Trading Regime Analysis Using Chart Patterns- Part 2

[Do Or Die 10]

Hi,

In Trading Regime Analysis Using Chart Patterns- Part 1 I discussed how regime analysis can be done with familiar chart patterns which indicate a trading range compression. Let’s look now at some other popular chart patterns.

 

Again, these are the main points to consider:

• The patterns mentioned in this article differ a lot in form and duration, so please refer to a particular pattern for trading it.
  
• For the sake of Trading Regimes, a lenient definition of the patterns will do; i.e. you do not need to go strictly by the books in marking them.
  
• The price target for a breakout (magnitude of a following move) is usually the broadest part of the range of the chart pattern.
  
• If prior to any of these patterns, a distinct extended move (trend) exists, then it favors the outcome; i.e. the move after the pattern will be stronger in magnitude.
  

Broadening Triangles usually occurs at long-term turning points in the market, be that at whatever time fractal the pattern occurs. Mark these patterns on one time frame higher than the time frame you trade. So the practical implication is to trade using a trend following strategy on one time frame lower.

Broadening Wedges are more common than broadening triangles and can be traded similar to them. The only difference is in the internal structure; wedges tend to have more overlapping retracements and are not so distinct in shape.

The period of price action when the Head and Shoulders pattern is forming is more often than not a range-trading regime. When the neckline of the head and shoulders breaks down, the market accelerates down on that particular week and the trading regime analysis is skewed strongly to a trending regime developing. The most important thing in identifying a H&S pattern is existence of a prior trend. You can be ready to take full advantage of the regime switch by, for example, increasing risk on trend following models/methods or by reducing risk on range-trading models/methods.

Double tops and bottoms again are skewed to the trending regime rather than ranging regime. However, please note that a double top may lead to triple top which can further lead to a trading range (lol!) and regime will be skewed to range bound. For a double bottom to be confirmed, we need to see the market rally up past the reaction high which is the level it reached after making the first low. Until that high is broken, the market has a lot of potential to carry on in the downtrend and could be in the making of a descending triangle.

Diamond patterns usually form over several months in very active markets. Volume will remain high during the formation of this pattern. The Continuation Diamond (Bullish) pattern forms because prices create higher highs and lower lows in a broadening pattern. Then the trading range gradually narrows after the highs peak and the lows start trending upward. The Breakout occurs when trading range compresses to complete the ‘diamond’ shape.

Price Shock based patterns are either caused by 1.) huge gaps, 2.) wide range bars, and 3.) reversal bars. Mark these patterns on TWO time frame higher than the time frame you trade. So the practical implication is to trade using a trend following strategy on 2 time frame lower. For example, if you are trading on hourly TF, look for these patterns on weekly TF.

 

Examples of Gap based patterns are island tops/bottoms and dead-cat-bounce.

Examples of wide range bar patterns are one day reversal, pipes and climactic bars.

Example of reversal bars are hammers, shooting star, hanging man, dark cloud cover, harami etc. (most of the classic candlestick patterns).

 

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[Rashedbgd 10]

Very nice and useful article ! Thanks a lot for sharing such type of useful writings.

[Perrin 10]

Thank you. There is some really great information on Traders Laboratory. It all needs to be read, absorbed, filtered through your brain box and then tested & applied (in demo mode!). If only trading was as easy as just clicking 'buy' or 'sell'