Profitable Chart Formations
PLAYING THE BREAKOUT
Playing breakouts from consolidations, on both intraday and daily charts, has provided a consistent means of profit for many traders over the years. Patience and discipline is key when these situations arise. By following the One Shot – One Kill Method, you will be attacking these trading formations with a close eye on profitability.
Breakouts and breakdowns occur after a stock hits an area of consolidation, thereby moving sideways, gathering steam before making its next move. Then, once it can break the strug-gle from either the bulls or the bears, which occurs during con-solidation, it moves like hell, with determination in its eyes.
A consolidation breakout occurs after a stock has been trad-ing in consolidation for some time, usually 5 to 15 periods, some-times a lot longer. While in this consolidation period, the stock is building a base and resting up for its next big run. It is during this next run that you will plan to get into the trade. Charts 3.13 and 3.14, of Maxim Integrated Products (MXIM), shows a stock that was in consolidation for 15 days before breaking big time to
CHART 3.13 Movement of Maxim Integrated Products (MXIM), showing how stock was in consolidation for 15 days before moving to the upside.
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CHART 3.14 A classic cup-and-handle formation.
Amateur investors chase breakdowns and breakouts! The pros know that most breakouts or breakdowns will usually pull back and test an area near their initial inflection point. It is this retracement that you should look for, because oftentimes they permit you to get back in the trade, provided the indicators are in agreement. This is usually a good time to scale into the trade with the rest of your position. Determining where the pivot points, 15-period MA, and/or Fibonacci Friends are hanging out serves as an excellent gauge as to where to take profits and move on.
Another kind of breakout is the cup-and-handle formation.
A cup and handle occurs when a stock runs up. It then retraces and then bases, building up steam for its next run. It comes back up to test that initial level of resistance. This run will usually fail, because those who bought at the previous top will usually use this as an opportunity to sell the stock, just to get even. This first part of the chart formation is called the cup (see Chart 3.15).
The handle occurs when the stock fails to break through resistance, it moves back slightly, forming what looks to be a handle on the cup. The stock then makes another run at the prize, but this time it breaks through the resistance and moves up with incredible thrust.
Once again, these breakouts will normally retrace and leave you with the opportunity to get back in the trade, if you weren’t able to get in at a good spot on the initial move. It is a common occurrence for these breakouts to find resistance at cer-tain points called Fibonacci expansion points (explained in the next chapter), backed up by indicators such as the Detrended Oscillator, TRI, and Vertical/Horizontal Filter showing its time to take profits.
The next example will focus on a stock that broke down from consolidation at a double top and continued moving lower.
Chart 3.16 shows how CMGI started its disastrous spiral in a prohibitive downtrend, following its meteoric rise from 50 to 163 and then its subsequent collapse, before finding support with some bargain hunters and short covering at around $35 a share.
While the stock was falling, it continually went into periods of consolidation before it resumed its downward trend.
Eventually, it became sadly apparent to the longs that this stock was not going up again. It kept breaking lower ranges of
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CHART 3.15 Disastrous downward spiral of CMGI.
consolidation and headed lower very sharply. However, like many breakdowns, it also retraced a number of times, to give short sellers another chance to sell strength in a declining stock, continually. As the CMGI chart graphically illustrates, the mar-ket will usually give you many chances to get into trade. Having a keen understanding of this offers peace of mind to many pro-fessionals, which allows them to look for the best setups.
Like every profitable pattern discussed in this chapter, chart patterns alone do not constitute enough of a reason to
“load the boat” and enter a trade. Confirmation from other indi-cators in the One Shot – One Kill Method is essential to enhancement of your chances for making consistently successful trades.
SUMMARY
As this chapter explained when covering the aforementioned formations, the One Shot – One Kill Method is about buying weakness in rising markets, selling strength in falling markets, and taking profits at predetermined price targets. The chart for-mation comprises 10 of the 30 points that go into making a Netto Number. Formations like double tops, double bottoms, and ascending triangles are fairly common in the market and pro-vide some great trading opportunities. However, it is not my style to chase the initial move off of these formations, but instead to wait for the subsequent move to emerge as it will usu-ally provide a better risk-to-reward ratio. It is important to understand that within these formations, there are good spots and bad spots to enter both the long and short side of the trades.
By using pullbacks within the underlying trend to get in, as well as profit targets to get out, you stand the best chance to profit from these setups and consistently give yourself the best chance to make money in the market.
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