Trading Patterns Within Patterns
My favorite strategy for entering trades is to
look for patterns within patterns where a breakout in the lower timeframe could
lead to a breakout and significant move in the larger timeframe. To illustrate
this I’ve taken some examples from old columns I wrote.
Example #1 — Daily and Weekly Cup & Handle Breakout
Pacific Internet (PCNTF) had an interesting breakout today of both small and big
picture cup & handles. Let’s look at a few charts to see what I’m talking
about.
You can see on the weekly chart below that PCNTF formed a 9-month Cup & Handle
formation. The pivot was around $12.44. Depending on the stop methodology used,
two potential areas to set stops are shown below. The 1st is an 8% stop, used by
William O’Neil. The 2nd option is the low of the handle, around $9.42.
A look at the daily chart shows that the handle part of the formation actually
formed a Cup & Handle on its own. Those looking at the daily chart would have
seen a pivot above the $11.71 high and a stop level below the low of the handle
at $10.89.
By taking the breakout of the daily pattern you can get in at a lower cost, with
a tighter stop.
Example # 2 — Intraday and Daily Cup and Handle Breakout
Here’s a daily chart of Aeropostale (ARO) from Feb. 12th. As you can see it was
set up in a cup & handle formation. (Since then it has seen a nice pullback and
move higher.)
As I’ve mentioned many times before, one way to enter a stock ahead of its
breakout is to look for an entry pattern in a smaller time frame.
On Feb 11th ARO gapped lower but quickly reversed and ran higher on good volume.
Many times stocks will have quick shakeouts below the low of the handle before
they make their breakout. If you were watching the stock, the morning action may
have caught your attention. As the day moved on, a cup & handle formed on the
5-minute chart. Rather than waiting for the breakout of the daily cup & handle,
you could take the breakout of the 5-min cup & handle.
Summary
When patterns develop within patterns, many times you can take the breakout of
the smaller timeframe in anticipation of a big picture breakout. The above
examples were Cup & Handles, but any valid pattern can be used. Triangles, Head
& Shoulders, High Tight Flags, Candlestick patterns, anything. A chart is a
chart. A setup is a setup. The timeframe used doesn’t matter. By taking the
breakout on the smaller timeframe chart you can normally use a tighter stop,
thereby reducing risk. You’re also be in a position to benefit from the bigger
picture breakout. (At a lower cost.)
Lower potential risk and higher potential reward are always a good tradeoff.
Keep your eye out for patterns within patterns similar to the ones above.
Rob Hanna