then let the stock play out. It's like day trading on the 1 millisecond scale (you control playback speed). In seconds, I'll know whether the trade made money or not.
What I'm doing is training my brain not only to view the chart pattern, but to get a feel for the conditions where the pattern will thrive or fail. It's an easy way to train your brain to recognize winning and losing setups.
Suppose you find a stock showing a chart pattern you wish to buy. Spend an hour searching for similar setups using the Patternz simulator and you'll be able to tell whether your trade will likely work or not.
It's easy to find chart patterns. The Patternz software will find them for me. But having the experience to know whether they will work is what separates a seasoned professional from amateurs.
Amateurs are the ones paying for the dreams of the professionals. Stop giving away your money. Take the time to do the research to discover when a chart pattern will work and when it won't. Then put that knowledge to use to fill your wallet or purse.
That's how you trade chart patterns and make money doing it.
Another Way
I mentioned this setup in the introduction to this chapter. Look for a bullish pattern and buy it when it confirms. Sell when a bearish pattern appears. For example, Figure 1.7 shows a double bottom at AB. The two valleys bottom near the same price. The squiggles turn into an actual double bottom when price closes above the horizontal line. That happens at C (the breakout). The next day, D, you buy the stock at the opening price and receive a fill of 7.40.
Figure 1.7 Here is a swing trade using a double bottom and a double top.
From then on, you look for a bearish pattern, one that says the stock is going down. A double top appears at EF. The two peaks top out near the same price. It confirms as a valid double top when price closes below the horizontal line, G. The next day, you sell your shares at the open and receive a fill at 10.60. The difference is $3.20 or 43% above the buy price.
In fact, if you had spotted an earlier double top (I), you could have sold a day after the downward breakout (J) and received a slightly better fill, at 11.00, for a net gain on the trade of 49%.
If you sold the day after J, you might be kicking yourself for selling too soon. Why? Because price continued to rise to E and higher to F. If you were astute, you may have recognized a 2B pattern at F and sold sooner, making even more money. Don't look for the 2B pattern in this book because I don't review it. Visit my website for details if you're interested in the 2B.
Of course, I cherry picked this trade, and often things aren't as easy as this example suggests. But the idea is simple. Buy bullish patterns and sell bearish ones. Yes, you'll have to find stocks that you believe show promise in an industry doing well and during a rising market (you will want the stock, industry, and market trending in the same direction for the best result).
You may want to score the chart pattern, too. I described the scoring mechanism in my second book, Trading Classic Chart Patterns. A review of the technique over a decade later shows it still works well. It will help you select patterns that perform better and avoid the duds.
Knots and Swing Trading Pullbacks
Let's dig in and discuss some swing trading setups. Figure 1.8 shows what I call a knot. It's a useful way of detecting when a pullback will start and at what price. It's ideal for swing traders who want to make money when price breaks out downward from a chart pattern in its initial push lower.
Let's look at Steelcase on the left of the figure. A double top forms at AB and confirms at C when price closes below the horizontal line. How low will the stock drop in its initial descent?
Answer: to the knot at D. I define a knot as a place in a strong trend (E to A in this example) where price moves sideways for at least 3 days. When it's the first knot closest to the double bottom (the first location of support, really, below the pattern's breakout), expect the stock to bottom there and begin a pullback.
In this example, knot D is the first support area below C. Price reaches the area at F and begins to pull back to the price of C.
In my experience with knots, I know to place an order to close out the trade at the top of the knot, not the middle or bottom. Sometimes, price touches the top of the knot and reverses. At other times, the stock drops like we see here at F before reversing.
Setup 2
Let's take the case on the far right of the figure (“Setup 2”). In the rise from I to H, there is no knot of support. The uphill move is fast and long.
The way to trade this is to split the move in half and place an order to close out the trade there. In this example, midway up the run from I to H is J. Place an order to cover a short at J. After the double top FG confirms when price closes below H, price drops to K before beginning a pullback.
Figure 1.8 Shown are three ways to trade a pullback.
You don't see this setup often because there is usually a knot along the uphill run from I to H, but it does happen. Take advantage of it and expect the stock to find support midway in the I to H run like it does here at J.
If the run does show a knot but it looks too far below the chart pattern, then split the run in half like I've explained. In technical terms, if support is too far away, then price will reverse closer to the chart pattern. What is closer? Most pullbacks bottom in the 7% to 8% range. If a knot is 10% or 15% away, then that's too far unless there's a fundamental reason to drive price down hard and fast (bad earnings, bad future outlook, that kind of thing).
If the move from I to H is exceptionally long, you might want to split the run into thirds and place a trading order a third of the way down to I from H. Search for other stocks showing the same pattern and see where they turn. The Patternz simulator can make the search easy.
Setup 3
Another setup is similar to Setup 2 except there's support between J and H, but not in the same upward trend. Let's rewind the tape and start at the beginning.
Imagine that the line separating Setup 3 from Setup 2 is missing. We see a strong move higher from I to H. We could take half that move and assume price is going to drop back to that area, just as we did in Setup 2. However, looking to the left of I, we see peak L. It's a mean‐looking knot of support with price going horizontal for a week or two (but need not be that extensive; a simple well‐defined top can do).
Instead of using Setup 2 to place the exit trade midway at J, it's more likely that the stock will drop to the price of L and reverse there. So L is our target. We place a stop a penny above G, place our order to short a penny below the price of H, and use the top of L as the exit.
Knots and Throwbacks
Figure 1.9 shows two more scenarios for swing trading the stock. The left panel shows a double bottom at AB, confirmed when price closes above C. As a swing trader, you don't want to
