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Trend Line ApplicationsтАФChart Formations

Trend Line ApplicationsтАФChart Formations

As I've indicated above, I feel that the use of trend lines, although seen by many as too simple, can, in fact, be a very effective day-trading method. Many very large intraday price moves have given trend line signals. I recommend the use of trend line analysis as both an effective as well as time-tested method. While there is clearly some art to the sciВэence of trend line analysis, it is a technique which few traders use durВэing these days of high-tech trading.

Flags and Pennants. A flag or pennant chart formation is exactly what its name implies. Figure 12-4 shows a few flags on intraday charts. As you can see, the narrowing portion of a flag usually develops into a breakout up or down. The trader using such formations will be alert to the possibility of a breakout as the flag narrows, and he or she will trade with the direction of the breakout.

Rounding Tops, Rounding Bottoms. Yet another classical chart formation i6 the rounding top or bottom. Figures 12-5 and 12-6 show such patterns on intraday charts. Day traders will want to sell short or exit long positions when the lowest portion of the rounding top has been penetrated. Day traders will want to buy when the highest portion of the rounding bottom has been penetrated. In practice such formations are rather rare on intraday charts. Study intraday charts and see how many of these formations you can spot.

Breakaway Gaps. Typically such a pattern is a good one; however, the majority of research on such gaps has been on daily price charts. In practice, breakaway gaps rarely occur on intraday charts. Figure 12-7 shows such a formation. Chartists feel that such gaps, if in the up direcВэtion, are very bullish and, if in the down direction, are very bearish.

Key Reversals. A key reversal up occurs when a market trades below the low of its last price bar, above the high of its last price bar, and closes above the close of its last price bar. My research has shown such patterns not to be too effective on daily bar charts, but they appear to be much more significant on intraday charts. Figure 12-8 shows such a formation and its consequence.

A key reversal down occurs when the market trades above its last price bar, below its last price bar, and then closes below the close of its last price bar. Figure 12-9 shows such a formation.

Reversals tend to be good signals for day trading, apparently much better than they are for short-term or position trading.

Congestion and Breakouts. These are very important patterns on intraday charts. Congestion occurs when prices trade within a very well defined range either after a rally or a decline or within an existing periВэod of strength or weakness. Figure 12-10 shows a few examples of price congestion. They also show what occurs after a breakout from congesВэtion. As you can see, breakouts following periods of congestion can be very profitable within the day time frame. I recommend you follow them. While this is not a totally mechanical methodology, it is not diffiВэcult to use and can yield large rewards. It does take some training and experience, however.

Although some traders will criticize the use of chart patterns as lacking the kind of objectivity required in this day and age of computerized trading, I do not agree. I feel that the skilled chartist can trade much more profitably than can the pure technician. It is, however, much more difficult to become skilled at recognizing and using chart patterns than it is to read a simple technical indicator. But in order to do so the trader

Summary and Conclusions

will need to have considerable experience, experience which can only be acquired through practice, practice, and more practice. Therefore, my advice to would-be chartists who plan to use their skills for day trading is to become very familiar with the patterns described above and with those described in the standard technical analysis texts such as Edwards and McGee.[1]