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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
(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.
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