Common Patterns and Trend Reversals

I wanted to just talk about some of my favorite trading patterns in this article.

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“Double Tops”

Double tops are typically one of the most predictable patterns because many traders expect the third top to break out of that previous resistance line. The common strategy is to open a position either right after it breaks out or once it confirms the breakout by “bouncing” off the previous resistance line or zone.

For longer periods of time other than intraday, the bottom of consolidation (sometimes right after a double bottom) is the entry point to go for ride after a confirmation is seen on the daily candles by having a green candle open at or bounce off of the previous green candle close.

This is typical for a swing trade and longer term trades that use a daily candles within yearly periods.

You would typically set a stop loss right below support (or at resistance if you’re shorting) and watch for increased volume to help the push upwards. However, significant volume is not necessarily needed for these swings trades on larger cap stocks.

FINVIZ can scan for double tops or double bottoms but only on a daily basis so your broker or specific scanners might have to fill those gaps for your research and planning purposes.

In some instances, using custom codes for charting software like ThinkOrSwim or Trading View can help spot these moves in different timeframes such as intraday and not only on the daily charts.

If you’re trading intraday, you might be better off waiting for the breakout confirmation instead of opening a position while you see some upwards price action towards the resistance line.

It will all vary but I’ve seen that more often than not, especially for popular “hot runners” for a day, getting in before the breakout is confirmed while trading intraday is more of a “hit or miss” than viable strategy. Of course, like with anything, experiences will vary based on innumerable factors and variables.

Conversely, for swing trades, opening a position on the way to the resistance line can be more predictable as it gives you more reaction time due to the longer timeframe. In other words, buying with anticipation of the double top breakout in a swing trade that’s being planned based on a daily chart gives you more reaction time as opposed to using the same approach intraday where the reaction time might even be seconds instead of minutes or days. In either scenario you may miss the move or ride it but the intraday moves are inherently riskier than those that happen over several days.

You will always benefit from simultaneously using two or even three timeframes at once. I’ve mostly benefited from using the one minute chart along with the daily chart side-by-side. That way I can meticulously plan my entries using the one minute chart while looking at the daily charts to account for longer term trends like multi-day or multi-week breakouts, among others.

I mostly use limit orders to get in but may use a market order for extremely fast-moving listed stocks. Notice I said “listed stocks” and not OTCs. NEVER use a market order for OTCs as the spreads can be ridiculously wide and the stocks can have a 20% move in one downtick right when your market order is being executed. Being down 20% is not a great way to begin your trade.

Using BenzingaPro or FINVIZ and comparable scanners and screening tools will help you pick out the top movers so you can add them to your watchlist and set alerts to let you know when they’re approaching some key levels that might help you plan and execute your trade.

One of the best confirmations anticipating a breakout will be the increasing volume and the simultaneous double top in the intraday chart (minute candles touching the top on more than two separate occasions within that trading day) as well as the daily chart (two different days have touched the top).

If you have the increase in volume and both double tops, you have higher probabilities that the breakout will happen and if it holds, it’s a matter of setting your automatic stop loss (especially for swing trades) and deciding how much profits you’d like to take.

Positive Signs Anticipating Double Tops

Mainly, like in any other strategy, you want to see sideways consolidation after a double top. For swing trades you might want to look at weekly candles to identify key entry and exit levels but for day trading you might be able to get away with looking at daily or even hourly candles, depending on your strategy and risk tolerance.

The sideways consolidation may indicate price movement stabilization and potential upside to the trade since it has found enough buyers at that price level but it’s never guaranteed.

You should keep in mind that the shorter the timeframe on the chart (one or five mins) the more unreliable it typically is; this is especially true for highly volatile stocks in the small cap market.

However, when looking at daily charts for a swing trade, the longer time elapses between double tops without any significant action, the less likely it is to break out. You want sideways consolidation but eventually a move to the upside and the longer they consolidate without any significant move, the less likely it is they’ll break out, especially without any type of catalyst.

Lastly, remember that for some reason we gravitate towards whole numbers so numbers that end in five or zero are more likely to be identified by traders and used as psychological support and resistance lines and key levels.

Therefore, look for those numbers on the weekly candles for swing trading and on the daily candles or even shorter timeframes to identify key levels of support and resistance for intraday trading.

Hope this helps!

Russell

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