7 Patterns- Ed Downs

8/14/2019 7 Patterns- Ed Downs

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Powerful Chart Patterns

that ConsistentlyMake Money

A 20-year veteran of trading, Ed Downs is the developer of the OmniTrader software, which was

released in 1994. Now in its fifth version, OmniTrader is recognized around the world as one of the

leaders in trading system automation.

Downs is also the editor of the SignalWatch daily market column, where he evaluates the overall

market, provides trading lessons, and selects charts that are exhibiting proven technical analysis

patterns. The column can be viewed at www. signalwatch.com.

Downs is also the author of the best selling book: 7 Chart Patterns That Consistently Make Money .

Nirvana Systems

[email protected]

(800)880-0338


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The 7 Chart Patterns that

Consistently Make Money

Ed Downs


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What is a Pattern?

Patterns indicate

the psychology of

a market.

Patterns also

determine the

behavior of a

market.


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Example: Buying at Support

Price had been here.

24 was established

by 2 touches as the

value point.

Confirmed

support


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Goals of Chart Pattern Analysis

1. Identify the most predictablepatterns.

2. Define rules for trading patternswhich result in winning trades.

3. We should have more winnersthan losers, and the losses shouldbe smaller than the gains.


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Do Chart Patterns Work?

P u b l i c a t i o n : T h e Ec o n o m i s t , A u g u s t 1 9 , 2 0 0 0

A r t i c l e : H e ad & S h ou l d e r s , B r o a d e n i n g B o t t o m s

A u t h o r s : Cr a i g M a c K i n l a y , Wh a r t o n S c h o ol a n d

A n d r e w L o , M a s s ac h u s e t t s I n s t i t u t e o f T e ch n o l o g y

Using American share prices during 1962-96,

MacKinley and Lo focused on technical

indicators that were especially controversial

among economists such as head and shoulders

and triangle tops and bottoms.


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Yes, they do.

The results showed that the various

technical patterns mostly occurred far morefrequently than they would have done if

they were truly random events. In general,

the charts contained useful information

about future share prices.


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Nasdaq is better for patterns.

(However), there was a significant difference

between the results for different markets.

For shares listed on the New York Stock

Exchange and American Stock Exchange,

seven of the ten technical patterns had enough

predictive power to be statistically significant.

For Nasdaq shares, all ten of the patterns

tested did.


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More Art than a Science

The traditional patterns used in technical

analysis were, of necessity, fairly crude,

determined by what was readily visible to the

eye. As a result, technical analysis has always

been more of an art than a science.

In fact, text books on Technical Analysis

are very quick to point this out


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Edwards & Magee An [exhaustion gap] should not be read

as a sign ofMajorreversal, nor even, of reversal at all. It calls

stop, but the halt is ordinarily followed by some sort of area

pattern, whichmay

lead to reversal

Martin Pring It should not be concluded that every gap

breakout that takes place is a valid one, because there is no such

thing as a sure thing in technical analysis.

William Jiler A [breakaway gap] generally occurs after animportant chart pattern has been completed, and it often marks

the beginning of a major move.

More Art than Science (continued)

Ambiguity in Chart Pattern Recognition is universal!


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We Conclude That . . .

Chart Patterns are Predictive.

However, identifying Chart Patternsthat work 100% of the time is

difficult (or impossible).

Rules are needed to assess and trade

the opportunities.


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Chart Pattern Overview


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There are 7 Key Patterns

1. Support & Resistance

2. Trend Line Reversal & Break

3. Saucer Formations

4. Fibonacci Retracements

5. Price Gaps

6. Volume Climax & Trend

7. Consolidations

Lets discuss the Psychology of each one


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1. Support / Resistance

As market approaches support, and especially as

it reverses, the market participates adding morefuel to the fire. Support breaks can create PANIC.


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2. Trend Lines

An invisible line forms as price reacts to it. This

creates a similar psychology as Support andResistance lines do. Breaks can create panic.


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3. Saucer Formations

Saucers usually occur at support (resistance,

occasionally). Smooth transitions in price arenoticed, causing buyers (sellers) to enter.


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4. Fibonacci Retracements

Markets typically reverse on eighths, especially 3/8,

4/8, and 5/8 which is 38%, 50%, and 62%. This isan observed truth of market psychology.


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5. Price Gaps

Breakaway Gaps mark the beginnings of moves,

Measured Gaps mark the centers of moves, andExhaustion Gaps occur at the ends of moves.


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6. Volume Climax, Trend

Climaxes form powerful patterns, indicating an

exhaustion of supply or demand. If the marketdoes not reverse, it becomes a trend indication.


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7. Consolidations

Consolidations are the most powerful pattern.Each consolidation will typically imply a move ofequal distance from the last significant low or high.


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Rules & Tools

1) Establish a Timeframe

2) Determine a Reference3) The Rule of Eighths

4) Avoid Volatility

5) Watch for Opposites

6) Apply Reward:Risk


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1) Establish a timeframe based on

the size of the pattern

Timeframes

are dictated by

the size and

the timeframeof the pattern.

Once you

decide to trade

a timeframe,dont change

your mind.

Timeframe BTimeframe A

Small saucer Large saucerExample: saucer


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2) Only trade those Patterns which have a

clear size reference in the timeframe.

?

B is more ambiguous.

AB

At A we can use H.

H


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3) Rule of Eighths: Use eighths within the

reference to set trailing stops

4/8

3/8

5/8

Enter Trade at 1/8

Stop at zero

62%

50%

38%


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4) Avoid trading issues which reverse

across 2+ lines within 5 bars (volatile).

High Volatility Lower Volatility


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5) Patterns can indicate a Continuation

OR a Reversal of Trend.

TrendClimaxVolume

Break, MeasuredExhaustionGap

BreakReversalFibonacci

BreakReversalSaucer

BreakReversalTrend Line

BreakReversalSupport / Resist.

Failure

Reverse Trend

ContinuationConsolidation

Continue TrendPattern Type

Be prepared to trade both sides.


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Example: Consolidations usually break in the direction of

prior trend but can also reverse in the opposite direction.

Such failed consolidations can prove highly profitable.

A triangle consolidation will usually break in the

direction of the prior move (up in this case).

However, a failed triangle (breaking down) is

often more tradable. expected

move

oppositemove

Decision zone


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6) The most important factor is trading

opportunities with high Reward:Risk

On any opportunity...

Assess the Target and

initial Stop values.

Trade those patterns

with a Reward:Risk

Ratio of at least 2:1and preferably 3:1.

entry

stop

target

Reward:Risk = 3:1

Reward

Risk


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Pattern Structures

Pattern Dimensions

When to Get In.

Where to Place Stops.

When to Get Out.


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Support (& Resistance)

43

5

43

5

Long Entry

Short Entry

Break:

Down Through Support

Reverse:Rally off Support


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Support & Resistance

America Online, Inc.

Entry

Exit

Signal


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Support & Resistance

Aura Systems, Inc.

Signal

Entry

Exit


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Trend Reversals (Breaks)

43

5

4

3

5

Long

Entry

Short

Entry

Break

Reversal


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Trend Line Breaks

Public Service Ent. Group


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Trend Line Breaks

Lexmark International, Inc.


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Trend Line Breaks

CoPart, Inc.


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Saucer Patterns

4

3

5

Long Entry

Short EntryBreak:

Failed Support

Reverse:

Saucer Up

Distance to significant high (1.0) Distance to target (0.6)

center


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Saucer Patterns

Hydrogenics


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Saucer Pattern

Perot Systems


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Fibonacci Retracements

4

3

5

50% R

62% R

Reverse

38% R


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50% Retracements

Activcard


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50%, 62% Retracements

Thomson Multimedia

50%

62%


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Price Gaps

Breakaway, Measured & Exhaustion

4

3

5

Long Entry

Short Entry

Long Entry

Measured Gap

Exhaustion Gap

Breakaway Gap

No targets


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Measured & Exhaustion Gaps

Kemet Corp.

MG

EG


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Breakaway Gap

Genuine Parts Co.

AssumedReference

BG


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Volume Climax (Trend)

4

3

5

Long Entry

Short Entry

Short Entry

Long

VC VC

VC

VT

No Targets


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Volume Climaxes

Grant Prideco, Inc.

VCVC VC


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Volume Climax

Intervoice-Brite Inc.

VC


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Volume Climax

Worthington Industries

Aside: Note the

Consolidation

predicting low in

late December.

VC


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Volume Trends

Rite Aid Corporation

VT VT VT VT


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Consolidations(Symmetrical Triangle shown)

4

3

5

Long Entry

Short Entry

widthwidth width

Reverse:

Failure

Break:Continuation


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Consolidation

Huntington Bancshares


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Consolidation

Ameren Corp.


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Consolidation

Network Appliance

Did not make it

to the target.


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Finding the Patterns

Technical Scans

Web Sites

Software


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Using Moving Average

Convergence / Divergence (MACD)

MACD plots the

difference between

the 12 and 26 period

moving averages. A

separate trigger

average identifies

the swings.

MACD signals can

be examined asreversal pattern

entry candidates.

Supt/Resistance

Trend Line


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Web Sites

These web

sites scan the

market for

technical

factors and or

signals which

can be

compared

against charts

for technical

patterns.


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Technical Analysis Software

MetaStock has a wide array of technical

indicators, and an Explorer feature

making it easy to run indicator scans

across directories of data.

OmniTrader ** is designed to scan for

opportunities using systems related to

patterns, such as the Trend Line BreakSystem and the Gap System.

www.equis.com

www.omnitrader.com

** All Signals in this presentation were generated by OmniTrader.


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A Summary of

The 7-Pattern Method1. Start with an Opportunity List.

We use OmniTrader, but any rational approachthat finds viable candidates is fine.

2. Look for one of the 7 Patterns to confirm.

3. Establish a Reference Scale. Move trailing stopsbehind the position on the eighths.

4. If stopped out, re-enter on an eighth, providedthe Reward:Risk ratio remains 2:1 or better.


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Conclusion

Identifying and using

Chart Patterns at any

trading opportunity cansubstantially improve

your odds.

Remember 1% a day is all you need!


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end

The 7 Chart Patterns thatConsistently Make Money


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The 7 Chart Patterns that

Consistently Make Money

Workbook


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Pattern Guide for

The 7 Chart Patterns

that ConsistentlyMake Money

Each pattern reflects a psychology.

Each pattern creates a psychology.

Pattern Guide for

The 7 Chart Patterns

that Consistently

Make Money

Each pattern reflects a psychology.

Each pattern creates a psychology.Support

Resistanc

e

Support and Resistance

TR TR

TB

TBTR = Trend Line Reversal

TB = Trend Line Break

TR = Trend Line Reversal

TB = Trend Line Break

Upper Trend Line

Lower Trend Line

Trend Line Break & ReversalSaucer Formations


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Fibonacci Retracements Price Gaps

VT VC VT VC

VT = Volume Trend

VC = Volume Climax

VT = Volume Trend

VC = Volume Climax

A

B

C

D

E

AB=BC, BD=DC, CE=EFAB=BC, BD=DC, CE=EF

F

Volume Climax & Trend Consolidations


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Instructions:

For each pattern, draw

the Reference Grid.

Then, follow each

Entry Signal to the

most likely Close. If

you are stopped out and

a re-entry was

warranted, mark that on

the chart as well with

the symbol

Mark Pattern Only


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2) Price Gaps.Mark and trade all gaps.

Mark BG for Breakout,

MG for Measured, and

EG for Exhaustion


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3) Trend LinesMark and Trade all Trend Lines

greater than 2 weeks in size.


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4) Volume Climax and

Volume TrendMark and Trade all Volume

Climax VC and Volume Trend

VT patterns


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5) Fibonacci

RetracementsMark and Trade all

Retracements, using 38R

(38%), 50R (50%), 62R

(62%).


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6) ConsolidationsMark and Trade all Consolidations

Patterns, identifying the Start (SC),

Center (CC), and End (EC) of each

consolidation you identify.


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What is DELL likely to do here? Why?

Mark patterns on chart.

Extra Credit: Mark all additional patterns on the charts in the exercise,

for example mark all the Gaps (use BG, MG, EG) and other patterns

you see, on each chart in the workbook.

Pattern RecognitionMark and Trade ALL Patterns of

Significance.

7 Patterns- Ed Downs

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