The Canadian Rational Investor
Brian Beamish FMA, FCSI
Chart Patterns & Formations
Chart basics from trend-lines to Fibonaci retracements.
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Introduction


This is an introductory seminar on chart pattern & formation identification. This information is meant for a basic understanding of some general concepts behind technical analysis and by no means represents a thorough examination. My goal today is to try and convey a few of the pieces of market wisdom I have picked up over the past fifteen years. This analysis is more price based rather than indicator based as I feel the actual price-action of a security will tell you where prices want to go. Having said that, many of the patterns & formations can be found inside indicators as well and are often significant events too. I strongly encourage feedback and hope to hear your questions as all of these seminars are an ongoing work in progress.

Technical terms defined
3 Common Bottoms
3 Common Tops
Retracements
Divergances
3 Examples of Tops
3 Examples of Bottoms
Basic trading rules

The first part of the seminar is focused on defining some basic technical terms. Getting your head around the nomenclature of technical analysis is half the battle. We then move on to look at three very common 'tops' and three 'bottoms'. Next, we explore the concepts of retracements and divergence. Lastly, we look at three typical examples of bottoms and three typical examples of tops.


Technical terms defined

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Time-frame Different investors look at different time frames. Long term investors concentrate on longer time frames while day-traders focus on very short time frames. Some popular time frames include: quarterly, monthly, weekly, daily, 60 minutes, 30 minutes, 15 minutes, 10 minutes, 5 minutes, 1 minute and tick-by-tick.




Trend A trend in simplest terms is the tendency of a given object to move in one specific direction over a given time frame. For our purposes, we primarily look at trends in price, but also look at momentum, sentiment and volume for directional tendencies too. Trends over time can be expressed as long-term, intermediate-term, and short-term trends.




Trendline If a trend is the direction something is moving in, then a trend-line is a visual indication of that direction. Usually the trend-line is drawn off the two most significant recent extremes.




Support The point inwhich demand outweights supply in the market-place and prices cannot move lower.




Resistance The point inwhich supply outweights demand in the market-place and prices cannot move higher.




Market Bottom A market is said to have 'bottomed' when resistance has been broken and a new trend-line has been defined.




Market Top A market is said to have 'topped' when support has been broken and a new trendline has been defined.




Trading range A market is said to be in a trading range when neither support nor resistance can be broken. The market then drifts between these two points until some fundamental news changes the supply/demand dynamic.




Breakout A market is said to have broken-out if current price is above or below the previous trading range. Usually this is accompanied by heavy volume. If volume is poor it may be a false breakout and prices may come back into the previous trading range.




Momentum It is simply the tendency of a security to continue movement in a single direction or the perceived strength behind a price movement. Momentum investors seek to take advantage of upward or downward trends in stock prices or earnings. They believe that these stocks will continue to head in the same direction because of the momentum that is already behind them. The idea relies on the belief that there are a large number of investors in the market who will buy whatever stock is already hot. Momentum investors do not necessarily believe that momentum stocks will do well in the long run, but they do think that in the short run people will continue to buy them as they have in the immediate past.


Contrarian An investor who does the opposite of what most investors are doing at any particular time. According to contrarian opinion, if everyone is certain that something is going to happen, it won’t. This is because most people who say the market will go up are fully invested so they have no more purchasing power, which means the market is at its peak. When people predict decline they have already sold out, so the market can only go up. Contrarian investing shares many qualities with value investing. The difference is, contrarian stocks aren't just cheap, they are also actively disliked by investors. That can make them risky but potentially lucrative investments.


Macro & Micro applicability Because charts reveal real supply and demand for any given asset, chart analysis is relevant and important in studying the largest of currencies to the smallest of companies. Should demand outweigh supply, prices will rise which will become apparent on the chart. Similarly, should supply suddenly outweigh demand, prices will fall which will also be apparent on the chart. It's the significant moves through historical resistance and support levels, which are clearly seen on price charts, that makes them so valuable.




Swing trading Swing Trading is simply looking for the patterns and formations listed in this seminar on short term chart (ie 10 minute or 30 minute charts). One may hold a position for several hours or maybe several days. Strict discipline and an acute understanding of the relationship between an individual market and the broader market as a whole is essential when dealing with short term, swing-trading models. Follow Brian's swing-trading model in Technical Notes' Nasdaq 100 Swing Trader





3 Common Bottoms

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Bullish Key Reversal A bullish key reversal (or engulfing pattern) usually occurs at the end of a down move and is an indication demand is growing. The previous two days are completely engulfed. The open is below the two previous day's lows and the close is higher than the two previous day's highs.
Double Bottom The double bottom is a major reversal pattern that forms after an extended down-trend. As its name implies, the pattern is made up of two consecutive troughs that are roughly equal, with a moderate peak in between.

Flag-pole Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.

3 Common Tops

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Bearish Key Reversal A bearish key reversal (or engulfing pattern) usually occurs at the end of an up move and is an indication demand is waning. The previous two days are completely engulfed. The open is above the two previous day's highs and the close is lower than the two previous day's lows.
Double Top The double top is a major reversal pattern that forms after an extended up-trend. As its name implies, the pattern is made up of two consecutive peaks that are roughly equal, with a moderate trough in between.

Inverted Flag-pole Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.

Retracments

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50% Rule Based loosely on Fibonacci retracements, the 50% rule is a simple guide to determining where a market may move should the current trend reverse. Take the most recent high and add it to the most recent low, then divide the result by two. The rule is valid for both up and down markets.
> 50% retracement The next key support level is 66% of the previous move. Should a market find support below the 50% level it is an indication the current trend is in doubt.

< 50% retracement The first key support level is 33% of the previous move. Should a market find support above the 50% level, it is an indication the current trend is strong.


Divergances

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Bullish Divergance A bullish divergence usually occurs at the end of a down move and is an indication demand (Volume), momentum (MACD) or sentiment (RSI) is growing. Double bottoms in an associated indicator is an easy way to see the divergence.

Bearish Divergance A bearish divergence usually occurs at the end of an up move and is an indication demand (Volume), momentum (MACD) or sentiment (RSI) is waning. Double bottoms in an associated indicator is an easy way to see the divergence.

Three Market Bottoms

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Bullish Key Reversal A bullish key reversal (or engulfing pattern) usually occurs at the end of a down move and is an indication demand is growing. The previous two days are completely engulfed. The open is below the two previous day's lows and the close is higher than the two previous day's highs.

Double Bottom The double bottom is a major reversal pattern that forms after an extended downtrend. As its name implies, the pattern is made up of two consecutive troughs that are roughly equal, with a moderate peak in between.

Flag-pole Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.


Three Market Tops

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Bearish Key Reversal A bearish key reversal (or engulfing pattern) usually occurs at the end of an up move and is an indication demand is waining. The previous two days are completely engulfed. The open is above the two previous day's highs and the close is lower than the two previous days' lows.

Double Top The double top is a major reversal pattern that forms after an extended uptrend. As its name implies, the pattern is made up of two consecutive highs that are roughly equal, with a moderate trough in between.

Flag-pole Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.


Trading Rules

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Avoid fear Sounds simple, but it isn't. Simply put, scared money is dead money. Therefore, you should only risk what you can afford to loose and be constantly asking yourself, 'why am I invested?' If the answer has changed, get out. He, who fights and runs away, lives to fight another day.




Trend is your friend Trading with a trend is allotted easier than trading against a trend. For purchases, try to identify key support levels and look for buy signals at or near those levels. For short sales, try to identify key resistance levels and look for sell signals at or near those levels.




Partial Profits Always look to book partial profits on any move in your direction. Markets are volatile and don't always continue to move in the direction you expect. With this in mind, if a market does move in your direction, capture some of those profits right away to make the overall trade less risky and to reward yourself on a good directional call.




Stops For long positions, use stop-buy orders to enter positions on breakouts and use stop-loss orders to protect profits and limit losses. For short positions, use stop-sell orders to enter positions on breakouts and use stop-buy orders to protect profits and limit losses.




Money Management Probably the single most important trading rule. How one manages their trading capital can make the difference between taking a small loss and getting wiped out. A general rule of thumb is to never risk more than 5% of what you have to work with on any one single trade.




Be repetative Trading for consistent profits is a matter of identifying entry and exit points on potentially profitable trades. This cookie-cutter process should be very simple in nature and easily repeatable. Doing the same thing over and over again can lead to success. Erratic, irrational trading can only lead to disaster.




Reward yourself The market give and the markets take away. When the market gives you a nice profit, reward yourself. Consistently profitable trading isn't easy; in fact it is hard work. When you have success reward yourself; it makes all the hard work tangible and that's what all of this is about...