Chart Patterns Guide

Dear Trader,

I am away on holiday until August 3rd, so in the interim I shall be continuing the Chart Patterns series to be sent automatically each day to my email list while I am away. Here is the first of the week's lesssons. Sign up at http://www.tonihansen.com/ on the left to receive the rest!

All my best,
Toni Hansen

Toni's Market Action Newsletter : Special Chart Patterns Edition #10

For more information, go to http://www.swingtrader.net/


Breakout Buy Setup

Description: Also called a “rectangle”, this pattern is based upon a sideways trading range breaking higher. It is most commonly traded as a continuation pattern which is then called a consolidation, but a sideways range can at times also break in the direction opposite of the trend that had been in place heading into the trading range. In this description the traits will be discussed as if they are in a continuation buy setup, but they can easily be reversed in order to use them in a short setup.

Criteria: The criteria for a rectangular breakout pattern from a sideways trading range is very similar to a triangle range breakout. Most of the same criteria, as well as pros and cons will apply. The difference is that there are more comparable highs and lows, as opposed to a narrowing range or trend channel. There must be at least two highs and two lows within the range to be identified as a trading range if there is back and forth action. If there is just a lot of overlap from one bar to the next, then these waves of buying and selling will be more difficult to discern.

Entry: As in a triangle pattern, there are several entry techniques that work well on this pattern. The technique which is the most widely taught is to draw a line connecting the highs of the range to each other and connecting the lows of the range. In the case of an upside range breakout, the trigger would occur when that upper trend line breaks higher. This is one of the least preferred methods to entering a breakout, second only to taking a breakout from the absolute highs of the range.

1. Another method in the case of a buy setup is to enter above the previous high once at least two highs are established.


2. A third setup, which is the one that will generate the highest reward compared to risk, is to watch the moves within the range and monitor the pace of each of the moves. When the security pulls back more gradually off the highs then before, or hugs the upper trend line, then use a break higher from that smaller downtrend or sideways trend within the larger trading range for an entry trigger.

Stop: Under the last pivot low within the range, or if it bases on a smaller time frame within the larger trend channel, then a stop can be placed under the lows of that smaller range. Use greater caution when keeping a tighter stop such as this if the security is very volatile, meaning there is a lot of back and forth action and overlap even as it trends, if the pace has yet to change within the range when it breaks, or if the security is thinly traded.

Target: The targets on a breakout will depend upon whether they are continuations or reversals of the previous trend.

• In the case of a continuation buy pattern, when the pace or momentum on the breakout move is comparable to that of the move heading into the trading range itself, then a target is an equal or measured move. This involves taking the move into the range, from the lows of that move to the highs at the start of the range, and then comparing that to the lows at the start of the breakout and projecting them higher. If the momentum is slower than the previous rally, then it will be more difficult to hit that equal move and it will be necessary to identify closer resistance levels. If the momentum is stronger than that previous move, then a larger than equal move can form.


• When the breakout from the range is a reversal pattern off lows, however, then monitor the price and moving average resistance levels overhead. If a downtrend preceded the base at lows and then it turned around and headed higher, then the level at which a previous bear flag broke lower would be resistance and a strong initial target, as would a resistance level such as a 200 period simple moving average, although any number of major moving averages can come into play on multiple time frames to serve as resistance. The resistance will be much stronger if several resistance levels are hitting at about the same time.
  

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  Ideal 5 Tech Tools Traits on a Breakout from a Trading Range:
  
  Pace: As a trading range begins, it is common for the initial downside move(s) to be average or stronger than average. As the range progresses, however, the odds are highest when the pullbacks from the highs are more gradual than the upside moves within the range. A base near the highs of the range or move with only a very slight downside slant off the upper end of the range is preferred.
  
  Volume: Watch for declining volume throughout the pattern's development with higher volume on the upside moves within the range and lighter volume on the downside as the pattern progresses. The best ones are when the volume is at its lightest level of the day just prior to the breakout as it bases at highs or pulls back gradually (in the case of a daytrade).
  
  Correction Periods: It is ideal when the last pivot low within the range, or the breakout from the range occur at the same time as a correction period.
  
  Support/Resistance:
  
• As a continuation pattern this setup is most ideal when it forms into the uptrend line on a larger trend, or moving average support such as a 20 period sma. Check to see if that level was also support on a previous correction, or if this is the first correction in a new uptrend, then look to see what the previous moving average resistance level was that broke to create the first higher high.


• If there is strong resistance on a larger time frame, such as the range forming intraday on a 15 minute time frame and there is a 50 day sma overhead that will be hitting for the first time in the trend move, then that level will have a more difficult time breaking. The same is true if it forms on a 5 minute chart and has a 5 minute 200 sma shortly overhead.

Trend Placement/Trend Development: A breakout is typically considered to be a continuation pattern, but can also be a reversal pattern.

• As a continuation pattern, it is best if the uptrend has only has one or two waves of upside.


• As a reversal pattern it helps if the pace of each of the downside moves in the previous downtrend is slower then the one that preceded it and that there were three waves of selling within that downtrend.


• A typical breakout tends to take place on the third or fourth test of the upper trend line for the trading range.
  
  
  The material presented in this email are expanded upon in Toni Hansen's in depth Trading Made Simple CD series. To learn more about this course, go to http://www.swingtrader.net/. Included is a pdf file detailing all setups in the Chart Pattern Editions of this newsletter (titled Successful Market Timing Guide). Thank you for your support!
  
  
  

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DISCLAIMER: Trading in securities may not be suitable for all individuals. Consult your broker or other professional to determine your suitability. The discussions provided by Trading From Main Street are for educational purposes only and should not be taken as a ecommendation to buy or sell the referenced security. Past performance is not indicative of future results.