1.1) but a different period (2018). The large breakaway gap up in early November (A) was because of third quarter results, which the market liked (hence the bullish gap). After that, price moved horizontally at B and made a strong push lower to C, followed by a headline‐fetching rise up to G.
Along the way, earnings came out and helped momentum push the stock up (D and E). Near the top, earnings at F sent the stock lower, but only for a day. Perhaps the weak quarter was a warning of a coming trend change. At H, the market disliked earnings and seemed to confirm an end to the upward move, at least for a time.
I visited the company's website and found a headline for I (near the diving board), titled, “UBS Global Media and Communications Conference” webcast. I didn't listen to the broadcast, but the stock turned sharply lower a few days later, making a straight‐line run down to C. I don't know if the webcast was the cause of the decline or what happened to send the stock skittering to C. If you owned this stock at the time, it would have been wonderful if you knew the cause of the drop (from I to C).
Figure 1.4 This diving board is on the daily chart.
This chart, on the daily scale, is similar to Figures 1.1 and 1.2. You can use these historical charts to formulate how to trade the pattern. If you can time your entry near C, then you can ride price back up to the base of the diving board (B).
You can wait for price to close above the highest peak at B and ride price upward to G. Below the bottom of the diving board (B) provides a good stop location, too.
The ride upward to G may not be as smooth as shown on this chart or in Figure 1.2 as price climbs from C to D. It might be as treacherous as the climb to D in Figure 1.1. When I look at this chart, though, I see dollar signs in the form of profit. All you have to do is find this pattern and have the courage to trade it.
Another Setup
Figure 1.5 shows another setup but one you should avoid (at least from the bullish side). The setup begins with price making a strong push higher, often in a straight‐line run (but be flexible as in this example). I show that upward move at A and then B. The uptrend lasts several months and takes price from about 9 to 13 (which means, a good rise).
Price moves horizontally at C as if trying to catch its breath (ignore the downward February spike at C). The horizontal move should be proportional to the AB move. If AB shows a breathtaking rise, then expect C to be a long horizontal move while the bulls and bears regroup. In this example, AB is about 4 months long and C is 6 months long.
Figure 1.5 This U‐shaped pattern delivers a failure.
After the topping pattern (C), price forms a chart pattern just below the base of the peak. I show that pattern at DE (a double bottom). The double bottom confirms at F when the doji (hard to see) closes above the top of the peak between valley's D and E. Price climbs only to G before reversing.
After G, the stock drops all the way to H. Traders expecting the double bottom to deliver profits to their wallet find holes in their pockets and the money gone.
I see this setup a lot. Price moves up, goes horizontal, and then a chart pattern appears (which can be any bullish pattern, like head‐and‐shoulders bottom, double bottom, or triple bottom). The pattern confirms as valid and price rises some before reversing and heading lower. The pattern busts its upward breakout, handing bulls a loss.
Just recognizing the double bottom (DE) as a tradable pattern isn't enough. If you research the setup by looking at other charts, you'll see how this setup can lead to a failure of a chart pattern.
This (the double bottom, or head‐and‐shoulders, or any bullish pattern at the end of the horizontal top) is a setup you'll want to avoid.
Pothole Setup
Figure 1.6 shows a rare setup on the weekly chart, but it's a variation of the pattern shown in the prior figure.
Figure 1.6 A pothole setup happens after a drop and flat base.
The company runs into trouble that lasts for the long term (months). That trouble takes price down from A to bottom at B. At B, the bears want to see the stock continue to drop, but bottom fishers like me see a good value. Buying demand keeps the stock from dropping much farther. A stalemate emerges with neither the bulls nor the bears winning, so the stock just lines sideways (the B to C move).
If the B to C move represents a highway, then CD is a pothole. It's a bear trap, though. Price drops to C and makes another bottom at D, forming a double bottom in this example. The CD move can represent any bullish pattern, like a head‐and‐shoulders bottom or triple bottom. Anyway, price climbs out of the hole and climbs and climbs and climbs (E).
If you're lucky, the stock will rise like it did here, but don't depend on that happening. I also find this example suspicious because it happens in 2013–2014, the same period as Figure 1.3. Still, it provides the template for the pothole setup.
The key to this pattern is the stock forming a bottom (flat base) followed by a pothole. Make sure the flat base appears after a downtrend. You don't want to go long if price trends up into the pattern (like Figure 1.5). See if you can find a reason why the stock wants to climb (during E in Figure 1.6). The reason could be a good quarter with a positive future outlook issued by the company. Maybe the cost of ingredients is going down or the company can raise prices on the goods they sell because the market for widgets is firming up.
If you look back at the figures in this chapter, they all have a flat base, a period of time where the stock goes horizontal. After that horizontal move, a pattern appears. In the first four figures, price drops (after the horizontal move). In the last two figures, a double bottom reversal sends price higher, at least for a time.
If you research these setups (that is, find examples in the stocks you trade), that will give you the confidence to trade a similar setup when it appears in a stock you'd like to own.
Here's another idea to help ease the research burden.
Patternz
I wrote pattern finding software for Windows that I call Patternz and made it available for free to download and use (visit my website: www.ThePatternSite.com). One of the things it does is simulate trades. I load up a bunch of stocks, tell it to find double bottoms (as an example, but they happen often), and let the program find them. Then I look at the context: the double bottom in the surrounding price landscape. I'll guess whether to make the trade or stay in
