situation materializes. Upon the observance of such an event. the price stagnation of the market in question remains intact. A more conservative approach is to wait and see if a retracement to the original trend line occurs. Though the likelihood of a profitable trade increases. the probability of successful trades can be increased by taking simply a certain percentage of the range as the profit goal. When price trading activity remains within the identified two trend lines. the potential investor can connect the relative highs and lows in order to obtain trend lines for signaling purposes. the investor also runs the risk a retracement does not occur.com/university/charts/charts6.Source: http://www. Trading Strategies When the price starts to trade outside the identified consolidation range. Not all subsequent movements will achieve these range goals that have been set. and. There are various techniques that are utilized by traders to take advantage of these chart pattern formations. and perhaps even retrace the movements slightly before resuming in the direction of the established underlying trend. The common practice with the utilization of flag and pennant chart formations is to measure the distance from the highest high to the lowest low observable in the chart pattern that has been identified. Upon entry. he or she undertakes the appropriate position. added or subtracted from the entry price. this is a distinct signal for the investor to contemplate the possibility of entering a position. If that trend line supports the price and then proceeds to move in that direction of the underlying trend. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. When implementing or considering the entry into an investment position. and moves in the direction of the previous established trend.

com  Page 27    . Consequently. after resumption of the original established price trend. "Whatever can go wrong. As a result. As it concerns pennants and flags. Regardless of the expertise developed. no successful trader enters a trade without being prepared for the worse to happen. Such occurrences will always result in unwanted losses. this is especially important. These patterns represent exceptional opportunities for profits with limited downside risk. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. stop loss orders should also be placed in order to limit losses. This skill can only arise from experience and practice. no one should blindly just start trading without first developing a comfort level and mastery of the techniques involved by trying to replicate trades on a blind basis using this historical data that is readily available. Within the context of flags and pennants. When using these types of techniques for investment purposes. Flags and pennants are established tools for successful investment strategies.  http://www. The trend line itself should not be the stop loss limit. as the stops are easily identifiable and when triggered represent modest losses relative to the gains achieved during successful results. stops are normally placed a certain modest percentage above or below the original trend lines that were penetrated. retracements can often be observed to the original breakout points. the stop loss point needs to be below or above the original entry signal to ensure that formation failure has occurred. when and if they occur.Proper recognition of chart formations and the breakouts that arise from these patterns is a skill that needs to be developed by any investor. as often during these formations these original trend lines tend to serve as support levels during retracements. if one does not want to be fooled into an entry because of a false signal. in order to avoid the creation of a loss that would have resulted in a gain.renegadetrader. Flags and pennant chart formations allow an investor to take advantage of a temporary stagnation in an established trend. As per Murphy's Law. Only when the strategies and techniques have been proven in such a manner should an individual actually contemplate using real capital. will go wrong!" Whenever a trade is implemented.

Head and shoulder chart patterns are one such reversal formation that is actively utilized by investors in order to undertake trades in an investment market.com  Page 28    . with the middle high point higher than the ones preceding and following it. Following the formation of the head. there is always a significant drop in volume. when a breakout occurs on the downward side. since it simply consists of three consecutive high points. though it has sometimes been correlated as a predictor of the intensity of the subsequent price decline.com/terms/h/head-shoulders. This formation typically appears at the end of a long movement of prices upwards.  http://www. The head and shoulders top pattern often arrives with a variety of shapes. Sometimes they can have multiple shoulders on either side of the head. A trend line drawn along the two low points between the three peaks forms what is called the neck line. It is easy to see on a historical price chart.renegadetrader.investopedia. Reversal patterns are those types of formations signaling the end of the trend in the probable movement in the opposite direction. Source: http://www. the subsequent correction downward after the appearance of the head and shoulder chart pattern usually results in prices falling back down to the original start of the preceding uptrend.asp Formation Characteristics Typically. the likelihood of continued downward movement is very high. If the prior uptrend has been of a relatively modest duration.Head and Shoulders Chart pattern formations are generally classified on the basis of their significance to the underlying current trend that has been generated by the price movements that are graphically represented on a historical chart. The reason for its popularity is that some studies have shown that up to 93 percent of the time. Another reason for the popularity of this formation is the relative ease of recognition. or previously during the formation of the left shoulder. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. the highest volume can be seen during the formation of the head. This trend line can neither slope upwards or downwards and the direction is considered inconsequential. One of the most popular chart patterns used by investors is called the head and shoulders top formation.

However. These data pattern formations will often show retracements back to the original neckline that signaled the pattern reversal. During the overwhelming majority of instances when this occurs. Some traders use this as a signal to increase their position. most traders do not insist upon a confirmation signal before undertaking a position. For any reversal pattern formation. upon implementation of any trading position based on the penetration of the neckline. unfortunately. when the neckline is broken. it immediately becomes a resistance level of particular importance. Entrance to the trade occurs when the price breaks downwards below the neckline. When a chart formation on a historical price chart exhibits the opposite or mirror image of a head and shoulders top formation. it signifies that significant resistance has been overcome and represents an excellent opportunity for upward movement. these target prices are just customary practices used by traders. a certain percentage above or below the penetration point. and research has shown that the extent of movement downward upon a breakout of a head and shoulders formation will not always reach this target. When considering such a strategy. Once the neckline is broken. subsequent to breaking under the neckline. and that prices should move appreciably higher in the opposite direction. most traders calculate a target price by measuring the distance from the highest price reached at the head to the corresponding point on the neckline drawn below. The type of strategy employed by any particular individual will be a function of his or her trading personality. This does not happen each and every time. the price will be successfully supported at that level and then subsequently resume the reversal of trend that has been demonstrated and signaled. Consequently.renegadetrader. it generally exhibits the same characteristics of a normal head and shoulders chart pattern with the same potential results. This type of chart formation signifies that the previously identified downtrend has reversed itself. On rare occasions.Trading Strategies When using the head and shoulders chart pattern as a trading signal. a trader should always protect himself or herself by having a stop loss order a modest amount above the original neck piercing point of entry. As mentioned previously in this book.  http://www. it is referred to as an inverse head and shoulders. the trader should always be certain that prices have fallen back underneath the neckline a minimum amount.com  Page 29    . Copyright 2008 Mark Deaton DO NOT COPY or reproduce. such as head and shoulder chart patterns. As with the normal head and shoulders formation. a conservative investor may wish to witness a retracement back to the neckline and demonstrated support before undertaking an investment position. Since this type of chart pattern rarely fails. Consequently. The smaller the percentage of profit desired relative to the target range increases the probability of a successful trade. A more aggressive trader will simply buy when the neckline is broken because of the high probability of success that has been demonstrated historically. one should also have stop loss order in place. or above the higher of the two previous lows represented by the shoulders. You can think of it as someone standing on his head. especially for those instances when formation failure occurs. and then fail to penetrate. and proceed sharply lower. There is a clearly identifiable low-price with upside down shoulders to the left and to the right of the midpoint low. It is not uncommon for the price to recuperate to the neckline. prices will recuperate and move higher.

  http://www. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. any tool is only as effective as the person who has learned how to use it. it cannot be emphasized enough that prior to taking and risking any real capital in no matter which market. As a result. a trader should hone his skills to perfection. prior to using any of the chart patterns explained in this book. However.renegadetrader. The head and shoulders chart pattern is considered to be one of the most reliable and classic technical analysis tools available for a trader in the investment markets. Because of this fact.depending upon whether a normal or inverse head and shoulders formation is under consideration. it is very important for the individual to practice their recognition on historical data that is readily available.com  Page 30    .

Both of these types of reversals. they can represent an opportunity for the investor for a low risk. usually the result of some sort of unexpected news.renegadetrader. conservative investors will delay taking a position until this action has been completed and prices reconfirm their breakout direction. When these gaps appear within the formation of an island on a price chart.  http://www. Market participation fails to sustain the movement. Trading volume should be accelerating at the time of the initial breakout gap. as well as the subsequent reversal relative to the volume that preceded each of them. prices fail to move significantly in the direction of the trend. followed by a second one referred to as a breakaway gap. and after several days. The first gap is usually referred to as an exhaustion gap. As pullbacks and throwbacks are quite common. This sudden movement in price by an investment can only signify a significant change in demand. What usually happens next is the appearance of some sort of fundamental news event that contradicts the original information producing the first gap. Island reversals typically appear after an extended trend upwards or downwards and always begin with a price gap trading day in that direction.com  Page 31    . It is important in the identification of an island reversal that the gaps occur at the relative same price level. The pattern that is evident is what can visually be identified as a type of island. but are not necessarily the same size. regardless of whether they are bottoms are tops. and a new gap appears in the opposite direction Studies have shown success rates of as high as 87% for tops.Island Reversals Another relatively common chart pattern used by investors for trading purposes is referred to as island reversals. The price movement. The problems associated with this type of formation are that the gains that can be acquired are usually modest relative to other types of chart patterns. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. and 83% for bottoms. they should be considered for investment positions that would be held for only a relatively short period of time. The gaps materialize usually at the same price level. high probability trading opportunity. begin with a gap movement in the appropriate direction followed by another gap in the opposite direction. The appearance of a gap when it occurs alone provides evidence that there has been an important development concerning the fundamentals or psychology of the traders that has caused this movement to occur in market price action. however. As a result. cannot maintain itself. This unexpected breakout in the direction of the trend occurs with an exceptionally high volume relative to average previous trading activity. Formation Characteristics Island reversals are generally easily identified.

when trading this type of formation. this differential would be added to the highest high. The best way to profit from these sorts of chart patterns is to wait for penetration and then subsequent support to appear at the previous trend line identified during a reversal.au/knowledge-bank/Technical-Analysis/Gaps-IslandReversal/ Trading Strategies The target price for an island reversal chart formation is usually arrived at by taking the range represented by the highest high and the lowest low identified in the pattern. therefore. before taking a position. the subsequent movement upon their creation is typically been modest. Consequently. it is often advisable to wait for the pullback to the original breakout level before assuming an investment position. followed by the resumption of the original trend demonstrated upon breakout. The price is arrived at represent potential targets. Price movements subsequent to a breakout. liquidate the investment.  http://www. whereas for an island top chart pattern. it would be subtracted from the lowest low. As a result. be similar. traditionally show reluctance in continuing the directional movement demonstrated by the breakout. and then adding or subtracting this difference appropriately.renegadetrader. After a modest gain has been accomplished. for an island bottom formation. there has to be a clear piercing of the trend line and a return to that approximate level before entry into a position is contemplated. These ranges are rarely achieved in subsequent movement. prices often are likely to reverse direction and recover before resuming the trend demonstrated by the breakout. After a breakout occurs.com  Page 32    .com. unlike other chart formations. Though these formations have a demonstrated low failure rate.Source: http://www. these patterns have historically been shown not to be signals of significant large trend reversal movements and should be utilized accordingly.shareselect. In other words. and simply serve as a point of reference and guidance. Profit expectations on the part of the trader should. Though these types of chart patterns are actively used by traders because of the frequency of their appearance. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.

com  Page 33    . it would be beneficial for the trader to be aware these news developments in order to produce profitable results in trading activity. it is not uncommon to view a gap price day in the direction of the trend. As a result. It is a formation that can be used by any investor to increase his or her wealth.renegadetrader.  http://www. Formation of island reversals without any news rationale behind them that can be clearly identified should be considered somewhat suspect on the part of the trader contemplating an entry because of the identification of this type of pattern on a historical price chart.Investors should note that the formation of island reversal chart patterns are usually news driven and occur because of conflicting informational events that arise within a relatively short time frame. Subsequent trading over the next few days will usually occur in a relatively narrow range and then be followed by a gap trading day in the opposite direction. When prices have trended upwards or downwards over a significant period of time. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. The formation is easily identified and represents an island. Such situations are not uncommon and have been shown to produce modest profitable results when treated properly.

Ascending Triangles The chart formations referred to as ascending triangles are probably one of the most popular patterns among investors who use technical analysis tools to make investment decisions concerning their capital. requires recognition as such by the market. from which derives the name of this formation as an ascending triangle. or continues downward. and perhaps too simple. If at any time a trader questions the validity of a particular chart pattern. as well as an up sloping trend line when the relative minor lows are connected. In an ascending triangle. The ascending support trend line on the bottom is always sloping upwards. the return is more like 20%. forcing a sharp move higher. Once the final penetration occurs. The use of chart patterns as successful tools. Otherwise. Ascertaining an ascending triangle on a daily price chart is not difficult. When this upside breakout occurs. volume is initially strong. as it is probably one of the most misidentified chart formations in technical analysis. When this data is viewed from a frequency distribution perspective.  http://www. The reason for this popularity is the strong average return documented in historical studies when an upside breakout occurs. volume is typically is much heavier. as an indication that the formation is amassing strength for the eventual penetration. It is not uncommon for a breakout to occur and then subsequently be supported by the bottom trend line before the final breakout and a significant upward price movement occurs and results. The point at which that supply becomes depleted causes a breakout of the price from the formation. but then reduces itself until the occurrence of a breakout. there will be an adequate supply of the investment available within a certain range. the likelihood is that there are other investors who share the same feeling. during certain times. Volume is typically low precedent in this breakout. prices tend to rapidly rise and Copyright 2008 Mark Deaton DO NOT COPY or reproduce. One explanation of the price movements of an ascending triangle concerns the fact that for most investments. the probability that the event will produce the results that you anticipate is greatly diminished. the investment falls back onto itself and either regroups for another attempt at rising. Formation The pattern is considered relevant when the price movements in an historical price chart produces a horizontal trend line when the relative minor highs are connected.com  Page 34    . During the formation of this triangle. The top horizontal trend line must have demonstrated resistance at least twice and should have the upward sloping support trend line underneath. If demand continues to materialize. the horizontal trend line represents resistance and should have demonstrated several attempts of a lack of penetration where the price falls to this support trend line underneath and is repelled. Some research indicates an average return of 44%.renegadetrader. the prices remain strong. Volume generally diminishes as prices range between the support bottom trend line and the resistance top trend line. but this is not considered a prerequisite in this particular pattern formation. if you do not properly recognize the chart pattern. These trend lines intersect to reveal the characteristic triangular pattern. which is actually quite respectable. by a trader. As a result. however.

ascending triangles must be confirmed with a general pattern of decreasing volume. Source: http://www. causing the momentum upward to increase. this volume pattern will change and start to increase together with increasing prices. that individual may want to institute a series of trailing ascending stops placed at identified support areas in order to maximize the return on the trade. At some point. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. Some research tends to suggest that when this event happens. Should the investor have the good fortune of having discovered a significant resumption of an uptrend.com  Page 35    . but also as an entry point for a complete reversal of position.com/ascendingtrianglecharts. it usually signals that prices will continue downward and should be considered not only as a stop loss for the original trade.volume increases dramatically. When a breakout occurs. prices tend to drop another 20% when a downward breakout occurs.htm Trading Strategies One market practice for determining a target price to be achieved after entry into a position is to take the distance from the high point of the horizontal upper trend line and the low point of the lower bottom trend line and then to add that differential to the breakout point of the formation. Not all movements subsequent to breakout will move this distance. eventually prices tend to level out and volume returns to normal. a trader can greatly improve the likelihood of a profitable trade. It is not uncommon for the upward trend to continue for several years following the initial lower trend line support that was identified. and any trader should protect himself by having stops placed at the penetration point of the lower trend line. Should this support level be penetrated. After the breakout.  http://www.chartpatterns. it is usually followed by a significant movement upwards. as the formation materializes. As is evident in the example above. This does not always happen.renegadetrader. By taking only a percentage of this range.

it usually signals a reversal of the trend.  http://www. It is an extremely popular chart formation sought by investors due to statistics showing a high probability of profitable trading results. causing the price of the investment to move higher. Before trading any kind of triangle. any trader who wishes to use this formation for trading purposes must fully develop his skills in its identification so as to achieve the results that he desires. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. When failure does occur.An ascending triangle is considered a bullish chart pattern used in technical analysis that is rather easily identifiable due to the distinct shape created by the two trend lines. usually accompanied with increasing volume. investors aggressively enter the market.renegadetrader. Once the breakout occurs. It represents a consolidation period of the previous established upward trend. the investor should have practiced their recognition on historical data to prevent mistakes. such that any losses incurred can be recuperated and produce a net profit when both sides of the trades are combined. As a result. The risk with this type of chart formation lies in fact that it is easily misidentified and misinterpreted. There are many types of triangle chart patterns of which the ascending triangle is just but one.com  Page 36    .

prices rise to meet a downward sloping trend line that is formed on the top of the pattern. Volume during this formation period tends to be decreasing in size. Upon reaching that trend line. each high price achieved is lower than the previous one. In this formation. and when a break out below the horizontal support level that has been identified occurs. an observable downward sloping support trend line is revealed. Subsequent to the downward penetration of the lower horizontal trend line. making it relatively simple to identify. not to be significant. intensifying a downward pressure on prices. but in an ever decreasing manner.renegadetrader. such that when the relative highs are connected. Though this is not always Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www. prices continue their downward movement. Subsequent to this event. Value oriented buyers realize their mistakes. It represents a perception on the part of certain investors that due to the already significant fall in prices. they fall back. cover their positions. are in the minority. When a break out occurs. which has become a resistance level. Similar to a ball bouncing off the floor. according to studies. they rebound off a horizontal lower trend line that exists along the base of the formation. the investment has become somewhat undervalued. it is not uncommon for prices to rebound and then again be repelled by this lower trend line. Formation The chart pattern represented by a descending triangle is rather distinct. These traders.Descending Triangles The descending triangle chart formation is similar to the ascending triangle chart pattern when viewed as an opposite perspective.com  Page 37    . Unlike some other types of triangles. the volume on the breakout day appears. however. the volume pattern for descending triangles tends to recede as a break out is approached. where prices rebound each time that level is reached. The descending triangle chart pattern represents a consolidation during a previously identified downward trend. The formation is characterized by distinctive support at a relatively stable level.

As the average price movement upward is far greater than the one that occurs during a bottom trend line penetration. just as easily misclassified. It is always better to be safe than sorry. Making investment decisions based upon a misinterpreted chart formation could cause results to be less than expected. however. with certain research demonstrating an average price move of 42% when this type of event occurs. In other words. and to look elsewhere for a more definitive indication. a downward penetration of the bottom trend line will only happen for roughly 50 percent of these formations.the case. Triangles as a type of formation are relatively easy to identify.com  Page 38    . if the investor does not confirm any decreasing volume pattern. the price movement post-breakout is generally of a short to intermediate term nature. If at any time there is any doubt as to the true existence of a particular pattern. It is not uncommon to see these types of chart patterns occurring just prior to a total trend reversal. This represents the relative ideal level that one would wish to be achieved after taking the appropriate position. but also upon recognition by the market. however. the target price is arrived at by identifying the relative highs and low points that are used to draw the trend lines.renegadetrader. As a result. the evidence suggests that there will be continued significant downward movement up to 96 percent of the time. in order to determine a target price. it may be advisable to use this particular formation in conjunction with other signals before contemplating undertaking a position. and obtaining the differential between the two. Trading Strategies The problem with descending triangle chart patterns is that research tends to show that the failure rate for a downward break out to occur can be relatively high. The average returns for break outs that occur on the upside are far superior. This range is added to the breakout point. whether it is upwards or downwards.  http://www. when the formation occurs. it is best to ignore the signal. The successful use of chart formations as an investment tool depends not only on an individual trader recognizing the pattern. and at the same time. As with ascending triangles. Within the descending triangle chart pattern. As a result. Though descending triangles appear to be very similar to ascending triangles. though the trend lines may meet all requirements. depending upon the signal that is received. When such a break out does occur. break out occurs below the bottom trend lines only approximately 55 percent of the time. The continued downward move. averages only 19% with a frequency distribution analysis suggesting a far more modest return. with some studies showing unsuccessful indications running as high as 45 percent. he or she has not found descending triangle. should an investor decide to take a short position based on this type of Copyright 2008 Mark Deaton DO NOT COPY or reproduce. Unlike with ascending triangles. volume on the day the lower trend line is penetrated typically is much higher when compared to the previous day’s trading. based upon which trend line had been penetrated. an investor has an opportunity to either take a short position or a long position.

Like ascending triangles. for the trader who has undertaken a long position. formation failure is considered to have occurred when the price does not move in a direction intended. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. but actually reverses itself and penetrates the opposite trend line of the chart pattern. a trader has an excellent opportunity to recuperate the losses incurred upon the initial position by reversing himself or herself when a chart pattern failure occurs.com  Page 39    . Regardless of what position is taken.signal. Therefore. regardless of the type of position. he or she should have a stop loss at the point the price would cross the bottom trend line. you would be well advised to have a more modest goal than that one as represented by the target price.  http://www.renegadetrader. If the position undertaken was short. Thus. it is often an indication that the underlying trend has resumed or there has been a complete reversal. that stop loss should be placed at the penetration point of the upper trend line. when failure occurs in a descending triangle.

For a true wedge to be in existence. whereas narrowing wedges tend to show a decreasing volume at this point. or one that narrows in scope over the time frame represented in the historical price chart. Widening wedges are characterized by slightly increasing volume as the breakout is approached. neither of the trend lines can be horizontal.Ascending Wedges Ascending wedges are formed when two trend lines drawn connecting intermediate high points and intermediate low points result in two upward sloping lines. the continuing downward movement and prices is more often than not rather modest. demonstrating a broadening price action series. as some research has demonstrated that as much as 94 percent of the time. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. one can view price movements that are generally moving upward. Ascending widening wedges are the preferable chart pattern.investopedia. Source: http://www. The significant difference between the two is that when a widening wedge appears. there is a significant downward movement in price that follows. when that break out occurs. Conversely.renegadetrader.com/university/charts/charts7. the mouthpiece of the megaphone would appear on the bottom left of the chart. and. therefore has an upward slope that is greater than the bottom trend line.asp Formation An ascending wedge chart formation essentially resembles a megaphone. For narrowing ascending wedges. When this formation is of the widening variety.  http://www. the upper trend line is ascending at a faster rate. the opposite would be true for a narrowing ascending wedge. the bottom trend line has a higher slope than the upper one. when the penetration of the bottom trend line occurs.com  Page 40    . where the mouthpiece appears in the upper right of the historical price chart. These types of chart patterns can both produce a widening formation at the end. for widening ascending wedges of the upper trend line demonstrates the larger slope in contrast to the bottom trend line. Both trend lines must be upward sloping. Regardless of the type of wedge that is being formed. Though the high percentage of success upon the bearish break out the bottom trend line is attractive.

More aggressive traders would demand the penetration of the upper trend line to signify that a true formation failure has happened. prices start moving up after having touched the lower trend line and then stop their upward movement before approaching the upper trend line. When prices finally penetrate the bottom trend line.This chart pattern is not considered formed unless the trend lines that appear have been struck or nearly struck by price action at least three times on each trend line. this may signify that the bottom trend line boundary was incorrect and must be redrawn. The research seems to imply that the probability of a successful trade is in the investor’s favor when a breakout occurs on the down side in this type of formation. Pattern formations have been observed where this type of event can happen several times. however. Though breakouts can occur on the upside. it is a signal that a breakout has occurred and prices will continue to move downwards. but does not necessarily signify that such an event has occurred. What further distinguishes ascending wedges is the fact that the megaphone is pointing upwards.renegadetrader. This type of appearance is not usual for broadening formations over all. can be modest relative to chart indicators. An investor who has identified this type of formation is seeking confirmation of the reversal of the uptrend by the penetration of the bottom trend line. The distinguishing characteristic between the two types of ascending wedges is the fact that widening wedges generally demonstrate increasing volume during periods of rising prices. the conservative investor recuperates his funds over the long run by trading every signal. only to reverse themselves and decisively penetrate the bottom support level.  http://www.com  Page 41    . it is Copyright 2008 Mark Deaton DO NOT COPY or reproduce. if such a retracement were to occur. Retracements are not uncommon. Trading Strategies The target price for trading purposes is determined by the lowest observable daily low that occurred during the formation of the chart pattern. The conservative investor could use his bottom trend line as a stop loss point in order to liquidate his or her position. As target price achievement occurs more often than not with this particular chart pattern. However. and decreasing volume when prices are falling. and the trader should be aware of this possibility. The distinctive characteristic of ascending wedges is their megaphone shape. Though this volume pattern has been demonstrable. and penetration upwards of the bottom trend line can happen fairly frequently. investors should expect that prices will continue downwards at least to the level of the previously determined lowest low that existed in the formation identified in the historical price chart. This particular type of price action in this type of chart pattern has proved to be exceptionally successful for trading purposes. This could be an indication that the formation has failed. It is not unusual for prices to return to and even re-penetrate upwards the bottom trend line. It is important to note that this partial rise retracement must start from the lower trend line and not from somewhere in the middle of the identified trading range. The most successful formations of this type of chart pattern are those where prior to final breakout downwards. it is not considered a prerequisite for this chart pattern recognition. When a breakout occurs below the bottom trend line. the downside movement. If the break out occurred downward and then moved back in to where price action has ranged historically as presented in the chart. they are less reliable in nature. these types of investors will find that when a loss does occur.

Copyright 2008 Mark Deaton DO NOT COPY or reproduce.  http://www.renegadetrader. The type of strategy to be chosen is dependent upon the character of the individual who is making the trades. but at the same time he or she is increasing the statistical success rate of his or her trading activity.substantial.com  Page 42    .

Descending wedges are characterized by two down sloping trend lines. while with the narrowing descending wedge. Regardless of the type of the descending wedge.renegadetrader. When this has occurred.com  Page 43    . they differ not only in the fact that the direction of the megaphone is being pointed downwards. Source: http://www. The trend lines must be touched or approached several times by price movements for a confirmation of this type of Copyright 2008 Mark Deaton DO NOT COPY or reproduce. while with the widening descending formation.com/content/view/63/112/ Formation Both the widening and narrowing descending chart patterns are characterized by down sloping trend lines that limit a period of oscillating price movements. none of the trend lines can be horizontal in order to distinguish descending wedges from other similar chart patterns. This type of formation is called a narrowing descending wedge. and the megaphone image that is produced points downward with the mouthpiece located on the left. but they also occasionally differ in the price action that occurs when and if a break out happens. the largest negative slope is possessed by the bottom trend line. Volume action is also very different.  http://www. In regards to the descending widening wedge. the chart pattern is referred to as a widening descending wedge. What is interesting about descending wedges in contrast to ascending wedges is that the narrowing descending wedge can be viewed as a reversal formation. when the opposite is true. volume tends to increase over time.aboutcurrency. They are differentiated by the fact that the narrowing descending formation will have a top trend line with the largest downward slope. the mouth of the megaphone image will be on the right-hand side of the chart pattern. whereas widening descending wedges acts more like a consolidation of the prevailing trend. the bottom trend line has a more negative slope than that of the top trend line. this volume activity tends to decrease. When the upward down sloping trend line has a greater downward slope than the bottom trend line.Descending Wedges Though descending wedges resemble ascending wedges in their megaphone shape. In contrast.

In a widening descending wedge. this differential is added or subtracted to the penetration price in order to determine a desired target price movement. which represents a signal that the reversal is about to occur and a significant upward movement in prices can be anticipated. this type of volume activity is not considered mandatory for recognition of these chart formations.  http://www. depending upon which chart formation is under consideration. the higher the likelihood that a breakout will result in expected consequences for the investor. Traders normally look for a penetration of the upper trend line to signal that a reversal has occurred. may also Copyright 2008 Mark Deaton DO NOT COPY or reproduce. For widening downward wedge chart patterns. volume tends to usually be higher than has been demonstrated previously. The same is true for narrowing descending wedges. the investor on the other hand is looking for an opportunity to go short with an anticipated continuation of the established downturn. there is good correlation towards a successful trade when an upside breakout occurs. as this statistically has been shown to be the most successful strategy.formation.renegadetrader. is interpreted as a reversal pattern. investors should not contemplate undertaking a position without confirmation that the breakout has occurred. Though the evidence is inconclusive. this entails penetration of the upward identify trend line. if a partial rise or fall occurred prior to break out. At the point of breakout. the success for the trade may be diminished. These types of situations appear to produce the most desired results. For a narrowing downward wedge chart pattern. investors tend to look for a downside break out in order to take a position. however. the conservative investor would seek another confirmation signal that a reversal has occurred. Trading Strategies As with most chart pattern formations. Though volume tends to increase for a descending widening wedge. You subtract one from the other to obtain a price range differential. A widening downward wedge is generally regarded as a consolidation formation. on the other hand. the investor would preferably like to see a relatively continuous movement from the opposite trend line when penetration occurs. therefore. The greater the amount of such occurrences. as a result. One looks for the highest high and the lowest low in the previous trading range. depending on the type chart price pattern under consideration. Consequently. When a breakout occurs. a conservative investor may want this type of confirmation before instituting a position. A narrowing downward wedge. though this also is not a prerequisite for signal recognition. this is not to the same extent. the trader is looking for a signal that the reversal in trend has started in order to take out a long position. Opposite breakouts on the bottom trend line. Though heavier volume does not appear to be critical for the implementation of a successful trade.com  Page 44    . Should an upside breakout occur. and decrease for a narrowing descending wedge. however. Target prices are similarly calculated for both widening and narrowing descending wedges. for both these situations. research tends to show that the investor has a greater opportunity of success when a break out occurs on the lower trend line. Though widening descending wedges are viewed as consolidation patterns and. such that the investor is looking for a signal that the established downward trend will continue.

Compromise strategies can also be contemplated concerning risk management for these types of chart patterns.  http://www. while more aggressive traders will wait until the second trend line of the formation has been hit. it also produces greater losses when these types of events occur. The positioning of stop loss orders in order to limit losses when formation failure occurs depends upon the nature of the trader. This second technique results in more frequent positive trades. and these can be contemplated as such with the occurrence of other events in order to confirm that the underlying trend will continue. however.represent a short position opportunity. Generally speaking. risk-averse traders will place these types of orders at or just above the original penetration points of the underlying trend lines that were surpassed.renegadetrader. Copyright 2008 Mark Deaton DO NOT COPY or reproduce.com  Page 45    .

anyone thinking of using these types of methodologies for investment purposes should always have a risk management system in place that would limit their losses because of misinterpretation of a pattern on their part. such as chart patterns. Even the most successful traders who use these techniques tend to produce successful results only 40 percent of the time. With that being said.  http://www. However. such as chart pattern formations. that person must be able to let profits run and limit losses. There are documented individuals who have used technical analysis tools. then he or she will find that when they have taken the proper position. they will always be successful. the results from that position will more than compensate the modest losses that have been incurred. Winning traders in the investment markets have the total confidence that over the long term. Successful investors in these markets have developed the patience. However. if the individual has taken the time to develop an expertise in these techniques. The overwhelming majority of the traders who use technical analysis tools. or actual chart pattern failure. and not misinterpret chart patterns. and experience to wait for the proper point in time in order to undertake an investment.Conclusion Chart formations represent a wonderful way for the astute trader to take advantage of the opportunities available in the assorted investment markets that exist. to amass fortunes in the hundreds of millions of dollars in a relatively short period of time.com  Page 46    . these outstanding success stories were people who had an obsessive desire to succeed and were willing to do whatever was necessary in order for them to achieve their desired goals. and thus. As a result. any individual contemplating the utilization of chart patterns in order to make investment decisions should be aware that this is very much an acquired skill that can only be developed through long hours of practice and experience.renegadetrader. skills. They have developed the ability to discern when not to be in the market. Copyright 2008 Mark Deaton DO NOT COPY or reproduce. In order to be a successful trader utilizing technical analysis tools like chart pattern formations. produce a net result that can be outstanding in nature. and there is no chart pattern that works 100% of the time. This is because of the fact that proper recognition of these patterns is difficult. the successful investor will have to spend a tremendous amount of time on analysis in order to develop the skills necessary to properly recognize. while starting out with a capital base of only a few thousand. and when to be in the market. Both of these situations will arise. lose money in their investments. In order to develop this ability. They had all tested their methodologies and strategies on historical data and were absolutely positive that they could recognize recurrent chart pattern formations.

renegadetrader.  http://www. It is equally important to comprehend why the investment was unsuccessful.Mistakes will happen. Individuals willing to take the time and effort to carefully understand and recognize chart patterns should have no difficulty in taking advantage of the opportunities that they represent.com  Page 47    . Copyright 2008 Mark Deaton DO NOT COPY or reproduce. and a trader must always try to learn from these mistakes in order to allow history to repeat itself. as it is to understand why any particular trade produced gains.

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