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Basic Technical Analysis Trading Patterns

Recently, I've been receiving a few emails with questions and comments asking me how to use basic technical analysis trading patterns to enter the market. I want to show beginners as well as seasoned traders that these trading patterns are viable and important tools that should not be ignored by traders. 

It’s one thing knowing how to identify a pattern that’s developing but it’s another experience trying to understand when to enter and exit markets when using technical patterns.

The reason for this is rather simple, since patterns are subjective in nature they are harder to interpret than a moving average or other technical indicators that are based on math or statistical formulas.

With indicators, you know exactly where to enter and exit your orders. With chart patterns, it’s easy to misinterpret the chart as well as your entry and exit point.

Ignore Complicated Technical Analysis Trading Patterns

One of the first things you want to do is to ignore any pattern that seems difficult to interpret or seems overly confusing. There is always another opportunity in the market. Don’t feel like you have to trade every pattern that comes along. Stick to basic patterns such as head and shoulders, double tops and bottoms and triangles till you get a good feel for these, only then should you start experimenting with more advanced patterns.

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Learn To Trade Double Top And Double Bottom Patterns

The pattern I want to focus on today is one of those classic chart patterns that has been around for over 100 years. This pattern works with stocks, ETF’s, futures and foreign currency markets. The double top and double bottom pattern is very flexible and can be utilized for day trading, swing trading and long term investing. Many swing traders use this pattern with stocks and that’s what I’m going to cover in today’s tutorial.

The First Step Is To Identify First Swing Low

Typically you want to keep track of stocks or other markets that are making a minimum of 50 day highs or lows. I typically start looking for double tops and double bottoms by going through stocks and other markets that are making yearly highs or yearly lows.

Make sure that point one and point three are almost equal to each other and that there’s sufficient horizontal distance between the second point and the first and third point. After you see a few patterns like this one you will get a good visual feel for this pattern.

You have to keep in mind that visual chart analysis is part science part art.

Once the pattern is identified and all three points are determined, you need to find an entry point. I look for a gap to occur within 5 trading days after the third point is made on the chart. If I’m trading double bottoms I will look for a gap up within 5 trading days after point three is made and if I’m trading double tops I will look for a gap down after point three is made.

Gap up Occurred One Day After Point Three Is Made

In this particular case, the stock gapped immediately after the third point was made. You can give the market up to five days to gap up and if no gap occurs, the trade is nullified. The stop loss order is placed immediately below the third point in case the trade goes against you when you enter the order.

You Can See Entire Set Up and The Entry From This Example

The stock rallied and never looked back in this example. This is ideally what you want to see when trading technical trading patterns. Keep in mind that the pattern can take anywhere from two weeks to two months to develop, assuming you are using daily charts. Many traders apply this pattern to five-minute bar charts when day trading.

The Double Top Took Almost 2 Months to Completely Set Up

The double top is exactly the opposite of a double bottom. This stock has been setting up for almost two months and gaps down immediately after creating the third point. Double tops and double bottoms have to be traded exactly the same way. Don’t miss shorting opportunities that show promise, this is a major mistake made by beginners.

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You Can See Exactly Where Your Entry Opportunity Would Occur

In this example, the stock gapped down immediately after the third point was made. I typically give stocks no more than five days and if the stock rallies above the third point before the entry is triggered, the trade would be nullified because the pattern would be invalid.

This View Gives You A Good Idea Of The Pattern As Well As The Entry Point

You can see the entire progression from the first point to the entry on this chart. Remember always to wait for a gap down in case of a double top and a gap up for a double bottom as your pre-entry filter. This shows some additional interest in the stock or market you are trading and makes a great entry filter.

If you are trading double bottoms, your stop loss level is immediately below your number three point and if you are trading double tops, your stop loss level is immediately above the number three point. Make sure you remember the difference and don’t get confused when placing orders and stop orders with your broker. 

Roger Scott
Senior Publisher