Technical Temptations Explained - Part II - Concept and Patterns

The technical chart patterns that I like and based on which I generate my lists are: flags, pennants, triangles, wedges

For more details on each pattern, please visit these websites:

http://www.thestockbandit.com/Chart-patterns.htm

http://www.chartpatterns.com/

http://www.chartpattern.com/understanding_chart_patterns.html

Why don't I want to talk in detail about each pattern? One reason is that I am very lazy!

But seriously, it does not matter what is the exact pattern, as long as it fits the general principle of why some patterns keep appearing day after day and have high probability of short term big moves!

Some patterns are bullish, while some are bearish. As I like to keep things simple, I will call all bullish patterns - bull flag and all bearish patterns - bear flag

Why only bull flags and similar flavours? Easy to identify, widely followed, good upward potential, favourable risk rewards ratio. Hey come on! It's the favourite pattern of Dan Zanger too! (He is the world record holder of biggest annualized return. He turned 11 thousand dollars into 18 million in two years. He is also the founder of http://www.chartpattern.com/ ). Hope that gets your attention!!

As shown in figure 1, XOMA formed two bull flags in a space of 10 days. The first one is a classic bull flag. If I see such a pattern I usually take a trade once the upper trend line is broken!

As shown in figure 2, VSCN formed a bear flag and broke down hard once trend line was broken.

Figure 1: XOMA one month chart

Bull Flag: Price rises sharply upwards on big volume (green lines). This forms the pole of the flag. Then there is a consolidation phase with diminishing price/volume (Blue lines). This consolidation phase might look different for different stocks, but for simplicity of things we will still call it a flag. An upper trend line can be drawn joining the highs of the day. As price breaks this trend line on increasing volume (blue price line), then and only then should one buy. Price shoots up sharply on another big wave of volume (purple lines). This is the part of the move we are trying to catch. Stop goes just below the lowest price in the flag or any other low risk point (we will talk about stops in more detail).


Figure 2: VSCN bearish chart

Bear Flag: Bear flag is an inverted bull flag. Price falls sharply downwards on big volume (brown lines). This forms the pole of the bear flag. Then there is a consolidation phase with diminishing volume (green lines). A lower trend line can be drawn joining the lows of the day. As price breaks this trend line (lower green price line), then and only then should one short the stock. Stop goes just above the highest price in the flag or any other low risk point. For a falling stock, high volume is not a required condition to short the stock, stocks drop due to their own weight too! But high volume is always desired. Price again falls on higher volume (pink lines). This is the part of the move we are interested in.

That is the high level simplistic overview of the strategy, in the next post we will get into more details! (But don't worry, its all very simple)

Cheers!
Lazy