The Three Most Profitable Stock Chart Patterns
I love technical analysis. To me it’s clean, precise, and easy to understand. But to others technical analysis is tantamount to reading tea leaves or pig entrails. What these people don’t realize is that technical analysis isn’t about divining the direction of a financial product; it’s about identifying the probability of a price movement in a certain direction for a certain distance.
For those of you who love the thrill of short term trading and have the guts to weather the swings, here’s a list of my top three chart patterns.
Channels
I get goose bumps just thinking about price channels. I feel especially elated when the channels form near historical highs or lows. The thing that I love most about channels is that their price range is so well defined. If the price of a financial instrument is fluctuating within an eight-point range, then a potential profit of around 7 points exists when the issue is either near the top or the bottom of that range. Once the price approaches a support or resistance line, you buy or sell respectively then exit the position when the price reaches the other side of the channel.
Even if you’re wrong you only risk one and a half to two points and you can reverse your position knowing that a channel breakout will likely continue. Channels have great risk to reward ratios with easily defined support and resistance points.
Triangles
Triangles are almost as good as channels. The only difference here is that I’m looking for a breakout. By the time a triangle pattern is apparent, the price range is usually too narrow to trade profitably, but a breakout will often go the length of the triangle’s widest point before consolidating. Depending on the size of the triangle, this move can be very lucrative.
The downside to triangles is that they occasionally change dimensions. At first a pattern may look like an ascending triangle then a price move changes the pattern to a right triangle. This uncertainty adds an extra degree of risk to triangle trading.
Flags and Pennants
Flags and pennants are continuation patterns. After a major move, prices usually consolidate as people take profits and reevaluate their positions. Once these patterns finish, the primary trend usually resumes.
A flag is formed when price retraces. Flags look like small diagonal channels that run counter to the primary trend. Once this channel is broken, you can expect the primary trend to continue for at least the size of the flag. However flags have an ‘X’ factor. You never know when, or if, they’re going to end. You may watch a flag for a couple of days before you realize that it’s not really a flag, but a reversal. By then it’s too late to do anything.
Pennants, on the other hand, are easier to predict. Like flags, pennants are continuation patterns caused by profit taking and market uncertainty. These patterns look like little triangles because they start wide and get progressively narrower. This characteristic makes a completion point easier to predict. Once the pattern is complete, the primary trend can be expected to continue for at least the size of the pennant’s widest point.
Technical patterns are one of the easiest indicators to trade. There are no complicated formulas to follow and the risk to reward ratio can be incredible. If you’re just starting to use technical analysis, give patterns a try. It’s a great way to earn some money while you learn more about the behavior of your market.
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