Wednesday, November 13, 2013

TechniTrader Weekly Stock Discussion: “Breakout Pattern Analysis”

MetaStock® SPRS Series - Week 143 – November 1, 2013 - MetaStock Spatial Pattern Recognition Skills Series written by Martha Stokes CMT

American Express Company AXP is the example of a Breakout pattern.  AXP has been stuck in a 7 point sideways pattern for several months. It recently broke out to the upside as its earnings report was better than expected.  Several aspects of the sideways pattern indicated that this was a stronger sideways pattern with upside potential.
There are many types of sideways price action and identifying each is critical for successful investing and trading. This was not a true Trading Range because it was less than 10 points from peak to trough.
Trading Ranges also tend to have inconsistent highs and lows with plenty of inter range lower peaks or higher lows. This makes trading range bound stocks much more difficult than many people believe.
When a sideways pattern is less than 10 points wide from peak to trough, attempting to trade the range with a SAR, Stochastic, or other Trading Range strategy is substantially more difficult.  This is due to far greater risk because of the constant whipsaw action, long wicks and tails, and the inconsistent highs and lows of the range.
However when a pattern forms very consistent highs and lows, and maintains a stable level even when High Frequency Traders enter the stock periodically, then more is going on than is often evident on the surface.
One market participant is capable of controlling price within a consistent high and low range.  Their buying patterns maintain price within a narrower range than a true Trading Range pattern.
When studying AXP it is evident that Dark Pools were involved in maintaining the neat, concise appearance of this sideways pattern.  This pattern is called a Platform pattern because it is building a base upon which the stock can move upward, with stronger support beneath it when it does move up.
It is common for a stock that compresses as AXP did, to have a breakaway gap form.  The breakaway gap leaps over prior highs, establishing a new higher high for the stock.  The significance of this move is not just that the company had good earnings but also that the giant funds believe this company is going to continue to have strong growth moving forward.
Most of the time retail traders make the mistake of trying to swing trade these platforms with mediocre to terrible results. The Platform pattern is seldom recognized for what it is, and is often mistaken for a Trading Range or wider sideways pattern.
Being able to recognize the consistent highs and lows of the sideways pattern, can be hugely beneficial as the breakouts occur without much warning.  
During a Platform pattern Bollinger Bands may not compress, Stochastic may show a floating pattern or an extreme oversold pattern. So instead of holding the stock to reap the profits of the breakout, the trader exits just before the stock forms a breakaway gap.
Chart analysis requires an understanding of not only price but also which indicators should be used for the current market conditions, trading conditions, and the chart candlestick patterns.  Most short term trading losses are due to the following:
  1. Improper chart analysis
  2. Using the wrong indicators
  3. Not being aware of the current Market Condition
  4. Not recognizing compression patterns within a sideways pattern
  5. Using the wrong trading style for the chart pattern
  6. Using the wrong trading strategy
By increasing your ability to read charts and by using proper indicators, trading styles, and strategies your profitability will increase significantly.  In addition trading will be easier and much more fun to do.
Watch a technical analysis training video for more information here
Trade wisely,
Martha Stokes CMT
Member of Market Technicians Association
Master Rated Technical Analyst for Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader Stock Market Courses
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