Patterns are the key to trading

Not too long ago, I was jogging down the beach very early in the morning as the sun was rising.  I love running because I do my best thinking when I just let go and let thoughts randomly come across my mind.

Nobody was on the beach except for seagulls and horseshoe crabs.  Completely vacant.  As I looked ahead of me, I could see these large lumps in the sand that the sideways action of the ocean had created.

They were subtle hills that were probably 20 feet in length and about 1-2 feet high.  What was so cool is that they were repeating over and over for about 1 mile.  Again and again…so predictable.

While I was running I had the thought to close my eyes and see if I could feel the up and down movement of the subtle lumps.  Sure enough, I was able to tell where I was in the pattern, up..down…up…down.  I could tell myself that another lump was coming soon and sure enough…up…then down.

I thought, this is sort of like swing trading…and trading in general.  I look for the same pattern in a stock and then play the odds that thepattern I see will have the result in the future that I am expecting.

What is a pattern?

Here is how Wikipedia describes a pattern.

pattern for stock trading

 

I highlighted a few key points…they are easily noticed and repeat themselves in a predictable way.

Discernible regularity – So a pattern is something where you can see some type of “regularity” or “sameness” within whatever it is you happen to be looking at.  Whether it’s the mound on the beach or the patterns I look for in my swing trades…I clearly see that parts compose the pattern.

Repeat in a predictable pattern – You can see that the pattern happens over and over, one mound is followed by the next, in a predictable pattern.  One after the other.

With trading, you can take trades when you see patterns visually the charts, indicators or mathematics…that are exactly what you are ideally trying to find.

When I see a pattern that has all of the characteristics that I am looking for, I know immediately that it is an ideal trade for me.

But trading off of patterns does not mean you have to strictly trade from visual technical patterns.

Tons of traders and hedge funds take trades off of patterns using technical indicators or quantitative analysis.

Find a pattern and make it your own

One could take trades simply when technical indicators generate some type of signal (this squiggly line crosses that squiggly line) or take trades of mathematical models (when the ratio between x & y occurs, then take trade position z).

The method or pattern doesn’t matter.  No one pattern is better than any other pattern.

The key is that YOU SEE A PATTERN.  And when you see that pattern, you know from experience (and backtesting), that there is a likelihood that you know what the next move in prices will be.

Look how many technical indicators there are.

Look at how many classic technical chart patterns there are.

It is enough to make your head spin.

The key is to find a basic pattern (and variations of that pattern) and learn it completely.

It can take years to find a pattern that you are comfortable with that works for you.  It can take years more to fine tune that pattern when you learn all of the nuance to look for in an ideal trade.

Here is one of my trading patterns:

Let me give you an example of a specific pattern sub-set of my basic trade pattern that I look for (which is buying on a retracement after a sharp upward move in anticipation of a bounce back up).

Below are the patterns that I would typically look for with this screen.

See if you can find what I am ideally looking for?

Obviously each one is different, but all of them share the exact same characteristics…the same pattern.  I know and love this screen very well and have developed almost a “sixth-sense” to know whether the pattern has the chance to reverse and turn higher.

Let’s break these down a little bit….

First, all of them have a huge, tall white candle.  I call this screen of mine the “Tall White Candle”.

  1. I want to see a tall white candle.  Obviously there was a huge up day…some type of news.  But I don’t want an up day where the stock just gapped immediately higher, and then closed lower than the open, or didn’t have a huge tall body.  Tall white body…tall relative to the previous candles.  Maybe a 20+% gain.
  2. I want to see that this tall white body moved the price out of a previous trading range or trend
  3. Then I look and watch day by day for a decline.  What I ideally would like to see is a steady retracement, not a sudden red candle bringing the price right back down to the base.  I want it to take place over a series of days.  Allow the sellers to pick on that tall white candle, like little bullies go after a new kid on a playground. 🙂
  4. At some point, 2-3 days later…5 days later, 7 days later…I want to see a “signal”.  Either a nice up day, or a reversal candlestick signal like a matching low, or inverted hammer, something like that.  This should hopefully occur at an area near the bottom 1/4 of the tall white candle, or at the bottom of that tall white candle.  Here is where you will typically see support.  Buyers come in who missed out on that tall white candle up day.
  5. Then watch the very next day.  Did it open higher?  Good sign….  TAKE THE TRADE.

I also weed out stocks that have super low volume of less than 10,000 shares, or stocks that have huge candle wicks, or super-small bodies.

Let’s take a close-up look at one of these from the examples above…PTGX


Here, you can see in a bit more detail of what I described earlier.  That’s a thing of beauty, isn’t it?  I’ve circled my signal day(s).  What is cool is that the 2nd circle also presents another great trading opportunity to swing higher.

Now, if the decline happened with red candles, day after day, and the stock still approached the bottom with red candles, I would not be entering just because we were at the base of the tall white candle.  Who is to say it won’t keep going lower?  In that case, there would not be a sign that buyers are stepping in.

With my pattern that I am looking for, I would never be tempted to take the trade in the hopes of a move higher, simply because we were at the base of the tall white candle.  Details matter with technical trading.  It could be the smallest, most minute thing…

I’ve seen so many of these setups that don’t have the entry signal…they just continue knifing lower, one brutal red day after another.

My pattern HAS to include that up day or reversal candlestick pattern: that is a signal to buy.  No bending of that rule.

I learned that the hard way!

Here is the type of pattern I am NOT looking for:

The thing about my “Tall Candlestick Pattern” is…I know it when I see it!

Take a look at these examples that did make it through my screen, but I didn’t like their looks and would never think of touching them.

SLGL – Sloppy, choppy and sideways

GRIN – Wick on tall white candle is WAY too big

UEIC – I am looking for a steady, decline down the length of the tall white candle.  This is just stepping down sideways.  Where is the clear day where buyers step in to pick up their “bargain” with hopes for the move back up?

ALNA – I play bounces up after a nice retracement. This is just sideways hell…

It’s hard to put into words the exact pattern I’m looking for with this particular screen of mine, but I hope you can see from some of these examples what I am not looking for?

Again, my overall theme of a swing trading swing trading pattern is to buy on the retracement of a previous, clean upward move.  Whether the upward move was a period of weeks, or in this case a single tall white candle, I am using the general them of my trading strategy to use pattern because I believe I understand the psychology behind it!

Find Patterns That Work for You

My point of this post is to find your own patterns that you are comfortable with and trade them.  Trade patterns that you come to understand completely.  Patterns that you know and love!

Success in trading happens when you spend the time to see patterns in technical data, whether it’s indicators, mathematical ratios, classic chart patterns…it doesn’t freaking matter.

Trading is simply finding a pattern and making trades off of them again, and again and again…

It doesn’t have to be fancy or complicated or exciting.  Ideally…it should be boring.  Just look for the same pattern and trade off of it again and again.  And again.  🙂

It should be a pattern that you can clearly identify and has a good chance that you know what will happen after you identify the pattern.  In essence, the TOTAL PATTERN would include the move after your entry point.  That will help you to determine an anticipated profit.

You are entering in the last 1/3 or 1/4 of the total pattern.  Does that make sense?

What patterns do you typically look for in your trading?

-Glenn

 

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5 comments

  • Well written.

    Like

  • Hi Glenn,

    Well written.
    Looks like this is another variant slightly different than the simple pattern you have been trading for a while?
    Can you also share your screening criteria for this pattern?

    Thanks
    Bill

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    • Hey there Bill,
      Yep, another variant…all under the same basic concept of buying a dip after a clearly defined, previous move upward, then a retracement back to a point of either obvious support or the start of the initial previous move.

      For this, I am mainly looking for a tall white candle. So you can create criteria like…
      1) show me a stock that closed at least 20% above prior day’s close
      2) that the close is at least 15% above the open (this is the huge candle. If you don’t include this, you might see stocks that lets say opened 20% or more above the prior day, but never really moved…or moved down)
      3) include anything else you want that is important to you, such as: volume criteria, price min/max, moving averages.
      4), then simply watch the results from the screen, and go back and track what they are doing. Some keep launching upwards (I ignore, I don’t want to fomo in and it’s not my thing), but the ones I like retrace, lower & lower. When you finally see an up day or a reversal candlestick signal…and it looks appealing to me, I might enter at that point).

      Does that make sense?

      Like

  • And when you buy dip, you buy it at the first dip or you waiting for second dip and confirmation?

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    • I mostly buy on the first dip when I see the signs of a turnaround. I’ve bought second dips though, when the same signs of a turnaround show up. Pretty reliable pivot point because it was already “proven”, you know?

      Like

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